<PAGE>
3,000,000 SHARES
File Pursuant to
Rule 424(b)(4)
File #333-05583
[LOGO]
COMMON STOCK
---------------
All of the shares of Common Stock offered hereby (the "Offering") are being
sold by FX Energy, Inc., formerly known as Frontier Oil Exploration Company
(the "Company"). The Company's Common Stock ("Common Stock") is quoted on the
Nasdaq SmallCap Market under the symbol "FXEN." The Common Stock has been
approved for listing on the Nasdaq National Market under the symbol "FXEN",
subject only to notice of issuance. On August 1, 1996, the last reported price
for the Common Stock was $6.75 per share. See "Price Range of Common Stock and
Dividend Policy."
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" ON PAGE 7.
---------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share.................................. $5.75 $0.40 $5.35
Total(3)................................... $17,250,000 $1,200,000 $16,050,000
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
(1) See "Underwriting" for information concerning the compensation and
indemnification of the Underwriters and other information.
(2) Before deducting expenses of the Offering payable by the Company estimated
at $600,000.
(3) The Company has granted the Underwriters an option, exercisable within 30
days of the date hereof, to purchase up to 450,000 additional shares of
Common Stock for the purpose of covering over-allotments, if any. If the
Underwriters exercise such option in full, the total Price to Public,
Underwriting Discount and Proceeds to Company will be $19,837,500,
$1,380,000 and $18,457,500, respectively. See "Underwriting."
---------------
The shares of Common Stock are offered severally by the Underwriters when,
as and if delivered to and accepted by them, subject to their right to
withdraw, cancel or reject orders in whole or in part and subject to certain
other conditions. It is expected that delivery of the certificates
representing the shares will be made against payment on or about August 7,
1996, at the offices of Oppenheimer & Co., Inc., Oppenheimer Tower, World
Financial Center, New York, New York 10281.
---------------
OPPENHEIMER & CO., INC. HANIFEN, IMHOFF INC.
The date of this Prospectus is August 1, 1996.
<PAGE>
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"SEC") a Registration Statement on Form S-1 (of which this Prospectus is a
part) under the Securities Act of 1933, as amended (the "Securities Act"),
with respect to the securities offered hereby. This Prospectus does not
contain all the information set forth in the Registration Statement or the
exhibits thereto, to which reference is made concerning the contents of such
exhibits. Reference to each such exhibit qualifies all information related
thereto.
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and accordingly files
reports, proxy statements and other information ("Reports") with the SEC. The
Registration Statement, the Reports and the exhibits thereto can be inspected
and copied at prescribed rates at the public reference facilities maintained
by the SEC at 450 5th Street, N.W., Room 1024, Washington, D.C. 20549 and at
the regional offices of the SEC: Seven World Trade Center, 13th Floor, New
York, New York 10048 and Northwestern Atrium Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661. In addition, the SEC maintains a web site
that contains reports, proxy and information statements and other information
regarding the Company and other registrants that file electronically with the
SEC at http://www.sec.gov.
OIL AND GAS TERMS
The following terms have the indicated meaning when used in this Prospectus.
"API" means American Petroleum Institute.
"BPD" means barrels of oil per day.
"BBL" means barrel of oil.
"BCF" means billion cubic feet of natural gas.
"DEVELOPMENT WELL" means a well drilled within the proved area of an oil or
gas reservoir to the depth of a stratigraphic horizon known to be productive.
"EXPLORATORY WELL" means a well drilled to find and produce oil or gas in an
unproved area, to find a new reservoir in a field previously found to be
productive of oil or gas in another reservoir or to extend a known reservoir.
"MBBL" means thousand barrels of oil.
"MMBBL" means million barrels of oil.
"MMBOE" means million barrels of oil equivalent.
"PROVED RESERVES" means the estimated quantities of crude oil, natural gas and
natural gas liquids which geological and engineering data demonstrate with
reasonable certainty to be recoverable in future years from known reservoirs
under existing economic and operating conditions, i.e., prices and costs as of
the date the estimate is made. Proved reserves may be developed or
undeveloped.
"PV-10 VALUE" means the estimated future net revenue to be generated from the
production of proved reserves discounted to present value using an annual
discount rate of 10%. These amounts are calculated net of estimated production
costs and future development costs, using prices and costs in effect as of a
certain date, without escalation and without giving effect to non-property
related expenses such as general and administrative expense, debt service,
future income tax expense or depreciation, depletion and amortization. See
"Risk Factors--Factors Relating to the Oil and Gas Industry: Uncertainty of
Reserve Estimates and Future Net Revenues."
"RESERVOIR" means a porous and permeable underground formation containing a
natural accumulation of producible oil and/or gas that is confined by
impermeable rock or water barriers and that is distinct and separate from
other reservoirs.
"STRATIGRAPHIC TEST" means a drilling effort, geologically directed, to obtain
information pertaining to a specific geological condition. Such wells
customarily are drilled without the intention of being completed for
hydrocarbon production.
IN CONNECTION WITH THE OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET OR OTHERWISE. SUCH
STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
IN CONNECTION WITH THE OFFERING, THE UNDERWRITERS MAY ENGAGE IN PASSIVE
MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET
IN ACCORDANCE WITH RULE 10B-6A UNDER THE SECURITIES EXCHANGE ACT OF 1934. SEE
"UNDERWRITING."
2
<PAGE>
[FOLD OUT INSIDE FRONT COVER--LEFT PAGE]
UNITED STATES AREAS OF ACTIVITY
[This page consists of a map outlining the states of Montana, Wyoming, Utah
and Nevada, marked to show the location of the producing properties in the Cut
Bank field and the Bears Den field in Montana and the Trap Spring and Bacon
Flat fields in Railroad Valley, Nevada; the location of the Company's Cobb
Creek, Utah-Nevada, Lake Valley, Nevada and Hamlin Valley, Utah prospects; the
location of the Company's Salt Lake City, Utah headquarters; and the location
of the Company's Oilmont, Montana field office. The legend shows the map scale
and identifies the symbols for producing oilfields and exploration prospects
with the following text:]
The Company's property in Cut Bank field [color]
.10,600 gross acres
.Working interest--99.5%-100%
.78% of the Company's daily production
.Development program underway
.30(degrees) to 35(degrees) API gravity, low sulfur
<PAGE>
[FOLD OUT INSIDE FRONT COVER--RIGHT PAGE]
AREAS OF ACTIVITY IN POLAND
[This page consists of a map of Poland, identifying the principal cities and
adjacent countries and showing the area of the Company's Baltic Concession and
the area in the Carpathian region covered by the Company's joint study
agreement with the Polish Oil and Gas Company ("POGC"); the areas of the
country reserved for exclusive exploration by POGC; and the areas subject to
agreements or pending negotiations for oil and gas exploration rights with
government authorities.]
<PAGE>
PROSPECTUS SUMMARY
This summary is qualified in its entirety by the detailed information and
financial data appearing elsewhere in this Prospectus. Defined terms used
herein to describe quantities of oil and other matters are explained under "Oil
and Gas Terms." Unless otherwise indicated, the information contained in this
Prospectus assumes that the Underwriters' over-allotment option will not be
exercised. Investors should carefully consider the information set forth under
"Risk Factors."
THE COMPANY
The Company is engaged in the exploration, development and production of oil
and gas in the western United States and Poland. The Company currently produces
oil from fields in Montana and Nevada and explores for oil and gas primarily in
Poland. In August 1995, the Company was one of the first independent energy
companies to secure oil and gas exploration rights in Poland (the "Baltic
Concession"). The Baltic Concession covers approximately 2.4 million acres in
northern Poland and is part of a geological region (the "Baltic Platform")
which reportedly has produced in excess of 150 MMBbl from four fields located
approximately 50 miles to the northeast in the Kaliningrad district of Russia.
In May 1996, the Company also entered into a joint study agreement with the
Polish Oil and Gas Company ("POGC") to reprocess and reinterpret geological and
geophysical data collected from a 6.25 million acre area in the Carpathian
region of southeastern Poland (the "Carpathian JSA"). Management believes that
the Company's principal strengths are its existing prospects in Poland, its
access to previously collected geological and geophysical data, its established
network of strategic alliances and its inventory of domestic properties.
The Company has identified several potential drilling prospects in the Baltic
Concession through the reprocessing and reevaluation of previously collected
seismic and drilling data. The Company intends to explore and develop these
prospects with RWE-DEA AG ("RWE-DEA"), a subsidiary of RWE AG, Germany's fifth
largest industrial company. The Company and RWE-DEA recently initiated a 300
kilometer seismic survey on selected portions of the Baltic Concession. The
results of this survey will assist in the selection of the site of an
exploratory well scheduled to be drilled in late 1996. In the Carpathian JSA,
the Company and POGC are conducting a technical evaluation of a target area
and, if warranted, will apply for an exploration concession. The Company has
budgeted approximately $8.4 million for exploration and development activities
in Poland through 1997.
The Company currently produces oil exclusively in the United States. At
December 31, 1995, the Company had estimated proved reserves of 5.3 MMBbl with
a PV-10 Value (calculated without regard to future income tax expense) of
approximately $23.8 million. Approximately 78% of the Company's production and
96% of its reserves are concentrated in northern Montana's Cut Bank field. To
enhance production in this field, the Company intends to expand its current
infill drilling program which was initiated in late 1994. The Company is also
evaluating several exploration prospects in the western United States and has
identified a prospect in Nevada on which it intends to drill an exploratory
well in late 1996 in partnership with several independent energy companies. The
Company has budgeted approximately $6.9 million for exploration and development
activities in the United States through 1997.
BUSINESS STRATEGY
The Company explores and develops oil and gas prospects potentially
containing recoverable reserves in excess of 25 MMBOE for international
properties and 10 MMBOE for domestic properties. This strategy includes the
following key elements:
. Focus on Poland. The Company believes that the Baltic Concession and the
Carpathian JSA provide it with a foundation upon which to build a
significant exploration and development operation in Poland. The Company
believes this foundation will allow it to capitalize on Poland's
attractive combination of significant reserve potential, underexplored
acreage and favorable operating environment. Beginning in 1989, Poland
initiated a number of market-based reforms which have resulted in the
country's economy becoming one of the fastest growing in Europe.
Important elements of this transition have included the introduction of
both a broad-based privatization program and an internationally
competitive tax and royalty structure. Partially as a result of these
initiatives, Poland attracted approximately $6.8 billion in direct
foreign investment between 1989 and 1995. Several international oil
companies, including Texaco, Inc., Tenneco Co., Exxon Corp., Shell Oil
Co. and British Gas PLC, have either secured, or obtained the exclusive
right to negotiate for, exploration rights.
3
<PAGE>
. Access existing geological and geophysical data. The Company focuses on
areas where it can reevaluate previously collected geological and
geophysical data. Between 1950 and 1993, state-sponsored agencies in
Poland gathered hundreds of line miles of seismic data and drilled 15
test wells in the Baltic Concession to the same formation that is
productive in established fields in the Baltic Platform. While a majority
of these wells indicated the presence of hydrocarbons in that formation,
none was completed for production due, in management's opinion, to the
outdated equipment and poor techniques used to locate, drill and test the
wells. The Company, with the assistance of consultants that included
Halliburton Energy Services, Ryder Scott Company and Western Atlas, Inc.,
reevaluated seismic and well data generated by earlier exploration
efforts in the Baltic Concession. As a result of this effort, the Company
believes that it has identified potential oil reservoirs in two
structures that had previously been drilled and over a dozen undrilled
structures.
. Capitalize on strategic alliances. The Company seeks to form strategic
alliances to reduce its financial exposure and to gain additional
technical and operational expertise. This strategy is exemplified by the
Company's alliances with RWE-DEA covering the Baltic Concession and with
POGC in the Carpathian JSA. RWE-DEA, formerly Deutsche Texaco AG, is an
established producer, refiner and marketer of oil and gas in Europe and
currently produces oil in the Baltic Sea off Germany's northern coast.
Pursuant to an agreement with the Company, RWE-DEA will earn a 50%
interest in the Baltic Concession by paying the Company $250,000, by
providing up to $2.0 million for an ongoing seismic survey and a planned
exploratory well, and by funding 50% of the cost of a second exploratory
well. The Company will operate all wells it drills jointly with RWE-DEA.
In the Carpathian JSA, the Company is evaluating existing geological and
geophysical data contributed by POGC in order to determine the
hydrocarbon potential of a target area. The Company and POGC may apply
for exploration rights covering such target area upon the completion of
this analysis.
. Exploit domestic reserve base and prospects. The Company believes that
its existing domestic properties have significant development and
exploration potential. The Company recently completed an infill drilling
program on a 1,000 acre tract of the Cut Bank field which, based on
preliminary results, the Company believes will increase production over
the next two to three years. The Company plans to expand this program to
approximately 4,000 additional acres in the Cut Bank field beginning in
late 1996. The Company also has an ongoing program of prospect generation
and exploration in the western United States.
THE OFFERING
<TABLE>
<C> <S>
Common Stock Offered by the Company............. 3,000,000 shares
Common Stock Outstanding after the Offering(1).. 11,704,596 shares
Use of Proceeds(2).............................. Net proceeds of the Offering
will be used to repay bank
debt; to fund the Company's
capital expenditure program
which includes exploration
and development activities in
the Baltic Concession and
Carpathian JSA in Poland and
in the western United States;
and for general corporate
purposes.
Nasdaq Symbol................................... FXEN
</TABLE>
- --------
(1) Calculated as of March 31, 1996, and adjusted to give effect to the
subsequent issuance of 244,111 shares of Common Stock. Does not include an
aggregate of 3,077,028 shares issuable upon (i) the conversion of
outstanding preferred stock, (ii) the exercise of outstanding options and
warrants and (iii) the issuance of shares contingent upon attaining certain
production levels in Montana and Nevada. See "Management--Executive
Compensation," "Principal Stockholders," "Certain Transactions" and
"Description of Securities."
(2) See "Use of Proceeds."
4
<PAGE>
SUMMARY FINANCIAL DATA
The following tables, parts of which have been derived from the Company's
audited financial statements, set forth summary historical financial
information for the Company and should be read in conjunction with the
Company's Consolidated Financial Statements and Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere herein. The financial data for the three month periods ended
March 31, 1995 and 1996 were derived from the unaudited financial statements of
the Company and, in management's opinion, include all adjustments (consisting
of only normal recurring adjustments) necessary to present fairly the results
for such periods. The operating results for such periods are not necessarily
indicative of the operating results to be expected for a full fiscal year, and
none of the data presented below is necessarily indicative of future results.
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
---------------------------- ----------------
1993(1) 1994(1) 1995 1995 1996
--------- --------- -------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues......................... $ 276 $ 1,916 $ 2,167 $ 581 $ 505
Operating costs and expenses:
Production and operating
costs(2)....................... 7 680 1,272 338 325
Depreciation, depletion and
amortization................... 3 422 503 106 138
General and administrative...... 353 816 1,466 276 366
Other(3)........................ 654 829 1,003 105 213
------- ------- -------- ------- -------
Operating loss................... (741) (831) (2,077) (244) (537)
Interest and other income........ 39 53 98 10 36
Interest expense................. (2) (214) (448) (111) (82)
Minority interest: Non-cash
dividends(4).................... -- -- (93) (55) --
------- ------- -------- ------- -------
Loss before income taxes......... (704) (992) (2,520) (400) (583)
Benefit from income taxes........ 9 -- -- -- --
------- ------- -------- ------- -------
Net loss......................... $ (695) $ (992) $ (2,520) $ (400) $ (583)
======= ======= ======== ======= =======
Net loss per share............... $ (0.40) $ (0.44) $ (0.47) $ (0.14) $ (0.07)
Weighted average shares
outstanding..................... 1,750 2,229 5,389 2,811 8,086
OTHER FINANCIAL DATA:
EBITDA(5)........................ $ (699) $ (356) $ (1,476) $ (128) $ (363)
Capital expenditures............. 22 4,432 1,507 60 147
</TABLE>
<TABLE>
<CAPTION>
AS OF MARCH 31, 1996
AS OF ----------------------
DECEMBER 31, PRO FORMA
1995 ACTUAL AS ADJUSTED(6)
------------ ------- --------------
(IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit)................... $ (278) $ 399 $13,300
Net property and equipment.................. 8,612 8,560 8,560
Total assets................................ 10,039 10,148 22,869
Long-term debt.............................. 3,359 3,439 --
Stockholders' equity........................ 5,224 5,750 22,105
</TABLE>
- --------
(1) Certain balances have been reclassified to conform with current year
presentation. These changes had no effect on previously reported net
losses, total assets, liabilities or stockholders' equity.
(2) Includes production taxes.
(3) Other expenses include exploration costs, drilling costs and leasehold
abandonments.
(4) Non-cash dividend on the convertible preferred stock of FX Producing
Company, Inc., a wholly owned subsidiary of the Company.
(5) EBITDA represents net loss before interest, taxes, depreciation, depletion
and amortization and minority interest: non-cash dividends.
(6) As adjusted to give effect to (i) the sale of 3.0 million shares of Common
Stock offered hereby at an offering price of $5.75 per share and the
application of the net proceeds therefrom for repayment of bank debt as
described in "Use of Proceeds", (ii) the sale subsequent to March 31, 1996,
of 156,111 shares of Common Stock for net proceeds of $680,000, (iii) the
exercise of 80,000 options to purchase Common Stock for proceeds of
$120,000, (iv) the receipt of a $90,000 stock subscription receivable and
(v) the issuance of 8,000 shares of Common Stock for services.
5
<PAGE>
SUMMARY OIL RESERVE AND OPERATING DATA
The following table sets forth certain summary information as of December 31,
1995, from the reserve report of Larry D. Krause, independent petroleum
engineer, regarding the Company's proved oil reserves, the future net revenues
therefrom, and the PV-10 Value thereof. Estimates are based upon a weighted
average price of $16.48 per barrel of oil at December 31, 1995, holding prices
constant throughout the life of the properties in accordance with regulations
promulgated by the SEC, with the Company's ownership position adjusted to
reflect the Company's net interest after royalties and taxes. This information
is based upon numerous assumptions and is subject to various uncertainties due
to numerous factors. See "Business and Properties--Oil Reserves" and "Risk
Factors--Uncertainty of Reserve Estimates and Future Net Revenues." This
information should be read in conjunction with the Summary Reserve Report of
Larry D. Krause included as Appendix A to this Prospectus and is qualified in
its entirety by such report.
<TABLE>
<CAPTION>
DECEMBER 31, 1995
-----------------------------
PROVED PROVED TOTAL
DEVELOPED UNDEVELOPED PROVED
--------- ----------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
ESTIMATED NET PROVED RESERVES:
Oil and condensate (Bbl)....................... 2,683 2,574 5,257
Future net revenues............................ $19,528 $25,652 $45,180
PV-10 Value (1)................................ $ 7,735 $16,046 $23,781
</TABLE>
- --------
(1) The Company's PV-10 Value for total proved reserves, adjusted for future
income tax expense, is $17.7 million as set forth in Note 15 to the
Company's Consolidated Financial Statements.
The following table sets forth certain operating data of the Company for the
two years ended December 31, 1994 and 1995, and for the three months ended
March 31, 1995 and 1996 (unaudited), as derived from the Company's Consolidated
Financial Statements and Notes thereto for such periods.
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS
DECEMBER 31, ENDED MARCH 31,
------------- ---------------
1994 1995 1995 1996
------ ------ ------- -------
<S> <C> <C> <C> <C>
PRODUCTION DATA:
Oil production (MBbl)........................... 117 135 34 32
Average sales price (per Bbl)................... $14.07 $14.67 $ 14.92 $ 15.98
SELECTED DATA ($ PER BBL):
Production costs and taxes(1)................... $ 5.81 $ 9.42 $ 9.87 $ 10.29
Depreciation, depletion and amortization........ 3.61 3.73 3.10 4.38
Exploration costs............................... 5.58 5.54 2.74 5.98
General and administrative...................... 6.99 10.86 8.06 11.58
WELLS DRILLED (GROSS):
Development..................................... 5 5 -- --
Exploration..................................... 2 2 -- --
</TABLE>
- --------
(1) Production costs increased during 1995 because the Company increased the
level of maintenance to support long-term improvements in production
expected to result from the implementation of its infill drilling program
and due to the abnormally wet spring weather in the Company's principal
production area. Production costs per Bbl also increased during 1995 due to
a substantial decline in production from a well in Nevada with extremely
low production costs. See "Business and Properties--Production and
Marketing."
6
<PAGE>
RISK FACTORS
The purchase of Common Stock involves a high degree of risk. Prospective
investors should consider, in addition to the negative implications of all
other information and financial data set forth herein, the following factors
before making an investment in the Common Stock. This Prospectus contains
forward-looking statements within the meaning of Section 27A of the Securities
Act. Discussions containing such forward-looking statements may be found in
the material set forth under "Prospectus Summary--The Company", "Prospectus
Summary--Summary Oil Reserve and Operating Data", "Risk Factors",
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Business and Properties--General", "Business and Properties--
Exploration and Development Activities in Poland", "Business and Properties--
Exploration and Development Activities in the United States", "Business and
Properties--Oil Reserves", "Business and Properties--Baltic Concession Terms",
"Business and Properties--Operational Hazards and Insurance", "Business and
Properties--Government Regulation--United States", "Business and Properties--
Government Regulation--Poland", as well as in the Prospectus generally. Actual
events or results may differ materially from those discussed in the forward-
looking statements as a result of various factors including, without
limitation, the risk factors set forth below and the matters set forth in the
Prospectus generally.
FACTORS RELATING TO THE COMPANY
History of Operating Losses
From its inception in January 1989 through March 31, 1996, the Company
incurred cumulative losses of $4.8 million and, because of its continued
exploration activities, expects that it will continue to incur losses and that
its accumulated deficit will increase. The Company reported losses of $992,000
and $2.5 million for the years ended December 31, 1994 and 1995, respectively,
and a loss of $583,000 for the quarter ended March 31, 1996. The Company
anticipates that it will incur losses through 1996, and possibly beyond,
depending on whether exploration of the Baltic Concession results in the
commencement of production in quantities sufficient to cover related operating
expenses and whether the infill drilling program in the Cut Bank field results
in significant and sustained increased production. See "Selected Consolidated
Financial Data" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Dependence on Activities in Poland
The Company's success will depend to a high degree on its activities in
Poland. This dependence is likely to be reflected in both the short-term
performance of the Common Stock and the Company's long-term financial results.
The Company currently intends to drill one exploratory well in Poland in late
1996 and to continue exploratory drilling in 1997. The market price of the
Common Stock may experience significant fluctuations based on the outcome of
individual wells and the Company's other exploration efforts in Poland. These
fluctuations may be exacerbated by the fact that the Common Stock, in
management's opinion, currently trades to a significant degree on the
potential of the Company's current and planned activities in Poland. See
"Development Risks" and "Exploration Risks." The success of the Company's
efforts in Poland will depend on, in addition to the risks normally associated
with the exploration for oil, its ability to maintain its relationships with
its exploration partners and the Polish government and a number of other risks
associated with conducting operations in a foreign country. See "Risk
Factors--Factors Relating to Activities in Poland." If the Company's
activities in Poland are unsuccessful, the price of the Common Stock would
likely suffer a material decline, and investors would face the possible loss
of a substantial portion of their investment. Because of the preliminary stage
of the Company's activities in Poland, no assurance can be given that such
activities will be successful. See "Business and Properties--Exploration and
Development Activities in Poland."
Volatility of Common Stock
The market price for the Common Stock has been volatile in the past and
could fluctuate significantly in response to the results of specific
exploration drilling tests, variations in quarterly operating results and
changes
7
<PAGE>
in recommendations by securities analysts. Further, the trading volume of the
Common Stock is relatively small, and the market for the Common Stock may not
be able to efficiently accommodate significant trades on any given day.
Consequently, sizable sales or purchases of the Common Stock have in the past,
and may in the future, cause volatility in the market price of the Common
Stock to a greater extent than in other more actively traded securities. Until
more trading volume develops, larger transactions may not be able to be closed
at the then current market price for the Common Stock. In addition, the
securities markets regularly experience significant price and volume
fluctuations that are often unrelated or disproportionate to the results of
operations of particular companies. These broad fluctuations may adversely
affect the market price of the Common Stock. See "Price Range of Common Stock
and Dividend Policy."
Dependence on RWE-DEA Strategic Alliance
The Company has budgeted $7.0 million for exploration and potential
development of the Baltic Concession through 1997 based, to a significant
degree, on the participation of RWE-DEA. If RWE-DEA elects not to participate
in the Baltic Concession for any reason, the Company could, at the discretion
of management, either seek a replacement partner or proceed as planned with a
substantially increased budget funded largely with the proceeds of the
Offering. Although the Company believes it would be able to locate an
alternative strategic partner, there can be no assurance that the Company
would be successful in obtaining the participation of another partner, that
the terms of any such arrangement would be favorable to the Company or that
such efforts would not delay the Company's exploration and development of the
Baltic Concession.
Dependence on Polish Government Consent to RWE-DEA Assignment
Under the terms of its agreement with RWE-DEA, the Company is required to
assign to RWE-DEA 50% of its beneficial interest in its exploration and
exploitation agreement covering the Baltic Concession. RWE-DEA and the Company
are applying for approval of such assignment from the appropriate government
authorities. Although the Company believes, based on informal discussions
among representatives of the Company, RWE-DEA and the Polish government, that
such consent will be granted, there is no assurance that such consent will
actually be obtained. If the government does not consent to such assignment
and if the Company is not able to negotiate some other arrangement with RWE-
DEA, the Company will be required to reimburse RWE-DEA for all of its Baltic
Concession expenditures.
Dependence on Government Approval
Should the Company's exploration efforts discover hydrocarbons in the Baltic
Concession, the Company will be required to engage in negotiations with
national and local government officials of Poland regarding certain of the
terms and conditions of the required exploitation licenses. These negotiations
would include the determination of a development/exploitation fee within the
range of 0.001% to 0.05% of the market value of the economically recoverable
reserves estimated to be in place, payable in five equal annual installments.
In addition, the granting of an exploitation license requires the consent of
the local governments having jurisdiction over the production area. Although
the Company has the exclusive right to receive an exploitation license in the
Baltic Concession and the local governments will receive 60% of royalties
paid, the Company could be subject to significant delays in obtaining the
consents of local authorities or satisfying other governmental requirements
prior to obtaining an exploitation license. Finally, the granting of an
exploitation license would require the Company to comply with certain
environmental regulations and may require the preparation of an environmental
impact statement.
Exploration Risks
The Company's oil and gas exploration activities involve significant risks.
There can be no assurance that the use of technical expertise as applied to
geophysical or geological data will ensure that any well will encounter
hydrocarbons. Further, there is no way to know in advance of drilling and
testing whether any prospect encountering hydrocarbons will yield oil or gas
in sufficient quantities to be economically viable. Several test
8
<PAGE>
wells are typically required to explore each prospect or exploration area. The
Company may continue to incur exploration costs in specific areas, including
the Baltic Concession and the Carpathian region in Poland, even if initial
test wells are plugged and abandoned or, if completed for production, do not
result in production in commercial quantities. To date, the Company has
participated in six exploratory test wells in the western United States, none
of which has resulted in the establishment of commercial production or
reserves. The Company has yet to drill a well in Poland, and all of the wells
drilled previously by third parties in the Baltic Concession were plugged and
abandoned. Through 1997, the Company has allocated up to $8.4 million of its
capital budget for its activities in Poland. There can be no assurance that
the Company's efforts will be successful. Many of the Company's exploration
decisions are based on scientific data gathered by third parties, some of
which was gathered in the 1960s and 1970s. Although the Company has
reprocessed such data, there can be no assurance that such data is as reliable
as data gathered either using modern technology or under the Company's
supervision. See "Business and Properties."
Possible Changes in Royalty Rate
The Company's activities in Poland are subject to the risk of changes in the
royalty rate to be paid on production. Poland's Council of Ministers sets a
base royalty rate for the extraction of each mineral. The base royalty rate
for oil is currently 6%, but could be increased unilaterally up to 10% (the
current maximum base royalty rate) by the Council of Ministers. In addition,
the Polish government can set the royalty rate for any particular oil and gas
field in a range between 50% and 150% of the base royalty rate, depending on
the economic viability of such field. See "Business and Properties--
Exploration and Development Activities in Poland."
No Assurance of Commercial Production from the Baltic Concession
There has not been any commercial production of oil or gas from the Baltic
Concession. Various agencies of the Polish government have drilled seven
exploratory wells and eight stratigraphic wells in the Baltic Concession to
the same formation that is productive in established fields in the Baltic
Platform. None of these wells has been completed for production.
Notwithstanding the substantial data available regarding the Baltic Concession
from these previous drilling efforts and other exploration programs, the
Company believes that several exploration tests may be required to appraise
the potential of any structure which the Company identifies. There can be no
assurance that such tests will be successful. Although the Company has
identified certain structures within the Baltic Concession that it believes
contain oil reservoirs, there can be no assurance that oil is present in
commercial quantities or that the first exploratory well, the location of
which will be determined by RWE-DEA, will be drilled on one of these
identified structures. Further, there can be no assurance that the porosity,
permeability or other characteristics of any reservoir formation will support
the production of oil in commercial quantities. Similarly, although the
Company believes that it has identified a number of structures which have the
potential to contain hydrocarbons, there can be no assurance that such
structures actually contain hydrocarbons. See "Business and Properties--
Exploration and Development Activities in Poland."
No Assurance of Commercial Production from the Carpathian JSA
The exploration activity in the Carpathian JSA is in its initial stages and
no assurance can be given that it will result in any commercial production.
Although there is currently limited hydrocarbon production from certain
shallow formations in the Carpathian JSA, there has never been any commercial
production from the depths which the Company has the right to evaluate with
the POGC.
Dependence on Officers and Key Employees
The Company is dependent upon Mr. David N. Pierce, President, Mr. Andrew W.
Pierce, Operations Vice President, and other key personnel for its various
activities. The loss of the services of any of these individuals may
materially and adversely affect the Company. In addition, with respect to its
activities in Poland, the Company is dependent on Mr. Jerzey B. Maciolek, an
executive officer, and another employee, both Polish nationals, who have been
instrumental in assisting the Company in establishing its operations in
Poland, and the
9
<PAGE>
loss of the services of either person may materially and adversely affect the
Company's activities in Poland. The Company has entered into employment
agreements with Mr. David N. Pierce, Mr. Andrew W. Pierce, and Mr. Maciolek
and intends to enter into an employment agreement with the other individual
who was instrumental to the Company's activities in Poland. The Company does
not maintain key man insurance on any of its employees, nor does it currently
have directors' and officers' liability insurance. See "Management--Executive
Officers and Directors."
Risks Associated with Growth
The Company has had limited operations and, if its activities in Poland are
successful, may experience rapid growth following the Offering. The Company's
ability to manage this growth will depend, in part, upon its ability to
attract and retain quality management and technical personnel. No assurance
can be given that the Company will be able to attract or retain such employees
or otherwise manage any potential expansion of its business. The likelihood of
the success of the Company must be considered in light of the expenses,
difficulties, complications and delays frequently encountered in connection
with the early stages of an oil and gas company. In particular, the Company's
operations in Poland to date have focused primarily on the evaluation of
prospects, and the Company has little or no experience in Poland regarding
exploration, development, production and marketing and has not yet drilled a
well in Poland. Although the Company does have experience in these areas in
the United States, there can be no assurance that such experience will assist
in its activities in Poland.
Possible Future Need for Additional Capital
If exploration of either the Baltic Concession or the Carpathian JSA is
successful in proving substantial oil reserves, the Company may require
significant amounts of additional capital for a development program, oil
storage and handling facilities, oil transportation assets, or other assets
required to support production. In addition, the Company might require
additional capital to accelerate the infill drilling program in the balance of
its Cut Bank field property. The Company has no arrangement for any such
additional financing, but might seek funds from project financing, strategic
alliances or other sources, all of which may dilute the interest of the
Company in the specific project financed. In addition, the Company might seek
funds through the sale of debt or equity securities which could significantly
dilute the ownership of the Company's existing shareholders. There can be no
assurance that additional funds could be obtained or, if obtained, would be
obtained on terms favorable to the Company. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Risk of Impairment of Recorded Value of Unproved Properties
The Company capitalizes costs related to unproved oil and gas properties and
recognizes expenses for costs to drill exploratory wells that do not result in
proved reserves at the time the well is plugged or abandoned. In addition, the
Company reviews its unproved properties periodically to assess whether an
impairment allowance should be recorded. At March 31, 1996, the Company had
capitalized costs related to the acquisition of unproved oil and gas
properties in the amount of $1.7 million, $1.3 million of which related to the
Company's Lake Valley, Nevada, exploration prospect. Should future events such
as the drilling of dry holes evidence that an impairment of recorded value has
taken place, the adverse impact on the Company's results of operations for the
relevant period could be significant. As a result of the foregoing, the
results of operations of the Company for any particular period may not be
indicative of the results that could be expected over longer periods. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Risks of Adverse Weather
A significant portion of the Company's exploration and development
activities are subject to periodic interruptions due to weather conditions
that may be quite severe in the areas where such activities are conducted.
Heavy precipitation may make travel to exploration sites or drilling locations
difficult or impossible. Extremely cold temperatures may delay or interrupt
drilling, well servicing and production. The foregoing may reduce production
volumes or increase production costs.
10
<PAGE>
Shares Eligible for Future Sale
Substantially all of the approximately 8.7 million shares of Common Stock
currently issued and outstanding either (i) were sold in a registered
offering, (ii) have been held for in excess of two years and are eligible for
resale under Rule 144, promulgated under the Securities Act, (iii) were
registered for resale in registration statements declared effective March 30,
1995, or (iv) will be registered for resale in a registration statement filed
by the Company on July 22, 1996. Although the resale of 1.6 million of such
shares is subject to contractual restrictions (including 1.1 million shares
which are owned by officers and directors of the Company and are subject to
volume and other restrictions under Rule 144), the possible resale of the
remaining 7.1 million shares may have a depressive effect on the public
trading market for the Common Stock. See "Price Range of Common Stock and
Dividend Policy" and "Description of Securities--Covenants to Register Common
Stock."
Substantial and Immediate Dilution
Persons purchasing Common Stock will suffer a substantial and immediate
dilution of $3.86 per share below the purchase price to the net tangible book
value of their shares. See "Dilution."
Control of the Company by Management
The current executive officers and directors of the Company hold sole or
shared voting and dispositive power over approximately 1.1 million issued and
outstanding shares of Common Stock, which constitutes approximately 9.6% of
the approximately 11.7 million shares of Common Stock that will be outstanding
after the Offering (without giving effect to the exercise of any options or
warrants). Giving effect only to the exercise of all options held by officers
and directors, including options not yet completely vested, current executive
officers and directors would own a total of approximately 3.2 million shares,
or approximately 23.1% of the approximately 13.8 million shares that would be
issued and outstanding after the Offering. As a result of such ownership, such
persons will be able to substantially influence the election of all of the
directors of the Company and the outcome of other matters submitted to the
stockholders for consideration. See "Principal Stockholders" and "Description
of Securities."
Substantial Warrants and Options Outstanding
The Company has issued and outstanding warrants and options to purchase up
to 2.9 million shares of Common Stock at exercise prices ranging from $1.10 to
$3.00 with a weighted average exercise price of $2.52 per share. The existence
of such warrants and options may hinder future financings by the Company and
the exercise of such options may further dilute the interests of all other
stockholders. The possible future resale of Common Stock issuable on the
exercise of such options could adversely affect the prevailing market price of
the Common Stock. Further, the holders of warrants and options may exercise
them at a time when the Company would otherwise be able to obtain additional
equity capital on terms more favorable to the Company. See "Description of
Securities--Common Stock" and "Principal Stockholders."
Caution Respecting Forward-Looking Information
This Prospectus contains certain forward-looking information, including
discussions of the uncertainties of certain terms to be determined in the
future relating to the Baltic Concession and the Carpathian JSA; uncertainties
regarding future political, economic, regulatory, fiscal, taxation and other
policies in Poland; the future results of various exploration and development
activities; future events that may result in the need for additional capital;
future drilling and other exploration schedules and sequences for various
wells and other activities; the future ability of the Company to attract
drilling participants to share the costs of exploration and development; and
similar matters. Such information is based on present circumstances and on the
Company's predictions respecting events that have not occurred, which may not
occur or which may occur with different consequences from those now assumed or
anticipated. No assurance can be given that actual events may not be different
than the assumptions on which such forward-looking information is based. See
"Business and Properties."
11
<PAGE>
FACTORS RELATING TO THE OIL AND GAS INDUSTRY
Uncertainty of Reserve Estimates and Future Net Revenues
There are numerous uncertainties inherent in estimating quantities of proved
oil reserves. The estimates in this Prospectus are based on various
assumptions relating to rates of future production, timing and amount of
development expenditures, oil prices and the results of planned development
work. Actual future production rates and volumes, revenues, taxes, operating
expenses, development expenditures and quantities of recoverable oil reserves
may vary substantially from those assumed in the estimates. Any significant
change in these assumptions, including changes which result from variances
between projected and actual results, could materially and adversely affect
future reserve estimates. In addition, such reserves may be subject to
downward or upward revision based upon production history, results of future
development, prevailing oil prices and other factors. See "Business and
Properties--Oil Reserves" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources."
Development Risks
The Company's infill drilling program in the Cut Bank field in Montana is
based on the engineering model used in a similar program conducted on a
portion of the Company's property by a previous owner. There can be no
assurance that the results of the Company's development program will achieve
the results of the engineering model on which it is based, significantly
increase production or reserves or result in a financial return to the
Company. Whether or not the development program is successful, no assurance
can be given that the Company will be able to discover, develop or purchase
properties to replace its current reserve base. See "Business and Properties--
Exploration and Development Activities in the United States."
Volatility of Commodity Prices and Markets
Oil and gas prices have been and are likely to continue to be volatile and
subject to wide fluctuations in response to any of the following factors:
relatively minor changes in the supply of and demand for oil and gas; market
uncertainty; political conditions in international oil producing regions; the
extent of domestic production and importation of oil in certain relevant
markets; the level of consumer demand; weather conditions; the competitive
position of oil or gas as a source of energy as compared with other energy
sources; the refining capacity of oil purchasers; and the effect of federal
and state regulation on the production, transportation and sale of oil.
Adverse changes in the oil market or the regulatory environment would likely
have an adverse effect on the Company's ability to obtain capital from lending
institutions, industry participants, private or public investors or other
sources.
Operating Hazards and Uninsured Hazards
Oil and gas drilling involves hazards such as fire, explosions, blow-outs,
pipe failures, casing collapses, unusual or unexpected formations and
pressures and environmental hazards such as oil spills, gas leaks, ruptures
and discharges of toxic gases, any one of which may result in environmental
damage, personal injury and other harm that could result in substantial
liabilities to third parties and losses to the Company. The Company maintains
insurance against certain risks which it believes are customarily insured
against in the oil and gas industry by companies of comparable size and scope
of operations. The insurance that the Company maintains does not cover all of
the risks involved in oil exploration, drilling and production and if coverage
does exist, may not be sufficient to pay the full amount of such liabilities.
For example, the Company does not maintain insurance against risks related to
violations of environmental laws. The Company may not be insured against all
losses or liabilities which may arise from all hazards because such insurance
is unavailable at economic rates, because of limitations in the Company's
insurance policies or because of other factors. Any uninsured loss could have
a material and adverse effect on the Company. See "Business and Properties--
Operational Hazards and Insurance."
Intense Competition in Oil and Gas Industry
The oil and gas industry is highly competitive. Most of the Company's
current and potential competitors have greater financial resources and a
greater number of experienced and trained managerial and technical personnel
than the Company. There can be no assurance that the Company will be able to
compete effectively with such firms.
12
<PAGE>
United States Governmental Regulation, Taxation and Price Control
Oil and gas production and exploration are subject to comprehensive federal,
state and local laws and regulations controlling the exploration for and
production and sale of oil and gas and the possible effects of such activities
on the environment. Present, as well as future, legislation and regulations
could cause additional expenditures, restrictions and delays in the Company's
business, the extent of which cannot be predicted and which may require the
Company to limit substantially, delay or cease operations in some
circumstances. From time to time, regulatory agencies have proposed or imposed
price controls and limitations on production by restricting the rate of flow
of oil and gas wells below actual production capacity in order to conserve
supplies of oil and gas. Because energy and taxation policies are unclear and
are subject to constant revisions, no prediction can be made as to the
ultimate effect of such governmental policies and controls. See "Business and
Properties--Government Regulation: United States."
FACTORS RELATING TO ACTIVITIES IN POLAND
Political Uncertainties
The exploration, development and production of oil and gas in Poland will be
subject to ongoing uncertainties and risks, including risks of political
instability and changes in government, expropriation or nationalization of
private enterprises, export and transportation tariffs, local and national tax
requirements and other risks arising out of foreign government sovereignty
over the exploration area. The terms of the agreements with governmental
agencies are subject to administration by government officials and are,
therefore, subject to changes in government personnel, the development of new
administrative policies and practices and political changes in Poland. There
can be no assurance that the laws, regulations and policies applicable to the
Company will not change, that the laws and regulations will be applicable in
any particular circumstance or that the Company will be able to enforce its
rights in Poland. The Company anticipates that it will be required to
demonstrate, to the satisfaction of the Polish authorities, the Company's
compliance with the concession terms respecting exploration expenditures,
results of exploration, environmental protection matters and other factors.
Although the exploration and exploitation rights of the Company may be
canceled by the Company at any time, the Company would likely not be able to
recover previous payments made under the rights or any other costs incurred
respecting the rights upon such cancellation. There can be no assurance that
the Company will be able to take measures to provide adequate protection
against any of the political uncertainties discussed above. See "Business and
Properties--Exploration and Development Activities in Poland."
Currency Risks
The Company will be subject to a variety of currency risks, including the
risks that currencies will not be convertible at satisfactory rates, that the
official conversion rates between United States and Polish currencies may not
accurately reflect the relative value of goods and services available or
required in Poland and that inflation will lead to the devaluation of the
Polish Zloty.
Repatriation of Earnings
The Company may be restricted as to the amount, manner or timing of the
repatriation to the United States of earnings from activities in Poland. The
Company has formed a wholly owned Polish subsidiary through which it will
conduct its activities in Poland. Currently, there are no restrictions on the
ability of a Polish entity to repay debt to a foreign parent corporation or to
pay fair market compensation to a foreign parent corporation for legitimate
services. However, Polish entities are limited in their ability to pay
dividends. Dividends can be paid only once annually and are limited in amount
to the extent of profit, as determined in compliance with Polish accounting
and regulatory requirements and as verified by an audit satisfying Polish
professional standards. In addition, the payment of dividends by the Polish
subsidiary is subject to a 5% withholding tax. Although the Company is
entitled to a credit against its United States tax obligations equal to the
Polish withholding tax, the Company may not be able to use this credit unless
the Company owes taxes in the United States. See "Business and Properties--
Exploration and Development Activities in Poland."
13
<PAGE>
Lack of Exploration and Development Infrastructure
There can be no assurance that the Company will be able to conduct an
effective and efficient exploration program in Poland. Further, the Company is
subject to certain risks which could substantially increase the cost of
exploration, development and production activities and reduce potential
financial returns, including the limited availability of certain modern
exploration, drilling and production equipment, supplies and services and the
lack of availability or limited capacity of oil and gas gathering, storage,
transportation and processing facilities.
Lack of Transportation and Marketing Arrangements
The Company has no transportation, refining or marketing arrangements
relating to future oil production in Poland. Instead, the Company is relying
primarily on a continuous increase in international demand for oil products
and the fact that Poland reportedly imports over 95% of its oil as the basis
for its belief that an available market exists for any oil that may be
discovered. Subject to obtaining appropriate approval, the Company is not
precluded from exporting oil, but the Company presently has no such
arrangements. There can be no assurance that the Company will be able to
establish transportation, refining or marketing arrangements to sell any oil
discovered and produced in Poland on terms favorable to the Company or that
the Company will be able to make arrangements for the exportation of oil in
the event such exportation is desirable to the Company. See "Business and
Properties--Exploration and Development Activities in Poland."
Poland's Governmental Regulation
The Company's activities in Poland are subject to certain laws and
regulations relating to the exploration for and development, production,
marketing, transportation and storage of oil, including measures relating to
the protection of the environment. The regulatory regime governing these
activities was recently promulgated and is relatively untested. Therefore,
there is no enforcement history or established practice that can aid the
Company in evaluating how the regulatory regime will affect the Company's
operations. Although management believes that the regulatory infrastructure
currently in place and now being further developed in Poland is generally
consistent with the government's stated purpose of encouraging both foreign
investment and the development of Poland's natural resources, there can be no
assurance that such governmental policy will not change or that new laws and
regulations, administrative practices or policies or interpretations of
existing laws and regulations will not materially and adversely affect the
Company's activities in Poland.
Poland's Environmental Regulations
The Company's operations are subject to environmental laws and regulations
in Poland. Poland's environmental laws and regulations may provide for
restrictions and prohibitions on spills, releases or emissions of various
substances produced in association with oil exploration and development.
Additionally, if significant quantities of gas are produced in conjunction
with the Company's production of oil, regulations prohibiting the flaring of
gas and the absence of a gas gathering and delivering system may restrict
production or may require significant expenditures by the Company to develop
such a system prior to the production of oil. Certain aspects of the Company's
proposed operations may require the submission and approval of environmental
impact assessments to governmental authorities in Poland prior to commencing
production.
The Company has only recently initiated field activities in connection with
its seismic program and has not incurred material environmental remediation
costs to date. Management believes that the Company is currently in material
compliance with all applicable laws and regulations. However, there can be no
assurance of such compliance or that applicable regulations or administrative
policies or practices will not be changed by the Polish government. The cost
of compliance with current regulations or any changes in environmental
regulations could require significant expenditures, and breaches of such
regulations may result in the imposition of fines and penalties, any of which
may be material. There can be no assurance that these environmental costs will
not have a material adverse effect on the Company's financial condition or
results of operations in the future.
14
<PAGE>
COMPANY HISTORY
In January 1989, the Company began its oil exploration activities with the
formation of its predecessor, Frontier Exploration Company ("Exploration") by
Mr. David N. Pierce and Mr. Andrew W. Pierce. In 1992, Exploration was
reorganized with the Company, then known as Direct West, Inc., which then
changed its name to Frontier Oil Exploration Company and continued under the
management of the former officers and directors of Exploration. Exploration
continued as a wholly owned subsidiary of the Company. In June 1993, the
Company acquired Petrolex Corporation, an oil and gas lease brokerage business
owned principally by David Pierce. Effective April 1, 1994, the Company
purchased producing oil properties and related assets in Montana and Nevada
(the "Montana Acquisition"). In 1995, the Company launched a multi-year infill
drilling operation on specific portions of the acquired Montana oil fields to
develop additional proved producing reserves and increase the rate of
production. In August 1995, the Company acquired rights to the Baltic
Concession. At a meeting held on July 22, 1996, the Company's shareholders
approved the change of the Company's name from Frontier Oil Exploration
Company to FX Energy, Inc.
The Company's executive offices are located at 3006 Highland Drive, Suite
206, Salt Lake City, Utah 84106. Its telephone number is (801) 486-5555 and
its facsimile number is (801) 486-5575.
USE OF PROCEEDS
Based on an offering price of $5.75, the net proceeds to the Company from
the sale of the 3,000,000 shares of Common Stock offered hereby will be
approximately $15.5 million ($17.9 million, assuming exercise of the
Underwriters' over-allotment option) after deducting estimated underwriting
discounts and expenses of the Offering payable by the Company.
A portion of the net proceeds from the Offering will be used to repay the
$3.6 million balance on the Company's bank credit facility. The remainder of
the net proceeds from the Offering, together with cash available under the
Company's continuing bank credit facility and potentially available from
operations, will be used to fund the Company's 1996 and 1997 capital
expenditure budget of $15.3 million and for general corporate purposes. The
Company's planned capital expenditures through December 31, 1997, are as
follows: (i) approximately $7.0 million for exploration and potential
development activities related to the Baltic Concession, (ii) approximately
$1.4 million for the review and evaluation of available geological and
geophysical data and the potential initiation of exploratory activities in the
Carpathian JSA, (iii) approximately $6.1 million for infill development
drilling in the Cut Bank field in Montana and (iv) approximately $0.8 million
for exploration activities in the western United States. The allocation of the
Company's capital among the categories of anticipated expenditures is
discretionary and will depend upon future events that cannot be predicted.
Such events include the actual results and costs of future exploration and
development drilling activities. Consistent with previous practice, the
Company may obtain partial funding for its exploration and potential
development activities through strategic arrangements with industry or
financial partners. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources--Credit
Facility."
The Company's outstanding bank loan was made pursuant to a bank credit
facility established to provide a portion of the funds required to complete
the Montana Acquisition and is secured by the properties acquired in such
acquisition. The bank indebtedness bears interest at the lending bank's base
rate plus 1.25%, adjusted monthly. As of June 30, 1996, the interest rate on
borrowings under the bank credit facility was 9.5%. The current maturity of
the bank indebtedness is October 1, 1997.
Until the net proceeds of the Offering are utilized for the purposes
described above, they will be invested in interest-bearing bank accounts, U.S.
government securities, other investment grade debt securities and other short-
term investments.
15
<PAGE>
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
Effective June 7, 1996, the Common Stock began to be quoted on the Nasdaq
SmallCap Market under the symbol "FXEN." The Common Stock has been approved
for listing on the Nasdaq National Market under the symbol "FXEN," subject
only to notice of issuance.
Management believes that the trading market for Common Stock was extremely
limited prior to the completion of the Company's sale of 2 million shares of
Common Stock in September 1995. As a result, the potential existed prior to
September 1995 for the trading of a relatively minor number of shares to
result in a significant change in the trading price of the Common Stock.
Therefore, the Company does not believe that quotations before late 1995
should be considered reliable indicators of the existence of a viable trading
market for the Common Stock.
The following table sets forth the closing bid quotation for the Common
Stock, based on interdealer bid quotations, without markup, markdown,
commissions or adjustments, for the periods indicated as quoted on the OTC
Electronic Bulletin Board of the National Association of Securities Dealers,
Inc. under the symbol "FOEX" through June 6, 1996, and thereafter based on the
closing sales price on the Nasdaq SmallCap Market under the symbol "FXEN."
<TABLE>
<CAPTION>
LOW HIGH
----- -----
<S> <C> <C>
1996
Third Quarter (through August 1, 1996)............................ $6.75 $8.75
Second Quarter.................................................... 2.63 9.63
First Quarter..................................................... 2.00 3.91
1995
Fourth Quarter.................................................... $1.75 $2.75
Third Quarter..................................................... 1.25 2.13
Second Quarter.................................................... 2.00 3.00
First Quarter..................................................... 2.75 3.38
1994
Fourth Quarter.................................................... $2.75 $3.38
Third Quarter..................................................... 2.75 3.38
Second Quarter.................................................... 1.00 3.25
First Quarter..................................................... 1.00 3.25
</TABLE>
On August 1, 1996, the closing sales price for the Common Stock on the
Nasdaq SmallCap Market was $6.75 per share.
The Company has never paid cash dividends on the Common Stock or its
preferred stock and does not anticipate that it will pay dividends in the
foreseeable future. The Company currently intends to continue a policy of
using retained earnings primarily for the expansion of its business. The
Company's outstanding preferred stock does not have a preference on dividends,
but holders of preferred stock would participate with holders of the Common
Stock if, contrary to management's expectations, dividends were declared and
paid on the Common Stock.
On June 30, 1996, the Company had approximately 1,438 stockholders.
16
<PAGE>
CAPITALIZATION
The following table sets forth the actual capitalization of the Company as
of March 31, 1996, and as adjusted to give pro forma effect to the subsequent
issuance of 244,111 shares of Common Stock and the receipt of proceeds
therefrom and from a stock subscription receivable and to give effect to the
sale by the Company of the 3,000,000 shares of Common Stock offered hereby at
an offering price of $5.75 per share and the application of the net proceeds
therefrom for repayment of bank debt as described in "Use of Proceeds", but
without giving any effect to any other changes to the Company after March 31,
1996. This information should be read in conjunction with the Company's
Consolidated Financial Statements and the Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
presented elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AS OF MARCH 31, 1996
----------------------
PRO FORMA
ACTUAL AS ADJUSTED(1)
------ --------------
(IN THOUSANDS)
<S> <C> <C>
Current portion of long-term debt....................... $ 180 $ --
====== =======
Long-term debt, net of current portion.................. $3,439 $ --
------ -------
Stockholders' equity:
Preferred stock, $0.001 par value; 5,000,000 shares
authorized; 17,500 issued and outstanding............ -- --
Common Stock, $0.001 par value; 20,000,000 shares
authorized; 8,460,485 issued and outstanding;
11,704,596 shares issued and outstanding (pro forma
as adjusted)......................................... 8 12
Additional paid-in capital............................ 10,665 26,945
Stock subscription receivable......................... (90) --
Accumulated deficit................................... (4,833) (4,852)
------ -------
Total stockholders' equity............................ 5,750 22,105
------ -------
Total capitalization.................................... $9,189 $22,105
====== =======
</TABLE>
- --------
(1) Does not include an aggregate of 3,077,028 shares issuable upon (i) the
conversion of outstanding preferred stock, (ii) the exercise of
outstanding options and warrants and (iii) the issuance of shares
contingent upon attaining certain production levels in Montana and Nevada.
See "Management--Executive Compensation," "Principal Stockholders,"
"Certain Transactions" and "Description of Securities."
DILUTION
As of March 31, 1996, as adjusted to give pro forma effect to the subsequent
issuance of 244,111 shares of Common Stock and the receipt of proceeds
therefrom, the Company had a pro forma net tangible book value of $6.6
million, with 8,704,596 shares of Common Stock issued and outstanding, or
approximately $0.76 per share, after deducting a liquidation preference of
$17,500 respecting the 17,500 shares of the Company's outstanding preferred
stock. The following table illustrates per share dilution to new investors to
the net tangible book value of the shares of Common Stock to be sold in the
Offering.
<TABLE>
<S> <C> <C>
Public offering price per share.................................... $5.75
Pro forma net tangible book value per share at March 31,
1996(1)......................................................... $0.76
Increase attributable to new investors........................... 1.12
-----
Pro forma net tangible book value per share after the Offering... 1.89
-----
Dilution per share to purchasers in the Offering................. $3.86
=====
</TABLE>
- --------
(1) Subsequent to March 31, 1996, the Company issued 156,111 shares of Common
Stock for net proceeds of $680,000, issued 80,000 shares of Common Stock
on the exercise of options for $120,000, received $90,000 on a stock
subscription receivable and issued 8,000 shares for services. Does not
include an aggregate of 3,077,028 shares issuable upon (i) the conversion
of outstanding preferred stock, (ii) the exercise of outstanding options
and warrants and (iii) the issuance of shares contingent upon attaining
certain production levels in Montana and Nevada. See "Management--
Executive Compensation," "Principal Stockholders," "Certain Transactions"
and "Description of Securities."
17
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data of the Company for each
of the four years in the period ended December 31, 1995, are derived from the
audited financial statements and notes thereto of the Company, certain of
which are included elsewhere in this Prospectus. The selected consolidated
financial data for the three months ended March 31, 1995 and 1996, and for the
year ended December 31, 1991, are unaudited and, in management's opinion,
include all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the results for such periods. Results for
the interim periods are not necessarily indicative of results to be expected
for the entire year. The selected consolidated financial data should be read
in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Company's Consolidated Financial
Statements and the Notes thereto included elsewhere herein.
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
--------------------------------------- ----------------
1991 1992 1993 1994 1995 1995 1996
------ ------ ------ ------ ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues:
Oil sales.............. -- -- -- $1,692 $ 1,981 $ 516 $ 505
Drilling revenue....... -- -- -- 224 111 5 --
Other (1).............. $ 174 $ 342 $ 276 -- 75 60 --
------ ------ ------ ------ ------- ------- -------
Total revenues......... 174 342 276 1,916 2,167 581 505
------ ------ ------ ------ ------- ------- -------
Operating costs and
expenses:
Production and
operating costs(2).... 13 45 7 680 1,272 338 325
Exploration costs...... -- -- 654 651 747 94 189
Depreciation, depletion
and amortization...... 10 7 3 422 503 106 138
General and
administrative........ 178 259 353 816 1,466 276 366
Other(3)............... -- -- -- 178 256 11 24
------ ------ ------ ------ ------- ------- -------
Total operating costs
and expenses.......... 201 311 1,017 2,747 4,244 825 1,042
------ ------ ------ ------ ------- ------- -------
Operating income
(loss)................. (27) 31 (741) (831) (2,077) (244) (537)
Interest and other
income................. 20 36 39 53 98 10 36
Interest expense........ (1) (4) (2) (214) (448) (111) (82)
Minority interest: Non-
cash dividends(4)...... -- -- -- -- (93) (55) --
------ ------ ------ ------ ------- ------- -------
Net income (loss) before
income taxes........... (8) 63 (704) (992) (2,520) (400) (583)
Benefit from (provision
for) income taxes...... 3 (16) 9 -- -- -- --
------ ------ ------ ------ ------- ------- -------
Net income (loss)....... $ (5) $ 47 $ (695) $ (992) $(2,520) $ (400) $ (583)
====== ====== ====== ====== ======= ======= =======
Net income (loss) per
common share........... $(0.00) $ 0.03 $(0.40) $(0.44) $ (0.47) $ (0.14) $ (0.07)
Weighted average shares
outstanding............ 1,400 1,412 1,750 2,229 5,389 2,811 8,086
CASH FLOW STATEMENT
DATA:
Net cash provided by
(used in) operating
activities............. $ (35) $ 96 $ (569) $ (322) $(1,030) $ (64) $ (747)
Net cash (used in)
investing activities... (15) (265) (22) (4,432) (1,489) (127) (47)
Net cash provided by
(used in) financing
activities............. (136) 171 1,046 4,587 2,974 427 909
<CAPTION>
AS OF DECEMBER 31, AS OF MARCH 31,
--------------------------------------- ----------------
1991 1992 1993 1994 1995 1995 1996
------ ------ ------ ------ ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital
(deficit).............. $ 63 $ (154) $ 283 $ (272) $ (278) $ (170) $ 399
Total assets............ 143 374 1,317 8,436 10,039 9,379 10,148
Long-term debt.......... -- -- -- 4,091 3,359 4,009 3,439
Redeemable FX Producing
Company, Inc. preferred
stock.................. -- -- -- 550 -- -- --
Stockholders' equity.... 106 173 910 1,280 5,224 3,140 5,750
</TABLE>
- --------
(1) Other revenues include prospect sales and project management fees.
(2) Includes production taxes.
(3) Other expenses include drilling costs and leasehold abandonments.
(4) Non-cash dividend on FX Producing Company, Inc. convertible preferred
stock.
18
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis should be read in conjunction with the
Company's Consolidated Financial Statements and related Notes thereto and the
Selected Consolidated Financial Data included elsewhere in this Prospectus.
GENERAL
The Company is engaged in the exploration, development and production of oil
and gas in the western United States and Poland. The Company plans to focus on
the oil potential of Poland and to explore specific prospects utilizing modern
evaluation techniques to reinterpret existing well and seismic data. The
Company forms strategic alliances with industry partners to reduce its
financial exposure and to obtain the benefits of additional technical and
operating expertise. The Company's principal exploration efforts in the Baltic
Concession are being funded partially through an arrangement with RWE-DEA. The
Company has also entered into a joint study arrangement with POGC to evaluate
technical information previously collected from the Carpathian JSA and is
undertaking a long-term development project on its producing Montana
properties to increase cash flows and oil reserves.
From its organization in January 1989 through the first quarter of 1994, the
Company generated revenue principally from the sale of oil and gas prospects
in the western United States and from fees generated by the management of
domestic joint exploration groups formed by the Company. During such period,
the Company reported substantial operating losses. Effective April 1, 1994,
with the Montana Acquisition, the Company's activities were expanded
substantially, and the Company began generating revenue from oil production,
well drilling and related activities. Thereafter, the Company began to have
increased operating revenue but continued to report operating losses and
negative cash flows from operations. In August 1995, the Company acquired
exploration rights to the Baltic Concession and began to focus its exploration
efforts in Poland. The Company's activities expanded in May 1996 when the
Company and POGC initiated their joint evaluation of the Carpathian JSA.
The Company currently intends to continue its exploration activities,
principally in the Baltic Concession and Carpathian JSA, to develop its
Montana producing properties and to explore selected prospects in the western
United States.
RESULTS OF OPERATIONS
Comparison of Three Months Ended March 31, 1995 and 1996
REVENUES
Oil sales decreased 2% to $505,000 in the first quarter of 1996 from
$516,000 in the same quarter of 1995. The decrease was due to a 7.7% decrease
in oil production, to 31,598 Bbl for the first quarter of 1996 from 34,226 Bbl
for the same quarter in 1995. The decrease in production was primarily
attributable to formation damage that occurred in 1994 to a well in Bacon
Flat, Nevada, and normal production declines on the Company's other fields.
The decrease in production was partially offset by a 7.1% increase in the
average price per Bbl sold to $15.98 during the first quarter of 1996 compared
to $14.92 in the first quarter of 1995. In the first quarter of 1995, the
Company sold an interest in undeveloped acreage and recognized revenues of
$60,000 related to such sale.
19
<PAGE>
COSTS AND EXPENSES
Production and operating costs increased 10.6% to $293,000 ($9.28 per Bbl)
in the first quarter of 1996 from $265,000 ($7.74 per Bbl) in the first
quarter of 1995. The increase was due primarily to record cold weather
conditions in the Company's primary operating regions in the first quarter of
1996 and the continuation of an expanded maintenance and production
enhancement program in the Cut Bank field. Production costs per Bbl also
increased during 1995 due to a substantial decline in production from a well
in Nevada with extremely low production costs.
Production taxes decreased 56.2% to $32,000 ($1.01 per Bbl) in the first
quarter of 1996 from $73,000 ($2.13 per Bbl) in the same quarter of 1995. The
decrease was due primarily to an exemption, effective July 1, 1995, for
certain stripper well production affecting most of the Company's Montana
production. Effective January 1, 1996, another production tax of approximately
5.5% was eliminated on most of the Montana production. These production taxes
are not expected to be reinstated in the future.
Exploration costs increased 101.1% to $189,000 in the first quarter of 1996
from $94,000 in the first quarter of 1995. The increase was due primarily to
increased consulting, payroll and legal costs related to expanded exploration
efforts in Poland.
Depreciation, depletion and amortization increased 30.3% to $138,000 ($4.38
per Bbl) in the first quarter of 1996 from $106,000 ($3.10 per Bbl) in the
first quarter of 1995. The increase was due primarily to an increase in the
cost of capitalized oil and gas properties of approximately $1.3 million in
the first quarter of 1996 and a reduction of total proved reserves used to
calculate depreciation, depletion and amortization for the quarter ended March
31, 1996, compared to the quarter ended March 31, 1995.
General and administrative expenses increased 32.6% to $366,000 in the first
quarter of 1996 from $276,000 in the first quarter of 1995. The increase was
due primarily to additional administrative requirements related to the
Company's expanded exploration and development activities.
INTEREST AND OTHER INCOME (EXPENSE)
Interest and other income increased to $36,000 in the first quarter of 1996
as compared to $10,000 for the first quarter of 1995. The increase was due
primarily to increased interest income resulting from an increase in the
Company's average cash balance during 1996 and the Company's receipt of a
liquidating distribution of $15,000 from a partnership in which the Company
owned an interest. Interest expense decreased to $82,000 for the first quarter
of 1996 as compared to $111,000 for the first quarter of 1995, primarily due
to a decrease in the average outstanding balance of the Company's long-term
debt.
During the first quarter of 1995, the Company paid non-cash dividends in
preferred stock of $55,000 on convertible preferred stock of its oil-producing
subsidiary. All preferred shares of the subsidiary had been converted into
Common Stock of the Company as of December 31, 1995; accordingly, there was no
preferred stock dividend payment in the first quarter of 1996.
INCOME TAXES
The Company did not recognize any tax benefit from its losses in the three
months ended March 31, 1996, and March 31, 1995.
NET LOSS
Net loss increased 45.8% to $583,000 in the first quarter of 1996 from
$400,000 in the first quarter of 1995. The increase was due primarily to a
decrease in total revenues and increases in exploration and general and
administrative costs as discussed above.
20
<PAGE>
Comparison of Years Ended December 31, 1994 and 1995
The Company's results of operations for the fiscal year ended December 31,
1995, includes one full year of revenues from oil production, well servicing
and related activities and interest expense related to bank debt, whereas the
year ended December 31, 1994, includes only revenues and expenses from the
date of the Montana Acquisition. Therefore, in management's opinion, the
results of operations for the fiscal years ended December 31, 1994 and 1995
are not comparable.
REVENUES
During 1995, oil sales increased 17.1% to $2.0 million from $1.7 million in
1994 primarily due to the inclusion of one full year of oil sales in 1995 as
compared to a partial year in 1994. Oil sales also increased due to a 4.3%
increase in the average price per Bbl sold to $14.67 in 1995 from $14.07 in
1994. These increases were partially offset by a 15.4% decrease in oil
production in 1995. The decrease in production in 1995 was primarily due to
the loss of 51 Bpd in average net production from a well in the Bacon Flat
field that sustained formation damage in 1994 and a production decrease of 17
Bpd from the Cut Bank field. The decline in Cut Bank production represents a
normal production decline which the Company's infill drilling and waterflood
project is designed to overcome.
Drilling revenue decreased 50.5% in 1995 to $111,000 from $224,000 in 1994.
One well was drilled in 1995 with the Company's drilling rig as compared to
two wells in 1994. Prospect sales revenue increased in 1995 due to the
conveyance of an interest in the Cobb Creek prospect for $75,000. There were
no such sales in 1994.
COSTS AND EXPENSES
Production and operating costs increased 131.0% to $1.0 million ($7.42 per
Bbl) in 1995 from $434,000 ($3.71 per Bbl) in 1994. The increase was due
primarily to the inclusion of one full year of oil production in 1995 compared
to a partial year in 1994. The increase on a per Bbl basis was due primarily
to increased labor costs resulting from abnormally wet weather conditions in
the second quarter of 1995, increased maintenance expenditures on the Cut Bank
field in conjunction with the Company's plan to enhance production and a
substantial decline in production from a well in Nevada with extremely low
production costs.
Production taxes increased 10.2% to $271,000 ($2.00 per Bbl) in 1995 from
$246,000 ($2.10 per Bbl) in 1994. The increase was due primarily to the
inclusion of one full year of oil production in 1995 as compared to a partial
year in 1994. The decrease on a per Bbl basis was due primarily to an
exemption for certain stripper well production, which became effective on July
1, 1995, and which applied to most of the Company's Montana production.
Exploration costs increased 14.7% to $747,000 in 1995 from $651,000 in 1994.
The increase was due primarily to an expansion of exploration activities in
Poland in 1995. The Company participated in two dry holes in the United States
in both 1995 and 1994.
Depreciation, depletion and amortization increased 19.2% to $503,000 ($3.73
per Bbl) in 1995 from $422,000 ($3.61 per Bbl) in 1994. The increase was due
primarily to the inclusion of one full year of production in 1995 compared to
a partial year in 1994.
Drilling costs decreased 20.8% to $141,000 in 1995 from $178,000 in 1994.
The decrease was primarily due to the Company drilling rig drilling one well
in 1995 as compared to two wells in 1994.
The Company reported leasehold abandonment expense of $115,000 in 1995 as
compared to no such expense in 1994. Leasehold abandonments will vary from
year to year based, in part, upon management's periodic assessment to
determine whether unproved properties have been impaired.
21
<PAGE>
General and administrative expenses increased 83.8% to $1.5 million in 1995
from $816,000 in 1994. The increase was due primarily to non-cash expenses of
$425,000 relating to the issuance of stock options to employees and the
issuance of 200,000 shares of Common Stock to a shareholder as compensation
for financial consulting. The increase was also a product of additional
administrative requirements due to a general expansion of the Company's
activities.
INTEREST AND OTHER INCOME (EXPENSE)
Interest and other income increased 84.9% to $98,000 in 1995 from $53,000 in
1994. This increase was due primarily to a $20,000 increase in interest income
due to a greater average cash balance during 1995 and the sale of equipment in
1995 which resulted in a gain of $16,000. Interest expense increased 109.0% to
$448,000 in 1995 from $214,000 in 1994. A full year of interest expense
related to the Company's credit facility is included in 1995 compared to the
inclusion of only a partial year of interest expense in 1994.
Preferred stock of the Company's oil-producing subsidiary required payment
of cumulative dividends. Dividends of $93,000 were paid in preferred stock of
such subsidiary in 1995. All of the outstanding preferred stock of such
subsidiary had been converted into Common Stock of the Company as of December
31, 1995. No such dividend payments were made in 1994.
INCOME TAXES
The Company incurred net operating losses in 1993, 1994 and 1995 which can
be carried forward to offset future taxable income. Statement of Financial
Accounting Standards (SFAS) No. 109 requires that a valuation allowance be
provided if it is more likely than not that some portion or all of a deferred
tax asset will not be realized. The Company's ability to realize the benefit
of its deferred tax asset will depend on the generation of future taxable
income through profitable operations and the expansion of the Company's oil
and gas producing activities. The market and capital risks associated with
achieving the above requirement are considerable, resulting in the Company's
conclusion to provide a valuation allowance equal to the deferred tax asset.
Accordingly, the Company did not recognize any tax benefit in its consolidated
statement of operations for the years ended December 31, 1993, 1994 and 1995.
NET LOSS
Net loss increased 150.0% to $2.5 million in 1995 from $1.0 million in 1994.
The increase was due primarily to increases in production and operating costs,
interest expense and general and administrative costs as discussed above.
Comparison of Years Ended December 31, 1993 and 1994
Prior to the Company's Montana Acquisition, effective April 1, 1994, the
Company had no revenue from oil production, well drilling and related
activities. Accordingly, the Company's results of operations for the fiscal
year ended December 31, 1994, includes revenues and expenses from the date of
the Montana Acquisition and the interest expense from related bank debt,
whereas the year ended December 31, 1993, includes no revenues from oil
production, well drilling and related activities and no interest expense
related to bank debt. The results of operations for the fiscal years ended
December 31, 1993 and 1994 are, in management's opinion, therefore not
comparable.
Revenues for the year ended December 31, 1994, increased to $1.9 million
from $276,000 in 1993. This increase was primarily due to the $1.7 million in
oil and gas revenue and $224,000 in drilling revenue earned after the Montana
Acquisition. Operating costs and expenses for the year ended December 31,
1994, increased 170.0% to $2.7 million from $1.0 million in 1993, also
primarily due to the Montana Acquisition. Expenses for 1994 included $1.1
million in costs directly related to the acquired oil production, including
production and operating costs, production taxes and depreciation, depletion
and amortization. General and administrative expenses increased 131.1% to
$816,000 in 1994 from $353,000 in 1993 primarily as a result of the Company's
expanded operations after the Montana Acquisition.
22
<PAGE>
CAPITALIZED COSTS FOR UNPROVED OIL AND GAS PROPERTIES
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 expensed. The costs of development wells are capitalized whether
productive or nonproductive. Geological and geophysical costs on exploratory
prospects and the costs of carrying and retaining unproved properties are
expensed as incurred. An impairment allowance is provided to the extent that
capitalized costs of unproved properties, on a property-by-property basis, are
considered to be not realizable. At December 31, 1995 and March 31, 1996, the
Company had capitalized costs related to unproved oil and gas properties in
the amount of $1.8 and $1.7 million, respectively, of which $1.4 million and
$1.3 million, respectively, related to the Company's Lake Valley exploration
prospect. Should future events, such as the drilling of dry holes, indicate
that an impairment of recorded value has taken place, the impact on the
relevant period of results of operations could be significant. As a result of
the foregoing, the results of operations of the Company for any particular
period may not be indicative of the results that could be expected over longer
periods.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has relied primarily on proceeds from the sale of
equity securities to fund its operations. To complete the Montana Acquisition,
the Company utilized bank financing, supplemented by proceeds from the sale of
securities of a subsidiary. The Company also benefits from funds provided by
other participants in drilling groups formed by it to undertake specific
exploration. In 1995, the Company sold 2.1 million shares of Common Stock at
$2.00 per share for net proceeds of $4.0 million. In the first quarter of
1996, the Company sold 372,000 shares of Common Stock for net proceeds of $1.1
million, of which $90,000 was received in April 1996. Subsequent to March 31,
1996, the Company sold 157,000 shares of Common Stock at $4.50 per share for
net proceeds of $680,000 and received $120,000 from the exercise of stock
options.
Operating Activities
The Company used cash of $747,000 in operating activities during the three
months ended March 31, 1996, compared to cash used of $64,000 during the
corresponding period in the prior year. This increase in the use of cash in
1996 was primarily due to a larger net loss and a substantial reduction in
accounts payable and accrued liabilities. During 1993, 1994 and 1995,
operations required net cash of $569,000, $322,000 and $1.0 million,
respectively. The 1994 decrease as compared to the previous year was primarily
due to the Montana Acquisition and the corresponding increase in depreciation,
depletion and amortization in 1994 as compared to 1993. The increase in 1995
was due principally to a substantially larger operating loss in that year as
the Company significantly expanded its operations.
Financing Activities
Financing activities provided net cash of $909,000 during the quarter ended
March 31, 1996, compared to $427,000 for the same period of the preceding
year. The net cash provided during the quarter ended March 31, 1996, resulted
from net proceeds of $966,000 received from the sale of 342,393 shares of
Common Stock and $26,000 received from the exercise of warrants to purchase
22,004 shares of Common Stock, offset by expenditures of $83,000 by the
Company for repayment of long-term debt. The net cash provided during the
quarter ended March 31, 1995, resulted from net proceeds of $395,000 received
from the sale of 260,000 shares of Common Stock and $111,000 received from the
collection of a stock subscription receivable from 1994 related to the sale of
convertible preferred stock of FX Producing, Inc., a wholly owned subsidiary
of the Company ("FX Producing"), offset by expenditures of $79,000 by the
Company for repayment of long-term debt.
23
<PAGE>
In 1993, financing activities provided net cash of $1.0 million principally
from the receipt of net proceeds from the sale of 1,280,000 shares of the
Company's preferred stock. Net cash of $4.6 million provided by financing
activities in 1994 was generated principally from a long-term loan under the
Company's credit facility described below. In 1995, financing activities
provided net cash of $3.0 million, resulting from net proceeds of $4.0 million
received from the sale of 2.1 million shares of Common Stock and $111,000
received from the collection of a stock subscription receivable from 1994
related to the sale of the preferred stock of FX Producing, offset by
expenditures by the Company of $737,000 for repayment of long-term debt, and
$465,000 for redemption of preferred stock of FX Producing.
The improvement in the Company's working capital to $399,000 as of March 31,
1996, as compared to a deficit of $170,000 on the same date a year earlier,
was primarily due to net proceeds received from the sale of Common Stock in
the first quarter of 1996. Subsequent to March 31, 1996, the Company's working
capital was increased by $680,000 from the sale of Common Stock, $120,000 from
the exercise of stock options and $90,000 from the collection of a stock
subscription receivable. As of December 31, 1993, 1994 and 1995, the Company
had working capital (deficit) of $283,000, ($272,000) and ($278,000),
respectively. Working capital shortages in the past were primarily due to the
Company's losses from operations.
Credit Facility
In June 1994, the Company established a bank credit facility with Bank One,
Texas, NA, (the "Bank") to provide a portion of the funds required for the
Montana Acquisition. This facility provides for a total loan amount of $5.0
million, with a borrowing base determined at least semi-annually by the Bank
based on its analysis of the Company's producing reserves and cash flow. The
borrowing base as of June 30, 1996, was $3.6 million and will next be subject
to redetermination on September 30, 1996. During the term of the loan, the
Company is required to make monthly payments of interest on the unpaid
principal balance at a rate equal to the Bank's base rate plus 1.25% and to
reduce the outstanding principal by $25,000 per month. As of June 30, 1996,
the interest rate was 9.5%. As of December 31, 1995, the Company was in
violation of the credit facility's cash flow-to-debt service requirements
applicable to FX Producing. Non-compliance with any such ratios and covenants
could result in termination of the credit facility. The Bank, however, waived
the cash flow-to-debt service requirement for the quarters ending December 31,
1995 and March 31, 1996 and amended this provision for the quarters ending
June 30, 1996 and thereafter. This amendment also waived the monthly principal
reductions of $25,000 for the period from March 1 through September 30, 1996
and required the Company to purchase a $300,000 certificate of deposit
maturing November 1, 1996, which was pledged as additional collateral to the
bank note. Based on preliminary financial information, the Company believes
that it was in compliance with the amended cash flow-to-debt service
requirement as of June 30, 1996 and expects that it will be in compliance
throughout the remainder of 1996. In May 1996, the due date of the loan was
extended to October 1, 1997. The Company anticipates repaying the credit
facility's outstanding principal balance of $3.6 million with net proceeds
from the Offering. However, the Company anticipates that the credit facility
will remain in place and the Company may borrow additional funds for the
working capital needs. See "Use of Proceeds."
Investing Activities
During each of the three month periods ended March 31, 1995 and 1996 and the
years ended December 31, 1993, 1994 and 1995, the Company required cash to
fund its investing activities, which consisted primarily of the acquisition
of, or improvement to, oil and gas properties and other property and
equipment. The largest single investment in 1994 was the $4.2 million Montana
Acquisition. The $1.5 million used in investing activities during 1995
consisted principally of capitalized additions to oil and gas properties
related to the infill drilling program in the Cut Bank field.
24
<PAGE>
Capital Requirements
As of March 31, 1996, as adjusted to give effect to the subsequent receipt
of $890,000 from the sale of securities (including $90,000 received from a
stock subscription receivable) and the exercise of options, the Company had
working capital of approximately $1.3 million. This working capital, together
with the $250,000 received during the second quarter of 1996 from RWE-DEA
related to its participation in the exploration and potential development of
the Baltic Concession, is expected to satisfy the Company's operating
requirements during 1996.
As of March 31, 1996, the Company had utilized approximately $600,000 of its
own funds for expenditures associated with obtaining the Baltic Concession,
obtaining and analyzing data provided by Polish sources and advancing the
related exploration effort to its current stage. The Company is obligated
under the Baltic Concession agreement to pay annual fees of approximately
$58,000, one-time geological and geophysical expenditures of $250,000 and to
begin drilling one well (at an estimated dry hole cost of approximately $1.0
million) during 1996.
RWE-DEA, under a joint exploration arrangement, will, in addition to the
$250,000 paid in the second quarter of 1996, provide up to $2.0 million for an
ongoing seismic study and the cost of drilling and testing the initial test
well in the Baltic Concession. If a second well is drilled in the Baltic
Concession, RWE-DEA must fund 50% of the cost of such well to retain its
interest in the Baltic Concession. The Company has budgeted $15.3 million in
capital expenditures through 1997, including (i) approximately $7.0 million
for exploration and potential development activities related to the Baltic
Concession, (ii) approximately $1.4 million for the review and evaluation of
available geological and geophysical data and the potential initiation of
exploratory activities in the Carpathian JSA, (iii) approximately $6.1 million
for infill development drilling in the Cut Bank field in Montana and (iv)
approximately $0.8 million for exploration activities in the western United
States. The actual expenditures for the foregoing items will be dependent upon
the actual results and costs of future exploration and development activities.
The Company estimates that the capital received from the net proceeds of the
Offering, combined with capital available under the Company's existing credit
facility and, to the extent available, cash from operations, should be
sufficient to meet the Company's capital requirements through December 31,
1997.
Prior to the end of 1997, however, the Company may need additional capital
to accelerate planned exploration and development programs in both Poland and
the United States. If exploration of the Baltic Platform or the Carpathian JSA
is successful in proving substantial oil reserves, the Company may require
additional capital to fund a multi-well development program, install oil
storage and handling facilities or purchase other assets or related
investments required to support large-scale production. The Company has no
arrangement for any such additional financing, but may seek required funds
from the sale of additional securities, project financing, strategic alliances
with other energy or financial partners or other arrangements, all of which
may dilute the interest of existing shareholders in the Company or in the
specific project financed. There can be no assurance that additional funds
could be obtained or, if obtained, would be on terms favorable to the Company.
25
<PAGE>
BUSINESS AND PROPERTIES
GENERAL
The Company is engaged in the exploration, development and production of oil
and gas in the western United States and Poland. The Company currently
produces oil from fields in Montana and Nevada and explores for oil and gas
primarily in Poland. In August 1995, the Company was one of the first
independent energy companies to secure oil and gas exploration rights in
Poland (the "Baltic Concession"). The Baltic Concession covers approximately
2.4 million acres in northern Poland and is part of a geological region (the
"Baltic Platform") which reportedly has produced in excess of 150 MMBbl from
four fields located approximately 50 miles to the northeast in the Kaliningrad
district of Russia. In May 1996, the Company also entered into a joint study
agreement with the Polish Oil and Gas Company ("POGC") to reprocess and
reinterpret geological and geophysical data collected from a 6.25 million acre
area in the Carpathian region of southeastern Poland (the "Carpathian JSA").
Management believes that the Company's principal strengths are its existing
prospects in Poland, its access to previously collected geological and
geophysical data, its established network of strategic alliances and its
inventory of domestic properties.
The Company has identified several potential drilling prospects in the
Baltic Concession through the reprocessing and reevaluation of previously
collected seismic and drilling data. The Company intends to explore and
develop these prospects with RWE-DEA AG ("RWE-DEA"), a subsidiary of RWE AG,
Germany's fifth largest industrial company. The Company and RWE-DEA recently
initiated a 300 kilometer seismic survey on selected portions of the Baltic
Concession. The results of this survey will assist in the selection of the
site of an exploratory well scheduled to be drilled in late 1996. In the
Carpathian JSA, the Company and POGC are conducting a technical evaluation of
a target area and, if warranted, will apply for an exploration concession. The
Company has budgeted approximately $8.4 million for exploration and
development activities in Poland through 1997.
The Company currently produces oil exclusively in the United States. At
December 31, 1995, the Company had estimated proved reserves of 5.3 MMBbl with
a PV-10 Value (calculated without regard to future income tax expense) of
approximately $23.8 million. Approximately 78% of the Company's production and
96% of its reserves are concentrated in northern Montana's Cut Bank field. To
enhance production in this field, the Company intends to expand its current
infill drilling program which was initiated in late 1994. The Company is also
evaluating several exploration prospects in the western United States and has
identified a prospect in Nevada on which it intends to drill an exploratory
well in late 1996 in partnership with several independent energy companies.
The Company has budgeted approximately $6.9 million for exploration and
development activities in the United States through 1997.
BUSINESS STRATEGY
The Company explores and develops oil and gas prospects potentially
containing recoverable reserves in excess of 25 MMBOE for international
properties and 10 MMBOE for domestic properties. This strategy includes the
following key elements:
. Focus on Poland. The Company believes that the Baltic Concession and the
Carpathian JSA provide it with a foundation upon which to build a
significant exploration and development operation in Poland. The Company
believes this foundation will allow it to capitalize on Poland's
attractive combination of significant reserve potential, underexplored
acreage and favorable operating environment. Beginning in 1989, Poland
initiated a number of market-based reforms which have resulted in the
country's economy becoming one of the fastest growing in Europe.
Important elements of this transition have included the introduction of
both a broad-based privatization program and an internationally
competitive tax and royalty structure. Partially as a result of these
initiatives, Poland attracted approximately $6.8 billion in direct
foreign investment between 1989 and 1995, according to reports from the
Polish State Foreign Investment Agency published by the Polish embassy.
Several international oil companies, including Texaco, Inc., Tenneco Co.,
Exxon Corp., Shell Oil Co. and British Gas PLC, have either secured, or
obtained the exclusive right to negotiate for, exploration rights.
26
<PAGE>
. Access existing geological and geophysical data. The Company focuses on
areas where it can reevaluate previously collected geological and
geophysical data. Between 1950 and 1993, state-sponsored agencies in
Poland gathered hundreds of line miles of seismic data and drilled 15
test wells in the Baltic Concession to the same formation that is
productive in established fields in the Baltic Platform. While a majority
of these wells indicated the presence of hydrocarbons in that formation,
none was completed for production due, in management's opinion, to the
outdated equipment and poor techniques used to locate, drill and test the
wells. The Company, with the assistance of consultants that included
Halliburton Energy Services, Ryder Scott Company and Western Atlas, Inc.,
reevaluated seismic and well data generated by earlier exploration
efforts in the Baltic Concession. As a result of this effort, the Company
believes that it has identified potential oil reservoirs in two
structures that had previously been drilled and over a dozen undrilled
structures.
. Capitalize on strategic alliances. The Company seeks to form strategic
alliances to reduce its financial exposure and to gain additional
technical and operational expertise. This strategy is exemplified by the
Company's alliances with RWE-DEA covering the Baltic Concession and with
POGC in the Carpathian JSA. RWE-DEA, formerly Deutsche Texaco AG, is an
established producer, refiner and marketer of oil and gas in Europe and
currently produces oil in the Baltic Sea off Germany's northern coast.
Pursuant to an agreement with the Company, RWE-DEA will earn a 50%
interest in the Baltic Concession by paying the Company $250,000, by
providing up to $2.0 million for an ongoing seismic survey and a planned
exploratory well, and by funding 50% of the cost of a second exploratory
well. The Company will operate all wells it drills jointly with RWA-DEA.
In the Carpathian JSA, the Company is evaluating existing geological and
geophysical data contributed by POGC in order to determine the
hydrocarbon potential of a target area. The Company and POGC may apply
for exploration rights covering such target area upon the completion of
this analysis.
. Exploit domestic reserve base and prospects. The Company believes that
its existing domestic properties have significant development and
exploration potential. The Company recently completed an infill drilling
program on a 1,000 acre tract of the Cut Bank field which, based on
preliminary results, the Company believes will increase production over
the next two to three years. The Company plans to expand this program to
approximately 4,000 additional acres in the Cut Bank field beginning in
late 1996. The Company also has an ongoing program of prospect generation
and exploration in the western United States.
EXPLORATION AND DEVELOPMENT ACTIVITIES IN POLAND
The Company believes that Poland offers an attractive environment in which
to explore for and develop oil and gas prospects that meet the Company's
established criteria of potentially containing recoverable reserves in excess
of 25 MMBOE for international prospects. By applying modern interpretive
techniques to previously collected seismic, geological and well data, the
Company believes that it will be able to capitalize on the combination of
Poland's hydrocarbon potential and its relatively new policies to encourage
the development of the country's domestic energy resources. In August 1995,
the Company was granted an exclusive right to explore and potentially develop
the Baltic Concession, an onshore 2.4 million acre undeveloped area extending
approximately 50 miles southward from the Baltic Sea in northern Poland. In
addition, the Company recently completed a geological review of selected oil
and gas prospect areas in Poland and, as a result of this review, in May 1996
entered into an agreement with POGC to reevaluate and reprocess existing
geophysical and geological data regarding the Carpathian region of
southeastern Poland. If warranted, the Company and POGC may apply for a formal
concession in a limited target area of the Carpathian JSA in the first half of
1997. The Company and POGC may also elect to jointly evaluate other areas of
Poland in the future.
The Republic of Poland
The Republic of Poland is bordered on the north by the Baltic Sea, on the
west by Germany, on the south by the Czech Republic and Slovakia and on the
east by Lithuania, Belorussia, Ukraine and the Kaliningrad district of Russia.
Poland is comprised of approximately 121,000 square miles, with a population
of
27
<PAGE>
approximately 40 million people. Between 1945 and 1989, Poland's political and
economic systems were directly influenced by the former Soviet Union. In 1989,
Poland peacefully asserted its independence, adopted a new constitution which
established a parliamentary democracy and began the transition to a market-
based economy.
Poland has one of the fastest growing economies in Europe. According to a
report published in the June 15, 1996, issue of The Economist, Poland's gross
domestic product grew by an estimated 7.0% in 1995, compared to 5.0% for the
Czech Republic, 1.5% for Hungary and negative 4.0% for Russia. One of the most
important elements of Poland's economic growth has been the country's
development of an entrepreneurial private sector. In 1993, private enterprises
employed 58.9% of Poland's workforce as compared to 33.3% in 1989. Poland's
international trade has also undergone significant change since Poland gained
its independence. For example, in 1986, the former Soviet Union accounted for
33% of Poland's imports and 28% of its exports. By 1993, these figures had
decreased to 4.6% and 5.5%, respectively, while the countries of the European
Union purchased 71.3% of Poland's exports and provided 63.9% of its imports.
Foreign investment in Poland between 1989 and 1995 was $6.8 billion.
Between the 1850s, when oil was first commercially produced in the
Carpathian region of southeastern Poland, and 1945, Poland produced
approximately 61.4 MMBbl of oil and 303 Bcf of natural gas. War damage and
overproduction following the 1939 invasions of Poland by Germany and the
Soviet Union severely restricted oil and gas production. Over the last several
decades, the exploration for and the development of Poland's oil and gas
resources have been hindered by a combination of limited financial resources,
political difficulties and a lack of modern exploration technology. Poland
currently imports over 95% of its oil, primarily from the countries of the
former Soviet Union and the Middle East.
The Baltic Concession
The Baltic Concession is part of a geological region known as the Baltic
Platform which covers the southeastern portion of the Baltic Sea and portions
of the bordering onshore areas of Poland, the Kaliningrad district of Russia,
Lithuania and Latvia. The B-3 oilfield, located off Poland's Baltic coast and
first placed into production in 1992, produced over 1.2 MMBbl through 1994,
according to a POGC publication. Onshore, approximately 34 fields have been
discovered in the Baltic Platform in an area that extends from approximately
50 to 100 miles to the northeast of the Baltic Concession in the Kaliningrad
district of Russia. Four of the largest fields in this region reportedly have
produced an aggregate of over 150 MMBbl through 1994. Oil produced from the
Baltic Concession is generally of high quality with an average API gravity of
approximately 40(degrees) and contains insignificant amounts of sulfur, heavy
metals or similar contaminants. See "Risk Factors--Exploration Risks."
Between 1950 and 1993, various agencies of the Polish government explored
the Baltic Concession, gathering hundreds of line miles of seismic data and
drilling seven exploratory wells and eight stratigraphic survey wells to the
same formation that is productive in established fields in the Baltic
Platform. Although none of these wells was completed for production, the
majority indicated the presence of hydrocarbons. The Company, in conjunction
with consultants that included Halliburton Engineering, Western Atlas, Inc.
and Ryder Scott Company, was able to apply modern reprocessing techniques to
reevaluate a significant portion of the seismic and well log data obtained
from these wells. This information has enabled the Company to identify two
drilled structures (as indicated by the Gladysze-1 and Gladysze-2 wells) and
more than a dozen undrilled structures in the Baltic Concession that, in
management's opinion, are similar in structural type and contain the same
formations as productive wells in other regions of the Baltic Platform.
At the Company's request, Halliburton Engineering completed a detailed log
analysis of the 15 wells described above, including the Gladysze-1 and
Gladysze-2 wells. Halliburton reported that both Gladysze wells appear to have
encountered movable hydrocarbons, with 8% or more effective porosity and
calculated water saturations of less than 30%. While there is no guarantee
that Halliburton's interpretation of these relatively old Russian-style well
logs accurately reflects actual downhole conditions, the Company believes
Halliburton's interpretation is consistent with other geological and
geophysical data reviewed by the Company. This
28
<PAGE>
information includes contemporaneous drilling reports and core sample
descriptions. Based on the foregoing, the Company has concluded that both
Gladysze wells encountered reservoirs of movable oil.
Although the Company believes that the Gladysze-1 and Gladysze-2 were the
only wells drilled on geological structures, neither of these wells was
completed for production. The Company attributes this fact primarily to the
outdated equipment and poor techniques used to locate, drill and test the
wells. Both wells were drilled with very heavy drilling mud, a common practice
in eastern Europe and the Soviet Union at the time. The heavy drilling mud
likely caused formation damage by sealing off porous reservoir rocks. The
short periods during which the wells were tested were, in Management's
estimation, probably insufficient for the formations to recover from the
damage to permit an accurate test.
There can be no assurance that wells drilled on any structure, including the
Gladysze structures, will encounter oil reservoirs or that the porosity,
permeability or other characteristics of any reservoir formations encountered
will support production of oil in commercial quantities. Notwithstanding the
substantial data available respecting the Baltic Concession, the Company
believes that several exploration tests may be required to appraise the
potential of the identified structures. There can be no assurance that any of
such tests will be successful.
Exploration, Development and Production Plans
The Company has begun to develop a comprehensive exploration and development
program for the Baltic Concession. In May 1996, the Company, in partnership
with RWE-DEA, initiated a 300 kilometer seismic program which will build upon
previously collected data and assist in the determination of a drillsite for
an exploratory well from among three identified structures. The Company
currently intends to drill its first exploratory well to a target depth of
approximately 9,500 feet in late 1996. Ultimately, the Company intends to
drill exploratory wells on all three identified structures. If one or more of
these wells is found to have commercial production, the Company will prepare a
long-term field development plan in conjunction with RWE-DEA. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources." The Company has budgeted $7.0
million for its share of exploration and development expenditures on the
Baltic Concession through 1997.
The crude oil produced from existing fields on the Baltic Platform is
generally of high quality with an average API gravity of approximately
40(degrees) and contains no significant amounts of sulfur, heavy metal or
similar contaminants. There are two nearby refineries in Gdansk and Plock,
Poland, both of which the Company believes could process crude oil produced in
the Baltic Concession. RWE-DEA also has an ownership interest in a refinery in
Schwedt, Germany, on the Polish border. This refinery might purchase crude
produced from the Baltic Concession. Under current Polish law, the Company
may, upon obtaining appropriate approval, export oil produced in the country.
The Company currently has no agreement or arrangement for the sale, delivery
or refining of any oil that may be produced in Poland. The Company believes,
however, that it would be able to sell any oil produced from the Baltic
Concession in the spot market. The Baltic Concession contains a well-developed
infrastructure of hard surface roads and railways over which oil could
probably be delivered for sale. The Company could incur expenditures for the
construction and operation of crude oil transportation and handling facilities
if substantial oil production were established. Poland currently imports over
95% of its crude oil requirement, principally from the countries of the former
Soviet Union and the Middle East.
Strategic Alliance with RWE-DEA
In May 1996, the Company entered into a strategic alliance with RWE-DEA for
joint operations on the Baltic Concession. RWE-DEA currently produces oil in
the Baltic Sea off Germany's northern coast and is a member of a consortium of
German and Russian oil companies that has been established to develop an
offshore oilfield in the Kaliningrad district of Russia, north of the Baltic
Concession. RWE-DEA, formerly Deutsche
29
<PAGE>
Texaco AG, is a subsidiary of RWE AG, the fifth largest industrial enterprise
in Germany. RWE-DEA is a fully integrated major oil and gas company with 1995
fiscal year revenue of U.S. $15.9 billion from worldwide energy and chemical
businesses. The Company selected RWE-DEA as its partner in the Baltic
Concession because of its established oil producing, refining and distribution
business throughout Europe, including limited gasoline marketing within
Poland, and its international exploration and production experience. In
addition, RWE-DEA's parent has business activities in Poland outside of the
oil and gas industry, including construction and power generation. The
relationship with RWE-DEA should provide the Company with additional technical
and operational expertise.
Under its agreement with the Company, RWE-DEA will earn a 50% interest in
the Baltic Concession by paying the Company $250,000, by providing up to $2.0
million for an ongoing seismic survey and a planned exploratory well, and by
funding 50% of the costs of a second exploratory well. All costs in excess of
the amounts indicated above, in addition to the cost of any subsequent
exploration and development activity, will be borne equally by the Company and
RWE-DEA. If RWE-DEA does not participate in a second well, RWE-DEA's interest
in the Baltic Concession will terminate. The Company will be the operator for
all joint operations. The assignment of a 50% interest in the Baltic
Concession is subject to approval by the Polish government. The Company
expects that such approval will be obtained based on discussions among
representatives of the Company, RWE-DEA and the Polish government. If such
approval is not obtained, the Company will reimburse RWE-DEA for its direct
expenditures related to the Baltic Concession. The Company has agreed to pay a
fee of $125,000 to an unaffiliated party for activities related to the search
for an international joint venture partner which resulted in the Company
forming a strategic alliance with RWE-DEA.
Strategic Alliance with POGC
The Polish government has granted to POGC exclusive rights to explore for
and develop hydrocarbons in areas covering a substantial portion of Poland. In
January 1996, the Company and POGC initiated a limited review of Poland's
hydrocarbon potential. The purpose of this review was to select a region on
which to undertake a detailed joint study program.
Carpathian Region
On May 21, 1996, the Company entered into a joint study agreement with POGC
in order to identify drillable hydrocarbon prospects in a selected area of the
Carpathian JSA in southeastern Poland. Oil was first discovered in the
Carpathian Mountains in the 1850s and has been produced there continuously
from several fields, including discoveries in the 1960s.
The initial goal of the joint study agreement is to identify a promising
target area in the Carpathian JSA (the "Carpathian Target Area") primarily
through the review of existing geological and geophysical data. Thereafter,
the Company and POGC will conduct a more detailed analysis of existing seismic
and other data contributed by POGC, supplemented by limited reprocessing of
such data to assess the Carpathian Target Area's hydrocarbon potential and to
generate drillable oil and gas prospects. The Company and POGC will each
contribute technical personnel to participate in the study. The Company will
fund approximately $100,000 of the initial technical research and analysis
costs, including seismic data reprocessing, third-party data purchases and
laboratory analysis.
In the first half of 1997, the Company, if warranted, plans to submit with
POGC an application to the appropriate Polish authorities for exploration
rights or concessions over designated portions of the Carpathian Target Area.
The Company and POGC will share equally in new exploration rights that are
obtained through this arrangement, except that if one party elects not to
proceed with an application for an exploration license over designated
portions of the Carpathian Target Area, the other party may do so
independently. Upon obtaining
30
<PAGE>
an exploration license or concession, the Company will gather additional
seismic or other geophysical data to further define exploration targets and to
develop a specific exploration drilling program in conjunction with POGC. The
exploration drilling program may be undertaken by the Company and POGC on an
equal basis or the Company could elect to decrease its interest in a project,
with the consent of the POGC, by sharing its ownership with a third party. The
Company has budgeted $1.4 million through 1997 for exploration activities in
the Carpathian JSA. See "Use of Proceeds."
EXPLORATION AND DEVELOPMENT ACTIVITIES IN THE UNITED STATES
Cut Bank Field Development
The Company owns and operates producing oil wells in the Cut Bank and Bears
Den fields in Montana and the Bacon Flat and Trap Spring fields in Nevada. The
Company's 10,600 acres in the Cut Bank field account for approximately 96% of
its proved reserves and 78% of its current oil production. In January 1996,
the Company completed an infill drilling program on 1,000 acres in the Cut
Bank field which included the drilling of eight new production wells and five
water injection wells and the conversion of two production wells to water
injection wells. The Company's infill drilling program is based on a similar
program that resulted in significant production increases in a separate part
of the Company's Cut Bank field properties by a previous owner.
Through the end of 1997, the Company intends to spend approximately $6.1
million on an expanded infill drilling development program on strategically
selected areas in the remainder of the Company's Cut Bank property. The
Company has engaged Ryder Scott Company to conduct an in-depth engineering
analysis of the Company's Cut Bank field properties, to review the recent
infill drilling program and to assist in designing the expanded program.
Although management believes the expanded development program will increase
oil revenues and proved oil reserves, there can be no assurance that the
Company will actually realize substantial increases in production or that any
increases that are realized will be sufficient to recover development costs
incurred or result in a financial return to the Company. See "Use of
Proceeds."
Domestic Exploration Prospects
The Company has a number of exploratory prospects in the western United
States in various stages of evaluation, prospect identification and drillsite
selection. Domestically, the Company seeks exploration prospects with the
potential for recoverable reserves of at least 10 MMBOE that can be acquired
or controlled with a limited financial commitment and that have a sufficient
risk/reward profile to attract drilling partners. The Company's traditional
policy is not to drill an exploratory well until it can reduce its own
financial commitment (and confirm its own evaluation of the prospect's merit)
by forming a drilling group with other energy companies. As part of the
Montana Acquisition, the Company acquired a drilling rig which it seeks to use
in exploration tests in Nevada in order to offset some portion of the cost of
participating in specific exploration prospects. The Company has an ongoing
program of prospect generation and exploration and has budgeted approximately
$0.8 million for its share of western United States exploration costs through
1997. See "Use of Proceeds."
Cobb Creek. The Cobb Creek prospect is located in Hamlin Valley, Nevada,
near the Utah border approximately 225 miles southwest of Salt Lake City. The
Company has identified a large undrilled anticline covering approximately nine
square miles, through the reprocessing of geological and geophysical data
previously collected by other parties. The Company, as operator, intends to
drill an exploratory well in the Cobb Creek prospect in late 1996 with a group
of industry partners.
Lake Valley. The Lake Valley region of Nevada is geologically similar to
Railroad Valley, Nevada's most prolific producing region that lies
approximately 60 miles to the west. The Company, with a group of industry
partners, identified and drilled one structural feature in Lake Valley in
1993. This well was eventually plugged. In 1994, the Company and a group of
industry partners purchased and reprocessed approximately 70 line miles
31
<PAGE>
of seismic data and acquired additional geophysical and geochemical data over
approximately 70,000 acres. The initial operator discontinued its western
United States exploration activities and its rights reverted to the Company.
The Company became the operator and, based on the reprocessed and
reinterpreted seismic data, identified six potential exploratory drillsites.
The Company has since concluded that additional test wells are warranted and
it is currently seeking additional industry partners to join in this program.
The Company now holds approximately 13,863 gross (12,819 net) acres in the
Lake Valley prospect.
Hamlin Valley. Hamlin Valley is located about 50 miles east of Lake Valley,
Utah, near the Nevada state border. The Company was attracted to Hamlin Valley
because of the presence of an oil seep and has collected a
limited amount of related geological, geochemical and geophysical data.
Further exploration of this prospect is planned for 1997, subject to the
Company's ability to form an industry drilling group. The Company's current
plan consists of acquiring drillsite seismic and other geophysical data to
further identify and define potential drillable structures.
PROPERTIES
All of the Company's producing properties were acquired as part of the
Montana Acquisition. The Company is the operator of all its producing
properties, except for the Bacon Flat well.
Cut Bank Field
Production in the Cut Bank field in Montana commenced with the discovery of
oil in the 1940s at an average depth of approximately 2,900 feet. The
Southwest Cut Bank Sand Unit, which is the core of the Company's interest in
the field, was originally formed by Phillips Petroleum Company in 1963. In
1964 Phillips initiated a pilot waterflood and eventually converted the entire
unit to a waterflood with producing wells on 40 and 80 acre spacings. The
Company owns an interest in 135 producing oil wells, 36 water injection wells
and three water supply wells in the Cut Bank field. Working interests owned by
the Company in the field range from 99.5% to 100%. The Company's production
from this field in 1995 averaged 342 Bpd (285 Bpd net). As of December 31,
1995, the Company's interest in the Cut Bank field represented 95.8% of the
Company's total PV-10 Value.
Bears Den Field
The Bears Den field in Montana was discovered in 1929 and has been under
waterflood since 1990. Oil is produced at an average depth of approximately
2,430 feet. The Company owns an interest in five producing oil wells, four
water injection wells and one water supply well in the Bears Den field. The
Company's working interest in this property is 48.0%.
Trap Spring Field
Discovered in 1976, the Trap Spring field in Nevada produces from fractured
volcanics at an average depth of 3,700 feet. The Company owns interests in six
producing oil wells in the Trap Spring field. Working interests owned by the
Company in this field range from 21.6% to 50.5%.
Bacon Flat Field
The Company owns a 16.9% working interest in one well in the Bacon Flat
field in Nevada which was drilled in 1993. This well suffered formation damage
in mid-1994, after which production declined significantly to approximately 10
Bpd, net to the Company.
32
<PAGE>
PRODUCTION AND MARKETING
The following table sets forth the Company's average net daily oil
production, average sales price and average production costs associated with
such production during the periods indicated. The Company had no production
prior to 1994 and no gas production for any of the periods for which
information is presented.
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
------------- -------------------
1994 1995 1995 1996
------ ------ --------- ---------
<S> <C> <C> <C> <C>
Average daily net oil production (Bbl)....... 436 369 380 347
Average sales price (per Bbl)................ $14.07 $14.67 $ 14.92 $ 15.98
Average production costs (per Bbl)(1)........ $ 5.81 $ 9.42 $ 9.87 $ 10.29
</TABLE>
- --------
(1) Production costs for 1994 reflect the fact that, after the Company
acquired the properties in the Montana Acquisition in April 1994, it
continued routine maintenance consistent with the practice of the previous
owners. In late 1994, the Company initiated an infill drilling and
enhanced waterflood operation on portions of the Cut Bank property and,
therefore, increased the level of maintenance to support long-term
increases in production expected to result from such development. In
addition, abnormally wet weather conditions in the late spring of 1995
resulted in increased labor costs. Production costs per Bbl also increased
due to the substantial decline in production from the Bacon Flat well,
which had extremely low production costs, due to formation damage. Because
of the fixed costs that are included in average production costs, any
production increases resulting from the development work described above
should result in a moderate decrease in the average production cost per
Bbl.
The Company sells oil at posted field prices to one of several purchasers in
each of the areas in which it has productive oil wells. For the years ended
December 31, 1994 and 1995, 89% and 85%, respectively, of the Company's total
oil sales were to CENEX, a regional refiner and marketer. Posted prices are
published and are generally competitive among the various purchasers. The
crude oil sales contracts are terminable by either party on 30 days' notice.
The Company has benefited in recent months from increases in the prices at
which it is able to sell oil produced in Montana and Nevada, but will be
adversely affected by any decline in prevailing oil prices. The Company has no
gas production.
33
<PAGE>
OIL RESERVES
The Company's oil properties containing proved oil reserves are located in
Montana and Nevada. All information set forth in this Prospectus regarding
proved reserves, related future net revenues and PV-10 Value is taken from the
report of Larry D. Krause, independent petroleum engineer, Billings, Montana.
Mr. Krause's estimates were based upon the review of production history and
other geological, economic, ownership and engineering data provided by the
Company. In accordance with SEC guidelines, the Company's estimates of future
net revenues from the Company's proved reserves and the PV-10 Value are made
using a sales price of $16.48, the weighted average oil sales price in effect
as of December 31, 1995, the date of such estimate, and are held constant
throughout the life of the properties. The information contained herein is
qualified in its entirety by the Summary Reserve Report of Larry D. Krause
included as Appendix A to this Prospectus. See "Risk Factors--Caution
Respecting Forward-Looking Information; --Uncertainty of Reserve Estimates and
Future Net Revenues and --Volatility of Commodity Prices and Markets."
<TABLE>
<CAPTION>
DECEMBER 31, 1995
------------------------
ESTIMATED PROVED RESERVES OIL(BBL) PV-10 VALUE(1)
------------------------- --------- --------------
<S> <C> <C>
DEVELOPED PRODUCING
Cut Bank......................................... 2,239,528 $ 5,433,246
Other............................................ 188,320 988,413
--------- -----------
Total.......................................... 2,427,848 6,421,659
DEVELOPED NONPRODUCING
Cut Bank......................................... 254,825 1,314,330
Other............................................ -- --
--------- -----------
Total.......................................... 254,825 1,314,330
UNDEVELOPED
Cut Bank......................................... 2,574,500 16,045,459
Other............................................ -- --
--------- -----------
Total.......................................... 2,574,500 16,045,459
--------- -----------
TOTAL PROVED RESERVES(2)........................... 5,257,173 $23,781,448
========= ===========
</TABLE>
- --------
(1) The operating costs, based on information provided by the Company,
represent actual recurring expenses for each of the properties, held
constant for the purposes of the evaluation, except that a 6% reduction in
production taxes for the Cut Bank field was recognized to reflect the
effect of an agreement signed on December 31, 1995, between the State of
Montana and the Blackfoot Tribe which will eliminate double taxation on
wells on the Blackfoot Reservation. See the Summary Reserve Report of
Larry D. Krause included as Appendix A to this Prospectus and Company's
Consolidated Financial Statements and Notes 14 and 15 thereto.
(2) The Company's PV-10 Value for total proved reserves, adjusted for future
income tax expense, is $17.7 million as set forth in Note 15 to the
Company's Consolidated Financial Statements.
34
<PAGE>
DRILLING ACTIVITIES
The following table sets forth the wells drilled and completed by the
Company during the periods indicated. Wells drilled during 1994 and 1995
include drilling activities on the Company's Montana and Nevada properties
acquired effective April 1, 1994. The Company has not participated in the
drilling of any wells since December 31, 1995.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1993 1994 1995
--------- --------- ---------
GROSS NET GROSS NET GROSS NET
----- --- ----- --- ----- ---
<S> <C> <C> <C> <C> <C> <C>
DEVELOPMENT WELLS:
Producing....................................... -- -- 5.0 3.8 5.0 5.0
Non-producing................................... -- -- -- -- -- --
--- --- --- --- --- ---
Total......................................... -- -- 5.0 3.8 5.0 5.0
=== === === === === ===
EXPLORATORY WELLS:
Producing....................................... -- -- -- -- -- --
Non-producing................................... 2.0 0.8 2.0 1.1 2.0 1.1
--- --- --- --- --- ---
Total......................................... 2.0 0.8 2.0 1.1 2.0 1.1
=== === === === === ===
</TABLE>
The above does not include five water injector wells drilled in each of 1994
and 1995 as part of the Cut Bank field infill development program. No gas
wells were drilled by the Company during the indicated periods.
WELLS AND ACREAGE
As of December 31, 1995, the Company had 155 gross and 147 net producing oil
wells, all of which are in Montana and Nevada. The following table sets forth
the Company's gross and net acres of developed and undeveloped oil and gas
leases as of March 31, 1996.
<TABLE>
<CAPTION>
DEVELOPED ACREAGE UNDEVELOPED ACREAGE
------------------ --------------------
GROSS NET GROSS NET(1)
--------- -------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
DOMESTIC
Montana............................... 11 10 1 1
Other................................. -- -- 42 41
-------- -------- --------- ---------
Total............................... 11 10 43 42
POLAND.................................. -- -- 2,375 1,187
-------- -------- --------- ---------
Total............................... 11 10 2,418 1,229
======== ======== ========= =========
</TABLE>
- --------
(1) Gives effect to the assignment of a beneficial 50% interest in the Baltic
Concession to RWE-DEA under the Company's joint exploration arrangement.
See "Business and Properties--Exploration and Development Activities in
Poland--Strategic Alliance with RWE-DEA".
35
<PAGE>
TITLE TO PROPERTIES
Nearly all of the Company's domestic working interests are held under leases
from third parties. The Company usually seeks to obtain a title opinion
concerning such properties prior to the commencement of drilling operations.
The Company has obtained such title opinions or other third party review on
nearly all of its producing properties and is of the opinion that it has
satisfactory title to all such properties sufficient to meet standards
generally accepted in the oil and gas industry. The Company's properties are
subject to common burdens, including customary royalty interests and liens for
current taxes, but the Company has concluded that such burdens do not
materially interfere with the use of such properties. Further, the Company
believes that the economic effects of such burdens have been appropriately
reflected in the Company's acquisition costs of such properties. All of the
Company's producing properties are mortgaged to secure repayment of the
outstanding bank indebtedness, which will be repaid with net proceeds from the
Offering. See "Use of Proceeds." Title investigation before the acquisition of
undeveloped properties is less thorough than that conducted prior to drilling,
as is standard practice in the industry. A title opinion is typically obtained
prior to the commencement of drilling exploratory wells.
With respect to the Baltic Concession, the Company relies on sovereign
ownership of such mineral rights by the Polish government and has not
conducted and does not plan to conduct any independent title examination. The
Company has been advised by legal counsel in Poland respecting compliance with
Polish laws.
BALTIC CONCESSION TERMS
In 1994, Poland adopted the Geological and Mining Law which outlined the
process for energy companies to obtain domestic exploration and exploitation
rights. In August 1995, the Ministry of Environmental Protection, Natural
Resources and Forestry of the State Treasury granted exploration rights
covering the Baltic Concession to the Company's wholly-owned Polish
subsidiary. The Company subsequently acquired the concession licenses required
for surface access.
The Company's exploration rights are divided into two successive three-year
phases expiring in December 1998 and December 2001, respectively. To retain
its rights in the Baltic Concession, the Company is required to commence one
exploratory well by December 1996, and a second exploratory well by December
1999. The Company is also required to relinquish 50% of its acreage in the
Baltic Concession by December 1998. The Company is required to pay an annual
fee of $33,333 and to spend at least $25,000 annually in the training of
Polish citizens. To date, the Company believes that it has satisfied all
material terms of the Baltic Concession agreement.
If a commercially viable discovery of oil were made, the Company would be
required to apply for an exploitation license with a term of 30 years and
thereafter during the productive life of the property. At this point, the
Company will be obligated to pay a fee to be negotiated within the range of
0.001% to 0.05% of the market value of the estimated recoverable reserves in
place, payable in five equal annual installments. The Company's activities in
Poland are subject to the risk of changes in the royalty rate to be paid on
production. Poland's Council of Ministers sets a base royalty rate for the
extraction of each mineral. The base royalty rate for oil is currently 6%, but
could be increased unilaterally to 10% by the Council of Ministers. In
addition, the Polish government entity which grants concessions can set the
royalty rate for any particular oil and gas field in a range between 50% and
150% of the base royalty rate, depending on the economic viability of such
field.
OPERATIONAL HAZARDS AND INSURANCE
The Company is engaged in the drilling and production of oil, and as such,
its operations are subject to the usual hazards incident to the industry.
These hazards include blowouts, cratering, explosions, uncontrollable flows of
oil, natural 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.
36
<PAGE>
In order to lessen the effects of these hazards, the Company maintains
insurance of various types to cover its domestic operations. The Company has
$5.0 million of general liability insurance. This insurance, however, does not
cover all of the risks involved in oil exploration, drilling and production of
oil and, if coverage does exist, may not be sufficient to pay the full amount
of such liabilities. The Company may not be insured against all losses or
liabilities which may arise from all hazards because such insurance is
unavailable at economic rates, because of limitation in the Company's
insurance policies or because of other factors. For example, the Company does
not maintain insurance against risks related to violations of environmental
laws. The occurrence of a significant adverse event that is not fully covered
by insurance could have a materially adverse effect on the Company. Further,
the Company cannot assure that it will be able to maintain adequate insurance
in the future at rates it considers reasonable.
The Company has investigated preliminarily risk management practices and the
availability of casualty and liability insurance in Poland. In accordance with
the agreement with RWE-DEA, at such time as the Company's Polish subsidiary
initiates drilling activities or acquires tangible assets, the Company would
be required to obtain such insurance coverage. There can be no assurance that
the Company will be able to obtain insurance coverage for proposed activities
in Poland or that any insurance obtained will provide coverage customary in
either the industry or in the United States or comparable to the insurance now
maintained by the Company. The failure or inability to obtain adequate
insurance would expose the Company to additional risks and constitute an event
of default under the agreement with RWE-DEA.
GOVERNMENT REGULATION--UNITED STATES
State and Local Regulation of Drilling and Production
State regulatory authorities have established rules and regulations
requiring permits for drilling, drilling bonds and reports concerning drilling
and producing activities. Such regulations also cover the location of wells,
the method of drilling and casing wells, the surface use and restoration of
well locations, the plugging and abandoning of wells, the density of wells
(well spacing) within a given area and other matters.
Environmental Regulations
The Company's activities are subject to numerous federal and state laws and
regulations concerning the storage, use and discharge of materials into the
environment, the remediation of environmental impacts and other matters
relating to environmental protection, all of which may adversely affect the
Company's operations and the costs of doing business. There can be no
assurance that future legislation or administrative regulations or
interpretations will not impose stricter requirements that could have an
adverse impact on the operating costs of the Company and the oil and gas
industry in general. The Company does not currently believe that it will be
required in the near future to expend material amounts due to environmental
laws and regulations. A bond is posted with the Environmental Protection
Agency as security for the Company's compliance with the environmental
requirements administered by that agency respecting the water injection wells
in the Company's Montana producing properties.
Federal and Bureau of Indian Affairs Leases
A substantial part of the Company's Montana producing properties are
operated under oil and gas leases issued by the Bureau of Land Management or
by certain Indian nations under the supervision of the Bureau of Indian
Affairs. These activities must comply with rules and orders that regulate
aspects of the oil and gas industry, including drilling and operating on
leased land and the calculation and payment of royalties to the federal
government or the governing Indian nation. Operations on Indian lands must
also comply with applicable requirements of the governing body of the tribe
involved including, in some instances, the employment of tribal members.
37
<PAGE>
Safety and Health Regulations
The Company must also conduct its operations in accordance with various laws
and regulations concerning occupational safety and health. Currently, the
Company does not foresee expending material amounts to comply with these
occupational safety and health laws and regulations. However, since such laws
and regulations are frequently changed, the Company is unable to predict the
future effect of these laws and regulations.
GOVERNMENT REGULATION--POLAND
The Company's activities in Poland are subject to political, economic and
other uncertainties, including the adoption of new laws, regulations or
administrative policies that may adversely affect the Company or the terms of
its exploration or production rights; political instability and changes in
government or public or administrative policies; export and transportation
tariffs and local and national taxes; foreign exchange and currency
restrictions and fluctuations; repatriation limitations; inflation;
environmental regulations and other matters. The Company's operations in
Poland are subject to the Geological and Mining Law as well as the Act of
January 31, 1980 Concerning the Protection and Management of the environment,
which are the primary statutes governing environmental protection. The
agreements between the Company and the government of Poland relating to the
Baltic Concession also create certain standards to be met by the Company
regarding environmental protection. The Company generally is required to
adhere to good international petroleum industry practice, including practices
relating to the protection of the environment. The Company is required to
prepare and submit to the appropriate agency of state geological
administration for its approval, a geological work plan, with specific
attention to environmental matters, prior to engaging in field operations,
such as seismic acquisition, exploratory drilling and field-wide development.
Poland's regulatory framework respecting environmental protection is not as
fully developed and detailed as that which exists in the United States. The
Company intends that its operations in Poland will be designed to meet good
international petroleum industry practice and, as they develop, Polish
requirements. See "Risk Factors--Factors Relating to Activities in Poland."
EMPLOYEES AND CONSULTANTS
As of June 1, 1996, the Company had 28 employees, consisting of six in Salt
Lake City, Utah; 20 in the Company's Oilmont, Montana, field office; and two
in Houston, Texas. None of the Company's employees is represented by a
collective bargaining organization, and the Company considers its relationship
with its employees to be satisfactory. In addition to its employees, the
Company regularly engages technical consultants to provide specific
geological, geophysical and other professional services.
OFFICES AND FACILITIES
The Company's executive offices, located in approximately 1,650 square feet
of office space at 3006 Highland Drive, Salt Lake City, Utah, are rented at
$1,413 per month under a month to month agreement. The Company expects that in
the near future it will expand its executive offices or relocate to larger
facilities. The Company owns a 16,160 square foot office building located at
the corner of Central and Main in Oilmont, Montana. The Company utilizes 4,800
square feet for its field office and rents the remaining space to unrelated
third parties for $880 per month. The registered address of the Company's
Polish subsidiary is Wal Miedzesynski 646, 03-994 Warszawa, Poland, where an
office is provided to this subsidiary at nominal cost by an unrelated person.
LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings, and no
material legal proceedings have been threatened by the Company or, to the best
of its knowledge, against it.
38
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
<TABLE>
<CAPTION>
NAME TITLE
---- -----
<S> <C>
David N. Pierce... Chairman of the Board, President and Chief Executive Officer
Andrew W. Pierce.. Vice-President, Secretary and Director
Scott J. Duncan... Vice-President, Treasurer and Director
Thomas B.
Lovejoy.......... Vice Chairman and Director
Peter L. Raven.... Director
Jerzy B.
Maciolek......... Vice-President, International Exploration
</TABLE>
David N. Pierce, age 50, has been President and a Director of the Company
since March 1992. For over three years previously, he was Vice-President and
director of the Company's predecessor, which he co-founded with his brother,
Andrew W. Pierce, in January 1989. He became president and director of the
Company on its acquisition of Exploration in March 1992. Mr. David Pierce has
been engaged in an executive capacity with privately held oil and gas
companies since 1979 and has served exclusively in such a capacity with
Exploration since its formation and with the Company since its acquisition of
Exploration. He is an attorney with over 20 years' experience in natural
resources, securities and international business law. He is a graduate of
Princeton University and Stanford Law School. Mr. David Pierce, whose present
term as a director expires at the 1996 annual meeting, will stand for election
at the stockholders' meeting scheduled for July 22, 1996, for a term expiring
at the 1999 annual meeting.
Andrew W. Pierce, age 48, has been Vice-President and a Director of the
Company since March 1992. For over three years previously, he was the
President and a Director of the Company's predecessor, which he co-founded
with his brother, David N. Pierce, in January 1989. He has over 20 years of
oil and gas exploration, drilling, production and leasing experience. Mr.
Andrew Pierce has held primary management and line responsibility for drilling
and completion operations on more than 60 oil and gas wells in Montana,
Wyoming, Utah and Nevada over the last 20 years and supervises all field
operations of the Company. Mr. Andrew Pierce's term as a director expires at
the 1997 annual meeting.
Scott J. Duncan, age 47, has been Vice-President, Treasurer and a Director
of the Company since May 1993. He was a financial consultant to the Company
from 1992 through April 1993, when he became a full-time employee. From
December 1988 through February 1992, Mr. Duncan served as a director and
principal shareholder of MusicNet Holding Company, Salt Lake City, Utah. In
March 1989, he became secretary/treasurer of MusicNet and in December 1989 was
elected its president. He continued in those positions until February 1992.
Mr. Duncan served as president, director and principal shareholder of Hastings
Corp., Salt Lake City, Utah, from May 1990 until January 1992, when it
acquired Anodyne Corporation, a Whitmore Lake, Michigan, manufacturer of a
patented lift device. Mr. Duncan is a graduate of the University of Utah
School of Business. Mr. Duncan, whose present term as a director expires at
the 1996 annual meeting, will stand for election at the stockholders' meeting
scheduled for July 22, 1996, for a term expiring at the 1998 annual meeting.
Thomas B. Lovejoy, age 60, joined the Company as Vice-Chairman of the Board
of Directors and a Director in October 1995 and has been engaged in financial
advisory and investment banking activities since 1961. In November 1992, Mr.
Lovejoy formed Lovejoy Associates, Inc., Greenwich, Connecticut, to provide
financial strategic advice respecting private placements, mergers and
acquisitions and other financial alternatives. For three years prior to
forming Lovejoy Associates, Inc., Mr. Lovejoy was managing director and head
of natural resource, utility and mining groups for Prudential Securities,
Inc., New York, New York. From 1980 to 1988, he was managing director and head
of the energy and natural resources group of Paine Webber, Inc. Since 1993,
Mr. Lovejoy has been a director of Scaltech, Inc., Houston, Texas, which
processes petroleum refinery oily waste. Mr. Lovejoy received an MBA from
Harvard Business School and a B.S. from the Massachusetts Institute of
Technology. Mr. Lovejoy's term as a director expires at the 1998 annual
meeting.
39
<PAGE>
Peter L. Raven, age 57, joined the Company as a director in March 1996. For
over 25 years, Mr. Raven was employed by Ultramar, PLC, London, England, a
British holding company for a world-wide group of operating companies engaged
in the exploration for, and production of, crude oil and natural gas and the
shipping, refining and marketing of crude oil and petroleum products. From
1957 through 1985, Mr. Raven held various positions with Ultramar and its U.K.
and American subsidiaries. From 1985 through 1988, Mr. Raven was executive
vice president, and from 1988 through 1992, was president of American
Ultramar. During this time, he also served as the chief financial officer of
Ultramar PLC. Mr. Raven received his education from the Downside School in
England, obtained his associate's degree from the Institute of Chartered
Accountants in 1962 and graduated from the Harvard Business School Advanced
Management Programme in 1987. Mr. Raven, whose term as a director expires at
the 1998 annual meeting, will stand for election at the 1996 annual meeting,
for a term expiring at the 1999 annual meeting.
Jerzy B. Maciolek, age 46, who was instrumental in the Company's efforts to
secure its rights to its Baltic Concession, became employed by the Company in
September 1995 and was elected Vice-President of International Operations in
April 1996. Mr. Maciolek also serves as a member of POGC's advisory board.
Prior to becoming a Company employee, Mr. Maciolek was a private consultant
for over five years, including consulting on the hydrocarbon potential of
Poland and Kazakhstan, translating and interpreting geological and geophysical
information for several integrated hydrocarbon potential reports on Poland and
Kazakhstan, and developing applied integrated geophysical interpretations over
gold mines in Nevada, California and Mexico. Since 1992, Mr. Maciolek has also
provided consulting services to the Company regarding exploration projects in
the western United States and Poland. Mr. Maciolek received a master's degree
in exploration geophysics from the Mining and Metallurgy Academy in Krakow,
Poland.
NOMINEE TO BOARD OF DIRECTORS
The Company has expanded the board of directors to six persons and has
appointed Mr. Jay W. Decker to the vacancy created thereby, effective on the
day after the closing of the Offering, to serve until the 1997 annual meeting.
Mr. Decker, age 44, has been the Executive Vice President and a director of
Hugoton Energy Corporation, a public independent oil company ("Hugoton"),
since September 1995. From 1989 until its merger into Hugoton, Mr. Decker was
the President and Chief Executive Officer of Consolidated Oil & Gas, Inc., a
private independent oil company based in Denver, Colorado ("Consolidated").
Between 1989 and 1995, Mr. Decker oversaw and directed the growth of
Consolidated and its predecessor company from a start-up until its merger with
Hugoton, at a net asset value of more than $100 million. Prior to 1989, Mr.
Decker served as Vice President--Operations for General Atlantic Energy
Company and in various capacities for Peppermill Oil Company, Wainoco Oil &
Gas and Shell Oil Company. Mr. Decker received his Bachelor of Science Degree
in Petroleum Engineering from the University of Wyoming. Mr. Decker is also a
director of Patina Oil & Gas Corporation, a public independent oil company.
Mr. Decker's term as a director expires at the 1997 annual meeting.
KEY EMPLOYEES
Eva K. Sokolowska, age 31, who was instrumental in securing the Company's
exploration license for the Baltic Concession, joined the Company in June 1995
as Manager of International Relations and Governmental Liaison. Between 1989
and 1994, Ms. Sokolowska has been involved in various projects, including
consulting on the hydrocarbon potential of Poland and Kazakhstan and
translating geological information for several integrated hydrocarbon
potential reports on Poland and Kazakhstan. Ms. Sokolowska received a degree
in business administration from Warsaw College of Business and Management in
1984.
James A. Giauque III, age 42, joined the Company in November 1995 as its
controller. Mr. Giauque began his 19 years in public accounting with Coopers &
Lybrand L.L.P. in 1977 working in its audit department until 1990. His clients
included public companies in the mineral extractive industry. In 1990, he
established his own accounting practice specializing in financial reporting
requirements and investigative auditing, continuing in such practice until
joining the Company. Mr. Giauque received his MBA and B.A. in accounting from
the University of Utah.
40
<PAGE>
EXECUTIVE COMPENSATION
Summary Compensation
The following table sets forth, for the last three fiscal years of the
Company, the annual and long term compensation earned by, awarded to or paid
to the person who was chief executive officer of the Company as of the end of
the last fiscal year. None of the Company's other executive officers as of the
end of the last fiscal year received total annual salary and bonuses in excess
of $100,000 for all services rendered in all capacities to the Company and its
subsidiaries.
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
-----------------------------
ANNUAL
COMPENSATION AWARDS PAYOUTS
--------------------------- --------------------- -------
SECURITIES
OTHER RESTRICTED UNDERLYING
NAME AND YEAR ANNUAL STOCK OPTIONS/ LTIP ALL OTHER
PRINCIPAL ENDED SALARY BONUS COMPENSATION AWARD(S) SARS PAYOUTS COMPENSATION
POSITION DEC. 31, ($)(1) ($) ($) ($) (NO.) ($) ($)
--------- -------- -------- ----- ------------ ---------- ---------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
David N. Pierce......... 1995 $120,000 -- -- -- 100,000 -- --
President (CEO) 1994 $99,569 -- -- -- 500,000 -- --
1993 $90,000 -- -- -- 150,000 -- --
</TABLE>
- --------
(1) Figures shown for 1993 and 1994 represent the compensation component of
amounts paid to Pierce-Arrow Management, Inc., owned by David N. Pierce
and Andrew W. Pierce.
Option/SAR Grants in Last Fiscal Year
The following table sets forth information respecting all individual grants
of options and stock appreciation rights ("SARs") made during the last
completed fiscal year to the chief executive officer of the Company.
<TABLE>
<CAPTION>
POTENTIAL REALIZED
VALUE AT ASSUMED
% OF TOTAL ANNUAL RATES OF STOCK
NUMBER OF OPTIONS/SARS APPRECIATION FOR
SECURITIES UNDERLYING GRANTED TO OPTION TERM(2)
OPTIONS/SARS EMPLOYEES DURING EXERCISE OR BASE ----------------------
NAME GRANTED (NO.) FISCAL YEAR PRICE ($/SHARE) EXPIRATION DATE 5%($) 10%($)
---- --------------------- ---------------- ---------------- --------------- ----------------------
<S> <C> <C> <C> <C> <C> <C>
David N. Pierce......... 100,000 8.5% $3.00 October 6, 2000 -- $ 62,365
President (CEO)
</TABLE>
On October 6, 1995, the Company granted options to purchase 100,000 shares
of Common Stock, subject to adjustment for certain events of dilution, to Mr.
David Pierce. See below for a discussion of the terms of such options.
41
<PAGE>
Aggregate Option/SAR Exercises in Last Fiscal Year and Year End Option/SAR
Values
The following table sets forth information respecting the exercise of
options and SARs during the last completed fiscal year by the chief executive
officer of the Company and the fiscal year end values of unexercised options
and SARs.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS/SARS AT FY OPTIONS/SARS AT FY
SHARES ACQUIRED END (NO.) END ($)
NAME ON EXERCISE (NO.) VALUE REALIZED ($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ----------------- ------------------ ------------------------- -------------------------
<S> <C> <C> <C> <C>
David N. Pierce......... -- -- 350,000/400,000(1) $56,250/--(2)
President (CEO)
</TABLE>
- --------
(1) Includes options to purchase 100,000 shares of Common Stock at any time
through October 6, 2000, at an exercise price of $3.00 per share; 150,000
shares of Common Stock at any time through May 7, 1998, at an exercise
price of $1.50 per share; and 500,000 shares of Common Stock exercisable
in installments of 100,000 shares per year commencing in June 1995, at an
exercise price of $3.00 per share.
(2) Based on the bid price for the Common Stock of $1.875 on December 31,
1995.
Executive Compensation and Benefits
On June 10, 1994, the Company entered into three-year employment agreements,
effective January 1, 1995, with David N. Pierce and Andrew W. Pierce, each of
whom is an officer and director, providing for annual salaries during 1995 of
$120,000 and $90,000, respectively, with annual increases of at least 7.5%, as
determined by the Board of Directors or a compensation committee. Each
employment agreement, as amended, provides that on the initiation of the first
test well in the Baltic Concession, the executive employee is entitled to
receive a bonus in the form of a $100,000 credit that may be applied against
the exercise of options to purchase Common Stock. The term of such employment
agreements are automatically extended for an additional year on the
anniversary date of each such agreement. In the event of termination of
employment resulting from a change in control of the Company not approved by
the Board of Directors, each of the above employees would be entitled to a
termination payment equal to 150% of his annual salary at the time of
termination and the value of previously granted employee benefits, including
the repurchase of outstanding options.
Compensation of Directors
The Company reimburses its directors for costs incurred by them in attending
meetings of the board of directors and its committees. In addition, the
Company has agreed to pay Thomas B. Lovejoy's company, Lovejoy Associates,
Inc., $10,000 per month for certain consulting services. See "Certain
Transactions--Interim Loan Commitment; Consulting Agreement." On Peter L.
Raven's appointment to the board of directors on March 4, 1996, the Company
issued to him 6,000 shares of Common Stock valued at $18,000, the approximate
market price of such stock as of such date, as compensation for his services
as a director through March 1997. The Company is currently determining the
fees to be paid to Mr. Decker upon joining the board of directors. The Company
does not pay any separate compensation to employees who serve on the board of
directors.
BOARD COMMITTEES
In June 1996, the Board of Directors created audit and compensation
committees and appointed Messrs. Lovejoy and Raven to serve on such
committees. Such committees have not yet met. Mr. Decker will also serve on
the audit committee when he becomes a director after the completion of the
Offering.
42
<PAGE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION
DECISIONS
The current members of the compensation committee are Thomas B. Lovejoy and
Peter L. Raven. During the 1995 fiscal year, prior to the formation of the
compensation committee, David N. Pierce, Andrew W. Pierce and Scott J. Duncan,
executive officers and employees of the Company, participated in deliberations
of the board of directors respecting executive compensation. No member of such
committee is a present or former officer or employee of the Company or any
subsidiary. There are no other interlocks. No member of such committee, his
family, or his affiliate was a party to any material transactions with the
Company or any subsidiary since the beginning of the last completed fiscal
year, except Mr. Lovejoy provided a credit facility, now expired, to the
Company, and the Company engaged Mr. Lovejoy's company, Lovejoy Associates,
Inc., as a financial consultant at a fee of $10,000 per month. In connection
with the foregoing transactions, the Company issued to Lovejoy Associates,
Inc., 200,000 shares of Common Stock and granted to Mr. Lovejoy options to
purchase 350,000 shares of Common Stock. See "Certain Transactions--Interim
Loan Commitment; Consulting Agreement". No executive officer or director of
the Company serves as an executive officer, director, or member of a
compensation committee of any other entity, for which an executive officer or
director of such entity is a member of the board of directors or compensation
committee of the Company.
OPTIONS AND WARRANTS TO OFFICERS, DIRECTORS AND EMPLOYEES
The Company currently has outstanding options to purchase an aggregate of
2,300,000 shares of Common Stock that have been granted to officers, directors
and employees of the Company. Of such options, 825,000 contain vesting
limitations contingent on continuing association with the Company. Options
held by officers, directors and employees are exercisable at prices of between
$1.50 and $3.00 per share. Options issued to executive officers and directors
contain terms providing that in the event of a change in control of the
Company and at the election of the optionee, in consideration of the
cancellation of unexercised options, the Company will pay to the optionee an
amount equal to the number of unexercised options multiplied by the amount by
which the fair market value of the Common Stock as of the date preceding the
date of the change of control exceeds the option exercise price. The grants of
options to officers and directors were not the result of arm's length
negotiations.
STOCK OPTION AND AWARD PLAN
On August 31, 1995, the Company adopted the 1995 Stock Option and Award Plan
(the "Plan"). The Plan is administered by a committee (the "Committee")
consisting of the Board of Directors or a committee of the board. Under the
Plan, the Committee may grant stock options, which may be incentive stock
options ("ISOs") as defined in the Internal Revenue Code, stock awards or
options which do not qualify as ISOs to employees and officers. All employees
of the Company are eligible to participate in the Plan. A maximum of 500,000
shares, subject to adjustment for certain events of dilution, are available
for grant under the Plan. During 1995, the Company granted to employees, none
of whom was an executive officer or director, options to purchase an aggregate
of 50,000 shares of Common Stock at $1.50 per share, the approximate fair
market value of the Common Stock as of the date of grant, exercisable through
August 30, 2000. The Plan was approved by the Company's shareholders at the
1996 annual shareholder meeting held July 22, 1996.
43
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth, as of the date of this Prospectus, the name,
address and shareholdings of each person who owns of record, or was known by
the Company to own beneficially, 5% or more of the Common Stock currently
issued and outstanding; the name and shareholdings of each director; and the
shareholdings of all executive officers and directors as a group. Unless
otherwise indicated, all shares consist of Common Stock and all such shares
are owned beneficially and of record by the named person or group.
<TABLE>
<CAPTION>
PERCENTAGE OF OWNERSHIP(2)
------------------------------
NAME OF PERSON OR GROUP NUMBER(1) BEFORE OFFERING AFTER OFFERING
----------------------- --------- --------------- --------------
<S> <C> <C> <C>
DIRECTORS
David N. Pierce.............. 977,993 (3)(7) 10.3% 7.9%
Andrew W. Pierce............. 910,000 (4)(7) 9.7% 7.3%
Scott J. Duncan.............. 292,000 (5)(7) 3.3% 2.5%
Thomas B. Lovejoy............ 769,000 (6)(7) 8.5% 6.4%
Peter L. Raven............... 32,500 0.4% 0.3%
Jay W. Decker................ -- -- --
All Executive Officers,
Directors and Nominees, as a
Group (7 persons)........... 3,181,493 29.6% 23.1%
PRINCIPAL STOCKHOLDERS
MML Management, Ltd.......... 804,383 (8) 9.2% 6.9%
19 Willis Street
Armadale 3143
Melbourne, Australia
</TABLE>
- --------
(1) Except as otherwise noted, shares are owned beneficially and of record
and such record shareholder has sole voting, investment and dispositive
power.
(2) Calculations of percentages of ownership outstanding for each individual
assumes the exercise of options held by that individual to which the
percentage relates, including options not yet fully vested. Percentages
calculated for totals of all executive officers and directors as a group
assume the exercise of all options held by the indicated group.
(3) Includes 127,493 shares held by Mr. David N. Pierce jointly with his
wife, Mary Phillips; 20,000 shares held by Mary Phillips; 40,000 shares
held by Mr. Pierce as custodian for minor children; 20,000 shares held by
Alyssa Thirsk, an adult child living in Mr. Pierce's household; and
20,000 shares held by Mary Phillips as custodian for a minor child. Also
includes 750,000 shares that are acquirable on exercise of options held
by Mr. Pierce. Options to purchase 300,000 shares are subject to equal
annual vesting over the next three years but are reflected in the table
as being fully vested and exercisable. Mr. Pierce is deemed to hold or
share voting and dispositive power over all of such shares. Mr. Pierce's
address is in care of the Company.
(4) Includes 10,000 shares held by a minor child. Also includes 700,000
shares that are acquirable on exercise of options held by Mr. Andrew W.
Pierce. Options to purchase 300,000 shares are subject to equal annual
vesting over the next three years but are reflected in the table as being
fully vested and exercisable. Mr. Pierce is deemed to hold or share
voting and/or dispositive power over all of such shares. Mr. Pierce's
address is in care of the Company.
44
<PAGE>
(5) Includes 10,000 shares held solely by Mr. Duncan; 172,000 shares held by
Mr. Duncan jointly with his wife, Cathy H. Duncan; 20,000 shares held
solely by Cathy H. Duncan; and 40,000 shares held by Cathy Duncan as
custodian for minor children. Includes 50,000 shares that are acquirable
on exercise of options held by Mr. Duncan. Mr. Duncan is deemed to hold or
share voting and/or dispositive power over all of such shares.
(6) Includes 12,000 shares held in trust for the benefit of Mr. Lovejoy's
children, 49,500 shares held in Mr. Lovejoy's IRA account and 208,000
shares held by Lovejoy Associates, Inc., (of which Mr. Lovejoy is sole
owner). Includes 350,000 shares acquirable on exercise of options held by
Mr. Lovejoy. Such options include options to purchase 200,000 shares that
are subject to vesting requirements. Mr. Lovejoy is deemed to hold or
share voting and/or dispositive power over all of such shares. Mr.
Lovejoy's address is 48 Burying Hill Road, Greenwich, Connecticut 06831.
(7) Includes options that give the holders the right to acquire shares of
Common Stock at prices ranging from $1.50 to $3.00 per share with various
expiration dates ranging from May 1998 to June 2004. Certain of the
options are subject to vesting requirements but are reflected in the table
as being fully vested and exercisable. See "Management--Executive
Compensation."
(8) Consists of 43,194 shares issuable on the exercise of warrants owned by
MML Management Ltd. ("MML"), an Australian fund manager/investment
advisor, and 724,689 shares owned and 36,500 shares issuable on exercise
of warrants owned by Australian unit trusts (similar to United States
mutual funds) that are managed by MML, no one of which owns beneficially
more than 5% of the outstanding stock of the Company. MML has voting and
dispositive power over the shares held by such unit trusts managed by it.
45
<PAGE>
CERTAIN TRANSACTIONS
The terms of the following transactions between related parties were not
determined as a result of arm's length negotiations. In each case, in the
opinion of management, the terms of the transaction were no less favorable to
the Company than would have been negotiated in an arms' length transaction.
AMOUNTS DUE TO AND FROM AFFILIATES
During 1994, David N. Pierce and Andrew W. Pierce provided their management
services to the Company through Pierce-Arrow Management, Inc. ("Pierce-
Arrow"), a company which they own. This arrangement was terminated December
31, 1994, and David N. Pierce and Andrew W. Pierce became employees of the
Company. As of December 31, 1995, the Company owed Pierce-Arrow a total of
$95,005, including interest at 9% per annum, which totals $17,997, for such
services previously provided. In the first quarter of 1996 the Company paid
Pierce-Arrow $60,000, reducing the outstanding balance due Pierce-Arrow to
$35,551 (including interest) as of March 31, 1996.
INTERIM LOAN COMMITMENT; CONSULTING AGREEMENT
Effective August 3, 1995, the Company entered into a loan agreement with an
existing shareholder, Thomas B. Lovejoy, which provided for borrowing, with
interest at the same rate at which the shareholder borrowed the funds to be
loaned to the Company, plus 2%, through March 31, 1996, up to $430,000,
reduced by the amount of any equity investment in the Company by such
shareholder after August 1, 1995. As a result of Mr. Lovejoy's subsequent
equity investment of $370,000, the available borrowing under this line of
credit was reduced to $60,000. No amounts were borrowed by the Company under
this credit facility prior to its expiration on March 31, 1996.
On August 3, 1995, the Company also agreed to engage Mr. Lovejoy's company,
Lovejoy Associates, Inc. ("LAI"), as financial consultant. The parties
subsequently entered into a formal consulting agreement, effective August 3,
1995, with LAI, under which it advises the Company respecting future financing
alternatives, identifying possible sources of debt and equity financing, with
particular emphasis on funding for the Baltic Concession and the Company's
relationship with the investment community, at a fee of $10,000 per month
commencing October 15, 1995, and continuing through December 31, 1997. The
Company agreed to reimburse out-of-pocket expenses.
In consideration of the consulting agreement and the loan agreement now
expired, the Company issued to LAI, 200,000 shares of restricted Common Stock
and granted to Mr. Lovejoy options to purchase 350,000 shares of Common Stock
at an exercise price of $3.00 per share. The options became immediately
exercisable to purchase 150,000 shares of Common Stock and subsequently become
exercisable respecting an additional 100,000 shares on December 31, 1996, and
an additional 100,000 shares become exercisable on December 31, 1997, unless
the consulting agreement with LAI, has previously been terminated by the
Company for cause. The options may be exercised at any time within five years
after they become exercisable. The Company recognized $400,000 as compensation
expense in connection with the issuance of such 200,000 shares. The Company
has agreed to register the resale of shares of Common Stock issuable on the
exercise of the option. At the optionee's election, any tax withholding
obligation may be satisfied by the optionee tendering shares of Common Stock
to the Company or by the Company withholding shares otherwise issuable on
exercise of the options.
46
<PAGE>
DESCRIPTION OF SECURITIES
The Company is authorized to issue 20,000,000 shares of Common Stock, $0.001
par value; and 5,000,000 shares of preferred stock, $0.001 par value.
PREFERRED STOCK
Under the Company's Articles of Incorporation, the Company's Board of
Directors is authorized, without shareholder action, to issue preferred stock
in one or more series and to fix the number of shares and rights, preferences
and limitations of each series. Among the specific matters that may be
determined by the Board of Directors are the dividend rate, the redemption
price, if any, conversion rights, if any, the amount payable in the event of
any voluntary liquidation or dissolution of the Company and voting right, if
any. The Company has 17,500 shares of preferred stock, with an aggregate
liquidation preference of $17,500, issued and outstanding as of March 31,
1996.
COMMON STOCK
As of the date of this Prospectus, the Company had 8,704,569 shares of
Common Stock issued and outstanding. The holders of Common Stock are entitled
to one vote per share on each matter submitted to a vote at any meeting of
stockholders. Holders of Common Stock do not have cumulative voting rights,
and therefore, a majority of the outstanding shares voting at a meeting of
stockholders are able to elect the entire Board of Directors, and if they do
so, minority stockholders would not be able to elect any members to the Board
of Directors. The Company's bylaws provide that a majority of the issued and
outstanding shares of the Company constitutes a quorum for stockholders'
meetings, except with respect to certain matters for which a greater
percentage quorum is required by statute.
Stockholders of the Company have no preemptive rights to acquire additional
shares of Common Stock or other securities. The Common Stock is not subject to
redemption and carries no subscription or conversion rights. In the event of
liquidation of the Company, the shares of Common Stock are entitled to share
equally in corporate assets after satisfaction of all liabilities and the
payment of any liquidation preferences.
Holders of Common Stock are entitled to receive such dividends as the Board
of Directors may from time to time declare out of funds legally available for
the payment of dividends. The Company seeks growth and expansion of its
business through the reinvestment of profits, if any, and does not anticipate
that it will pay dividends on the Common Stock in the foreseeable future.
The Company has reserved for issuance an aggregate of 3,077,028 shares of
Common Stock consisting of 17,500 shares issuable on the conversion of the
same number of shares of preferred stock, 2,034,528 shares on the exercise of
outstanding options and warrants at exercise prices ranging from $1.10 to
$3.00 with a weighted average exercise price of $2.33 per share, 825,000
shares on the exercise of options previously granted but not yet exercisable
at $3.00 per share and 200,000 shares issuable on the satisfaction of certain
contractual conditions relating to oil production levels from the Company's
producing properties in Montana and Nevada.
CERTAIN ARTICLE AND BYLAW PROVISIONS
The Company's Articles of Incorporation divide the members of the Board of
Directors into three classes of directors, with each class to be as nearly
equal in number of directors as possible, serving staggered, three-year terms.
See "Management." The Company's Articles of Incorporation also provide that
directors may be removed, with or without cause, by a two-thirds majority of
the shareholders at a meeting called for that purpose and that any resulting
vacancies can be filled by only a vote of a majority of the directors
remaining in office.
The Company's bylaws permit stockholders to nominate a person for election
as a director or bring other matters before a stockholder meeting only if
written notice of such intent is provided to the Company at least 30 days
prior to the meeting. Such notice of intent to nominate a person for election
as a director is required to set forth the same kind of information respecting
such nominee as would be required under the proxy rules of the SEC, including
the written consent of the nominee to serve as a director, if elected, and the
name and address of the stockholder making the nomination as well as the
number of shares of stock owned by such stockholder. In the case of other
proposed business, the notice must set forth a brief description of each
matter proposed, the name and address of the stockholder proposing the matter,
the number of shares of stock owned by such stockholder and any material
interest of such stockholder in such matter.
47
<PAGE>
Nevada law provides that a merger or consolidation, sale or similar
transaction involving all or substantially all of the Company's assets, the
issuance of securities having an aggregate value equal to 5% or more of the
aggregate market of all outstanding shares of the corporation or the
reclassification, recapitalization or similar transaction involving an
"interested stockholder" (as defined), within three years after the
stockholder became interested, cannot be completed unless such transaction is
approved by the Board of Directors of the Company. After the expiration of
three years after a person becomes an interested stockholder, a transaction
cannot be completed with the interested stockholder unless it is approved by
the Board of Directors or a majority of the outstanding voting power not
beneficially owned by the interested stockholder, unless certain "fair price"
provisions are met. Such fair price provisions generally require that the
amount of cash and the market value of the consideration of the cash to be
received per share by all holders of the outstanding Common Stock of the
Company not beneficially owned by the interested stockholder be at least equal
to the higher of the price per share paid by the interested stockholder or the
market value on the date of announcement of the proposed combination. For
purposes of these provisions, an interested stockholder is one who
beneficially owns, directly or indirectly, 10% or more of the voting power of
the outstanding stock of the corporation.
The foregoing provisions may tend to deter any potential unfriendly offers
or other efforts to obtain control of the Company that are not approved by the
Board of Directors and thereby deprive the stockholders of opportunities to
sell shares of Common Stock at prices higher than the prevailing market price.
On the other hand, these provisions may tend to assure continuity of
management and corporate policies and to induce any person seeking control of
the Company or a business combination with the Company to negotiate on terms
acceptable to the then elected Board of Directors.
INDEMNIFICATION OF OFFICERS AND DIRECTORS; LIMITATION OF LIABILITY
The Company's articles of incorporation and bylaws provide for
indemnification of the Company's officers and directors to the fullest extent
permitted by the Nevada corporation law, which provides for indemnification
for damages, including costs and attorney's fees, incurred in any pending or
completed action by reason of the fact that such person was an officer or
director of the Company if he acted in good faith and in a manner which he
reasonably believed to be in or not opposed to the best interests of the
Company. The Company's articles of incorporation contain a provision that
limits the personal liability of the Company's directors or officers for
damages for breach of fiduciary duty as a director or officer, except for
damages resulting from acts or omissions that involve intentional misconduct,
fraud or knowing violations of law or the payment of dividends in violation of
statute. The effect of this provision is to eliminate the rights of the
Company and its stockholders to recover money damages against a director or
officer for breach of fiduciary duty of care except in certain circumstances.
This provision does not limit or eliminate the rights of the Company or any
stockholder to seek non-monetary relief such as an injunction or rescission in
the event of a breach of fiduciary duty. Insofar as indemnification for
liabilities arising under the Securities Act may be permitted to directors,
officers and controlling persons of the Company pursuant to the foregoing
provision, or otherwise, the Company has been advised that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable.
COVENANTS TO REGISTER COMMON STOCK
Pursuant to the terms under which certain securities were previously issued
by the Company, it has agreed to register for resale under the Securities Act
an aggregate of approximately 5.5 million shares of outstanding Common Stock.
Of such shares, approximately 4.6 million shares were included in a
registration statement declared effective March 30, 1995, and have been
generally eligible for resale since that date. The Company believes that
approximately 2.3 million shares may remain to be sold under such registration
statement. Approximately 1.3 million additional shares are included in a
registration statement filed by the Company on July 22, 1996. Stockholders
owning an aggregate of 516,000 of the shares included in the registration
statement filed July 22, 1996, have agreed that they will not sell such shares
during the 30 days after the last closing in the Offering.
48
<PAGE>
UNDERWRITING
Subject to the terms and conditions set forth in the Underwriting Agreement
among the Company and the Underwriters named below, for whom Oppenheimer &
Co., Inc. and Hanifen, Imhoff Inc. are acting as representatives (the
"Representatives"), the Underwriters have severally agreed to purchase from
the Company, and the Company has agreed to sell to the Underwriters, the
number of shares of Common Stock set forth opposite their respective names:
<TABLE>
<CAPTION>
UNDERWRITERS NUMBER OF SHARES
------------ ----------------
<S> <C>
Oppenheimer & Co., Inc......................................... 1,250,000
Hanifen, Imhoff Inc............................................ 650,000
George K. Baum & Company....................................... 100,000
Chatfield Dean & Co. Inc....................................... 100,000
Fechtor, Detwiler & Co., Inc................................... 100,000
First Albany Corporation....................................... 100,000
Jefferies & Company............................................ 100,000
Johnson Rice & Company L.L.C................................... 100,000
McDonald & Company Securities, Inc............................. 100,000
Morgan Keegan & Company, Inc................................... 100,000
Petrie Parkman & Co............................................ 100,000
Rauscher Pierce Refsnes, Inc................................... 100,000
Southcoast Capital Corp........................................ 100,000
---------
Total...................................................... 3,000,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
thereunder are subject to approval of certain legal matters by counsel and to
various other conditions. The nature of the Underwriters' obligations is such
that they are committed to purchase all of the above shares of Common Stock if
any are purchased.
The Underwriters propose to offer the shares of Common Stock directly to the
public at the offering price set forth on the cover page of this Prospectus
and at such price less a concession not in excess of $0.21 per share of Common
Stock to certain securities dealers who are members of the National
Association of Securities Dealers, Inc. The Underwriters may allow and such
dealers may reallow concessions not in excess of $0.10 per share to certain
other securities dealers. After the Offering, the offering price and other
selling terms may be changed by the Representatives.
The Underwriters have been granted a 30-day over-allotment option to
purchase from the Company up to an aggregate of 450,000 additional shares of
Common Stock at the public offering price less the underwriting discount. If
the Underwriters exercise such over-allotment option, the Underwriters have
severally agreed, subject to certain conditions, to purchase approximately the
same percentage thereof as the number of shares of Common Stock to be
purchased by it as shown in the above table bears to the number of shares of
Common Stock offered hereby. The Underwriters may exercise such option only to
cover over-allotments made in connection with the sale of Common Stock offered
hereby.
The rules of the SEC generally prohibit the Underwriters from making a
market in the Common Stock of the Company during the two business days prior
to commencement of sales in this Offering (the "Cooling Off Period"). The SEC
has, however, adopted Rule 10b-6A under the Exchange Act ("Rule 10b-6A"),
which provides an exemption from such prohibition for certain passive market
making transactions. Such passive market making transactions must comply with
applicable price and volume limits and must be identified as passive market
making transactions. In general, pursuant to Rule 10b-6A, a passive market
maker must display its bid for a security at a price not in excess of the
highest independent bid for the security. If all independent bids are lowered
below the passive maker's bid, however, such bid must then be lowered when
certain purchase limits are exceeded. Further, net purchases by a passive
market maker on each day are generally limited to a specified percentage of
the passive market maker's average daily trading volume in a security during a
specified prior period and must be discontinued when such limit is reached.
Pursuant to the exemption provided by Rule 10b-6A, certain of the Underwriters
and selling group members may engage in passive market making in the Common
Stock during the Cooling Off Period. Passive market making may stabilize the
market price of the Common Stock at a level above that which might otherwise
prevail, and, if commenced, may be discontinued at any time.
49
<PAGE>
Upon the closing of the Offering, the Company has agreed to issue and
deliver to the Representatives warrants to purchase 150,000 shares of Common
Stock. The warrants will have a term of five years, will be exercisable after
one year at an exercise price equal to 120% of the public offering price and
will be transferable to either of the Representative's officers and partners.
The Company has agreed to reimburse the Representatives up to $150,000 for
reasonable accountable expenses in certain circumstances.
The Representatives have advised the Company that they do not intend to
confirm sales to any accounts over which they exercise discretionary
authority.
The Company has agreed to indemnify the Underwriters against certain
liabilities, losses and expenses, including liabilities under the Securities
Act or to contribute to payments that the Underwriters may be required to make
in respect thereof.
The Company and its officers and directors holding 1,131,493 outstanding
shares and 2,050,000 options in the aggregate have agreed that for a period of
180 days after the date of this Prospectus they will not sell, contract to
sell or otherwise dispose of, directly or indirectly, shares without the prior
written consent of the Representatives.
LEGAL MATTERS
The validity of the Common Stock under Nevada corporation laws will be
passed upon for the Company by Kruse, Landa & Maycock, L.L.C. and certain
matters related to the laws of Poland will be passed on for the Company by
White & Case, Warsaw, Poland. Certain legal matters will be passed upon for
the Underwriters by Gibson, Dunn & Crutcher LLP.
EXPERTS
The Consolidated Financial Statements and the Notes thereto of the Company
and its subsidiaries included in this registration statement have been audited
by Coopers & Lybrand L.L.P., independent accountants, for the period indicated
in their report thereon appearing elsewhere in this registration statement.
The financial statements audited by Coopers & Lybrand L.L.P. have been
included in reliance upon such report and upon the authority of said firm as
experts in accounting and auditing.
The financial statements of the Company for the year ended December 31, 1993
and 1994, included in this Prospectus, have been audited by Barker & Folsom,
certified public accountants, as stated in their report appearing herein, and
have been included in reliance upon such report given upon the authority of
such firm as experts in accounting and auditing.
The statement of operations of B&B Production Company for the year ended
December 31, 1993, included in this Prospectus has been audited by Hamilton
Misfeldt & Company, P.C., certified public accountants, as stated in their
report appearing herein, and has been included in reliance upon such report
given upon the authority of such firm as experts in accounting and auditing.
The statement of operations of J.R. Bacon Drilling, Inc., for the year ended
December 31, 1993, included in this Prospectus, has been audited by Barker &
Folsom, certified public accountants, as stated in their report appearing
herein, and has been included in reliance upon such report given upon the
authority of such firm as experts in accounting and auditing.
The estimates of oil and gas reserves of the Company respecting its
properties are included herein under the caption "Business and Properties--Oil
Reserves" in reliance upon the authority of Larry D. Krause, independent
petroleum engineer, Billings, Montana, as an expert in petroleum engineering.
For additional information relating to the Company's reserves, see the Summary
Reserve Report of Larry D. Krause included as Appendix A to this Prospectus.
The opinion based on the detailed log analysis of the Gladysze-1 and
Gladysze-2 wells is included herein under the caption "Business and
Properties--Exploration and Development Activities in Poland: the Baltic
Concession" in reliance upon the authority of Halliburton Energy Services as
an expert in oil well log interpretation.
50
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS OF FX ENERGY, INC. (FORMERLY KNOWN AS
FRONTIER OIL EXPLORATION COMPANY), AND SUBSIDIARIES
Report of Coopers & Lybrand L.L.P., certified public accountants......... F-2
Report of Barker & Folsom, certified public accountants.................. F-3
Consolidated Balance Sheet at December 31, 1994, 1995 and March 31, 1996
(unaudited)............................................................. F-4
Consolidated Statement of Operations for the years ended December 31,
1993, 1994 and 1995 and the three months ended March 31, 1995 and 1996
(unaudited)............................................................. F-5
Consolidated Statement of Cash Flows for the years ended December 31,
1993, 1994 and 1995 and the three months ended March 31, 1995 and 1996
(unaudited)............................................................. F-6
Consolidated Statement of Stockholders' Equity for the years ended
December 31, 1993, 1994 and 1995 and the three months ended March 31,
1996 (unaudited)........................................................ F-7
Notes to Consolidated Financial Statements............................... F-8
STATEMENT OF OPERATIONS OF B & B PRODUCTION COMPANY (A GENERAL
PARTNERSHIP)
Report of Hamilton Misfeldt & Company P.C., certified public
accountants............................................................. F-22
Statement of Operations for the year ended December 31, 1993............. F-23
Notes to Financial Statements............................................ F-24
STATEMENT OF OPERATIONS OF J.R. BACON DRILLING, INC.
Report of Barker & Folsom, certified public accountants.................. F-28
Statement of Operations for the year ended December 31, 1993............. F-29
Notes to Financial Statements............................................ F-30
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of FX Energy, Inc. (formerly known
as Frontier Oil Exploration Company), and Subsidiaries:
We have audited the accompanying consolidated balance sheet of FX Energy,
Inc. (formerly known as Frontier Oil Exploration Company), and Subsidiaries as
of December 31, 1995 and the related statements of operations, stockholders'
equity, and cash flows for the year 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 audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of FX Energy,
Inc. (formerly known as Frontier Oil Exploration Company), and Subsidiaries as
of December 31, 1995, and the consolidated results of their operations and
their cash flows for the year then ended in conformity with generally accepted
accounting principles.
COOPERS & LYBRAND L.L.P.
Salt Lake City, Utah
March 29, 1996
F-2
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
FX Energy, Inc. (formerly known as Frontier Oil Exploration Company), and
Subsidiaries:
We have audited the accompanying consolidated balance sheet of FX Energy,
Inc. (formerly known as Frontier Oil Exploration Company), and Subsidiaries as
of December 31, 1994, and the related statements of operations, stockholders'
equity, and cash flows for the years ended December 31, 1993 and 1994. 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of FX Energy,
Inc. (formerly known as Frontier Oil Exploration Company), and Subsidiaries as
of December 31, 1994, and the consolidated results of their operations and
their cash flows for the years ended December 31, 1993 and 1994 in conformity
with generally accepted accounting principles.
BARKER & FOLSOM
Ogden, Utah
February 24, 1995
F-3
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES (FORMERLY KNOWN AS FRONTIER OIL EXPLORATION
COMPANY)
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------- MARCH 31,
1994 1995 1996
------- ------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents...................... $ 289 $ 744 $ 559
Cash--restricted............................... -- -- 300
Receivables:
Accrued oil sales............................. 258 254 284
Due from joint interest owners................ 98 132 125
Inventory...................................... 17 16 15
Other current assets........................... 5 32 75
------- ------- -------
Total current assets......................... 667 1,178 1,358
------- ------- -------
Property and equipment, at cost:
Oil and gas property (successful efforts
method):
Proved........................................ 4,850 6,063 6,139
Unproved...................................... 1,525 1,797 1,715
Other property and equipment................... 1,600 1,625 1,699
------- ------- -------
7,975 9,485 9,553
Less accumulated depreciation, depletion and
amortization.................................. (447) (873) (993)
------- ------- -------
Net property and equipment................... 7,528 8,612 8,560
------- ------- -------
Other assets:
Certificates of deposit........................ 154 217 217
Loan origination costs, net of accumulated
amortization of $33 in 1994, $96 in 1995 and
$111 in 1996.................................. 87 32 13
------- ------- -------
Total other assets........................... 241 249 230
------- ------- -------
Total assets................................. $ 8,436 $10,039 $10,148
======= ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................... $ 220 $ 354 $ 362
Accounts payable--related parties.............. 86 95 35
Accrued liabilities............................ 302 682 382
Current portion of long-term debt.............. 331 325 180
------- ------- -------
Total current liabilities.................... 939 1,456 959
Long-term debt................................... 4,091 3,359 3,439
------- ------- -------
Total liabilities............................ 5,030 4,815 4,398
------- ------- -------
Minority interest in FX Producing convertible
preferred stock, par value $0.001 per share,
3,300,000 shares authorized; 1,442,147 shares
outstanding in 1994, liquidation preference of
$2,165,501 in 1994.............................. 1,576 -- --
------- ------- -------
Redeemable FX Producing preferred stock.......... 550 -- --
------- ------- -------
Commitments and contingencies (Notes 3 and 12)
Stockholders' equity:
Preferred stock, $0.001 par value, 5,000,000
shares authorized, issued and outstanding
1,500,000 shares in 1994, 137,500 in 1995 and
17,500 in 1996; liquidation preference of
$1,500,000 in 1994; $137,500 in 1995 and
$17,500 in 1996............................... 1 -- --
Common stock, $0.001 par value, 20,000,000
shares authorized, issued and outstanding
2,595,602 in 1994, 7,898,995 in 1995 and
8,460,485 in 1996............................. 3 8 8
Additional paid-in capital..................... 3,006 9,466 10,665
Stock subscription receivable.................. -- -- (90)
Accumulated deficit............................ (1,730) (4,250) (4,833)
------- ------- -------
Total stockholders' equity................... 1,280 5,224 5,750
------- ------- -------
Total liabilities and stockholders' equity... $ 8,436 $10,039 $10,148
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements
F-4
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES (FORMERLY KNOWN AS FRONTIER OIL EXPLORATION
COMPANY)
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
-------------------------- ------------------
1993 1994 1995 1995 1996
-------- -------- -------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Oil sales.................. -- $ 1,692 $ 1,981 $ 516 $ 505
Drilling revenue........... -- 224 111 5 --
Prospect sales............. $ 247 -- 75 60 --
Project management fees.... 29 -- -- -- --
------- ------- -------- --------- ---------
Total revenues........... 276 1,916 2,167 581 505
------- ------- -------- --------- ---------
Operating costs and expenses:
Production and operating
costs..................... 7 434 1,001 265 293
Production taxes........... -- 246 271 73 32
Exploration costs.......... 654 651 747 94 189
Drilling costs............. -- 178 141 11 24
Depreciation, depletion and
amortization.............. 3 422 503 106 138
Leasehold abandonments..... -- -- 115 -- --
General and
administrative............ 353 816 1,466 276 366
------- ------- -------- --------- ---------
Total operating costs and
expenses................ 1,017 2,747 4,244 825 1,042
------- ------- -------- --------- ---------
Operating loss............... (741) (831) (2,077) (244) (537)
------- ------- -------- --------- ---------
Other income (expense):
Interest and other income.. 39 53 98 10 36
Interest expense........... (2) (214) (448) (111) (82)
Minority interest: Non-cash
dividends on FX Producing
convertible preferred
stock -- -- (93) (55) --
------- ------- -------- --------- ---------
Total other income
(expense)............... 37 (161) (443) (156) (46)
------- ------- -------- --------- ---------
Net loss before benefit from
income taxes................ (704) (992) (2,520) (400) (583)
Benefit from income taxes.... 9 -- -- -- --
------- ------- -------- --------- ---------
Net loss..................... $ (695) $ (992) $ (2,520) $ (400) $ (583)
======= ======= ======== ========= =========
Net loss per common share.... $ (0.40) $ (0.44) $ (0.47) $ (0.14) $ (0.07)
======= ======= ======== ========= =========
Weighted average number of
shares outstanding.......... 1,750 2,229 5,389 2,811 8,086
======= ======= ======== ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements
F-5
<PAGE>
FX ENERGY INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
-------------------------- --------------
1993 1994 1995 1995 1996
---------------- -------- ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activi-
ties:
Net loss.......................... $ (695) $ (992) $ (2,520) $ (400) $ (583)
Adjustment to reconcile net loss
to net cash used in operating
activities:
Depreciation, depletion and
amortization.................... 3 422 503 120 138
Net current assets acquired from
Petrolex........................ 18 -- -- -- --
Leasehold abandonments............ -- -- 115 -- --
Gain on sale of equipment......... -- -- (16) -- --
Minority interest: Non-cash
dividends on FX Producing
convertible preferred stock..... -- -- 93 55 --
Loss on disposition of
partnerships.................... -- 23 -- -- --
Common stock and options issued
for services.................... 100 168 443 14 114
Increase (decrease) from changes
in:
Cash-restricted................. (143) 143 -- -- --
Receivables..................... (86) (266) (30) (204) (23)
Inventory....................... -- (17) 1 1 1
Other current assets............ 1 (4) (27) (16) (43)
Accounts payable and accrued
liabilities.................... 219 201 408 366 (351)
Income taxes payable............ 14 -- -- -- --
------ -------- -------- ------ ------
Net cash used in operating
activities.................... (569) (322) (1,030) (64) (747)
------ -------- -------- ------ ------
Cash flows from investing
activities:
Additions to oil and gas
properties....................... (22) (2,725) (1,404) (57) (89)
Additions to other property and
equipment........................ -- (1,553) (25) (3) (58)
Additions to other assets......... -- (154) (78) (67) --
Proceeds from sale of interest in
unproved property................ -- -- -- -- 100
Proceeds from sale of equipment... -- -- 18 -- --
------ -------- -------- ------ ------
Net cash used in investing
activities.................... (22) (4,432) (1,489) (127) (47)
------ -------- -------- ------ ------
Cash flows from financing
activities:
Proceeds from long-term debt...... -- 4,364 -- -- --
Repayment of long-term debt....... -- (63) (737) (79) (84)
Proceeds from issuance of FX
Producing convertible preferred
stock............................ -- 1,695 111 111 --
Proceeds from issuance of
redeemable FX Producing preferred
stock............................ -- 550 -- -- --
Redemption of FX Producing
convertible preferred stock...... -- (2,151) -- -- --
Redemption of redeemable FX
Producing preferred stock........ -- -- (465) -- --
Proceeds from issuance of
preferred stock.................. 1,028 192 -- -- --
Proceeds from issuance of common
stock and exercise of warrants,
net of offering costs............ 18 -- 4,065 395 993
------ -------- -------- ------ ------
Net cash provided by financing
activities.................... 1,046 4,587 2,974 427 909
------ -------- -------- ------ ------
Increase (decrease) in cash and
cash equivalents.................. 455 (167) 455 236 115
Cash and cash equivalents at
beginning of period............... 1 456 289 289 744
------ -------- -------- ------ ------
Cash and cash equivalents at end of
period (including restricted cash
of $300 at March 31, 1996)........ $ 456 $ 289 $ 744 $ 525 $ 859
====== ======== ======== ====== ======
Supplemental disclosure of cash
flow information:
Cash paid during the year for:
Interest.......................... $ 2 $ 178 $ 422 $ 111 $ 89
Income taxes...................... 9 -- -- -- --
</TABLE>
The accompanying notes are an integral part of these financial statements
F-6
<PAGE>
FX ENERGY INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
ADDI-
PREFERRED STOCK COMMON STOCK TIONAL STOCK SUB- ACCU-
------------------ ---------------- PAID-IN SCRIPTION MULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL RECEIVABLE DEFICIT
---------- ------ --------- ------ ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1992................... -- -- 1,051,200 $ 1 $ 85 $ (43)
Common stock issued for
cash................... -- -- 10,000 -- 10 -- --
Common stock issued for
unproved oil and gas
properties............. -- -- 321,255 -- 291 -- --
Common stock issued for
services............... -- -- 100,000 -- 100 -- --
Common stock issued in
connection with
Petrolex acquisition... -- -- 400,000 1 133 -- --
Preferred stock issued
for cash, net of
offering costs of
$172................... 1,279,500 $ 1 -- -- 1,106 -- --
Net loss................ -- -- -- -- -- -- (695)
---------- ----- --------- ---- ------- ---- -------
Balance, December 31,
1993................... 1,279,500 1 1,882,455 2 1,725 -- (738)
Preferred stock issued
for cash, net of
offering costs of $29.. 220,500 -- -- -- 192 -- --
Common stock issued for
unproved oil and gas
properties............. -- -- 500,000 1 883 -- --
Common stock issued for
services............... -- -- 112,000 -- 168 -- --
Common stock issued for
cancellation of note
payable................ -- -- 25,453 -- 38 -- --
Common stock issued as
commission for
placement of FX
Producing preferred
stock.................. -- -- 75,694 -- -- -- --
Net loss................ (992)
---------- ----- --------- ---- ------- ---- -------
Balance, December 31,
1994................... 1,500,000 1 2,595,602 3 3,006 -- (1,730)
Common stock issued for
cash, net of offering
costs of $182.......... -- -- 2,087,500 2 3,991 -- --
Common stock issued for
services and line of
credit................. -- -- 207,000 -- 418 -- --
Conversion of FX
Producing preferred
stock into common
stock.................. -- -- 1,504,458 2 1,779 -- --
Conversion of redeemable
FX Producing preferred
stock into common
stock.................. -- -- 64,935 -- 85 -- --
Conversion of preferred
stock into common
stock.................. (1,362,500) (1) 1,362,500 1 -- --
Exercise of warrants.... -- -- 65,000 -- 72 -- --
Common stock issued for
unproved oil and gas
properties............. -- -- 12,000 -- 27 -- --
Compensation related to
granting of stock
options at below-market
value.................. -- -- -- -- 25 -- --
Additions to oil and gas
properties resulting
from granting of stock
options at below-market
value.................. 63 --
Net loss................ -- -- -- -- -- -- (2,520)
---------- ----- --------- ---- ------- ---- -------
Balance, December 31,
1995................... 137,500 -- 7,898,995 8 9,466 -- (4,250)
Common stock issued for
cash, net of offering
costs of $48
(unaudited)............ -- -- 372,393 -- 1,056 (90) --
Exercise of warrants
(unaudited)............ -- -- 22,004 -- 27 -- --
Conversion of preferred
stock into common stock
(unaudited)............ (120,000) -- 120,000 -- -- -- --
Common stock issued for
services (unaudited)... -- -- 46,000 -- 114 -- --
Common stock issued for
proved oil properties
(unaudited)............ -- -- 1,093 -- 2 -- --
Net loss (unaudited).... (583)
---------- ----- --------- ---- ------- ---- -------
Balance at March 31,
1996 (unaudited)....... 17,500 $ -- 8,460,485 $ 8 $10,665 $(90) $(4,833)
========== ===== ========= ==== ======= ==== =======
</TABLE>
The accompanying notes are an integral part of these financial statements
F-7
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Information as of March 31, 1996, and for the three month periods ended
March 31, 1995 and 1996, is unaudited.
Organization
FX Energy, Inc. (formerly known as Frontier Oil Exploration Company), a
Nevada corporation ("Frontier"), and its subsidiaries (collectively
hereinafter referred to as the "Company") operate in the oil and gas industry
in the United States and Poland (see Note 12). The Company is engaged in
acquiring, exploring and developing oil and gas properties. In addition, the
Company owns and operates a drilling and well servicing company. Acquisitions
of certain subsidiaries and assets are discussed in Note 4 Acquisitions.
The Company believes that its working capital as of December 31, 1995, plus
additional amounts received after year-end (see Note 13) will satisfy the
Company's operating requirements during 1996. However, the Company will
require substantial amounts of additional capital to continue its planned
geological and geophysical studies, well drilling, and other exploration and
development activities. The Company will be dependent on its ability to raise
such funds through exploration groups formed with others, the sale of
securities, bank loans, or the sale of interests in one or more of the
projects.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation. At December 31, 1995, the
Company owned 100% of the voting common stock of its subsidiaries, including
FX Producing Company, Inc. ("FX Producing"). At December 31, 1994 FX Producing
had 1,442,147 shares of nonvoting convertible preferred stock outstanding
which were not owned by the Company. All of these shares were converted into
common stock of the Company during 1995. The dividends on the convertible
preferred stock are reflected in the consolidated statement of operations as a
minority interest.
Inventory
Inventory consists primarily of tubular supplies and other well equipment
and is valued at the lower of average cost or market.
Oil and Gas Properties
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 expensed. The costs of development wells are capitalized whether
productive or nonproductive.
Geological and geophysical costs on exploratory prospects and the costs of
carrying and retaining unproved properties are expensed as incurred. An
impairment allowance is provided to the extent that capitalized costs of
unproved properties, on a property-by-property basis, are considered to be not
realizable. Depletion, depreciation and amortization ("DD&A") of capitalized
costs of proved oil and gas properties is provided on a property-by-property
basis using the units of production method. The computation of DD&A takes into
consideration restoration, dismantlement and abandonment costs and the
anticipated proceeds from equipment salvage. The
F-8
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
estimated restoration, dismantlement and abandonment costs are expected to be
offset by the estimated residual value of lease and well equipment.
An impairment loss will be recorded if the net capitalized costs of proved
oil and gas properties exceed the aggregate undiscounted future net revenues
determined on a property-by-property basis. The impairment loss recognized
will equal the excess of net capitalized costs over the expected discounted
future net revenues from the related property.
Gains and losses are recognized on sales of entire interests in proved and
unproved properties. Sales of partial interests are generally treated as a
recovery of costs.
Other Property and Equipment
Other property and equipment, including drilling and well servicing
equipment, are stated at cost. Depreciation of other property and equipment is
calculated using the straight-line method over the estimated useful lives. The
cost of normal maintenance and repairs is charged to operating costs and
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 other property and equipment sold, or otherwise
disposed of, and the related accumulated depreciation are removed from the
accounts, and any gain or loss is reflected in current operations. Other
property and equipment is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31, ESTIMATED
------------- MARCH 31, USEFUL LIFE
1994 1995 1996 (IN YEARS)
------ ------ ----------- -----------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Drilling and well service equipment...... $1,317 $1,323 $1,378 6
Trucks................................... 137 137 152 5
Building................................. 80 80 80 40
Office equipment......................... 66 85 89 3 to 6
------ ------ ------
$1,600 $1,625 $1,699
====== ====== ======
</TABLE>
Other Assets
Other assets include loan origination costs which are being amortized over 2
years on a straight-line basis, which approximates the interest method.
Concentration of Credit Risk
Substantially all of the Company's receivables are within the oil and gas
industry, primarily from the purchasers of its oil (see Note 14) and joint
interest owners. Collectibility of the Company's receivables is dependent upon
the general economic conditions of the industry. The receivables are generally
not collateralized and, to date, the Company has experienced minimal bad
debts.
The majority of the Company's cash and cash equivalents is held by three
financial institutions located in Salt Lake City, Utah, Shelby, Montana and
Houston, Texas.
Net Income (Loss) Per Share
Net income (loss) per share of common stock is computed based on the
weighted average number of common and common equivalent shares outstanding
during the period. Options, warrants and convertible preferred stock are
excluded from the calculation, when their effect would be antidilutive.
F-9
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Cash Equivalents and Statement of Cash Flows
The Company considers all highly-liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents.
Non-cash transactions not reflected in the consolidated statement of cash
flows include the following:
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED
------------------------ --------------
1993 1994 1995 MARCH 31, 1996
--------------- -------- --------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Common Stock issued for:
.Unproved oil and gas properties..... $ 291 $ 884 $ 27 $ --
.Cancellation of note payable to
related party....................... -- 38 -- --
Conversion of FX Producing convertible
preferred stock into the Company's
common stock.......................... -- -- 1,781 --
Conversion of redeemable FX Producing
preferred stock into the Company's
common stock.......................... -- -- 85 --
Conversion of the Company's preferred
stock into common stock............... -- -- 1,363 120
FX Producing convertible preferred
stock issued for oil and gas
properties............................ -- 2,111 -- --
Additions to oil and gas properties
resulting from granting of stock
options at below market value......... -- -- 63 --
Additions to oil and gas properties
financed with trade accounts payable.. -- -- 115 --
Additions to other property and
equipment financed with long-term
leases................................ -- -- -- 18
</TABLE>
Income Taxes
Deferred income taxes are provided on the difference between the tax basis
of an asset or liability and its reported amount in the financial statements
that will result in taxable or deductible amounts in future years when the
reported amount of the asset or liability is recovered or settled,
respectively.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Reclassifications
Certain balances in the December 31, 1993 and 1994 financial statements have
been reclassified to conform with the current year presentation. These changes
had no effect on previously reported net loss, total assets, liabilities or
stockholders' equity.
Unaudited Financial Information
In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting only of normal
recurring items) necessary to present fairly the consolidated financial
position of the Company as of March 31, 1996 and the consolidated results of
operations and cash flows for the
F-10
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
three months ended March 31, 1995 and 1996. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to the SEC's rules and regulations. The results of operations for the
periods presented are not necessarily indicative of the results to be expected
for the full year.
Accounting Pronouncements
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation.
The Company has elected to continue to apply the current stock based
compensation methods pursuant to APB 25 and to furnish the additional
disclosures required by SFAS No. 123. The Company also adopted, as of January
1, 1996, SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed of. The adoption of SFAS No. 121 had no
impact on the Company's financial statements.
2. CASH-RESTRICTED:
In accordance with an amendment to the Company's bank loan agreement in the
first quarter of 1996, the Company is required to purchase a certificate of
deposit in the amount of $300,000 in lieu of making its normal principal
reduction payments of $25,000 per month for the period from March 1 to
September 30, 1996. The certificate of deposit was purchased in April 1996 and
matures on November 1, 1996. The certificate of deposit is pledged as
collateral for the bank note through its maturity date of November 1, 1996.
3. PERFORMANCE BOND DEPOSITS:
The Company maintains certificates of deposit of $217,400 at December 31,
1995, which are held at financial institutions in lieu of performance bonds
for various federal and state agencies.
As of December 31, 1995, the Company had provided a replacement bond to a
federal agency in the amount of $463,000, collateralized by a $67,400
certificate of deposit included in the amount above and $164,100 provided by B
& B Production Co. (a related party). The Company is required to reimburse B &
B Production Co. upon demand and is paying B&B Production Co. interest at 9%
on the $164,100.
4. ACQUISITIONS:
In June 1993, the Company acquired Petrolex Corporation ("Petrolex"), a
privately-held oil and gas lease brokerage, arbitrage and investment company.
The Company acquired all of the issued and outstanding shares of Petrolex's
common stock in exchange for 400,000 shares of the Company's common stock.
Because common control existed between the Company and Petrolex, the
transaction was accounted for at historical cost.
Effective April 1994, the Company, through its subsidiaries, FX Producing
and FX Drilling Company, Inc., acquired certain producing oil properties from
B&B Production Company (B&B) and well servicing equipment and related assets
from J.R. Bacon Drilling, Inc. for a total purchase price of $5,650,000. The
acquisition was funded with bank borrowings and the issuance of FX Producing
preferred stock. The acquisition was accounted for by the purchase method with
the purchase price allocated between the proved oil properties, well servicing
equipment and related assets based on their relative fair values.
The unaudited pro forma condensed consolidated statements of operations for
the years ended December 31, 1993 and 1994 have been prepared to give effect
as if the transactions had occurred on January 1, 1993 and 1994, respectively.
The pro forma adjustments included are based on assumptions and estimates and
are not necessarily indicative of the results of operations of the Company as
they might have been or as they may be in the future.
F-11
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
PRO FORMA FOR THE
YEARS ENDED
DECEMBER 31,
------------------
1993 1994
-------- --------
(IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
Revenues................................................... $ 3,801 $ 2,984
Operating costs and expenses............................... 4,140 4,065
-------- --------
Operating loss............................................. (339) (1,081)
Other income (expense)..................................... (295) (247)
-------- --------
Net loss................................................... $ (634) (1,328)
======== ========
Net loss per common share.................................. $ (0.36) $ (0.60)
======== ========
</TABLE>
5. LONG-TERM DEBT:
The following is a summary of long-term debt:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- MARCH 31,
1994 1995 1996
------ -------------- -----------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C>
Note payable to a bank by FX Producing,
bearing interest at prime plus 1.25%, (9.5%
at March 31, 1996) with monthly payments of
$25,000 of principal plus interest, collat-
eralized by the common stock and producing
oil properties of FX Producing............. $4,350 $3,640 $3,565
Notes payable, bearing interest at rates
from 6% to 8.9%, with monthly payments of
principal and interest totaling $2,644,
collateralized by well service vehicles and
equipment.................................. 72 44 54
------ ------ ------
4,422 3,684 3,619
Less current portion........................ (331) (325) (180)
------ ------ ------
Total....................................... $4,091 $3,359 $3,439
====== ====== ======
</TABLE>
Future maturities of long-term debt are as follows at December 31:
<TABLE>
<S> <C>
1996.................................................................. $ 325
1997.................................................................. 3,359
------
$3,684
======
</TABLE>
The note payable to a bank, which is guaranteed by the Company, is subject
to extension at the option of the lender for successive one-year periods
following semi-annual reviews of FX Producing's oil reserve data and
recalculation of the borrowing base. Should the outstanding balance of the
loan exceed the borrowing base, the Company may be required to fund the
deficiency.
Provisions of the loan agreement related to the note payable to a bank
require compliance with certain covenants, including tangible net worth
requirements of FX Producing and the Company and other financial ratios. In
addition, the loan imposes restrictions on other indebtedness, guarantees,
loans to other parties, and sales or pledges of collateralized assets. The
Company is also prohibited from declaring or paying cash dividends on any
class of FX Producing's or the Company's capital stock, and is prohibited from
making distributions on, and purchasing or redeeming any shares of, any class
of FX Producing's or the Company's capital stock.
F-12
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As of December 31, 1995, the Company was in violation of the loan
agreement's cash flow-to-debt service requirements applicable to FX Producing.
Non-compliance with any such ratios and covenants could result in termination
of the loan agreement, however the bank waived the cash flow-to-debt service
requirement for the quarters ending December 31, 1995 and March 31, 1996 and
has amended this provision for the quarters ending June 30, and September 30,
1996 and thereafter. The amendment waived the monthly principal reductions of
$25,000 for the period from March 1 through September 30, 1996 and required
the Company to purchase a $300,000 certificate of deposit maturing November 1,
1996, which certificate of deposit is pledged as collateral to the bank note.
The Company expects that it will be in compliance with the amended cash flow-
to-debt service requirement as of June 30, 1996 and throughout the remainder
of 1996.
On May 13, 1996, the bank amended the loan agreement to extend the maturity
date of the note from January 1, 1997 to October 1, 1997 (unaudited).
6. INCOME TAXES:
The Company recognized no income tax benefit from the losses generated
during the years ended December 31, 1993, 1994 and 1995.
The components of the net deferred tax asset as of December 31, 1994 and
1995 are as follows.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1994 1995
------- --------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax liability:
Property and equipment basis differences................... $ (24) $ (519)
Deferred tax asset:
Net operating loss carryforwards........................... 669 2,045
Valuation allowance........................................ (645) (1,526)
------ --------
Net deferred tax asset..................................... $ -- $ --
====== ========
</TABLE>
The change in the valuation allowance during the years ended December 31,
1993, 1994 and 1995, is as follows:
<TABLE>
<CAPTION>
1993 1994 1995
---- ----- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Balance, beginning of year............................... $-- $ -- $ (645)
Decrease due to property and equipment basis differ-
ences................................................... -- 24 495
Increase due to net operating loss....................... -- (669) (1,376)
---- ----- -------
Balance, end of year..................................... $-- $(645) $(1,526)
==== ===== =======
</TABLE>
Statement of Financial Accounting Standards (SFAS) No. 109 requires that a
valuation allowance be provided if it is more likely than not that some
portion or all of a deferred tax asset will not be realized. The Company's
ability to realize the benefit of its deferred tax asset will depend on the
generation of future taxable income through profitable operations and
expansion of the Company's oil and gas producing activities. The market and
capital risks associated with that growth requirement are considerable,
resulting in the Company's conclusion that a full valuation allowance be
provided.
At December 31, 1995, the Company has net operating loss carryforwards of
approximately $5,480,000 available to offset future taxable income, which
expire from 2008 through 2010. The utilization of these
F-13
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
carryforwards against future taxable income may become subject to an annual
limitation due to a change in ownership.
7. RELATED PARTY TRANSACTIONS:
Officers of the Company have an interest in a company which prior to 1995
provided management services and office facilities to the Company. At December
31, 1995, the Company owed this company a total of $95,005, including interest
at 9% of $17,997. During the year ended December 31, 1993, this company also
billed the Company $28,000 for rent and $13,254 for labor provided. During the
years ended December 31, 1993 and 1994, this company billed the Company
$150,000 and $195,067, respectively, for management services.
In August 1995, the Company issued to a director's consulting company, in
consideration of a loan agreement and consulting agreement, 200,000 shares of
restricted common stock and granted to the director options to purchase
350,000 shares of common stock at an exercise price of $3.00 per share. The
Company recognized $400,000 as compensation expense in connection with the
issuance of such 200,000 shares.
8. REDEEMABLE FX PRODUCING PREFERRED STOCK:
During the year ended December 31, 1994, the Company issued 366,666 shares
of redeemable FX Producing preferred stock with a liquidation preference
totaling $550,000. During the year ended December 31, 1995, 301,731 of these
shares were redeemed for cash payments of $464,666 and 64,935 of these shares
were converted into common shares valued at $85,334.
9. MINORITY INTEREST IN FX PRODUCING CONVERTIBLE PREFERRED STOCK:
FX Producing has been authorized to issue up to 3,300,000 shares of
convertible preferred stock which bears a dividend of 8% payable in cash or
kind. Holders of FX Producing convertible preferred stock have preference on
liquidation proceeds from FX Producing. One share of FX Producing preferred
stock is convertible at the election of the holder to one share of Company
common stock, subject to adjustment, at any time during 1995. Dividends on FX
Producing preferred stock will be paid at the rate of 8% of the original
issuance price of $1.50 per share, payable in cash or in additional shares of
FX Producing preferred stock at the Company's discretion, and subject to bank
loan covenants, cumulative from the date of issuance. Dividends are payable
each June 30 and December 31, beginning December 31, 1994.
During the year ended December 31, 1994, the Company issued 1,791,667 shares
of FX Producing convertible preferred stock valued at $2,111,070 for producing
oil properties and well servicing equipment, and issued 1,267,480 shares for
cash proceeds of $1,694,527. During 1994 the Company also redeemed 1,617,000
shares of FX Producing convertible preferred stock for $2,150,400. In
addition, stock subscriptions receivable of $111,000 were due FX Producing as
of January 1, 1995. During the year ended December 31, 1995, FX Producing
received the $111,000 in proceeds from the stock subscriptions receivable,
accrued for issuance 62,311 convertible preferred shares at a value of $93,466
as dividends, and converted 1,504,458 shares into the Company's common stock
at a value of $1,780,462, resulting in no shares of FX Producing convertible
preferred stock outstanding as of December 31, 1995.
10. COMMON STOCK ISSUABLE, STOCK OPTIONS AND WARRANTS:
Common Stock Issuable
In connection with the purchase of the Company's' producing oil properties
and well servicing equipment in 1994, the Company agreed to issue to the
former owners up to 400,000 shares of Company common stock in
F-14
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
semi-annual increments of 50,000 shares each beginning October 1, 1994 on the
attainment of certain levels of oil production from the properties acquired.
Production levels as of October 1, 1995 had not attained required levels and
thus 150,000 shares which might have been issued through October 1, 1995 had
not been issued. Accordingly, the number of shares which may be issued in the
future has been reduced to 250,000 shares as of December 31, 1995, and further
reduced to 200,000 shares as of March 31, 1996 (unaudited).
Stock Options
On August 31, 1995, the Company adopted the 1995 Stock Option and Award Plan
(the "Plan"). This Plan replaced the 1994 Employee Incentive Plan under which
no options have been issued. The Plan is administered by a committee (the
"Committee") consisting of the board of directors, or a committee thereof. At
its discretion, the Committee may grant stock options to any employee,
including officers, in the form of incentive stock options ("ISOs") as defined
in the Internal Revenue Code, stock awards or options which do not qualify as
ISOs. A maximum of 500,000 shares, subject to adjustment for certain events of
dilution, is available for grant.
During the year ended December 31, 1995, the Company issued 50,000 incentive
stock options under the Plan. The Company also issued non-qualified options
during the years ended December 31, 1993, 1994 and 1995. Changes in
outstanding stock options during 1993, 1994 and 1995 were as follows:
<TABLE>
<CAPTION>
SHARES PRICE RANGE
--------- -----------
<S> <C> <C>
Outstanding at December 31, 1992: -- --
Options granted to two officers and directors;
immediately exercisable; expiring May 7, 1998......... 300,000 $ 1.50
Options granted to an individual for consulting
services; immediately exercisable; expiring May 7,
1998.................................................. 120,000 1.50
--------- -----------
Outstanding at December 31, 1993: 420,000 1.50
Options granted to two officers and directors;
exercisable 20% per year beginning June 9, 1995;
expiring June 9, 2004................................. 1,000,000 3.00
--------- -----------
Outstanding at December 31, 1994: 1,420,000 1.50- 3.00
Options granted to two individuals directly involved in
obtaining Poland exploration rights. 125,000 shares
immediately exercisable; 100,000 shares exercisable as
specific performance benchmarks are achieved; expiring
August 31, 2000....................................... 225,000 1.50
Options granted to a shareholder's company for
financial consulting and providing a line of credit of
$60,000 through March 31, 1996; 150,000 immediately
exercisable; 100,000 vest on December 31, 1996 and
1997; expiring August 3, 2000 to 2002................. 350,000 3.00
Options granted to officers and directors, including
150,000 options immediately exercisable at $2.00 per
share which replaced a contingent obligation to issue
100,000 shares of common stock pursuant to an
employment agreement; expiring September 29 to October
6, 2000............................................... 400,000 2.00- 3.00
Options granted to employees; 75,000 currently
exercisable and 75,000 vesting in 1996; expiring
October 9 to November 9, 2000......................... 150,000 3.00
Incentive stock options granted to employees under the
1995 Stock Option and Award Plan; expiring August 31,
2000.................................................. 50,000 1.50
--------- -----------
Outstanding at December 31, 1995......................... 2,595,000 $1.50-$3.00
========= ===========
Exercisable at December 31, 1995......................... 1,420,000 $1.50-$3.00
========= ===========
</TABLE>
F-15
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Warrants
Changes in outstanding warrants during 1993, 1994 and 1995 were as follows:
<TABLE>
<CAPTION>
SHARES PRICE RANGE
------- ------------
<S> <C> <C>
Outstanding at December 31, 1992: -- --
Warrants granted as commission to broker; expiring May
31, 1998............................................. 150,000 $ 1.10
------- ------------
Outstanding at December 31, 1993: 150,000 1.10
Warrants granted as commission to brokers; expiring
September 30, 1999................................... 82,198 1.65
------- ------------
Outstanding at December 31, 1994: 232,198 1.10--1.65
Warrants granted as commission to brokers; expiring
September 30, 1999................................... 4,000 1.65
Warrants granted in consideration of consulting agree-
ment; expiring September 30, 1998.................... 60,000 2.20
Warrants granted in consideration of consulting agree-
ment; expiring November 9, 2000...................... 100,000 3.00
Warrants exercised..................................... (65,000) 1.10
------- ------------
Outstanding and exercisable at December 31, 1995........ 331,198 $1.10--$3.00
======= ============
</TABLE>
During the three months ended March 31, 1996, no warrants were granted and
22,004 were exercised at an average price of $1.20 per warrant. No options
were granted or exercised during the same period (unaudited).
11. ISSUANCE OF PREFERRED STOCK:
The Company has been authorized to issue up to 5,000,000 shares of preferred
stock. The issued and outstanding Company preferred stock does not have a
preference on dividends but participates with the common stock outstanding on
a share-for-share basis. Holders of the Company's preferred stock have
preference on liquidation proceeds, equal to $1.00 per share.
In 1993 and 1994, the Company issued a total of 1,500,000 shares of
preferred stock in a private placement at $1.00 per share. One share of
preferred stock is convertible into one share of common stock. During the year
ended December 31, 1995, 1,362,500 preferred shares were converted into the
same number of common shares resulting in 137,500 preferred shares of stock
outstanding at December 31, 1995. Liquidating preferences total $137,500 for
this class of preferred stock at December 31, 1995.
During the three months ended March 31, 1996, 120,000 preferred shares were
converted into the same number of common shares resulting in 17,500 preferred
shares of stock (with liquidating preferences totaling $17,500) outstanding at
March 31, 1996 (unaudited).
12. COMMITMENTS:
Poland Exploration Agreement:
On August 22, 1995, the Company entered into an exploration agreement (the
"Agreement") with the Government of Poland covering a 2.25 million acre block
in the onshore Baltic Platform area of north central Poland. The Agreement
provides for a six-year exploration term with a 30-year exploitation right as
to any commercial discoveries. The Agreement requires the Company to spud one
well in 1996, annual fees of approximately $58,000, and geological and
geophysical expenditures of $250,000 during the first 18 months.
F-16
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In order to fund the required expenditures under the Agreement, the Company
must either enter into a joint venture arrangement with a partner (see Note
13) with adequate financial resources or raise additional debt or equity (in
addition to that raised in the private placement discussed in Note 13). If the
Company is unable to fund the required expenditures under the Agreement, it
would attempt to sell or farm-out its entire interest in the agreement or it
would forfeit its interest in the project, which had a capitalized cost of
$370,000 at December 31, 1995 ($390,000 at March 31, 1996, unaudited).
Employment Agreements:
Effective January 1, 1995, the Company entered into three-year employment
agreements with two officers. The agreements provide for aggregate annual
compensation of $210,000 with annual increases of at least 7.5%, as determined
by the Board of Directors or a compensation committee. Each employment
agreement, as amended, provides that on the initiation of the first test well
in the Baltic Concession, the executive employee is entitled to receive a
bonus in the form of a $100,000 credit that may be applied against the
exercise of options to purchase Common Stock. The terms of such employment
agreements are automatically extended for an additional year on the
anniversary date of each such agreement. In the event of termination of
employment resulting from a change in control of the Company not approved by
the Board of Directors, each of the two officers would be entitled to a
termination payment equal to 150% of his annual salary at the time of
termination and the value of previously granted employee benefits, including
stock options and stock awards.
Consulting Agreement:
The Company entered into a consulting agreement, effective August 3, 1995,
with a director's consulting company under which it advises the Company
respecting future financing alternatives, identifying possible sources of debt
and equity financing, with particular emphasis on funding for the Baltic
Concession and the Company's relationship with the investment community at a
fee of $10,000 per month commencing October 15, 1995, and continuing through
December 31, 1997.
13. EVENTS SUBSEQUENT TO MARCH 31, 1996 (UNAUDITED):
During April and May 1996, the Company sold 156,111 shares of common stock
at an offering price of $4.50, resulting in net proceeds of approximately
$680,000. During the same period, 80,000 options to purchase common stock were
exercised at $1.50 per share, resulting in proceeds to the Company of
$120,000.
On May 3, 1996, the Company entered into an agreement with RWE-DEA,
Aktiengesellschaft fur Mineraloel und Chemie, Hamburg, Germany ("RWE-DEA"),
which provides for joint operations on the Company's approximately 2.4 million
acre on-shore Baltic Platform concession area in northern Poland.
This agreement grants to RWE-DEA the right to earn a 50% interest in the
concession area by paying the Company $250,000 in cash as reimbursement of
costs incurred to date, paying up to $1,000,000 (plus 10% contingency) for a
seismic study now being initiated on the Gladysze and two other structures
within the concession area, and bearing up to $1,000,000 of the cost of an
exploratory well scheduled for the last half of 1996 at a location to be
designated by RWE-DEA. Should the costs of the planned seismic or drilling of
the first exploratory well in 1996 exceed the amounts RWE-DEA is obligated to
pay, the Company will be required to pay 50% of the excess. In order to obtain
necessary funds, the Company may have to seek amounts of additional equity or
funding through an industry-formed drilling group. The Company is designated
as the operator of all joint operations. The Company has agreed to pay an
unaffiliated party a fee of approximately $125,000 for assisting the Company
in its search for an international joint venture partner.
F-17
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The agreement with RWE-DEA is subject to approval by the Polish authorities.
Based on informal discussions between the Company, RWE-DEA, and the Polish
authorities, the Company expects that such approval will be obtained. If such
required approval is not obtained, the Company is required to return the
initial $250,000 cash payment and reimburse all of RWE-DEA's direct
expenditures.
In June 1996, the Company entered into a letter of intent with investment
bankers to provide services concerning a proposed public offering of the
Company's securities.
14. DISCLOSURES ABOUT OIL AND GAS PROPERTIES AND PRODUCING ACTIVITIES:
The Company's significant oil and gas properties are located in Montana,
Nevada, Utah and Poland. The Company had no working interest in any producing
wells until April 1, 1994, when FX Producing acquired certain oil properties.
For the years ended December 31, 1994 and 1995, the Company sold oil to one
purchaser comprising 89% and 85%, respectively, of the Company's total oil
sales, all of which occurred in the United States.
Capitalized costs relating to oil and gas producing activities as of
December 31, 1994 and 1995 are summarized as follows:
<TABLE>
<CAPTION>
UNITED STATES POLAND TOTAL
------------- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
DECEMBER 31, 1994:
Proved properties.......................... $4,850 $-- $4,850
Unproved properties........................ 1,525 -- 1,525
------ ---- ------
6,375 -- 6,375
Less accumulated depreciation, depletion
and amortization.......................... (229) -- (229)
------ ---- ------
Total.................................... $6,146 $-- $6,146
====== ==== ======
DECEMBER 31, 1995:
Proved properties.......................... $6,063 $-- $6,063
Unproved properties........................ 1,426 370 1,796
------ ---- ------
7,489 370 7,859
Less accumulated depreciation, depletion
and amortization.......................... (406) -- (406)
------ ---- ------
Total.................................... $7,083 $370 $7,453
====== ==== ======
Costs incurred in oil property acquisition, exploration and development
activities during the years ended December 31, 1993, 1994 and 1995, whether
capitalized or expensed, are summarized as follows:
<CAPTION>
UNITED STATES POLAND TOTAL
------------- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
DECEMBER 31, 1993:
Acquisition of properties
Proved properties.......................... $ -- $-- $ --
Unproved properties........................ 332 -- 332
Exploration costs............................ 654 -- 654
------ ---- ------
Total costs incurrued.................... $ 986 $-- $ 986
====== ==== ======
</TABLE>
F-18
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
UNITED STATES POLAND TOTAL
------------- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
DECEMBER 31, 1994:
Acquisition of properties
Proved properties............................ $4,265 -- $4,265
Unproved properties.......................... 910 -- 910
Exploration costs.............................. 651 -- 651
Development costs.............................. 585 -- 585
------ ---- ------
Total costs incurred....................... $6,411 $-- $6,411
====== ==== ======
DECEMBER 31, 1995:
Acquisition of properties
Proved properties............................ $ 48 $-- $ 48
Unproved properties.......................... 16 370 386
Exploration costs.............................. 533 214 747
Development costs.............................. 1,175 -- 1,175
------ ---- ------
Total costs incurred....................... $1,772 $584 $2,356
====== ==== ======
</TABLE>
15. SUMMARY OIL AND GAS RESERVE DATA (UNAUDITED):
The following quantity and value information is based on prices as of the
end of each respective reporting period. No price escalations were assumed
except for sales made under terms of contracts which include fixed and
determinable escalations. Operating costs and production taxes were deducted
in determining the quantity and value information. Such costs were estimated
based on current costs and were not adjusted to anticipate increases due to
inflation or other factors. No amounts were deducted for general overhead,
depreciation, depletion and amortization and interest expense.
The determination of oil and gas reserves is based on estimates and is
highly complex and interpretive. The estimates are subject to continuing
change as additional information becomes available and an accurate
determination of the reserves may not be possible for several years after
discovery.
F-19
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Estimated Quantities of Proved Oil Reserves
Following is a reconciliation of the Company's interest in net quantities of
proved oil reserves. All proved oil reserves are located in the United States.
Proved reserves are the estimated quantities of crude oil which geological and
engineering data demonstrate with reasonable certainty to be recoverable in
future years from known reserves under existing economic and operating
conditions. Changes in estimated oil reserves of the Company for the years
ended December 31, 1994 and 1995, are as follows:
<TABLE>
<CAPTION>
FOR THE YEARS
ENDED DECEMBER 31,
--------------------
1994 1995
--------- ---------
(MBBL)
<S> <C> <C>
Total proved reserves:
Beginning of year....................................... -- 5,734
Purchase of minerals-in-place........................... 4,863 146
Extensions and discoveries.............................. 1,255 --
Revisions of previous estimates......................... (267) (488)
Production.............................................. (117) (135)
--------- ---------
End of year........................................... 5,734 5,257
========= =========
Proved developed reserves:
Beginning of year....................................... -- 2,655
========= =========
End of year............................................. 2,655 2,683
========= =========
</TABLE>
The downward revisions of previous estimates of total proved reserves in
1994 were principally due to a decline in the average price of oil during the
nine months from April 1, 1994 (date of acquisition), to December 31, 1994,
and an abnormal increase in water production rates in one field causing a
decrease in estimated remaining reserves. The decrease in 1995 was principally
due to substantial completion of a water flood project resulting in removal of
proved undeveloped reserves with no corresponding increase in proved developed
reserves as production rates in the field had not then shown adequate
production to justify recognition as proved developed reserves.
Standardized Measure of Discounted Future Net Cash Flows and Changes Therein
Relating to Proved Oil Reserves
Estimated discounted future net cash flows and changes therein were
determined in accordance with Statement of Financial Accounting Standards No.
69. Certain information concerning the assumptions used in computing the
valuation of proved reserves and their inherent limitations are discussed
below. The Company believes such information is essential for a proper
understanding and assessment of the data presented.
Future cash flows are computed by applying period-end prices of oil relating
to the Company's proved reserves to the period-end quantities of those
reserves.
The assumptions used to compute the proved reserve valuation do not
necessarily reflect the Company's expectations of actual revenues to be
derived from those reserves nor their present worth. Assigning monetary values
to the reserve quantity estimation process does not reduce the subjective and
ever-changing nature of such reserve estimates.
F-20
<PAGE>
FX ENERGY, INC., AND SUBSIDIARIES
(FORMERLY KNOWN AS FRONTIER OIL EXPLORATION COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Additional subjectivity occurs when determining present values because the
rate of producing the reserves must be estimated. In addition to errors
inherent in predicting the future, variations from the expected production
rate also could result directly or indirectly from factors outside the
Company's control, such as unintentional delays in development, environmental
concerns and changes in prices or regulatory controls.
The reserve valuation assumes that all reserves will be disposed of by
production. However, if reserves are sold in place, additional economic
considerations also could affect the amount of cash eventually realized.
Future development and production costs are computed by estimating
expenditures to be incurred in developing and producing the proved oil
reserves at the end of the period, based on period-end costs and assuming
continuation of existing economic conditions.
A discount rate of 10% per year was used to reflect the timing of the future
net cash flows.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
1994 1995
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Future cash flows....................................... $ 72,914 $ 86,643
Future production and development costs................. (33,728) (41,463)
--------- ---------
Future net cash flows................................... 39,186 45,180
Future income tax expense............................... (8,064) (11,628)
--------- ---------
Future net cash flows................................. 31,122 33,552
10% annual discount for estimated timing of cash flows.. (14,369) (15,891)
--------- ---------
Standardized measure of discounted future net cash
flows.................................................. $ 16,753 $ 17,661
========= =========
</TABLE>
Standardized Measure of Discounted Future Net Cash Flows and Changes Therein
Relating to Proved Oil Reserves:
The following are principal sources of changes in the standardized measure
of discounted future net cash flows:
<TABLE>
<CAPTION>
1994 1995
------- -------
(IN THOUSANDS)
<S> <C> <C>
Balance, beginning of year.................................... $ -- $16,753
Sales of oil produced, net of production costs................ (1,035) (709)
Net changes in prices and production costs.................... (1,377) 4,663
Purchases of minerals in-place................................ 20,125 681
Extensions and discoveries, net of future costs............... 5,236 --
Changes in estimated future development costs................. (630) 349
Development costs incurred during the year.................... 134 1,298
Revisions in previous quantity estimates...................... (1,015) (2,467)
Accretion of discount......................................... 1,509 1,675
Net change in income taxes.................................... (2,404) (2,178)
Changes in rates of production and other...................... (3,790) (2,404)
------- -------
Balance, end of year.......................................... $16,753 $17,661
======= =======
</TABLE>
F-21
<PAGE>
HAMILTON MISFELDT & COMPANY P.C.
CERTIFIED PUBLIC ACCOUNTANTS
INDEPENDENT AUDITORS' REPORT
TO THE GENERAL PARTNERS
B&B PRODUCTION COMPANY
SHELBY, MONTANA
We have audited the accompanying statement of operations of B & B Production
Company (a general partnership) for the year ended December 31, 1993. This
financial statement is the responsibility of the Company's management. Our
responsibility is to express an opinion on this financial statement based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statement is free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statement. An audit
also includes assessing the accounting principles used and the significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statement referred to above presents fairly,
in all material respects, the results of operations of B & B Production
Company (a general partnership) for the year ended December 31, 1993 in
conformity with generally accepted accounting principles.
HAMILTON MISFELDT & COMPANY, P.C.
February 14, 1994
- -------------------------------------------------------------------------------
118 EAST MAIN CUT BANK, MONTANA 59427 (406) 873-5564 FAX (406) 873-4410
F-22
<PAGE>
B & B PRODUCTION COMPANY
(A GENERAL PARTNERSHIP)
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1993
<TABLE>
<S> <C>
Sales
Oil sales........................................................ $2,457,348
Contract services................................................ 509,281
Consulting fees.................................................. 30,627
----------
2,997,256
----------
Operating expenses
Royalty.......................................................... 384,262
Production taxes................................................. 282,100
Operating expense................................................ 1,883,282
Travel & other expense........................................... 1,361
Telephone........................................................ 7,341
Office supplies.................................................. 2,068
Legal............................................................ 1,527
Accounting....................................................... 56,690
Bank charges..................................................... 711
Bad debt......................................................... 36,705
Recording fees................................................... 1,672
Postage.......................................................... 2,288
Contract services................................................ 26,010
Clerical services................................................ 57,250
Leases and equipment rental...................................... 172
Utilities........................................................ 3,053
Office maintenance............................................... 3,720
Property taxes................................................... 1,091
Dry hole costs................................................... 157,593
Insurance........................................................ 538
Reclamation costs................................................ 201,145
Depreciation..................................................... 113,903
Depletion........................................................ 58,781
Dues and subscriptions........................................... 409
Donations........................................................ 228
----------
TOTAL OPERATING EXPENSES....................................... 3,283,900
----------
LOSS FROM OPERATIONS............................................... (286,644)
----------
LOSS FROM OPERATIONS (brought forward)............................. (286,644)
OTHER INCOME (EXPENSES)
Interest expense................................................. (19,289)
Interest and dividend income..................................... 38,868
Gain on sale of equipment........................................ 3,240
Loss on sale of leasehold........................................ (4,210)
Other income..................................................... 12,914
Royalty income................................................... 2,681
----------
34,204
----------
NET LOSS....................................................... $ (252,440)
==========
</TABLE>
See accompanying notes to financial statements
F-23
<PAGE>
B & B PRODUCTION COMPANY
(A GENERAL PARTNERSHIP)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1993
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
B & B Production Company is a general partnership formed in the State of
Montana on August 14, 1986. The general partners are J.R. Bacon Drilling,
Inc., a Utah corporation, and RLB Oil Company, a Montana corporation. The
Company was created to explore, develop, and produce hydrocarbons from oil and
gas properties.
Depletion and depreciation--The costs of producing properties are
capitalized as leaseholds for accounting purposes. Depletion is provided for
under the cost depletion method for financial statement purposes. For income
tax purposes, depletion is provided for under the cost depletion method for
properties purchased in 1990 and prior, and the percentage depletion method
for properties purchased in 1991 and thereafter. Depletion for the year ended
December 31, 1993, was $58,781.
All of the depreciable assets are carried at cost. Depreciation is
calculated using straight-line and accelerated methods over useful lives of 5,
7, and 10 years for both financial statement and income tax purposes.
Depreciation for the year ended December 31, 1993, was $113,903.
Income taxes--Federal and state income taxes are the personal obligations of
the partners. Therefore, no provision for income taxes has been provided in
the financial statements.
Oil and gas properties--The Company uses the successful efforts method of
accounting for oil and gas producing activities. Costs to acquire mineral
interests in oil and gas properties, to drill and equip exploratory wells that
find proved reserves, and to drill and equip development wells are
capitalized. Costs to drill exploratory wells that do not find proved
reserves, geological and geophysical costs, and costs of carrying and
retaining unproved properties are expensed.
Unproved oil and gas properties that are individually significant are
periodically assessed for impairment by providing an impairment allowance.
Other unproved properties are amortized based on the Company's experience of
successful drilling and average holding period. Capitalized costs of producing
oil and gas properties, after considering estimated dismantlement and
abandonment costs and estimated salvage values, are depreciated and depleted
by the unit of production method. Support equipment and other property and
equipment are depreciated over their estimated useful lives.
On sale or retirement of a complete unit of a proved property, the cost and
related accumulated depreciation, depletion, and amortization are eliminated
from the property accounts, and the resulting gain or loss is recognized. On
retirement or sale of a partial unit of proved property, the cost is charged
to accumulated depreciation, depletion, and amortization with a resulting gain
or loss recognized in income.
On sale of an entire interest in an unproved property for cash or cash
equivalent, gain or loss on the sale is recognized, taking into consideration
the amount of any recorded impairment if the property had been assessed
individually. If a partial interest in an unproved property is sold, the
amount received is treated as a reduction of the costs of the interest
retained.
NOTE 2: RELATED PARTY TRANSACTIONS
B & B Production Company (B & B) does a significant amount of business with
the J.R. Bacon Drilling, Inc. (JRB) which is a general partner in B & B. JRB
is the operator of the Southwest Cut Bank Sand Unit (SWCBSU).
F-24
<PAGE>
B & B PRODUCTION COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993
J.R. Bacon Drilling, Inc. is the major supplier of oil field services for
the Company. The amount paid for these services for the year ended December
31, 1993, was $952,072.
Total clerical services paid to JRB for accounting services for the year
ended December 31, 1993, was $57,250.
B & B receives consulting fees from JRB for well drilling consulting work.
In 1993, fees collected by B & B were $30,627.
Contract services includes $19,728 in 1993, paid to RLB Oil Company, a
general partner in B & B for accounting services.
NOTE 3: ACCRUED RECLAMATION COSTS
The Company has estimated its future costs of plugging its oil wells and
reclaiming the land as required by federal and state regulations. Costs have
been estimated using current dollars on a per barrel of production basis.
Accrued reclamation costs charged to expense for the year ended December 31,
1993, was $201,145.
NOTE 4: SIGNIFICANT CUSTOMERS
The Company's oil sales were made to only four customers, one of which is
located in Montana and three of which are located in Utah.
NOTE 5: OIL PRODUCING PROPERTIES AND ACTIVITIES
All oil operations of the Company are conducted in the United States.
Costs both capitalized and expensed, incurred in oil producing activities
during the year ended December 31, 1993, are as follows:
<TABLE>
<S> <C>
Acquisition costs................................................ $ 62,359
========
Exploration costs................................................ $157,593
========
Development costs................................................ $ 68,871
========
</TABLE>
Results of operations for oil producing activities for the year ended
December 31, 1993, is as follows:
<TABLE>
<S> <C>
Oil sales.................................................. $ 2,457,348
Loss on sale of leasehold.................................. (4,210)
Royalty.................................................... (384,262)
Production costs........................................... (2,165,382)
Exploration expenses....................................... (157,593)
Depreciation, depletion, and amortization.................. (172,684)
-----------
Results of operations for oil producing activities (exclud-
ing overhead and financing costs)......................... $ (426,783)
===========
</TABLE>
NOTE 6: SUPPLEMENTAL INFORMATION ON OIL RESERVES (UNAUDITED)
Estimated quantities of proved oil reserves--Reserve calculations involve
the estimation of future net recoverable reserves of oil and the timing and
amount of future net revenues to be received therefrom. These
F-25
<PAGE>
B & B PRODUCTION COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993
estimates are based on numerous factors, many of which are variable and
uncertain. Accordingly, it is common for the actual production and revenues to
vary from earlier estimates. Estimates made in the first few years of
production from a property are not likely to be as reliable as later estimates
based on longer production history. Hence, reserve estimates and estimates of
future net revenues from production may be subject to substantial revision
from year to year. Reserve information presented herein is based on reports
prepared by an independent petroleum engineer.
Proved oil reserves are the estimated quantities of crude oil, which
geological and engineering data demonstrate with reasonable certainty to be
recoverable in future years from known reservoirs under existing economic and
operating conditions, existing equipment and operating methods. However,
reserve information should not be construed as the current market value of the
Company's oil reserves or the costs that would be incurred to obtain
equivalent reserves.
Set forth below is the unaudited summary of the changes in the net
quantities of the Company's proved crude oil reserves.
<TABLE>
<CAPTION>
BARRELS
---------
<S> <C>
Proved reserves, December 31, 1992............................. 2,241,005
Production..................................................... (240,680)
Revisions in previous estimates................................ 2,230,932
---------
Proved reserves December 31, 1993.............................. 4,231,257
=========
Proved developed reserves:
December 31, 1993.............................................. 2,731,418
=========
</TABLE>
The Company's proved reserves (in barrels) are located in the following
states at December 31, 1993:
<TABLE>
<CAPTION>
PROVED
PROVED DEVELOPED
RESERVES RESERVES
--------- ---------
<S> <C> <C>
Montana............................................... 3,802,545 2,482,514
Nevada................................................ 428,712 248,904
--------- ---------
Total................................................. 4,231,257 2,731,418
========= =========
</TABLE>
F-26
<PAGE>
B & B PRODUCTION COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONCLUDED)
DECEMBER 31, 1993
The following is the unaudited standardized measure of discounted future net
cash flows and changes therein relating to proved oil reserves. Future net
cash flows were computed using year-end prices and costs (adjusted for
permanent differences, that relate to existing proved oil reserves in which
the Company has an interest). No provision for income taxes has been provided,
as taxes are the personal obligations of the partners. However, a pro forma
column has been presented for December 31, 1993, to show the effect of a
provision for future income tax expense on discounted future net cash flows,
as if the Company was a taxable entity.
<TABLE>
<CAPTION>
PRO FORMA
DECEMBER 31, DECEMBER 31,
1993 1993
------------ ------------
<S> <C> <C>
Future cash inflows............................... $ 48,090,318 $ 48,090,318
Future development and production costs........... (26,629,086) (26,629,086)
Net capital investment............................ (2,535,575) (2,535,575)
------------ ------------
Future net cash flows............................. 18,925,657 18,925,657
Future income tax expense......................... (3,895,000) --
------------ ------------
15,030,657 18,925,657
10% annual discount for estimated timing of cash
flows............................................ (7,172,349) (9,030,970)
------------ ------------
Standardized measure of discounted future net cash
flows............................................ $ 7,858,308 $ 9,894,687
============ ============
</TABLE>
The following is a summary by state of the standardized measure of
discounted future net cash flows at December 31, 1993:
<TABLE>
<S> <C>
Montana......................................................... $7,448,281
Nevada.......................................................... 2,446,406
----------
Total........................................................... $9,894,687
==========
</TABLE>
The following are the unaudited principal sources of changes in the
standardized measure of discounted future net cash flows for the year ended
December 31:
<TABLE>
<CAPTION>
PRO FORMA
1993 1993
---------- ----------
<S> <C> <C>
Standardized measure beginning of year.................. $7,150,093 $9,002,702
Sales of oil, net of production costs................... (291,966) (291,966)
Acquisition of minerals in place........................ 62,359 62,359
Net change due to revisions in quantity estimates....... 3,156,203 3,156,203
Net change due to changes in price...................... (2,034,611) (2,034,611)
Net change in income taxes.............................. (183,770) --
---------- ----------
Standardized measure, end of year....................... $7,858,308 $9,894,687
========== ==========
</TABLE>
F-27
<PAGE>
BARKER & FOLSOM
CERTIFIED PUBLIC ACCOUNTANTS
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholdersof J.R. Bacon Drilling, Inc.Shelby,
Montana
We have audited the accompanying statement of operations of J.R. Bacon
Drilling, Inc., a Utah corporation, for the year ended December 31, 1993. This
financial statement is the responsibility of the Company's management. Our
responsibility is to express an opinion on this financial statement based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statement. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statement referred to above presents fairly,
in all material respects, the results of operations of J.R. Bacon Drilling,
Inc. for the year ended December 31, 1993 in conformity with generally
accepted accounting principles.
Barker & Folsom
Ogden, Utah
February 28, 1994
2655 KIESEL AVENUE/OGDEN, UTAH 84401
(801) 621-0390/FAX (801) 392-7729
F-28
<PAGE>
J.R. BACON DRILLING, INC.
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1993
<TABLE>
<S> <C>
REVENUES
Well service income............................................... $1,427,241
Drilling income................................................... 476,309
----------
Total revenues.................................................. 1,903,550
----------
EXPENSES
Officers' salaries................................................ 157,429
Other salaries and wages.......................................... 343,431
Payroll taxes and benefits........................................ 145,358
Operating expenses................................................ 345,031
Administrative expense............................................ 238,103
Interest expense.................................................. 6,473
Depreciation...................................................... 205,509
----------
Total expenses.................................................. 1,441,334
----------
Income from operations............................................ 462,216
----------
Other income (loss)
Loss from partnership............................................. (126,220)
Show horse loss................................................... (47,533)
Loss on sale of horses and equipment.............................. (95,457)
Interest and dividend income...................................... 74,312
Loss on marketable securities..................................... (3,672)
----------
Total other loss................................................ (198,570)
----------
Income before income taxes........................................ 263,646
Income taxes
Current........................................................... 49,103
Deferred.......................................................... 20,861
----------
Total income taxes.............................................. 69,964
----------
NET INCOME...................................................... $ 193,682
==========
</TABLE>
The accompanying notes are an integral part of the financial statements
F-29
<PAGE>
J.R. BACON DRILLING, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1--ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
This summary of accounting policies of J.R. Bacon Drilling, Inc., is
presented to assist in understanding the Company's financial statements. The
accounting policies conform to generally accepted accounting principles and
have been consistently applied in the preparation of the financial statements.
Organization
J.R. Bacon Drilling, Inc. (the "Company"), was organized as a Utah
corporation on April 28, 1975. The Company's offices are located in Oilmont,
Montana, and it is engaged primarily in the oil and gas field service
business. The Company also provides well drilling and well workover services,
as well as operating services.
The Company has a fiscal year-end of March 31. However, the Company's
financial statements have been restated and are presented here using a
calendar year format in order to be comparable to the fiscal year of other
entities who have a calendar year end and are presented for the twelve-month
calendar year ended December 31, 1993.
Property and Equipment and Depreciation
Property and equipment is recorded at cost. The cost of property and
equipment is depreciated over the estimated useful lives of the related
assets. The Company depreciates its equipment using straight-line and
accelerated methods over estimated useful lives ranging from three to ten
years. Expenditures for maintenance and repairs are expensed.
Income Taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" which
requires the use of the "liability method" of accounting for income taxes.
Accordingly, deferred tax liabilities and assets are determined based on the
difference between the financial statement and tax bases of assets and
liabilities, using enacted tax rates in effect for the year in which the
differences are expected to reverse. Current income taxes are based on the
year's income taxable for federal and state income tax reporting purposes.
The Company files its corporate income tax return using the modified accrued
method of accounting which results in timing differences in recognizing income
and expenses for tax purposes.
NOTE 2--PARTNERSHIP INCOME (LOSS)
The Company owns 50% of the general partnership of B & B Production Company,
formed in August of 1986. The Company accounts for its investment in B & B
Production Company using the equity method. B & B Production Company acquires,
operates, explores for, develops, reworks, and produces hydrocarbons from oil
and gas properties located in Montana and Nevada.
The gross sales, net income and partners' withdrawals for the year ended
December 31, 1993, is as follows:
<TABLE>
<S> <C>
Gross sales......................................................... $2,997,256
Net income (loss)................................................... (252,440)
Partners' withdrawals............................................... 302,000
</TABLE>
The Company reported 50% of the partnership net loss on their statements of
operations of ($126,220) for the year ended December 31, 1993.
F-30
<PAGE>
J.R. BACON DRILLING, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
NOTE 3--RELATED PARTY TRANSACTIONS
The Company performs pumping, management and well workover services for B &
B Production Company, as well as the South West Cut Bank Sand Unit (SWCBSU)
Kye Trout oil field which is owned by B & B Production Company (see Note 2).
Gross revenue for services provided to these related parties for the year
ended December 31, 1993, were as follows:
<TABLE>
<S> <C>
South West Cut Bank Sand Unit................................. $1,002,405
B & B Production Company...................................... 313,121
----------
Total....................................................... $1,315,526
==========
</TABLE>
The Company also leases a compressor on a month-to-month basis at a monthly
rate of $3,000 from Mr. Bacon.
NOTE 4--INCOME TAXES
Income taxes computed by applying the statutory rate to income before income
taxes are reconciled to the provision for income taxes set forth in the
financial statement for the year ended December 31, 1993, as follows:
<TABLE>
<S> <C>
Federal income tax............................................... $89,640
State income tax, net of federal tax benefit..................... 11,733
Tax benefit of statutory depletion deduction..................... (31,409)
-------
Total income tax expense....................................... $69,964
=======
</TABLE>
The provision for income taxes included the following:
<TABLE>
<S> <C>
Current tax....................................................... $49,103
Deferred tax...................................................... 20,861
-------
$69,964
=======
</TABLE>
Deferred income tax expense results from temporary differences in the
recognition of revenue and expenses and basis of assets and liabilities for
tax and financial statement purposes. The source of these differences results
from the enterprise using the modified accrual basis of accounting for tax
purposes and the accrual basis of accounting for financial statement purposes.
In particular, net accounts receivable are not recognized as income for income
tax purposes until the cash is received. Timing of receipts of cash from
receivables and payment of accounts payable accounts for all of the deferred
tax liability and changes therein.
F-31
<PAGE>
LARRY D. KRAUSE
PETROLEUM ENGINEERING CONSULTANT 2812 1ST AVENUE NORTH, SUITE 205
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
BILLINGS, MONTANA 59101
(406) 252-2975
JANUARY 30, 1996
Mr. David Pierce
Frontier Oil Exploration Company
3006 Highland Drive, Suite 206
Salt Lake City, Utah 84106
Re: Appraisal of Frontier Oil Exploration Company'sInterest in Various Oil
Producing Properties as of December 31, 1995
Dear Mr. Pierce:
As per your request, I have prepared an independent appraisal of Frontier
Oil Exploration Company's interest in various oil producing properties using
Securities and Exchange Commission guidelines. The result, net to appraised
interest, is as follows:
<TABLE>
<CAPTION>
FUTURE NET INCOME
--------------------------------
RESERVE CATEGORY OIL, BBLS UNDISCOUNTED DISCOUNTED AT 10.0%
- ---------------- --------- ------------ -------------------
<S> <C> <C> <C>
Proved Developed Producing......... 2,427,848 $17,416,164 $ 6,421,659
Proved Nonproducing................ 254,825 2,111,711 1,314,330
Proved Undeveloped................. 2,574,500 25,652,415 16,045,459
--------- ----------- -----------
Totals........................... 5,257,173 $45,180,290 $23,781,448
</TABLE>
The weighted average oil price of $16.48 per barrel used in the evaluation
was based on prices paid for December 31, 1995, sales. This price, provided by
Frontier Oil Exploration Company, was adjusted for any applicable gravity
corrections and bonuses paid by the purchasers. This price was held constant
for the purpose of this evaluation.
The lease operating expenses used in the evaluation were provided by
Frontier Oil Exploration Company. The expenses represent actual recurring
expenses for each of the properties that were evaluated. The expenses were
held constant. Operating expenses for the Southwest Cut Bank Sand Unit were
adjusted to take into account wells being shut-in and/or abandoned as they
became uneconomical to produce. Operating expenses do not include such items
as depreciation and state and federal income taxes. Ad valorem and production
severance taxes were deducted separately. These taxes were deducted at the
published rate for each state. They were input as a decimal and applied as a
percentage of undiscounted net revenue. The taxes were combined with operating
expenses in the operating expense column.
On December 21, 1995, the State of Montana and Blackfeet Tribe signed an
agreement which will eliminate double taxation on the Blackfeet Reservation.
This resulted in a 7.0% reduction in production taxes for the Southwest Cut
Bank Sand Unit. Plugging and abandonment costs were assumed to be
approximately equal to salvage values for the equipment. Therefore, neither
were included in the evaluation.
The discounted figures have been reduced by estimated development costs of
$6,115,089. This reflects the estimated cost of infill drilling and waterflood
operations on four specific areas within the Cut Bank field designed to
increase production rates, flood efficiency, and ultimate oil recovery. These
efforts include returning eight shut-in wells to producing status, converting
12 shut-in water injection wells to producing oil wells, converting seven
areas in the field to inverted five-spot waterflood patterns, and drilling six
producing wells at
A-1
<PAGE>
various locations to further develop the field. For purposes of the reserve
evaluation, it was assumed that the subject work will be performed during 1996
and 1997. The amount and timing of future development and operating costs may
differ from those used in the estimate.
The reserves considered in this evaluation are proved developed producing,
proved developed nonproducing, and proved undeveloped. The definition of oil
and gas reserves is included at the end of this report.
The oil reserves assigned to the properties in this evaluation were
determined by analyzing current test data, extrapolation of historical
production data, and comparison to production history of similar wells in the
area. The current volatility of oil prices provides an element of uncertainty.
If prices should vary significantly from those projected in the appraisal, the
resulting values could change substantially. The reserve estimates contained
in this evaluation are based on accepted engineering and evaluation principles
and are believed to be reasonable. The information contained in this report is
for the benefit of Frontier Oil Exploration Company and does not necessarily
represent an estimate of a fair market value for the evaluated properties.
Very truly yours,
/s/ Larry D. Krause
Petroleum Engineer
A-2
<PAGE>
DEFINITIONS FOR OIL AND GAS RESERVES
PROVED RESERVES
Proved 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, by established operating
practice and under current government regulations. Current economic conditions
include prices and costs prevailing at the time of the estimate. Estimates of
proved reservoirs do not include crude oil, natural gas and natural gas
liquids, the recovery of which is subject to reasonable doubt because of
geology, reservoir characteristics or economic factors.
Reserves estimates generally will be revised as reservoirs are produced, as
additional geologic and/or engineering data become available or as economic
conditions change.
Reserves do not include volumes of crude oil, natural gas or natural gas
liquids being held in inventory. If required for financial reporting or other
special purposes, reserves may be reduced for on-site usage and/or processing
losses.
The ownership status of reserves may change due to the expiration of a
production license or contract; when relevant to reserves assignment such
changes should be identified for each reserves classification.
In general, reserves are considered proved if commercial producibility of
the reservoir is supported by actual production or formation tests. The term
proved refers to the estimated volume of reserves and not just to the
productivity of the well or reservoir. In certain instances, proved reserves
may be assigned on the basis of electrical and other type logs and/or core
analyses that indicate the subject reservoir is hydrocarbon bearing and is
analogous to reservoirs in the same area that are producing or have
demonstrated the ability to produce on a formation test.
The area of a reservoir considered proved includes (1) that portion
delineated by drilling and defined by fluid contacts, if any and (2) the
immediately adjoining undrilled portions that can be reasonably judged as
economically productive on the basis of available geologic and engineering
data. In the absence of data on fluid contacts, the lowest known structural
occurrence of hydrocarbons controls the proved limit of the reservoir.
Proved reserves must have facilities to process and transport those reserves
to market that are operational at the time of the estimate or there is a
commitment or reasonable expectation to install such facilities in the future.
Proved reserves may be developed or undeveloped. In general, proved
undeveloped reserves are assigned to undrilled locations that satisfy the
following conditions: (1) the locations are direct offsets to wells that have
indicated commercial production in the objective formation, (2) it is
reasonably certain that the locations are within the known proved productive
limits of the objective formation, (3) the locations conform to existing well
spacing regulations, if any, and (4) it is reasonably certain that the
locations will be developed. Reserves for other undrilled locations are
classified as proved undeveloped only in those cases where interpretations of
data from wells indicate that the objective formation is laterally continuous
and contains commercially recoverable hydrocarbons at locations beyond direct
offsets.
Reserves may be attributed to either natural reservoir energy or improved
recovery methods. Improved recovery includes all methods for supplementing
natural reservoir energy to increase ultimate recovery from a reservoir. Such
methods include (1) pressure maintenance, (2) cycling, (3) waterflooding, (4)
thermal methods, (5) chemical flooding and (6) use of miscible and immiscible
displacement fluids.
Reserves that can be produced through the application of established
improved recovery methods are included in the proved classification when (1)
the successful testing by a pilot project or favorable production or pressure
response of an installed program in that reservoir, or one in the immediate
area with similar rock and fluid properties, provides support for the
engineering analysis on which the project or program is based and (2) it is
reasonably certain the project will proceed.
A-3
<PAGE>
Reserves to be recovered by improved recovery methods that have yet to be
established through repeated commercially successful applications are included
in the proved classification only (1) after a favorable production response
from subject reservoir from either (a) a representative pilot or (b) an
installed program, where the response provides support for the engineering
analysis on which the project is based and (2) it is reasonably certain the
project will proceed.
Reserves estimates are based on interpretation of geologic and/or
engineering data available at the time of the estimate. All reserve estimates
involve some degree of uncertainty, depending chiefly on the amount and
reliability of geologic and engineering data available at the time of the
estimate and the interpretation of these data. The relative degree of
uncertainty may be conveyed by placing reserves in one of two classifications,
either proved or unproved. Unproved reserves are less certain to be recovered
than proved reserves and may be subclassified as probable or possible to
denote progressively increasing uncertainty.
PROVED RESERVE STATUS CATEGORIES
Proved reserve status categories define the development and producing status
of wells and/or reservoirs.
Developed
Developed reserves are expected to be recovered from existing wells with
existing equipment and operating methods. Improved recovery reserves are
considered developed only after testing by a pilot project or after the
operation of an installed program has confirmed through production response
that increased recovery can be achieved and when the necessary equipment has
been installed or when the costs to do so are relatively minor. Developed
reserves may be subcategorized as producing or nonproducing.
Producing
Producing reserves are expected to be recovered from completion intervals
open at the time of the estimate and producing. Improved recovery reserves are
considered to be producing only after an improved recovery project is in
operation.
Nonproducing
Nonproducing reserves include shut-in and behind-pipe reserves. Shut-in
reserves are expected to be recovered from completion intervals open at the
time of the estimate, but which had not started producing or were shut-in for
market conditions or pipeline connection or were not capable of production for
mechanical reasons and the time when sales will start is uncertain.
Behind-pipe reserves are expected to be recovered from zones behind casing
in existing wells, which will require additional completion work or a future
completion prior to the start of production.
Undeveloped
Undeveloped reserves are expected to be recovered: (1) from new wells on
undrilled acreage, (2) from deepening existing wells to a different reservoir
or (3) where a relatively large expenditure is required to (a) recomplete an
existing well or (b) install production or transportation facilities for
primary or improved recovery projects. Under no circumstances should estimates
for proved undeveloped reserves be attributable to any acreage for which
improved recovery techniques are contemplated unless such techniques have been
proved effective by actual tests in the area and in the same reservoir.
A-4
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESMAN OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION IN CONNECTION WITH THE OFFERING
OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE
SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY
TIME SUBSEQUENT TO THE DATE HEREOF OR THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE SUCH DATE.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 7
Company History.......................................................... 15
Use of Proceeds.......................................................... 15
Price Range of Common Stock and Dividend Policy.......................... 16
Capitalization........................................................... 17
Dilution................................................................. 17
Selected Consolidated Financial Data..................................... 18
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 19
Business and Properties.................................................. 26
Management............................................................... 39
Principal Stockholders................................................... 44
Certain Transactions..................................................... 46
Description of Securities................................................ 47
Underwriting............................................................. 49
Legal Matters............................................................ 50
Experts.................................................................. 50
Index to Financial Statements............................................ F-1
Summary Reserve Report................................................... A-1
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
3,000,000 SHARES
(LOGO)
COMMON STOCK
----------------
PROSPECTUS
----------------
OPPENHEIMER & CO., INC.
HANIFEN, IMHOFF INC.
AUGUST 1, 1996
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
