<PAGE>
Filed pursuant to Rule 424(B)(1)
SEC File No. 333-12755
[ENERGY SEARCH INCORPORATED LOGO APPEARS HERE]
1,000,000 UNITS
EACH UNIT CONSISTING OF ONE SHARE OF COMMON STOCK AND
ONE REDEEMABLE SERIES A COMMON STOCK PURCHASE WARRANT
----------------
Energy Search, Incorporated (the "Company") is hereby offering 1,000,000
units (the "Units"), each Unit consisting of one share of Common Stock (the
"Common Stock"), no par value per share, and one Redeemable Series A Common
Stock Purchase Warrant (the "Series A Warrants"). The Units, the Common Stock
and the Series A Warrants are sometimes referred to as the "Securities." The
Common Stock and the Series A Warrants included in the Units may not be
separately traded until July 24, 1997, unless earlier separated upon three
days' prior written notice from Neidiger/Tucker/Bruner, Inc. and National
Securities Corporation (the "Representatives") to the Company at the
discretion of the Representatives. Each Series A Warrant entitles the holder
thereof to purchase one share of Common Stock (a "Warrant Share") at an
exercise price of 120% of the offering price per Unit at any time commencing
on February 28, 1998 until January 30, 2002, unless earlier redeemed. The
Series A Warrants are subject to redemption by the Company at a price of $0.05
per Warrant at any time commencing July 24, 1998, on thirty days prior written
notice, provided that the closing sale price per share for the Common Stock
has equaled or exceeded 200% of the offering price per Unit for twenty
consecutive trading days within the thirty-day period immediately preceding
such notice. See "Description of Securities" and "Underwriting."
Prior to this Offering, there has been no public market for the Securities,
and there can be no assurance that an active market will develop. The Units,
Common Stock and Series A Warrants have been approved, subject to official
notice of issuance, for listing on the Boston Stock Exchange under the symbols
"EYS.U," "EYS" and "EYS.WS.A," respectively, and for quotation on the Nasdaq
Small-Cap Market under the symbols "EGASU," "EGAS," and "EGASW," respectively.
----------------
THESE SECURITIES ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK AND
IMMEDIATE SUBSTANTIAL DILUTION FROM THE PUBLIC OFFERING PRICE. PROSPECTIVE
INVESTORS SHOULD CAREFULLY CONSIDER THE SECTIONS ENTITLED "RISK FACTORS"
BEGINNING ON PAGE 8 AND "DILUTION" CONCERNING THE COMPANY AND THIS
OFFERING.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
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>
UNDERWRITING DISCOUNTS
PRICE TO PUBLIC AND COMMISSIONS (1) PROCEEDS TO COMPANY (2)
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Unit (3).... $8.00 $.80 $7.20
- -------------------------------------------------------------------------------
Total........... $8,000,000 $800,000 $7,200,000
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
(1) Does not include compensation in the form of a non-accountable expense
allowance equal to 2.5% of the gross proceeds of this Offering. The
Company has also agreed to sell to the Representatives warrants (the
"Representatives' Warrants"), exercisable for four years commencing one
year from the date hereof, to purchase 100,000 Units at 125% of the
offering price per Unit. For information concerning indemnification
arrangements with the Underwriters and the other compensation payable to
the Representatives, see "Underwriting."
(2) Before deducting estimated offering expenses of $485,000 payable by the
Company, including the nonaccountable expense allowance to the
Representatives.
(3) The Company has granted to the Underwriters a 45-day option beginning on
the date of this Prospectus to purchase up to 150,000 additional Units at
the Price to Public less the Underwriting Discount solely to cover over-
allotments, if any. If such option is exercised in full, the total Price
to Public, the Underwriting Discounts and Commissions and Proceeds to the
Company will be $9,200,000, $920,000 and $8,280,000, respectively. See
"Underwriting. "
The Securities are being offered, subject to prior sale, when, as and if
delivered to and accepted by the Representatives, and subject to approval of
certain legal matters by counsel and other conditions. The Representatives
reserve the right to reject any order, in whole or in part. It is expected
that delivery of the certificates representing the Securities will be made
against payment therefor on or about January 30, 1997.
----------------
NEIDIGER/TUCKER/BRUNER, INC. NATIONAL SECURITIES CORPORATION
THE DATE OF THIS PROSPECTUS IS JANUARY 24, 1997.
<PAGE>
NARRATIVE DESCRIPTION OF IMAGE FOUND ON THE INSIDE FRONT COVER OF THE
PROSPECTUS
The inside front cover contains a primary map depicting, by grey color
shading, the Company's interest in the Beaver Coal Company Lease, Raleigh
County, West Virginia. The title of this map is "ENERGY SEARCH, INCORPORATED
INTEREST IN BEAVER COAL COMPANY LEASE." Included in the upper right hand
corner is a smaller insert map of the state of West Virginia showing the
general location of the Beaver Coal Company Lease within that state.
The following language is found at the lower left hand corner of this map:
FSI Interest
- ------------
. 17,000 + gross lease acres
. 100% working interest
. ESI plans to develop its interest in the lease with a portion of the proceeds
of this Offering
. proposed initial developmental drilling locations for purposes of determining
ESI's proved undeveloped reserves (PUDs) as disclosed in the prospectus
. Potential target horizons: Ravencliff, Maxton, Big Lime, Weir
Included on this map is a Legend indicating the depiction of ESI's lease
acreage (by grey color shading), public highways (by red lines and highway
symbols), ESI proved undeveloped reserve (PUD) drillsites (by red dots
surrounded by black circles), and accessible third party gas transmission
pipelines (by thick black lines). The grey color-shaded area depicting the
Company's interest in the Beaver Coal Company Lease contains, at various
locations therein, approximately 44 red dots with surrounding black circles
depicting the approximate location of the Company's proved undeveloped reserve
(PUD) drillsites.
This map also includes a compass and a scale.
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE SECURITIES AT
A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements (including notes thereto) appearing
elsewhere in this Prospectus. Unless otherwise indicated, the information in
this Prospectus assumes that the Underwriters' Over-allotment Option, as defined
below, will not be exercised. The Securities offered hereby involve a high
degree of risk. Investors should carefully consider the information set forth
under "Risk Factors." Certain terms relating to the oil and gas business are
defined under "Glossary of Terms" herein.
Unless specifically stated otherwise, all calculations and information
contained in this Prospectus assumes all of the following: (1) with respect to
the 450,000 shares of Preferred Stock (Class A and Class B), all of such shares
will be automatically converted to shares of Common Stock on a one share-to-one
share basis upon completion of this Offering; (2) certain currently outstanding
Common Stock purchase warrants which must be exercised, if at all, within 90
days after completion of this Offering, will be exercised and 13,975 shares of
Common Stock will be issuable as a result thereof; and all 550,000 shares of
Common Stock outstanding as of the date of this Prospectus, as well as the
450,000 shares of Common Stock into which the currently outstanding 450,000
shares of Preferred Stock are convertible, and the 13,975 shares of Common Stock
issuable pursuant to the above described Common Stock purchase warrants (all of
which are assumed will be exercised), will be split two-for-one immediately
prior to completion of this Offering.
THE COMPANY
Energy Search, Incorporated ("Energy Search" or the "Company") is an
independent oil and gas development and production company focusing primarily on
developmental drilling and production of natural gas reserves in the Appalachian
Basin and elsewhere in the mid-continent region of the United States. The
Company historically has developed oil and gas properties primarily by drilling
natural gas wells in joint ventures with Tennessee limited partnerships for
which the Company serves as managing general partner (the "Affiliated Drilling
Partnerships"). These Affiliated Drilling Partnerships were syndicated by the
Company's affiliate, Equity Financial Corporation ("EFC"), an NASD-member
broker-dealer, and capitalized with investor funds raised in various private
offerings. The Company also operates an approximately 60-mile gas gathering
system servicing its primary areas of operation in southeastern Ohio (the "Gas
Gathering System"). The Gas Gathering System is owned by a Tennessee limited
partnership (the "Pipeline Operating Partnership") which is comprised of the
Company, as managing general partner owning a 28.74% general partner interest,
and a single limited partner which is another Tennessee limited partnership (the
"Pipeline Income Partnership") for which the Company also serves as managing
general partner. The Company's principal operations presently include
evaluating, acquiring and developing gas and oil leases, sponsoring the
organization and offering of Affiliated Drilling Partnerships, serving as
driller-operator on wells drilled in joint ventures with Affiliated Drilling
Partnerships and for its own account, and operating the Gas Gathering System as
general partner of the Pipeline Operating Partnership. Since 1990, the Company
has conducted exploration, development and production activities, primarily
concentrating on natural gas reserves in its Bartlett and Torch Fields in
Washington, Athens and Meigs Counties located in southeastern Ohio. As of
September 30, 1996, the Company partially owned and operated approximately 175
wells and the Gas Gathering System in this region.
In late 1995, the Company acquired nine producing wells and 1,403 acres
of undeveloped acreage (the "Dupont Field") in Wood County, West Virginia. The
Company is currently in the process of acquiring another approximately 4,000
acres of leases in this area. In July of 1996, the Company made its most
significant acreage acquisition to date -- an approximately 17,000-acre tract of
acreage in Raleigh County, West Virginia (the "Beaver Coal Company Lease").
Based on review and evaluation by Kim A. Walbe, independent certified geologist,
total proved undeveloped reserves as of October 1, 1996 associated with the
Beaver Coal Company Lease are 12,191,855 Mcf of natural gas. As of the same
date, total estimated future net cash flows before income taxes associated with
the Beaver Coal Company Lease proved undeveloped reserves, discounted at 10%
(SEC Method), equal $13,392,565, assuming a constant price of $3.00 per Mcf for
natural gas. See "Business and Properties -- Oil and Gas Reserves."
<PAGE>
The Company's business plan is to increase its oil and gas reserves by
continued developmental drilling in southeastern Ohio in the area serviced by
the Gas Gathering System, as well as by conducting primarily developmental
drilling in its Dupont Field and on its Beaver Coal Company Lease in Wood and
Raleigh Counties, West Virginia, respectively. These areas in West Virginia are
well serviced by third parties operating gas gathering and transportation
systems. The Company may also undertake activities elsewhere in the Appalachian
Basin and the mid-continent region of the United States. It plans to drill an
increasing number of wells for its own account, while at the same time
continuing to drill wells with future Affiliated Drilling Partnerships to be
syndicated on a private placement basis by its affiliate, EFC.
Throughout the 1990's, the Company has averaged drilling approximately 25
to 35 wells per year. Substantially all of these wells were drilled in joint
ventures with Affiliated Drilling Partnerships. The business plan of the
Company anticipates drilling an average of approximately 30 to 50 wells per year
over the next five years both with Affiliated Drilling Partnerships and also
with internal sources of capital for its own account. Management believes that
with the proceeds of this Offering, its internal cash flow and its other sources
of capital, such as its Bank One Credit Facility, it can efficiently maintain
this level of drilling activity in the future. The proceeds of the Company's
earlier private Preferred Stock offering as well as of this Offering have, and
are expected to, reduce debt and increase working capital for internal drilling
and development activities of the Company for its own account. This, management
believes, will result in the growth of the Company's natural gas and oil
reserves, cash flow and value. As the Company's revenues and profits grow, the
Company intends to expand its drilling activities and the acquisition of natural
gas and oil properties, thereby further adding to the Company's growth.
The Company was organized as a Tennessee corporation in 1990. The
Company's principal executive offices are located at 280 Fort Sanders West
Blvd., Suite 200, Knoxville, Tennessee 37922. The Company's telephone number at
that location is (800) 551-5810.
2
<PAGE>
The Offering
Securities Offered.............. 1,000,000 Units, each Unit consisting of one
share of Common Stock and one Series A
Warrant, each Series A Warrant entitling the
holder to purchase one share of Common Stock
at a price of 120% of the offering price per
share exercisable on February 28, 1998 until
January 30, 2002,unless earlier redeemed. See
"Description of Securities."
Series A Warrants............... Each Series A Warrant will entitle the holder
thereof to purchase one share of Common Stock.
The Series A Warrants are exercisable
commencing on February 28, 1998 until
January 30, 2002, unless earlier redeemed, for
one share of Common Stock each, at an exercise
price of 120% of the offering price per Unit
in this Offering. The Series A Warrants may
not be separately traded until July 24, 1997,
unless earlier separated upon three days prior
written notice by Neidiger/Tucker/Bruner, Inc.
and National Securities Corporation (the
"Representatives") to the Company at the
discretion of the Representatives. The Series
A Warrants are redeemable by the Company at
$0.05 per Warrant at any time commencing
July 24, 1998, on thirty days prior written
notice, provided that the closing sale price
per share for the Common Stock has equaled or
exceeded 200% of the offering price per Unit
for twenty consecutive trading days within the
thirty-day period immediately preceding such
notice. See "Description of Securities."
Common Stock to be Outstanding
after the Offering.............. 3,027,950 shares. Does not include 1,000,000
shares issuable upon the exercise of the
Series A Warrants, 200,000 shares (100,000
shares and 100,000 shares underlying 100,000
Series A Warrants) underlying the 100,000
Units issuable upon exercise of the
Representatives' Warrants, or 300,000 shares
(150,000 shares and 150,000 shares underlying
150,000 Series A Warrants) underlying the
150,000 Units issuable upon the exercise of
the Underwriters' Over-allotment Option. See
"Underwriting." Also does not include 450,000
post-stock split shares that may be issued
upon the exercise of presently outstanding
Common Stock purchase warrants owned by the
three principal officers of the Company
(Messrs. Torrey, Remine and Cooper) which
shall become vested and exercisable in five
equal yearly installments of 30,000 shares per
officer as of January 1, in each of the years
1997, 1998, 1999, 2000 and 2001. See
"Management - Executive Compensation," and
"Principal Stockholders."
3
<PAGE>
Series A Warrants to be
Outstanding after the
Offering....................... 1,000,000 Series A Warrants. Does not include
100,000 Series A Warrants issuable upon
exercise of the Representatives' Warrants, or
150,000 Series A Warrants issuable upon
exercise of the Underwriters' Over-allotment
Option.
Use of Proceeds................. Retirement of debt owed to officers, payment
of accumulated dividends on Class A Preferred
Stock and for working capital purposes. See
"Use of Proceeds."
Risk Factors.................... The Securities offered hereby are speculative
and involve a high degree of risk and should
not be purchased by investors who cannot
afford the loss of their entire investment.
See "Risk Factors."
Boston Stock Exchange Symbols
Units......................... "EYS.U"
Common Stock.................. "EYS"
Series A Warrants............. "EYS.WS.A"
Nasdaq Small-Cap Market Symbols
Units......................... "EGASU"
Common Stock.................. "EGAS"
Series A Warrants............. "EGASW"
4
<PAGE>
SUMMARY NATURAL GAS AND OIL RESERVE INFORMATION
The following table sets forth summary information with respect to the
Company's estimated net proved natural gas and oil reserves and the discounted
present value of the estimated future net revenues therefrom as of December 31,
1995, and with respect to the Company's Beaver Coal Company Lease, as of October
1, 1996. The Company acquired its interest in the Beaver Coal Company Lease in
July of 1996. For additional information related to the Company's natural gas
and oil reserves, see "Business and Properties -- Oil and Gas Operations -- Oil
and Gas Reserves," the Supplementary Information --Costs incurred in Oil and Gas
Producing Activities and Estimates of Natural Gas and Oil Reserves included with
the Financial Statements and "Risk Factors--Risks Associated with the Company --
Geologist's Estimates of Reserves and Future Net Revenue" included elsewhere in
this Prospectus. The Company's oil and gas reserve estimates were reviewed and
evaluated, as of December 31, 1995, by Kim A. Walbe, certified independent
geologist. The oil and gas reserve estimates of the Company's Beaver Coal
Company Lease, acquired in July of 1996, were reviewed and evaluated, as of
October 1, 1996, by Kim A. Walbe, certified independent geologist.
With respect to the tables below, the Present Value of Estimated Future Net
Cash Flow (SEC Method) from Proved Oil and Gas Reserves is computed assuming a
constant price of $3.00 per Mcf. The weighted average price earned by the
Company for natural gas produced for the calendar year 1996 was $3.22 per Mcf.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1995
---------------------------------------------------------------
DEVELOPED UNDEVELOPED TOTAL
--------------- ------------- -----------
<S> <C> <C> <C>
ESTIMATED PROVED RESERVES
AS OF DECEMBER 31, 1995
Oil (Bbl) 11,724 10,616 22,340
Natural Gas (Mcf) 1,259,454 2,305,073 3,564,527
Equivalent Bbl (BOE) 221,633 394,795 616,428
Present Value of Estimated
Future Net Cash Flows
Before Income Taxes
Discounted at 10% $1,483,296 $ 1,237,353 $ 2,720,649
<CAPTION>
AS OF DECEMBER 31, 1995
---------------------------------------------------------------
DEVELOPED UNDEVELOPED TOTAL
--------------- ------------- -----------
<S> <C> <C> <C>
ADDITIONAL ESTIMATED
PROVED RESERVES
AS OF OCTOBER 1, 1996 FOR
BEAVER COAL COMPANY LEASE
(ACQUIRED BY THE COMPANY
AS OF JULY 16, 1996)
Oil (Bbl) 0 0 0
Natural Gas (Mcf) 0 12,191,855 12,191,855
Equivalent Bbl (BOE) 0 2,031,976 2,031,976
Present Value of Estimated
Future Cash Flows before
Income Taxes Discounted
at 10% $13,392,565 $13,392,565
<CAPTION>
DEVELOPED UNDEVELOPED TOTAL
--------------- ------------- -----------
<S> <C> <C> <C>
TOTAL ESTIMATED PROVED
RESERVES AS OF DECEMBER
31, 1995, COMBINED WITH
THE BEAVER COAL COMPANY
LEASE OF THE COMPANY AS
OF OCTOBER 31, 1996
Total Present Value of
Estimated Future Net Cash
Flows before Income Taxes
Discounted at 10% $1,483,296 $14,629,918 $16,113,214
</TABLE>
5
<PAGE>
SUMMARY FINANCIAL INFORMATION
(in thousands, except per share data)
<TABLE>
<CAPTION>
(UNAUDITED)
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------- -----------------
OPERATING DATA: 1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Gross Revenue $ 3,409 $ 4,168 $ 2,135
Net Revenue 1,458 2,492 938
Operating income (loss) (1,160) 284 (1,080)
Net income (loss) (1,203) 269 (748)
Net income (loss) per (1,002) 224 (1.36)
common share (1)
Weighted average shares 1,200 1,200 550,000
outstanding (1)
<CAPTION>
(UNAUDITED)
(UNAUDITED) AT SEPTEMBER 30,
AT DECEMBER 31, AT SEPTEMBER 30, AS ADJUSTED (2)
--------------- ---------------- ----------------
BALANCE SHEET DATA: 1995 1996 1996
---- ---- ----
<S> <C> <C> <C>
Working capital $(2,530) $(2,282) $ 4,360
Total assets 5,812 5,921 12,311
Long-term debt 2,286 47 47
Shareholders' equity (365) 3,169 9,810
(deficit)
</TABLE>
____________________________
(1) Computed in accordance with generally accepted accounting procedures.
(2) As adjusted to give effect to the sale of the 1,000,000 Units offered
hereby and the application of the net proceeds therefrom.
The Company's principal assets include current assets (including cash,
accounts receivable, amounts due from related partnerships and inventory), oil
and gas properties (including proved properties, wells and related equipment),
and other assets (including other property and equipment, investments in related
partnerships including Affiliated Drilling Partnerships formed since 1992, a
28.74% equity interest in the Pipeline Operating Partnership and a 1% equity
interest in the Pipeline Income Partnership, debenture issue costs and other
assets). The Company currently owns approximately 55,000 gas and oil leasehold
acres. As of September 30, 1996, the Company operated approximately 164 wells in
southeastern Ohio and 11 wells in West Virginia. Set forth below is a table
identifying the asset categories described above and allocating a dollar amount
and percentage of the total assets of the Company to each category based on the
audited balance sheet of the Company as of December 31, 1995.
6
<PAGE>
<TABLE>
<CAPTION>
ASSET CATEGORY ASSET VALUE PERCENTAGE OF TOTAL ASSETS
-------------- ----------- --------------------------
<S> <C> <C>
Current assets
Cash $ 105,978 2%
Accounts receivable 78,439 1%
Due from related partnerships 1,114,828 19%
Inventory 62,165 1%
Total current assets 1,361,410 23%
Oil and gas properties
Proved properties 487,313 8%
Wells and related equipment 4,920,839 85%
Less: accumulated depreciation,
depletion and amortization (2,447,439) (42%)
Net oil and gas properties 2,960,713 51%
Other assets
Other property and equipment less
accumulated depreciation 76,267 1%
Investment in related partnerships 1,223,928 22%
Net debenture issue costs 129,256 2%
Other assets 60,232 1%
Total other assets 1,489,683 26%
TOTAL ASSETS $5,811,806 100%
</TABLE>
The Company's primary revenues are derived from fees for turnkey drilling
services, oil and gas sales, management fees in connection with Affiliated
Drilling Partnerships and the Pipeline Operating Partnership, and other revenue.
Set forth below is a table identifying the revenue categories described above
and allocating a dollar amount and percentage of the net revenues of the Company
to each category based on the audited statement of operations of the Company for
the year ended December 31, 1995.
<TABLE>
<CAPTION>
NET REVENUE CATEGORY NET REVENUE PERCENTAGE OF TOTAL NET REVENUE
- --------------------------- ----------- -------------------------------
<S> <C> <C>
Turnkey drilling revenue $2,025,078 81%
Revenue from oil and gas
sales 173,162 7%
Management fees 175,350 7%
Other revenue 118,473 5%
TOTAL NET REVENUE $2,492,063 100%
---------- ------------
</TABLE>
7
<PAGE>
RISK FACTORS
AN INVESTMENT IN UNITS OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
PROSPECTIVE INVESTORS SHOULD CONSIDER THE FOLLOWING FACTORS IN ADDITION TO THE
OTHER INFORMATION SET FORTH IN THE PROSPECTUS BEFORE MAKING A DECISION
CONCERNING THE PURCHASE OF THE UNITS OFFERED HEREBY.
Risks Associated with the Company
The Company's Fiduciary Responsibility to its Related Partnerships. The
Company owes a fiduciary duty to each Affiliated Drilling Partnership, the
Pipeline Income Partnership, the Pipeline Operating Partnership, and any future
partnership in which the Company is the managing general partner, or serves in a
similar capacity. Accordingly, the Company has been, and will continue to be,
obligated to exercise good faith, reasonable business judgment and integrity in
handling each such Partnership's business and funds. If the Company were to
violate its above-described duties, the Company could be subject to legal
redress which could result in liability.
Conflicts of Interest. The nature of the Company's activities in the oil
and gas business results in many situations in which conflicts of interest may
arise. In general, conflicts of interest are inherent in oil and gas drilling
programs involving non-industry participants because transactions are entered
into without arms-length negotiation. The interests of the investors, on one
hand, and those of the Company, as managing general partner and driller-
operator, on the other hand, may be inconsistent in some respects or in certain
instances. Situations involving conflicts of interest include, but are not
limited to: the determination of JDOA or limited partnership agreement terms
(particularly relating to compensation of the Company) in syndicated Affiliated
Drilling Partnerships; the selection and allocation of drillsites as between the
Company and various Affiliated Drilling Partnerships; allocation of overhead
among related parties or affiliates; handling the "proving-up" by an Affiliated
Drilling Partnership of unproven acreage which such partnership has no
contractual right to drill; use of Company personnel or resources; structuring
of gas marketing arrangements; related-party transactions and similar
circumstances. The Company, as managing general partner of the Affiliated
Drilling Partnerships, the Pipeline Operating Partnership and the Pipeline
Income Partnership, is accountable to investor partners therein as a fiduciary
and must, therefore, exercise good faith and integrity in handling the affairs
of the various partnerships. This is particularly true in the handling of
conflicts between the Company's activity for its own account, and its activity
on behalf of partnerships it manages. The Company, in recognition of its
fiduciary responsibilities to investor partners, must endeavor to resolve any
and all such conflicts on a basis which the Company believes to be fair and
equitable and otherwise in or not opposed to the best interests of such investor
partners. With respect to the selection of drilling prospects and drillsites,
the Company is not obligated under the terms of the relevant limited partnership
agreements or JDOA's to offer to Affiliated Drilling Partnerships the prior
right to drill any acreage "proved up" by the drilling of any Partnership well.
Each of the Affiliated Drilling Partnerships, as well as the Pipeline Income
Partnership and the Pipeline Operating Partnership, present numerous situations
or circumstances which do, or could, result in a conflict of interest on the
part of the Company. Failure to adequately resolve such conflicts of interest
appropriately could result in liability or other adverse consequences to the
Company. The Company presently has no formal procedure to deal with conflicts
of interest but instead handles the evaluation and resolution of them on a case-
by-case basis taking into account all relevant facts and circumstances.
Present Lack of Outside Directors. Currently, the Company's Board of
Directors is comprised of Messrs. Torrey, Remine and Cooper, its principal
officers. The Company currently has no outside directors. The Company's
bylaws, as amended, state that within sixty days after closing of this Offering
the current directors shall appoint two outside directors. To qualify as an
outside director for this purpose, a director must be a "non-employee director"
as defined under Rule 16b-3 under the Securities Act of 1934, or any successor
provision thereto, and must not currently be, or have been within the last year,
an officer or regular salaried employee of the Company.
Limited Capital; Need for Significant Additional Financing. The Company
anticipates, based on the current plans and assumptions relating to its
operations, that the net proceeds of this Offering will be sufficient to satisfy
its operating cash requirements for approximately 18 to 24 months following the
consummation of this Offering. There can be no assurance, however, that the
Company will not require additional financing sooner than currently anticipated.
The net proceeds of this Offering may not be sufficient to develop fully
the Company's oil and gas properties or otherwise carry out the Company's
business plan. Development of the Company's oil and gas properties and execution
of the Company's business plan may require capital resources substantially
greater than the net proceeds of this Offering or resources otherwise currently
available to the Company. The Company's current arrangements for additional
sources of capital include its working capital revolving line of credit with
Bank One, Texas, N.A. (the "Bank One Credit Facility") and its contemplated
future
8
<PAGE>
offerings, on a private placement basis, of Affiliated Drilling Partnerships.
See "Business and Properties -- Affiliated Drilling Partnerships." There can be
no assurance that these, or any other, sources of capital will be available to
the Company on acceptable terms, or at all, in the future. The inability to
obtain additional financing would have a material adverse effect on the Company,
including requiring the Company to curtail significantly or farm-out its
development of its oil and gas properties. Any additional financing may involve
substantial dilution to the interests of the Company's then existing
shareholders.
Financing the Company's Growth Through Private Placement Securities
Offerings. The capital needs of the Company have increased materially since its
inception. Prior to 1996, substantially all of the Company's drilling capital
has been raised through the offering of investment interests in Affiliated
Drilling Partnerships to private investors. These Affiliated Drilling
Partnerships have been sponsored by principals of the Company, as well as by the
Company, and have been marketed by Equity Financial Corporation ("EFC"), an
NASD-member broker-dealer and an affiliate of the Company. See "Business and
Properties -- Affiliated Drilling Partnerships." It is anticipated that a
portion of the Company's drilling capital in the future will continue to be
raised by the offering of investment interests, on a private placement basis, in
future Affiliated Drilling Partnerships. To the extent the Company may depend on
capitalization through syndication of future Affiliated Drilling Partnerships,
there can be no assurance that future offerings will be successful or will raise
adequate capital for desired Company activities. Also, there is no assurance
that any other sources of capital will be available to the Company.
From 1991 through 1992 the Company raised working capital through the sale
of limited partnership interests, on a private placement basis, in Tennessee
limited partnerships which loaned the proceeds of investor subscriptions to the
Company. All of these loans from limited partnerships have been repaid in full
as of the date of this Prospectus. The Company has also raised capital to
finance the Gas Gathering System which services its wells in southeastern Ohio
by sponsoring and selling to private investors limited partnership interests in
the Pipeline Income Partnership. Management believes, and is advised by its
legal counsel, that these private placement offerings, together with the
Affiliated Drilling Partnerships, were exempt from registration under the
Securities Act of 1933, as amended (the "Securities Act"), in reliance on the
"private offering" exemption contained in Section 4(2) of the Securities Act and
Rule 506 promulgated thereunder. The availability of this exemption is dependent
upon a number of factors, including the manner of offering the investment, the
information furnished to investors, their investment experience, the method of
placing the securities, and the possible integration of several offerings. For
the most part, these placements have been made to "accredited investors" as that
term is defined under Rule 501(a) of the Securities Act. The Company has taken
all steps recommended by securities legal counsel to assure that it has complied
with the various federal and state requirements with respect to these private
placements. In the unlikely event that the Company is determined not to have
complied with those requirements, however, the Company could be subject to legal
claims for rescission, regulatory enforcement actions or penalties. The total
amount of such rescission claims, if such claims did exist, could, subject to
statute of limitations and other procedural and substantive defenses, equal the
total amount raised by the Company and its affiliates in all prior securities
offerings -- approximately $47,000,000. However, no such claims have been filed
or threatened to date, and management has no knowledge that any such claims are
contemplated.
Risk of Oil and Gas Operations. The Company's operations are subject to
all of the risks normally incident to the operation and development of oil and
gas properties and the drilling of oil and gas wells, including encountering
unexpected formations or pressures, blowouts, cratering and fires, which could
result in personal injuries, loss of life, pollution damage and other damage to
the properties of the Company or others. Oil and gas operations present risks
of environmental contamination from drilling operations and leakage from oil
field storage or transportation facilities. The Company has never experienced a
significant environmental mishap, but spills of oil and other liquids could
occur which could create material liability to the Company for clean-up
expenses. See "Business and Properties -- Insurance" for a discussion of the
Company's insurance coverage.
Accumulated Deficit; Working Capital Deficit. As of September 30, 1996 the
Company had an accumulated deficit of approximately $1,332,488 and a working
capital deficit of approximately $2,282,000. Future operating results of the
Company will depend on many factors. There can be no assurance that the Company
will be able to operate profitably in the future.
Dependence on Key Personnel. The Company depends to a large extent on the
abilities and continued participation of certain key employees, including
Charles P. Torrey, Jr., its chief executive officer, Richard S. Cooper, its
President, Robert L. Remine, its secretary and treasurer, and John M. Johnston,
vice president - exploration and production. The loss of any of these officers
or other key employees could have a material adverse effect on the Company's
business. In an effort to address this risk, the
9
<PAGE>
Company has purchased $500,000 "key man" term life insurance policies on the
lives of each of Messrs. Torrey, Remine and Cooper, and a $100,000 policy on the
life of Mr. Johnston, and has entered into employment contracts with Messrs.
Torrey, Remine, Cooper and Johnston. See "Management."
Development of Additional Reserves. The Company's future success depends
upon its ability to find or acquire additional natural gas and oil reserves that
are economically recoverable. Except to the extent that the Company conducts
successful exploration or development activities or acquires properties
containing proved reserves, the proved reserves of the Company will generally
decline as reserves are produced. There can be no assurance that the Company
will be able to discover and exploit additional commercial quantities of oil and
gas, or that the Company will have success drilling productive wells or
acquiring underdeveloped properties at low finding costs.
Limited Diversification of the Company's Activities and Properties. The
Company is engaged exclusively in the business of exploration for and production
and marketing of natural gas and oil. A large part of the Company's field
operations and activities are located in Washington, Athens and Meigs Counties,
Ohio, and in Raleigh and Wood Counties, West Virginia. See "Business and
Properties -- Properties -- Leasehold Acreage." It is likely that, for the
foreseeable future, the Company's activities and primary area of field
operations will not change materially.
Undeveloped Acreage May be Lost. The Company's oil and gas leases
typically require the drilling of wells, payment of minimum royalties or delay
rentals or the continued production of oil or gas in commercial quantities in
order for the leases to remain valid and not lapse. Typically, once a well is
drilled and becomes commercially productive, as long as commercial production
from such lease continues, the lease will not lapse and is deemed to be "held by
production." Nonetheless, lease termination or expiration clauses are specific
to each lease. As of December 31, 1995, the Company was the lessee on oil and
gas leases covering approximately 35,000 acres, approximately 15,000 of which
were held by production, and approximately 20,000 of which were not held by
production but instead subject to drilling obligations, delay rentals or minimum
royalties. With respect to the oil and gas leasehold acreage of the Company as
of December 31, 1995, assuming the Company elected to maintain all of its leases
and drilled no wells to hold leases, the Company would have to pay a total of
approximately $100,000 in delay rentals and minimum royalties to maintain its
leases. The Company has recently acquired an approximately 17,000 acre lease in
Raleigh County, West Virginia known as the Beaver Coal Company Lease which
requires that the Company pay a minimum royalty to the lessor of between $17,000
and $85,000 per year in order to continue to hold all of the acreage on the
lease. See "Business and Properties -- Properties -- Leasehold Acreage." If
existing and future production from the Beaver Coal Company Lease does not
generate the minimum royalty and the Company does not pay such minimum royalty
out of its other funds, the Company may lose the acreage under the portion of
the lease not held by production.
Geologist's Estimates of Reserves and Future Net Revenue. This Prospectus
contains estimates of the Company's oil and gas reserves and the future net
revenues therefrom which have been prepared by a certified independent
geologist. See "Business and Properties -- Oil and Gas Operations -- Oil and
Gas Reserves." These estimates are based on various assumptions and, therefore,
are inherently imprecise indications of future revenues. Actual future
revenues, development expenditures, operating expenses and quantities of
recoverable oil and gas reserves may vary substantially from the estimates. In
addition, the Company's reserves may be subject to downward or upward revision,
based on production history, results of future exploration and development,
prevailing oil and gas prices and other factors.
Properties Pledged to Secure Debt. Substantially all of the Company's
properties are pledged to secure the Bank One Credit Facility and an equipment
and vehicle loan from SunTrust Bank. A failure to pay the principal or accrued
interest on such secured obligations could cause the Company to lose its
interest in its principal properties. For further information on these secured
transactions, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and Notes to Financial Statements.
Certain Relationships and Related Transactions. Equity Financial
Corporation ("EFC") of Knoxville, Tennessee, is a Tennessee corporation and an
NASD-member broker-dealer. EFC is owned and managed by Messrs. Torrey and
Remine, each of whom hold securities licenses as registered principals. EFC
acted as the placement agent for each Affiliated Drilling Partnership and the
Pipeline Income Partnership for which the Company serves as general partner and
operator. Messrs. Torrey and Remine received sales commissions in connection
with the offerings of interest in Affiliated Drilling Partnerships and the
Pipeline Income Partnership. It is anticipated that EFC will act as placement
agent for future Company-sponsored Affiliated Drilling Programs. Messrs. Torrey
and Remine will receive sales commissions for selling interests in future
Affiliated Drilling Programs on behalf of EFC.
Through December 31, 1996, EFC shared its offices and certain office
equipment and facilities with the Company. For this the Company paid EFC
approximately $ 1,000 per month.
Prior to October 1996, the Company leased an airplane from Charles P.
Torrey, Jr., its chief executive officer and a director, pursuant to an aircraft
lease dated February 1, 1995. The term of the lease was month to month. The
lease required the Company to make payments of base rent of $1,575 per month
payable in advance. The base rent covered the first 12 hours of usage by the
Company. Any excess use was subject to a charge of $100 per hour. Mr. Torrey, as
lessor, was responsible for maintenance of the aircraft. In September of 1996,
Mr. Torrey's airplane was sold and the lease terminated.
The Company is the borrower under promissory notes payable to Charles P.
Torrey, Jr., in the principal amount of $65,000, to Richard S. Cooper, in the
principal amount of $66,773, and to Robert L. Remine, in the principal amount of
$120,000. All of the promissory notes are due on demand and bear interest at the
rate of 10% per annum. The Company plans to pay these notes with the proceeds of
this Offering.
The Company serves as managing general partner in thirteen syndicated
Affiliated Drilling Partnerships, as well as the Pipeline Operating Partnership
and the Pipeline Income Partnership. In connection with each Affiliated Drilling
Partnership, the Company has entered into a JDOA which establishes the terms and
conditions of the Company's participation in the wells and its services as
driller-operator. For a discussion of the Company's relationship to each of
these partnerships see "Business and Properties -- Sponsorship of Affiliated
Drilling Partnerships; Pipeline Operating Partnership and Pipeline Income
Partnership."
The proceeds of this Offering may indirectly benefit EFC or future
company-sponsored Affiliated Drilling Programs in an indeterminable amount by
providing the Company with working capital to enter into or continue business
arrangements with such related parties.
10
<PAGE>
Risks Associated with Oil and Gas Industry
Current Oil and Gas Markets. There is substantial uncertainty as to the
prices at which natural gas and oil produced by the Company may be sold, and it
is possible that under some market conditions the production and sale of oil and
gas from some or all of the Company's wells may not be economical. The
availability of a ready market for oil and gas and the prices obtained for oil
and gas depend upon numerous factors beyond the control of the Company,
including competition from other natural gas and oil suppliers and national and
international economic and political developments. The Company is not subject
to any gas price controls. Future changes in regulations may have an effect on
the Company's operations.
Reliance on Estimates of Proved Reserves and Future Net Revenues; Depletion
of Reserves; Price Volatility. There are numerous uncertainties inherent in
estimating quantities of proved reserves and in projecting rates of production
and timing of development expenditures, including many factors beyond the
control of the producer. The reserve data set forth in this Prospectus or
incorporated by reference herein represent only estimates. In addition, the
estimates of future net revenues from proved reserves of the Company and the
present value thereof are based on certain assumptions about future production
levels, prices, and costs that may not prove to be correct over time. The rate
of production from oil and gas properties declines as reserves are depleted.
Except to the extent the Company acquires additional properties containing
proved reserves, conducts successful exploration and development activities or,
through engineering studies, identifies additional behind-pipe zones or
secondary recovery reserves, the proved reserves of the Company will decline as
reserves are produced. Future oil and gas production is therefore highly
dependent upon the Company's level of success in acquiring or finding additional
reserves. See "Business and Properties -- Oil and Gas Operations -- Oil and Gas
Reserves." Oil and gas prices may be quite volatile, depending on numerous
factors, including steps taken by the Organization of Petroleum Exporting
Countries ("OPEC"), tensions in the Middle East and weather conditions. The
average gas prices received by the Company were $2.75, $2.34, and $3.32 per Mcf
in 1994, 1995 and 1996 (partial year), respectively, prior to reduction for
royalties, severance taxes and gathering and transportation charges. The
average oil prices received by the Company were $15.28, $16.48, and $19.06 per
Bbl in 1994, 1995 and 1996 (partial year), respectively.
Risks of Oil and Gas Activities. Significant risks are inherent in the oil
and gas business, including the drilling of dry and unsuccessful wells,
operating hazards and uninsured risks, intense competition for attractive
properties, governmental regulations, volatile prices and other uncontrollable
factors. Furthermore, oil and gas drilling is speculative. The possibility
always exists that wells drilled will be non-productive. Even wells that are
completed may not produce enough natural gas or oil to pay out.
Exploration and Development Risks. Exploration and development drilling
activities are subject to much greater risks of failure than those associated
with the ownership of producing properties. The drilling of exploratory wells
involves the greatest risks, since such wells are located in unproved areas. The
drilling of development wells, although generally consisting of drilling in
proven areas, may result in dry holes or the failure to produce oil or gas in
commercial quantities. The drilling of development wells and exploratory wells
also involves the risk that unusual or unexpected formations and pressures will
be encountered, and other conditions will exist, that could result in the
Company incurring substantial losses as well as liabilities to third parties or
governmental entities. See "Business and Properties -- Regulation --
Environmental Regulation."
Operating Hazards and Uninsured Risks. The Company's operations will be
subject to all risks inherent in the exploration for, and development and
production of, oil and gas, including such natural hazards as blowouts,
cratering and fires, which could result in damage or injury to, or destruction
of, formations, producing facilities or other property, or could result in
personal injury, loss of life or pollution of the environment. Any such event
could result in substantial loss to the Company which could have a material
adverse effect upon the financial condition of the Company. Under the terms of
the operating agreements to be entered into with the operators of wells not
operated by the Company, it is anticipated that the operators will carry
insurance to cover certain of these risks. It is anticipated that the Company
will be required to pay its proportionate share of the premiums for insurance
provided by the operator and will be named as an insured under the policies.
However, the Company may not be fully insured against all risks, either because
such insurance is not available or because of premium costs. The Company has
purchased and plans to maintain additional insurance in the form of an umbrella
policy to protect it against uninsured
11
<PAGE>
risks or amounts in excess of the insurance carried under its primary policies
or by another operator. See "Business and Properties -- Insurance." Although
such operational risks and hazards may be to some extent minimized, no
combination of experience, knowledge and scientific evaluation can eliminate the
risk of investment or assure a profit to any company engaged in oil and gas
operations.
Competition and Markets. The oil and gas business is highly competitive
and has few barriers to entry. The Company will be competing with other oil and
gas companies and investment partnerships in the search for, and obtaining of,
future desirable prospects, the securing of contracts with third parties for the
development of oil and gas properties, the contracting for the purchase or
rental of drilling rigs and other equipment necessary for drilling operations,
and the purchase of equipment necessary for the completion of wells, as well as
in the marketing of any oil and gas which may be discovered. Many of the
Company's competitors are larger than the Company and have substantially greater
access to capital and technical resources than does the Company and may
therefore have a significant competitive advantage. Many of the Company's
competitors are capable of making a greater investment in a given area than is
the Company, although large and small companies alike are subject to the
economics of cost effectiveness. The prices at which the Company will be able to
sell any oil or gas production will have a substantial effect on its earnings,
if any. See "Business and Properties -- Competition."
Competition from Alternative Energy Sources. Natural gas competes with
coal, oil, propane, butane, nuclear power and other fuels in the heating and
energy generation markets. Numerous factors, all difficult to predict, affect
the relative desirability or demand at any point in time for any given fuel.
The extent to which public or legislative initiatives to develop and use
alternative fuels will, in the future, affect the demand for oil or natural gas
cannot be predicted at this time.
Industry Conditions. In recent decades, there have been periods of
worldwide overproduction and underproduction of hydrocarbons as well as periods
of increased and relaxed energy conservation efforts. Such conditions have
resulted in periods of excess supply of, and reduced demand for, crude oil on a
worldwide basis and natural gas on a domestic basis. These periods have been
followed by periods of short supply of, and increased demand for, crude oil and,
to a lesser extent, natural gas. The excess or short supply of crude oil and
natural gas has placed pressures on prices and has resulted in dramatic price
fluctuations.
Shut-In Wells and Curtailed Production. In the recent past, production
from oil and natural gas wells (particularly gas wells) in many geographic areas
of the United States had been curtailed due to lack of market demand, and it is
possible that such curtailments may resume in the future. Therefore, it is
possible that the Company's wells may have to be shut-in or that oil or gas
produced from the wells may have to be sold at less than favorable prices.
Production may also be delayed or wells shut-in in the event there is difficulty
in securing markets for production, logistical problems develop in the
transportation of natural gas from the wells or there are title problems
associated with the drillsites. Although it is anticipated that substantially
all natural gas from the Company's wells will be sold to the Pipeline Operating
Partnership, an affiliate of the Company, the agreement regarding the gathering
and marketing of natural gas between the Company, for itself and on behalf of
Affiliated Drilling Partnerships, and the Pipeline Operating Partnership
governing such arrangement will not protect the Company from market or price
risks.
Regulation; General. Oil and gas exploration, production and related
operations are subject to extensive rules and regulations promulgated by federal
and state agencies. Failure to comply with such rules and regulations can
result in substantial penalties. The regulatory burden on the oil and gas
industry will increase the Company's cost of doing business and will affect its
profitability. Because such rules and regulations are frequently amended or
interpreted, the Company is unable to predict the future cost or impact of
complying with such laws. Oil and gas operations are regulated by an agency of
state government in every state of the United States. Many state authorities
require permits for drilling operations, drilling bonds and reports concerning
operation and impose other requirements relating to the exploration and
production of oil and gas. Some states also have statutes or regulations
addressing conservation matters, including provisions for the pooling of oil and
gas properties, the establishment of maximum rates of production from oil and
gas wells and the regulation of spacing, plugging and abandonment of such wells.
The statutes and regulations may also limit the rate at which oil and gas can be
produced from certain properties.
12
<PAGE>
In Ohio and West Virginia, where most of the Company's oil and gas
properties are located, such regulation is by the Ohio Department of Natural
Resources and the West Virginia Division of Environmental Protection Office of
Oil and Gas, respectively. Each of these agencies has been granted broad
regulatory and enforcement powers which are likely to create additional
financial and operational burdens on gas and oil operations like those of the
Company. Ohio and West Virginia also have in place other pollution and
environmental control laws which have become increasingly burdensome in recent
years. Enforcement efforts with respect to gas and oil operations have recently
increased and it can be anticipated that such regulation will expand and have a
greater impact on future gas and oil operations. See "Business and Properties -
- - Regulation." There is no assurance that laws and regulations enacted in the
future will not adversely affect the Company's exploration for, and production
and transmission of, oil and natural gas. Such legislation and/or actions of
local, state and federal governments may have a material effect on the Company
in the future. See "Business and Properties -- Regulation -- Proposed
Regulation." To the best knowledge of management, the Company has complied in
all material respects with applicable regulatory requirements of the states in
which it operates. To date, the Company has received no material notice of
violation or complaint concerning its compliance with environmental laws. There
can be no assurance, however, that the Company's business operations will not
result in violations of environmental laws or related liabilities in the future.
Environmental Regulation. The Company is subject to numerous laws and
regulations governing the discharge of materials into the environment or
otherwise relating to environmental protection. These laws and regulations may
require the acquisition of a permit before drilling commences, restrict the
types, qualities and concentration of various substances that can be released
into the environment in connection with drilling and production activities,
limit or prohibit drilling activities on certain lands lying within wilderness,
wetlands and other protected areas, and impose substantial liabilities for
pollution resulting from the Company's operations. Moreover, the recent trend
toward stricter standards in environmental legislation and regulation is likely
to continue. For instance, legislation has been proposed in Congress from time
to time that would reclassify certain oil and gas production wastes as
"hazardous wastes," which reclassification would make such wastes subject to
much more stringent handling, disposal and clean-up requirements. If such
legislation were to be enacted, it could have a significant impact on the
operating costs of the Company, as well as the oil and gas industry in general.
It is not anticipated that the Company will be required in the near future to
expend amounts that are material in relation to its total capital expenditure
program by reason of environmental laws and regulations, but because such laws
and regulations are frequently changed, the Company is unable to predict the
ultimate cost of such compliance. See "Business and Properties -- Regulation --
Environmental Regulation."
Environmental Risks and Liability. There are numerous natural hazards
involved in the drilling of wells, including unexpected or unusual formations,
pressures, blowouts involving possible damages to property and third parties,
surface damages, bodily injuries, damage to and loss of equipment, reservoir
damage and loss of reserves. Uninsured liabilities may result in the loss of
Company assets and may create theoretically unlimited liability for the Company.
Oil and gas operations present risks of environmental contamination from
drilling operations and leakage from oil field storage or transportation
facilities. The Company may be subject to liability for pollution, abuses of
the environment and other, similar damages. Although the Company will maintain
insurance coverage in amounts the Company believes are adequate, it is possible
that insurance coverage may exclude risks such as environmental contamination,
may be insufficient or subject to reduction or cancellation in the future. In
such event, the Company's assets may have to be utilized to pay costs of
controlling blowouts, replacing destroyed equipment, personal injury, property
damage and environmental contamination claims. Furthermore, oil and gas
activities can result in liability under federal, state and local environmental
regulations for activities involving, among other things, water pollution and
hazardous waste transportation, storage and disposal. Such liability can attach
not only to the operator of record of a well but also to other parties that may
be deemed to be current or prior operators or owners of a well or the equipment
involved. See "Business and Properties -- Regulation -- Environmental
Regulation." Since inception, the Company has experienced no material
environmental incident. There can be no assurance, however, that the Company
will not experience one or more environmental incidents and resulting liability
in the future in connection with its business operations.
Risks Associated with Investment in Securities
13
<PAGE>
No Assurance of Public Market; Possible Volatility of Unit, Common Stock,
and Series A Warrant Prices; Disclosure Relating to Low-Priced Stock. Prior to
this Offering, there has been no public trading market for the Units, Common
Stock or Series A Warrants, and there can be no assurance that a trading market
for the Company's securities will develop after this Offering or that, if
developed, it will be sustained. The absence of a trading market may render an
investor unable to liquidate his investment in the Company. The initial public
offering price of the Units and the exercise price of the Series A Warrants have
been determined by negotiations between the Company and the Representatives
based on several factors. The fact that such prices were negotiated does not
ensure that a market for the securities will develop or continue at that price
or at any price. The trading price for the Units, Common Stock and Series A
Warrants may be significantly affected by such factors as the operating results
of the Company, the United States and global economic conditions and various
other factors generally affecting the oil and gas products industry.
Additionally, the stock market has from time to time experienced extreme price
and volume fluctuations which have particularly affected the market price for
small and emerging growth companies. These extreme fluctuations, which often
have been unrelated to the operating performance of any particular company or to
any group of companies, may adversely affect the market price of the Units,
Common Stock and Series A Warrants. The Units, Common Stock and Series A
Warrants have been approved, subject to official notice of issuance, for listing
on the Boston Stock Exchange under the symbols "EYS.U," "EYS," and "EYS.WS.A,"
respectively, and for quotation on the Nasdaq Small-Cap Market under the symbols
"EGASU," "EGAS," and "EGASW," respectively. If, at any time, the Company's
securities are not quoted on a stock exchange, the Company's securities could
become subject to the "penny stock rules" adopted pursuant to Section 15(g) of
the Securities Exchange Act of 1934. The penny stock rules apply to companies
whose common stock trades at less than $5.00 per share or which have tangible
net worth of less than $5,000,000 ($2,000,000 if the company has been operating
for three or more years). Such rules require, among other things, that brokers
who trade "penny stock" to persons other than "established customers" complete
certain documentation, make suitability inquiries of investors and provide
investors with certain information concerning trading in the security, including
a risk disclosure document and quote information under certain circumstances.
Many brokers do not trade "penny stocks" because of the requirements of the
penny stock rules and, as a result, the number of broker-dealers willing to act
as market makers in such securities is limited. See "Description of Securities"
and "Underwriting."
Dividend Policy. The Company has not paid or declared any cash dividends
with respect to its Common Stock, nor does it anticipate any such payments or
declarations in the foreseeable future. Any future dividends will be declared
at the discretion of the Board of Directors of the Company and will depend,
among other things, on the Company's earnings, if any, its financial
requirements for future operations and growth, and such other factors as the
Company may then deem appropriate. Prospective investors should not rely on the
receipt of dividends in the near future or at any time in the future when
evaluating the merits of an investment in the Units. See "Dividend Policy."
Dilution. The principal shareholders of the Company have acquired Common
Stock at a cost per share which is substantially less than that at which the
Company intends to sell the Common Stock included in the Units to investors in
this Offering. Therefore, an investment in the Units offered hereby will result
in the investors experiencing immediate and substantial dilution in net tangible
book value of $4.73 per share of Common Stock, or 59.1% as a result of the
Offering. In the event that the Company issues additional Common Stock in the
future, including shares that may be issued upon the exercise of the Series A
Warrants, purchasers of the Units may experience further dilution in the net
tangible book value per share of the Common Stock of the Company. See
"Dilution."
Current Prospectus and State Blue Sky Registration Required to Exercise
Series A Warrants. Purchasers of Units will be able to exercise the Series A
Warrants included therein only if a current Prospectus relating to the Common
Stock underlying the Series A Warrants is then in effect and only if the
purchase of such Common Stock is qualified for sale or exempt from qualification
under the applicable securities laws of the state in which such purchaser
resides. Although the Company has agreed to take all necessary steps to
maintain the effectiveness of a current registration statement covering the
purchase of the Common Stock, Series A Warrants and the qualification of the
purchase of the Company's Common Stock under applicable state securities laws,
there can be no assurance that the Company will be able to obtain or, if
obtained, to maintain the effectiveness of such registration statement or such
state qualification. The value of the Series A Warrants may be greatly reduced
if a current registration statement covering the Common Stock issuable upon the
exercise of the Series A Warrants is not kept effective or if such Common Stock
is not qualified or exempt from qualification in the states in which the holders
of the Series A Warrants reside. A current registration statement must also be
kept effective for the sale of Units, Common Stock and Series A Warrants. See
"Description of Securities -- Series A Warrants."
Potential Adverse Effect of Redemption of Series A Warrants. The Series A
Warrants are subject to redemption by the Company at a price of $.05 per Warrant
under certain conditions at any time commencing eighteen months after the date
of this Prospectus on at least 30 days prior written notice. If the Warrants are
redeemed, Warrant holders will lose their right to exercise the Warrants except
during such 30-day redemption period. Upon receipt of a notice of redemption,
Warrant holders would be required to: (i) exercise the Warrants and pay the
exercise price at a time when it may be disadvantageous for them to do so, (ii)
all the Warrants at the then market price, if any, when they might otherwise
wish to hold the Warrants, or (iii) accept the redemption price which is likely
to be substantially less than the market value of the Warrants at the time of
the redemption. See "Description of Securities -- Series A Warrants."
14
<PAGE>
Warrants to Representatives. Upon completion of this Offering, the Company
will sell to the Representatives, for nominal consideration, Representatives'
Warrants to purchase 100,000 Units. To the extent that the Representatives'
Warrants are exercised, they would have a dilutive effect on the percentage of
outstanding shares held by stockholders purchasing Units in this Offering. The
exercise of the Representatives' Warrants is likely to occur at a time when the
Company could probably obtain additional equity capital on terms more favorable
than those provided by the Representatives' Warrants. See "Underwriting."
15
<PAGE>
USE OF PROCEEDS
The net proceeds of this Offering are anticipated to be $6,715,000, after
deducting the Underwriters' discount, non-accountable expense allowance and
estimated offering expenses ($7,765,000 if the Underwriters Over-allotment
Option is exercised in full). No value has been assigned to the Series A
Warrants included in the Units. The Company intends to use the net proceeds of
this Offering as follows:
<TABLE>
<CAPTION>
Approximate Percent
Approximate Amount of Proceeds
------------------ -------------------
<S> <C> <C>
Retirement of debt to officers (1) $ 277,000 4.125%
Dividends to Class A Preferred Stock (2) $ 48,000 0.715%
Working Capital (3) $6,390,000 95.160%
---------- ------
Total $6,715,000 100%
========== ======
- -----------------------------
</TABLE>
(1) The Company currently owes Charles P. Torrey, Jr. $65,000, Richard S.
Cooper $66,773 and Robert L. Remine $120,000, each plus accrued interest at the
rate of 10% per annum in the aggregate amount of approximately $25,227, pursuant
to certain promissory notes. These promissory notes are scheduled to mature on
demand. The proceeds of these loans were used by the Company for working
capital.
(2) Accrued dividends at 5% on the Company's Class A Preferred Stock are
payable in cash upon the completion of this Offering. At such time, all shares
of Preferred Stock will be automatically converted to Common Stock on a one
share-to-one share conversion ratio.
(3) To be used to explore for, acquire and develop natural gas and oil
reserves. At least 65% of the net proceeds of the Offering are expected to be
used by the Company for development of the Company's Beaver Coal Company Lease
and any current or later acquired leases in such area; as well as for
development of the Company's Dupont Field, and any extensions thereof, in Wood
County, West Virginia; and the Company's Torch and Bartlett Field, and any
extensions thereof, in or around the area serviced by the Gas Gathering System
operated by the Company.
The foregoing represents the best estimate by the Company of its use of net
proceeds based upon present planning and business conditions. The proposed
application of proceeds is subject to change as market and financial conditions
change. The Company, therefore, has reserved the right to vary its use of
proceeds in response to unanticipated events which may arise.
Pending use, it is anticipated that the proceeds to the Company resulting
from this Offering will be primarily invested in short-term, investment grade
obligations or insured bank certificates of deposit. It is anticipated that the
net proceeds of this Offering will satisfy the financial needs of the Company
for 18 to 24 months following the date of this Prospectus. See "Business --
Business Plan" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources."
Management has not definitively identified the uses of the net proceeds
which are allocated to working capital reserves. While it is presently
anticipated that these funds will be used, in part, for development of the
Beaver Coal Company Lease, other developmental drilling activities elsewhere in
southeastern Ohio and West Virginia, or acquisitions of oil and gas properties,
the net proceeds will ultimately be applied as business opportunities present
themselves.
16
<PAGE>
DIVIDEND POLICY
Since inception, the Company has not paid, and it has no current plans to
pay, cash dividends on the Common Stock. The Company intends to retain all
earnings to support the Company's operations and future growth. The payment of
any future dividends will be determined by the Board of Directors based upon the
Company's earnings, financial condition and cash requirements, possible
restrictions in future financing agreements, if any, business conditions and
such other factors deemed relevant. See "Risk Factors -- Risks Associated with
Investment in Securities -- Dividend Policy."
DILUTION
As of September 30, 1996, the net tangible book value of the Company was
$3,168,712 or $1.58 per share of Common Stock. The net tangible book value of
the Company is the aggregate amount of its tangible assets less its total
liabilities. The net tangible book value per share represents the total
tangible assets of the Company, less total liabilities of the Company, divided
by the number of shares of Common Stock outstanding. After giving effect to the
sale of 1,000,000 Units (comprised of 1,000,000 shares of Common Stock and
1,000,000 Series A Warrants) at the offering price per Unit of $8.00, and the
application of the net proceeds therefrom, the pro forma net tangible book value
per share would increase from $1.58 to $3.27. This represents an immediate
increase in net tangible book value of $1.69 per share to current holders of
Common Stock, including current holders of Preferred Stock, all of whom are
assumed to be converting their shares to Common Stock, and an immediate dilution
of $4.73 per share, to new investors, as illustrated in the following table.
<TABLE>
<CAPTION>
<S> <C> <C>
Public Offering price per share (1) $ 8.00
Net tangible book value per share before this Offering $ 1.58
Increase per share attributable to new investors $ 1.69
------
Adjusted net tangible book value per share after this Offering $ 3.27
------
Dilution per share to new investors $ 4.73
======
- ------------------------------------------------
</TABLE>
(1) For purposes of this table it is assumed that no part of the offering price
per Unit of $8.00, will be attributable to the Series A Warrants.
The following table summarizes, as of the date of this Prospectus, and
giving effect to the two-for-one stock split to be effected immediately prior to
completion of this Offering, the number of shares of Common Stock purchased from
the Company, the total consideration paid, and the average price per share paid
by the current Common Stockholders, the holders of Preferred Stock (assuming
conversion of the Preferred Stock into Common Stock), and the holders of Common
Stock purchase warrants (assuming exercise of such warrants), and the number of
shares of Common Stock purchased from the Company and the total consideration
paid by the new investors purchasing shares of Common Stock in this Offering
before deduction of the underwriting discounts and commissions and offering
expenses payable by the Company:
17
<PAGE>
<TABLE>
<CAPTION>
Shares
Purchased(1) Total Consideration Average
------------------ ---------------------- Per
Number Percent Amount Percent Share
------------------ ----------------------- -------
<S> <C> <C> <C> <C> <C>
Current Common Stockholders (1) 1,100,000 36.33% $ 1,200 0.01% $0.0011
Current Preferred Stockholders (2) 900,000 29.72% $ 4,500,000(3) 35.71% $ 5.00
Current Common Stock purchase
warrant holders (4) 27,950 0.92% $ 99,790 0.80% $ 3.57
New Investors 1,000,000 33.03% $ 8,000,000 63.48% $ 8.00
--------- ----- ----------- ------
Total 3,027,950 100.0% $12,600,990 100.0%
========= ===== =========== ======
- ---------------------------
</TABLE>
(1) The original holders of Common Stock of the Company were Messrs. Torrey,
Remine and Cooper. These original Common Stockholders have since transferred an
aggregate of 80,000 of the 1,100,000 shares of Common Stock shown here to key
employees and advisors of the Company.
(2) All shares of Preferred Stock will be automatically converted to Common
Stock on a one share-to-one share conversion ratio upon completion of the
Offering.
(3) Shares of Class A Preferred Stock were issued by the Company in May through
September of 1996 in consideration of retirement of $2,077,000 of the
Debentures. Shares of Class B Preferred Stock also were issued by the Company
during this time in consideration of $2,423,000 in cash.
(4) Currently employees of the Company and certain selling agents of the
Company's syndicated private offerings own warrants to purchase 19,950 (post-
stock split) shares of Common Stock at $5.00 per share (post-stock split)
including warrants to purchase 7,494 (post-stock split) shares of Common Stock
owned by Messrs. Torrey, Remine and Cooper. In addition, certain selling agents
currently own warrants to purchase 8,000 (post-stock split) shares of Common
Stock at $.005 (post stock split) per share. All of these warrants must be
exercised, if at all, within 90 days after completion of this Offering.
18
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
December 31, 1995 as reflected in the audited financial statements, the
capitalization of the Company as of September 30, 1996 as reflected in the
unaudited financial statements, and the pro forma capitalization of the Company
as of September 30, 1996 giving effect to the sale of the 1,000,000 Units
offered hereby and the application of the net proceeds therefrom.
<TABLE>
<CAPTION>
(unaudited) (unaudited)
December 31, September 30, September 30,
1995 1996 1996
Actual Actual As Adjusted (1)
--------------- --------------- ----------------
<S> <C> <C> <C>
Short-term debt:
Current portion of notes payable........ $ 783,254 $ 707,606 $ 455,833
---------- ----------- -----------
Total short-term debt................... $ 783,254 $ 707,606 $ 455,833
========== =========== ===========
Long-term debt:
Notes payable........................... $2,285,592 $ 46,716 $ 46,716
========== =========== ===========
Shareholders' equity (deficit):
Common Stock, no par value,
10,000,000 shares authorized,
3,000,000 shares issued and outstanding,
as adjusted, including conversion
of all Preferred Shares (1)........... $ 1,200 $ 4,501,200 $11,216,200
Retained earnings (deficit).......... (366,163) (1,332,488) (1,405,715)
---------- ----------- -----------
Total shareholders' equity (deficit).. $ (364,963) $ 3,168,712 $ 9,810,485
========== =========== ===========
Total capitalization......................... $2,703,883 $ 3,923,034 $10,313,034
========== =========== ===========
- -----------------------------------
</TABLE>
(1) Reflects the conversion of all outstanding shares of Preferred Stock to
Common Stock upon completion of this Offering. Does not assume that the
currently outstanding and vested Common Stock purchase warrants for 27,950
shares of Common Stock will be exercised, although management expects that all
such warrants will be exercised within 90 days from completion of this Offering.
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
The Company is an independent oil and gas development and production
company focusing primarily on developmental drilling and production of natural
gas reserves in the Appalachian Basin and elsewhere in the mid-continent region
of the United States. The Company historically has developed oil and gas
properties primarily by drilling natural gas wells in joint ventures with
Tennessee limited partnerships for which the Company serves as managing general
partner (the "Affiliated Drilling Partnerships"). These Affiliated Drilling
Partnerships were syndicated by the Company's affiliate, Equity Financial
Corporation ("EFC"), an NASD-member broker-dealer, and capitalized with investor
funds raised in various private offerings. The Company also operates an
approximately 60-mile gas gathering system servicing its primary areas of
operation in southeastern Ohio (the "Gas Gathering System"). The Gas Gathering
System is owned by a Tennessee limited partnership (the "Pipeline Operating
Partnership") which is comprised of the Company, as managing general partner
owning a 28.74% general partner interest, and a single limited partner which is
another Tennessee limited partnership (the "Pipeline Income Partnership") for
which the Company also serves as managing general partner. The Pipeline Income
Partnership was syndicated by EFC and capitalized with investor funds raised in
a private offering conducted in 1992 and 1993. Through the date of this
Prospectus, approximately $47,000,000 had been raised and applied by the Company
for various activities including oil and gas development and production
activities in connection with Affiliated Drilling Partnerships; formation of the
Pipeline Income Partnership and the Pipeline Operating Partnership and
acquisition and operation of the Gas Gathering System which services gas wells
owned and operated by the Company in co-ownership with Affiliated Drilling
Partnerships; and for the Company's working capital.
The Company's principal operations include evaluating, acquiring and
developing gas and oil leases, sponsoring the organization and offering of
Affiliated Drilling Partnerships, serving as driller-operator on wells drilled
in joint ventures with Affiliated Drilling Partnerships and for its own account,
and operating the Gas Gathering System as general partner of the Pipeline
Operating Partnership.
The Company's principal assets include direct ownership of natural gas and
oil properties with predominantly natural gas reserves, tangible well equipment,
its varying equity interests as managing general partner of all of the
Affiliated Drilling Partnerships formed since 1992, a 28.74% equity interest in
the Pipeline Operating Partnership and a 1% equity interest in the Pipeline
Income Partnership. The Company currently owns approximately 55,000 gas and oil
leasehold acres. As of September 30, 1996, the Company operated approximately
164 wells in southeastern Ohio and 11 wells in West Virginia. The Company's
primary revenues are derived from fees for services in connection with drilling
and production operations with Affiliated Drilling Partnerships and industry
partners, management fees from the Pipeline Operating Partnership, partnership
revenue from its 28.74% interest in the Pipeline Operating Partnership,
management and administrative fees received from Affiliated Drilling
Partnerships pursuant to various agreements governing the joint drilling,
development and operation of wells between the various Affiliated Drilling
Partnerships and the Company (the "JDOA[s]"), partnership revenue from its
varying equity interests in the Affiliated Drilling Partnerships formed since
1992, and production revenues attributable to its owned working interests in
wells. While the Company's primary focus historically has been the drilling of
development natural gas wells in the area known as the Bartlett and Torch Fields
in southeastern Ohio, it has recently begun to expand its activities into West
Virginia. In November 1995, the Company acquired nine producing wells and
approximately 1,403 acres of undeveloped acreage containing a number of
developmental drilling locations in Wood County, West Virginia (the "Dupont
Field").
Recently, two major factors have affected the financial condition of the
Company. First, in March of 1996 the Company began implementing a transition
from being primarily a driller-operator for syndicated Affiliated Drilling
Partnerships to an energy company developing reserves for its own account. The
Company has reduced its debt by converting $2,077,000 of its variable rate
subordinated debentures (the "Debentures" or "Debenture Issue") to 207,700
shares of Class A Preferred Stock. The Company has further raised $2,423,000 in
cash by the sale in private placements of 242,300 shares of Class B Preferred
Stock. The proceeds of Class A and Class B Preferred Stock were used to
eliminate substantially all long term debt of the Company. Remaining debt
outstanding in the Company included its operating line of credit (the "Bank One
Credit Facility"), a short term equipment loan and certain notes payable to
officers.
20
<PAGE>
Secondly, in July 1996, the Company negotiated its largest acreage
acquisition to date, expanding its operations into southern West Virginia. This
area, management believes, contains potential for higher reserves per well and
less production cost per cubic foot of gas recovered than the Company's current
areas of operation and other prospects. The Company leased in excess of 17,000
acres from Beaver Coal Company Ltd. (the "Beaver Coal Company Lease") on which
management believes there exist approximately forty-four (44) developmental
drilling locations (qualified under SEC guidelines as proved undeveloped
reserves, "PUDs") offsetting producing wells, and which, as substantiated by the
review and evaluation of Kim A. Walbe, independent geologist, contains PUD
reserves with a present value of discounted net cash flows (SEC Method) of
approximately $13,000,000. Management believes that this acreage may yield
additional developmental drill sites for which no proved reserve value has yet
been assigned, and that it will be a major focus for development by the Company
in future years. The acreage is crossed by or is adjacent to numerous
interstate and intrastate pipeline systems, providing access to markets.
Management believes that the Company has developed the infrastructure, in
terms of personnel, expertise and computerization, to exploit the Beaver Coal
Company Lease opportunity. The Company's present strategy is to raise capital
in this Offering and use a significant portion of the Offering proceeds to
develop the Beaver Coal Company Lease and other promising acreage held, or to be
acquired, by the Company through developmental drilling.
Developments Since September 30, 1996
The Company currently has outstanding 207,700 shares of Class A Preferred
Stock and 242,300 shares of Class B Preferred Stock. The Class A Preferred Stock
and Class B Preferred Stock was redeemable at $10 per share upon the occurrence
of a "Surrender Event" defined as: (a) the Company merging or consolidating
with another company in a transaction in which the Company is not the survivor;
(b) the Company selling or disposing of all, or substantially all, of its
assets; or (c) management of the Company undertaking a registration and initial
public offering of any of its Common Stock.
Contemporaneously with the filing of the Registration Statement in
connection with this initial public offering the Company sent notice to each
holder of Class A Preferred Stock and Class B Preferred Stock announcing the
occurrence of a Surrender Event and requiring any person desiring to redeem his
or her Preferred Stock to notify the Company within 30 days. No notices of
desire to redeem Preferred Stock were received by the Company. As a result, the
Class A Preferred Stock and Class B Preferred Stock is no longer redeemable.
All shares of Class A Preferred Stock and Class B Preferred Stock will
automatically be converted to Common Stock on a one share - to - one share basis
upon completion of the initial public offering.
In consideration of the foregoing, the Company has included Class A
Preferred Stock and Class B Preferred Stock in the shareholder equity account of
its September 30, 1996 unaudited balance sheet.
Nine Months Ended September 30, 1996 and 1995
Financial Condition
Total assets increased $1,190,029 or 25.2% from September 30, 1995, to
September 30, 1996, primarily due to an increase in investments in partnerships
of $309,942 or 24.7%, an increase in the net investment in oil and gas
properties of $426,831 or 15.4% and recognition of a deferred tax asset of
$498,019 in 1996 resulting from a change of the Company's tax status from a
subchapter "S" corporation to a "C" corporation.
Investments in partnerships are accounted for by the equity method, and the
increase in investment is due to contributions made to certain Affiliated
Drilling Partnerships and the net income (loss) recognized during the period.
The increase in net investment in oil and gas properties results from
acquisition by the Company of interests in proved undeveloped oil and gas
leases. The Company acquired oil and gas leases with significant value during
the third quarter of 1996. On July 17, 1996, the Company executed an
agreement
21
<PAGE>
to lease oil and gas property containing approximately 17,000 acres from Beaver
Coal Company, Ltd. (the "Beaver Coal Company Lease"). This property is
estimated by the Company, as substantiated by the review and evaluation of Kim
A. Walbe, independent geologist, to contain proven undeveloped oil and gas
reserves with a net present value of discounted net cash flows (SEC method) in
excess of $13,000,000.
The decrease in capitalized loan costs is due to the fact that these costs
were written down during 1996 concurrent with the payoff of the related debt as
discussed below.
Total assets increased $109,394 or 1.8% from December 31, 1995 to September
30, 1996, primarily due to a decrease in the net accounts receivable from
related partnerships of $948,353 and increases in oil and gas properties and
other assets of $1,046,873. The decrease in accounts receivable is due mostly
to the collection in 1996 of 1995-A Partnership drilling advances paid pursuant
to the JDOA which were expended in 1996 for the drilling and completion of 1995-
A Partnership wells. The increases in oil and gas properties and other assets
have been explained in the paragraphs above.
Total current liabilities decreased $139,619, or 4.9%, between September
30, 1995 and September 30, 1996, due to a decrease in drilling advances paid
pursuant to the JDOA of $431,341, or 23.9%, and an increase in accounts payable
and accrued expenses of $242,908, or 64.0%. A substantial amount of well
completion activity during 1996 caused these balances to vary accordingly.
Total long term debt decreased from September 30, 1995, to September 30,
1996 by $2,009,706 or 97.7%. This decline in long-term debt is primarily the
result of the conversion of substantially all of the Company's outstanding
Debentures as of September 30, 1996 to Class A Preferred Stock. The remaining
balance, approximately $92,500 inclusive of accrued interest, of the Debenture
Issue which was not converted to Class A Preferred Stock was paid in cash as of
September 30, 1996. From March through September of 1996, the Company undertook
a private offering of Class A Preferred Stock and Class B Preferred Stock. The
Class A Preferred Stock was issued in exchange for retirement of principal
outstanding on the Company's Debenture Issue. Any Debentures not converted to
Class A Preferred Stock were paid in full.
Total current liabilities decreased $1,185,405 or 30.5% and long-term debt
decreased $2,238,876 or 97.9% from December 31, 1995 to September 30, 1996. The
decreases in these accounts are due to well completion activity and conversion
of outstanding Debentures to Class A Preferred Stock which are more fully
explained above.
Results of Operations
During the nine months ended September 30, 1996, the Company had a net loss
of $748,484 compared to net income of $462,663 for the nine months ended
September 30, 1995. This decline in earnings is primarily the result of a
decrease in net turnkey revenues of $950,399 between these two periods. The
decrease in net turnkey revenues was the result of two factors: management's
control over drilling activities and the accelerated recognition of net turnkey
drilling revenues in 1995. The Company was able to accomplish the drilling to
total depth of more wells in 1995, thereby increasing the total number of wells
for 1995 for which net turnkey drilling revenues were recognized. The majority
of the turnkey expenses associated with completing the wells drilled in 1995
were not incurred and recognized until 1996. As a result, turnkey expenses did
not decrease in proportion with the decrease in net turnkey revenues. In
addition, the number of wells the Company has drilled in 1996 has decreased due
to a decrease in the amount of capital raised for Affiliated Drilling Programs
in 1996. The Company has concentrated its efforts in the third quarter of 1996
on raising capital through this Offering in order to increase the number of
wells drilled in the near future for its own account and to continue
developmental drilling in West Virginia.
Total Operating Expenses increased $488,629 or 32.0% from September 30,
1995 to September 30, 1996, primarily due to an increase in general and
administrative expenses of $269,718, or 41.3%, and an increase in interest
expense of $138,797, or 242.5%, due to interest paid on the Debenture Issue
outstanding during 1996 of $2,169,500. The increase in general and
administrative expenses is primarily due to an increase in officer's salaries of
$183,585, or 90.0%. The increase in officers' salaries is a result of a bonus
paid to the officers of the Company to compensate them for income tax paid
individually on the Company's 1995 earnings due to the Company's subchapter "S"
corporate tax status.
22
<PAGE>
The net loss for the period ending September 30, 1996, is also partially
the result of two one-time charges resulting from the Preferred Stock issuance
expense of $83,080 and the loss from extinguishment of long term debt of
$129,920 during 1996.
Effective January 1, 1996, the Company terminated its subchapter "S"
corporation tax election. As a result, net income of the Company is taxed at
the corporate level at federal statutory rates for 1996 and future years. An
income tax benefit of $438,366 and federal and state deferred tax assets of
$407,607 and $90,412, respectively, were recorded in 1996 to reflect the net
tax effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for federal
and state income tax purposes.
Twelve Months Ended December 31, 1995 and 1994
Financial Condition
Total assets of $5,811,806 at December 31, 1995, increased $629,769 or
12.1% from December 31, 1994. This increase is primarily due to an increase in
current assets of $258,563, or 23.4%, a net increase in oil and gas properties
of $242,091, or 8.9%, and an increase in other assets of $129,115, or 9.4%.
Current assets increased as a result of an increase in net accounts
receivable from related partnerships of approximately $250,000. Included in the
1995 amount due from related partnerships is $969,000 receivable from the 1995-A
Partnership, an Affiliated Drilling Partnership, for turnkey drilling contract
amounts under the JDOA which the 1995-A Partnership partners had subscribed to
but not paid in 1995. This balance of unpaid advances at December 31, 1995, was
approximately $314,000 higher than at December 31, 1994.
The increase in net oil and gas properties results from a significant
increase in drilling activity during 1995. Also during 1995, the Company
acquired certain proved undeveloped oil and gas leases and working interests in
certain projects operated by other oil and gas operating companies. Included in
proved properties are oil and gas leases and the Company's working interest in
producing oil and gas wells. The increase in oil and gas leases results from an
increase in acreage leased. The total acres leased increased from approximately
21,500 acres in 1994 to approximately 28,050 acres in 1995.
The increase in other assets results from an increase in the investments in
related partnerships of $230,170, or 23.1%, and a decrease in property and
equipment of $136,325, or 64.1%, which is due to the sale of the company
airplane. The increase in the investments is mainly due to the initial capital
contributions the Company made to the 1995 and the 1995-A Partnerships, which
contributions were $172,000 and $125,800, respectively, at December 31,
1995.
Current and long-term debt at December 31, 1995, of $783,254 and
$2,285,592, respectively, increased $493,849 and $619,821, respectively, from
December 31, 1994. The increase in long-term debt occurred largely as a result
of the issuance of additional Debentures. In 1994 the Company issued a total of
$1,282,500 in face value of Debentures. In 1995, the Company issued $887,000
in face value of Debentures.
Drilling advances decreased $850,876, or 26.0%, from December 31, 1994.
This is due to the Company drilling and completing more wells in 1995 than
1994.
Results of Operation
For the year ended December 31, 1995, the Company had net income of
$268,342 as compared to a net loss of $1,202,570 for the year ended December 31,
1994. The overall improvement in net earnings for 1995 was the result of an
increase in net turnkey revenues of $1,217,673, or 150.8%, from 1994 combined
with a decrease in operating expenses of $409,316, or 15.6%.
23
<PAGE>
The increase in net turnkey revenues over 1994 was the result of
management's control over drilling activities and the recognition of net turnkey
drilling profits. The Company was able to accomplish the drilling to total
depth of more wells in the fall of 1995 than in the same period of 1994, thereby
increasing the total number of wells for 1995 for which net turnkey drilling
revenues were recognized.
The decrease in operating expenses was primarily due to a decrease in
production costs of $269,540, or 38.4%, and a decrease in exploration costs of
$114,064, or 78.2%. Engineering exploration services were out-sourced in 1994
which resulted in a substantially larger exploration expense in 1994 than in
1995. The decreases in production costs are the result of an ongoing effort by
management to control and reduce these expenditures.
Liquidity and Capital Resources
The primary source of funds for both nine month periods ending September
30, 1996 and 1995 have been from issuance of preferred stock and issuance of
debt. The primary source of funds for the years ended December 31, 1995 and
1994 was from issuance of debt. Proceeds from this Offering will provide
significant funding for future development and will have a material impact on
the Company's short-term liquidity. Management expects to see positive cash
flow from operating activities in 1997 and beyond. The Company expects to
drill, operate and own (for its own account) additional wells from the net
proceeds of this Offering. These wells, along with the profits anticipated to
be earned on turnkey drilling costs paid pursuant to relevant JDOA's in
connection with future Affiliated Drilling Programs, will, in management's view,
generate additional positive cash flows.
The Company maintains the Bank One Credit Facility which provides for a
revolving line of credit not to exceed $900,000 secured by all oil and gas
assets of the Company. The amount of the Bank One Credit Facility reduces by
$10,000 per month pending reevaluation at the end of the annual credit period.
Pending renewal, interest only on the Bank One Credit Facility is payable on the
amounts drawn and outstanding. The interest rate applicable to the Bank One
Credit Facility is based on a floating rate equal to Bank One's base rate,
published from time to time, plus, one and three-fourths percent. The Bank One
Credit Facility is a source of liquidity and capital to the Company.
24
<PAGE>
BUSINESS AND PROPERTIES
General
The Company is an independent oil and gas development and production
company focusing primarily on developmental drilling and production of natural
gas reserves in the Appalachian Basin and elsewhere in the mid-continent region
of the United States. The Company historically has developed oil and gas
properties primarily by drilling natural gas wells in joint ventures with
Tennessee limited partnerships for which the Company serves as managing general
partner (the "Affiliated Drilling Partnerships"). These Affiliated Drilling
Partnerships were syndicated by the Company's affiliate, Equity Financial
Corporation ("EFC"), an NASD-member broker-dealer, and capitalized with investor
funds raised in various private offerings. The Company also operates an
approximately 60-mile gas gathering system servicing its primary areas of
operation in southeastern Ohio (the "Gas Gathering System"). The Gas Gathering
System is owned by a Tennessee limited partnership (the "Pipeline Operating
Partnership") which is comprised of the Company, as managing general partner
owning a 28.74% general partner interest, and a single limited partner which is
another Tennessee limited partnership (the "Pipeline Income Partnership") for
which the Company also serves as managing general partner. The Pipeline Income
Partnership was syndicated by EFC and capitalized with investor funds raised in
a private offering conducted in 1992 and 1993. Through the date of this
Prospectus, approximately $47,000,000 had been raised and applied by the Company
for various activities including oil and gas development and production
activities in connection with Affiliated Drilling Partnerships; formation of the
Pipeline Income Partnership and the Pipeline Operating Partnership and
acquisition and operation of the Gas Gathering System which services gas wells
owned and operated by the Company in co-ownership with Affiliated Drilling
Partnerships; and for the Company's working capital.
The Company's principal operations include evaluating, acquiring and
developing gas and oil leases, sponsoring the organization and offering of
Affiliated Drilling Partnerships, serving as driller-operator on wells drilled
in joint ventures with Affiliated Drilling Partnerships and for its own account,
and operating the Gas Gathering System as general partner of the Pipeline
Operating Partnership.
The Company's principal assets include direct ownership of natural gas and
oil properties with predominantly natural gas reserves, tangible well equipment,
its varying equity interests as managing general partner of all of the
Affiliated Drilling Partnerships formed since 1992, a 28.74% equity interest in
the Pipeline Operating Partnership and a 1% equity interest in the Pipeline
Income Partnership. The Company currently owns approximately 55,000 gas and oil
leasehold acres. As of September 30, 1996, the Company operated approximately
164 wells in southeastern Ohio and 11 wells in West Virginia. The Company's
primary revenues are derived from fees for services in connection with drilling
and production operations with Affiliated Drilling Partnerships and industry
partners, management fees from the Pipeline Operating Partnership, partnership
revenue from its 28.74% interest in the Pipeline Operating Partnership,
management and administrative fees received from Affiliated Drilling
Partnerships pursuant to various agreements governing the joint drilling,
development and operation of wells between the various Affiliated Drilling
Partnerships and the Company (the "JDOA[s]"), partnership revenue from its
varying equity interests in the Affiliated Drilling Partnerships formed since
1992, and production revenues attributable to its owned working interests in
wells. While the Company's primary focus historically has been the drilling of
development natural gas wells in the area known as the Bartlett and Torch Fields
in southeastern Ohio, it has recently begun to expand its activities into West
Virginia. In late 1995, the Company acquired nine producing wells and
approximately 1,403 acres of undeveloped acreage in Wood County, West Virginia.
In July of 1996, the Company acquired approximately 17,000 acres of proved
undeveloped acreage in Raleigh County, West Virginia (the "Beaver Coal Company
Lease").
The Company's business plan is to increase its oil and gas reserves
primarily by continued developmental drilling in southeastern Ohio in the area
serviced by the Gas Gathering System, as well as in Wood and Raleigh Counties,
West Virginia. The Company may also undertake activities elsewhere in the
Appalachian Basin and the mid-continent region of the United States. It plans
to drill an increasing number of wells for its own account, while, at the same
time continuing to drill wells with future Affiliated Drilling Partnerships to
be syndicated on a private placement basis by its affiliate, EFC.
25
<PAGE>
Sponsorship of Affiliated Drilling Partnerships; Pipeline Operating Partnership
and Pipeline Income Partnership.
Following is a summary of the Company's involvement in Affiliated Drilling
Partnerships, the Pipeline Operating Partnership and the Pipeline Income
Partnership.
The Company has served as supervising operator for all wells in Equity
Financial Natural Gas/Tax Credit 1990 Limited Partnership (the "1990 Drilling
Program"). The Company served as primary driller-operator for Equity Financial
Natural Gas/Tax Credit 1991 Limited Partnership (the "1991 Drilling Program"),
Equity Financial Natural Gas/Tax Credit 1992 Limited Partnership (the "1992
Drilling Program"), Energy Search Natural Gas/Tax Credit 1992-A L.P. (the "1992-
A Drilling Program"), Energy Search Natural Gas 1993 L.P. (the "1993 Drilling
Program"), Energy Search Natural Gas 1993-A L.P. (the "1993-A Drilling
Program"), Energy Search Natural Gas 1994, L.P. (the "1994 Drilling Program"),
Energy Search Natural Gas 1994-A, L.P. (the "1994-A Drilling Program"), Energy
Search Natural Gas 1995 L.P. (the "1995 Drilling Program"), Energy Search
Natural Gas 1995-A L.P. (the "1995-A Drilling Program"), Energy Search Natural
Gas 1996 L.P. (the "1996 Drilling Program") and Energy Search Natural Gas 1996-A
L.P. (the "1996-A Drilling Program.") The Company is also managing general
partner of the 1992-A Drilling Program, the 1993 Drilling Program, the 1993-A
Drilling Program, the 1994 Drilling Program, the 1994-A Drilling Program, the
1995 Drilling Program, the 1995-A Drilling Program, the 1996 Drilling Program
and the 1996-A Drilling Program. Charles P. Torrey, Jr. and Robert L. Remine,
both principal officers of the Company, are co-managing general partners of
Equity Financial Corporation Natural Gas/Tax Credit 1989 Limited Partnership
(the "1989 Drilling Program"), the 1990 Drilling Program, the 1991 Drilling
Program and the 1992 Drilling Program. Richard S. Cooper, president of the
Company, served as co-managing general partner of the 1991 Drilling Program and
the 1992 Drilling Program. The Company, or its principal affiliates, currently
maintains an ownership interest and operates all wells in the 1989 Drilling
Program, the 1990 Drilling Program, the 1991 Drilling Program, the 1992 Drilling
Program, the 1992-A Drilling Program, the 1993 Drilling Program, the 1993-A
Drilling Program, the 1994 Drilling Program, the 1994-A Drilling Program, the
1995 Drilling Program, the 1995-A Drilling Program and the 1996 Drilling
Program. The Company expects to maintain an ownership interest and operate all
wells in the 1996-A Drilling Program. Following is a summary of certain
information concerning the Affiliated Drilling Partnerships as of September 30,
1996. Note that the 1996-A Drilling Program was formed on or about December 31,
1996 and as of the date of this Prospectus, has not yet begun its drilling
activity.
<TABLE>
<CAPTION>
Drilling Results
---------------------------------------------
Affiliated Drilling Investor Funds Investor Funds Program Wells Wells in Dry
Partnership Raised Invested in Wells Wells Completed Progress Holes
----------- ------ ----------------- ----- --------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
1989 Drilling Program $ 6,000,000 $ 5,646,000 32 31 0 1
1990 Drilling Program 10,430,000 9,610,365 49 44 0 5
1991 Drilling Program 5,175,000 4,830,000 28 25 0 3
1992 Drilling Program 3,000,000 2,733,750 18 16 0 2
1992-A Drilling Program 830,000 766,652 4 4 0 0
1993 Drilling Program 3,000,000 2,778,750 16 12 1 3
1993-A Drilling Program 2,400,000 2,203,080 13 11 1 1
1994 Drilling Program 2,160,000 1,996,200 12 9 0 3
1994-A Drilling Program 1,020,000 946,305 4 4 0 0
1995 Drilling Program 1,575,000 1,512,000 8 7 0 1
1995-A Drilling Program 1,560,000 1,497,600 7 4 3 0
1996 Drilling Program 1,665,000 1,615,050 7 0 7 0
1996-A Drilling Program 480,000 456,000 0 0 0 0
----------- ----------- --- --- -- --
Totals $39,295,000 $36,591,752 198 167 12 19
=========== =========== === === == ==
</TABLE>
The Company also serves as managing general partner of Energy Search
Natural Gas Pipeline Income L.P. (the "Pipeline Income Partnership"), formed in
January 1993 to participate with the Company in the ESI Pipeline Operating L.P.
(the "Pipeline Operating Partnership") which owns and operates the natural gas
gathering system and pipeline servicing substantially all producing wells
operated by the Company. The Company manages the operation of the gathering and
pipeline system and is the managing general partner of the Pipeline Operating
Partnership.
26
<PAGE>
Business Plan
The Company historically has engaged in the drilling and production of
developmental natural gas wells in southeastern Ohio. Its drilling activity has
largely been funded by the syndication of Affiliated Drilling Partnerships
marketed by EFC. The Company has served as managing general partner of the
Affiliated Drilling Partnerships, as well as turnkey driller-operator and joint
venture co-owner of the wells under all JDOA's between the Affiliated Drilling
Partnerships and the Company since 1992. With respect to Affiliated Drilling
Partnerships formed between 1989 and 1992, the Company has served as contract
manager and operator. The Company operates the Gas Gathering System, servicing
its primary areas of natural gas production in southeastern Ohio. The Company
serves as managing general partner, and maintains a 28.74% partnership interest,
in the Pipeline Operating Partnership, and is managing general partner and
maintains a 1% partnership interest in the Pipeline Income Partnership, which is
the sole limited partner of the Pipeline Operating Partnership. In late 1995,
the Company acquired nine producing wells and 1,403 acres of undeveloped
acreage in Wood County, West Virginia. In July of 1996, the Company acquired
17,000 acres of proved undeveloped acreage in Raleigh County, West Virginia (the
"Beaver Coal Company Lease").
The Company's business plan is to increase its oil and gas reserves
primarily by continued developmental drilling in southeastern Ohio in the area
serviced by the Gas Gathering System, as well as to continue primarily
developmental drilling in Wood and Raleigh Counties, West Virginia. These areas
in West Virginia are well serviced by third parties operating gas gathering and
transportation systems. The Company may also undertake activities elsewhere in
the Appalachian Basin and the mid-continent region of the United States. It
plans to drill an increasing number of wells for its own account, while, at the
same time continuing to drill wells with future Affiliated Drilling Partnerships
to be syndicated on a private placement basis by its affiliate, EFC.
The Company has conducted exploration, development and production
activities, primarily concentrating on natural gas reserves in Washington,
Athens and Meigs Counties in southeastern Ohio, since 1990. As of September 30,
1996, the Company partially owned and operated approximately 175 wells and over
60 miles of gas gathering systems in this region. The Company has recently
acquired nine additional producing wells in the Dupont Field in West Virginia.
Over the past several years the Company has continued its growth in operations
and has undertaken a program to enhance its technology, personnel and
efficiencies in the areas of its geological, geophysical, operational and
administrative capabilities. The Company is currently actively engaged in oil
and gas exploration and production activities in Ohio and West Virginia. In
addition, the Company is currently evaluating opportunities in Tennessee,
Kentucky, Michigan, Texas, Oklahoma and Colorado in addition to Ohio and West
Virginia, the states in which it is presently active.
In 1994, the Company acquired a nonexclusive license for state-of-the-art
geological software (GeoGraphix) and accessories including hardware and
workstation, graphic plotter and scanner. The Company has also developed a
degree of expertise in analysis of two and three dimensional seismic data. In
late 1995 and early 1996, the Company participated as a non-operator in the re-
entry and short radius horizontal drilling of one well in Seminole County,
Oklahoma. Through this participation, the Company gained experience in the
application of short radius horizontal drilling and completion techniques
designed to further increase production in new and existing wells. While the
Company has no current plans to further develop or exploit this expertise and
technologies, the information remains available for future use.
Throughout the 1990's, the Company has averaged drilling approximately 25
to 35 wells per year. Substantially all of these wells were drilled in joint
ventures with Affiliated Drilling Partnerships. The business plan of the
Company anticipates drilling an average of approximately 30 to 50 wells per year
over the next five years both with Affiliated Drilling Partnerships and also
with internal sources of capital for its own account. Management believes that
with the proceeds of this Offering, its internal cash flow and its other sources
of capital, such as its Bank One Credit Facility, it can efficiently maintain
this level of drilling activity in the future. The proceeds of the Company's
earlier private Preferred Stock offering as well as of this Offering have, and
are expected to, reduce debt and increase working capital for internal drilling
and development activities of the Company for its own account. This, management
believes, will result in the
27
<PAGE>
growth of the Company's natural gas and oil reserves, cash flow and value. As
the Company's revenues and profits grow, the Company intends to expand its
drilling activities and the acquisition of natural gas and oil properties,
thereby further adding to the Company's growth.
Oil and Gas Operations
Exploration and Production Activities. The Company has drilled over 200
wells with Affiliated Drilling Partnerships, 175 of which the Company operated
as of September 30, 1996. The primary geological formations which the Company
has targeted in southeastern Ohio for exploration and development are the
Clinton Sandstone (approximately 5,500 feet in depth), the Medina Sandstone
(approximately 5,600 feet in depth), the Lockport Dolomite (approximately 4,600
feet in depth), the Oriskany Sandstone (approximately 4,250 feet in depth) and
the Berea Sandstone (approximately 2,200 feet in depth). The Company drills
primarily developmental wells and, on occasion, exploratory wells. In late 1995,
the Company completed an acquisition of primarily natural gas proved developed
and proved undeveloped reserves consisting of approximately 1,403 leasehold
acres in Wood County, West Virginia (the "Dupont Field"). An additional 4,000
acres in this area are available for lease by the Company or others. As of the
date of this Prospectus, the Company is in the process of leasing this acreage.
On July 17, 1996, the Company acquired another approximately 17,000 additional
leasehold acres (the "Beaver Coal Company Lease") of proved undeveloped reserves
in Raleigh County, West Virginia.
Substantially all of the Company's wells have been drilled in co-ownership
with thirteen Affiliated Drilling Partnerships which the Company, or its
affiliate, EFC, has syndicated and sponsored. All of the Affiliated Drilling
Partnerships have engaged in primarily development drilling in Washington,
Athens and Meigs Counties, Ohio. All of the Affiliated Drilling Partnerships are
structured substantially the same way. The Affiliated Drilling Partnerships
typically enter into a joint venture with the Company to drill and develop the
wells. This joint venture is evidenced by a joint drilling and operating
agreement ("JDOA") between the Company, as participant, project manager and
driller-operator, and the Affiliated Drilling Partnership, as participant.
Pursuant to the JDOA, drillsites are selected by the Company from its lease
inventory. The Company is obligated to contribute drillsites to the joint
ventures evidenced by the JDOA for each Affiliated Partnership on a drillsite-
by-drillsite basis. No Affiliated Drilling Partnership has any right to develop
any acreage "proved up" by the drilling of a well on its drillsite. See "Risk
Factors -- Risks Associated With The Company -- Conflicts of Interest." The
Company, as driller-operator, has discretion under the JDOA to select the target
geological formation and depth of the wells to be drilled, and to make all
operational decisions regarding drilling, completion (if warranted) or plugging
and abandonment of the wells.
The Company has historically drilled its wells with Affiliated Drilling
Partnerships on a "functional allocation" basis. Pursuant to this arrangement,
the Affiliated Drilling Partnership contributes to the joint venture drilling
funds for intangible drilling costs in exchange for direct ownership of a
working interest in the wells. The Company, on the other hand, contributes the
drillsite, tangible well equipment, excess intangible drilling funds in the
event of cost overruns and services in exchange for direct ownership of a
working interest in the wells. The allocation of the percentage of the working
interest owned between the Affiliated Drilling Partnership and the Company
varies somewhat from program to program, but is generally based on the Company's
estimate of the relative value contributed. The Company's direct ownership of
the working interest of the wells in various Affiliate Drilling Partnerships
ranges from approximately 7% to 20%. Under the JDOA, the Company, in its
capacity as driller-operator under the JDOA, agrees to drill and complete (if
warranted) or plug and abandon the wells on a "turnkey" basis for a "fixed
price" or "adjustable fixed price" (based on depth of the well and number of
zones stimulated). To the extent actual well development costs exceed the
"turnkey price" or "adjustable turnkey price," the Company may experience a loss
on drilling operations. However, to the extent actual drilling costs are less
than the "turnkey price" or "adjustable turnkey price" received, the Company may
realize a profit. Typically under a JDOA, the drilling funds are pre-paid to
the Company, in its capacity as driller-operator, to allow the Company the
opportunity to inventory drill sites, maintain a field office and line up
drilling rigs, related equipment and crews.
After Company wells are drilled and completed in its primary field of
operations in southeastern Ohio, a flow line is constructed and the well is
hooked up to the Gas Gathering System so that natural gas produced from the
wells can be transported to market. The Company is responsible for managing all
28
<PAGE>
production operations concerning the wells and the Gas Gathering System. Such
operations on the wells include equipment repairs and maintenance, well
swabbing, production chart reading, accounting and administration. For
performing such services, the Company generally receives a monthly, per-
producing-well "tending" fee and is reimbursed, generally at cost, for equipment
and generally charges standard rates for services provided to the wells. With
respect to the Gas Gathering System, the Company maintains and repairs the
equipment, monitors and reads gas meters, negotiates gas sales contracts and
otherwise manages the system. For performing these services, the Company
receives from the Pipeline Operating Partnership a monthly fee of $5,000
(subject to increase for inflation) and is reimbursed for materials, services
and administrative overhead contributed toward managing the system. The
Company, as the managing general partner in the Pipeline Operating Partnership,
maintains a 28.74% interest in such partnership entitling it to 28.74% of the
net revenues of the Pipeline Operating Partnership. For the year ended December
31, 1995, the Company's share of Pipeline Operating Partnership net revenue was
$37,959.
After a well has been completed and produced, and when a well is no longer
capable of production in commercial quantities, the Company, as operator under
the JDOA, is responsible for plugging the well and restoring the drillsite.
Costs of plugging and restoration are shared by the participants under a JDOA
according to the particular agreement. In substantially all cases, the
Company's ownership interest in the wells results from its furnishing of the
tangible well equipment. Accordingly, the Company is responsible, under the
JDOA, for paying reclamation costs allocable to such tangible well equipment and
is entitled to reclaim any salvageable tangible well equipment.
The Company is participating as a non-operator with Clinton Gas Company in
the development of two Rose Run/Trempeleau prospects in Ohio. The Company has a
25% working interest in the Chatham project, located in Medina County, Ohio, and
a 25% working interest in the Wayne East project, located in Wayne County, Ohio.
As of September 30, 1996, the Company has expended approximately $158,360,
substantially all of which was spent in 1994 and 1995, in developing these
projects. Thus far three dry holes have been drilled and neither of these
projects has resulted in the completion of a commercial well. Management plans
to expend no more than $50,000 in fiscal 1996 and 1997 in continued development
of these projects with Clinton Gas Company. The Company has the option to
continue its participation with Clinton Gas Company on these projects in an
identified area of mutual interest comprised of approximately 5,000 acres in
Medina and Wayne Counties, Ohio. It currently plans to seriously evaluate its
continued participation in these projects, and there is no assurance that the
Company will continue to participate in either project.
In late 1995 and early 1996, the Company participated as a non-operator
with Vector Drilling Company for a 1% working interest in the re-entry and
attempted open hole completion of the Reed #3 well in Seminole County, Oklahoma.
This project featured the test of relatively new proprietary technology
involving short-radius re-entry, drilling and completion techniques. The
Company expended $14,000 for its participation in this project which, to date,
has not resulted in any commercial production from the well. The Company has
the option to participate with Vector Drilling Company on similar projects
within an approximate 10-mile radius of the Reed #3 well in the future, but
currently has no plans to do so.
The Company's primary revenues are derived from fees for services in
connection with drilling and production operations with Affiliated Drilling
Partnerships and industry partners, gas gathering and transportation revenues as
well as management fees from the Pipeline Operating Partnership, management and
administrative fees from Affiliated Drilling Partnerships and production
revenues attributable to its working interest in wells. With respect to the
Company's wells, for the year ended December 31, 1995, average daily production
of natural gas was approximately 2 million cubic feet (2MMcf) and average
monthly sale of oil was approximately 650 Bbls. With respect to the Company's
wells, for the nine months ended September 30, 1996, average daily production of
natural gas was approximately 2.4 million cubic feet (2.4 MMcf) and average
monthly sale of oil was approximately 800 Bbls.
29
<PAGE>
Oil and Gas Reserves
The Company's oil and gas reserves are located in Ohio, West Virginia, and
to a limited extent, in Oklahoma. Proved reserves represent estimated
quantities of crude oil and natural gas which geological and engineering data
demonstrate to be reasonably certain to be recoverable in the future from known
reservoirs under existing economic and operating conditions. Proved developed
oil and gas reserves are proved reserves that can be expected to be recovered
through existing wells using existing equipment and operating methods. Proved
undeveloped reserves are proved reserves expected to be recovered from new wells
on undrilled acreage, or from existing wells at depths below the present bottom
of the wells.
The oil and gas reserve estimates as of December 31, 1995 and December 31,
1994 were reviewed and evaluated by Kim A. Walbe, independent certified
geologist. Mr. Walbe also reviewed and evaluated the oil and gas reserve
estimates relating to Beaver Coal Company Lease, located in West Virginia, as of
October 1, 1996.
The following tables summarize information with respect to the estimated
net proved oil and gas reserves as reviewed and evaluated by the independent
geologist attributable to the Company's interests in oil and gas properties as
of December 31, 1994 and 1995; and attributable to the Company's interest in the
Beaver Coal Company Lease only, as of October 1, 1996.
TOTAL ESTIMATED NET RESERVE QUANTITIES
<TABLE>
<CAPTION>
Beaver Coal Company Lease Only -
West Virginia (acquired by Company as of July 16, 1996) at October 1, 1996
------------------
<S> <C>
Total Proved Reserves: (1)
Oil (Bbls) 0
Natural Gas (Mcf) 12,191,855
Equivalent Bbls (BOE) (2) 2,031,976
Total Proved Undeveloped Reserves: (1)
Oil (Bbls) 0
Natural Gas (Mcf) 12,191,855
Equivalent Bbls (BOE) (2) 2,031,976
Total Proved Developed Reserves: (1)
Oil (Bbls) 0
Natural Gas (Mcf) 0
Equivalent Bbls (BOE) (2) 0
- ----------------------
</TABLE>
(1) Reserves are net to the Company's interest. Applicable royalties have been
deducted from these volumes. No risk factors have been applied to any of
these reserves.
(2) After conversion on the basis of 6 Mcf of natural gas to 1 barrel of crude
oil.
30
<PAGE>
<TABLE>
<CAPTION>
Company - Ohio at December 31,
---------------
1994 1995
---- ----
<S> <C> <C>
Total Proved Reserves: (1)
Oil (Bbls) 21,922 20,851
Natural Gas (Mcf) 747,993 2,594,209
Equivalent Bbls (BOE) (2) 146,588 453,219
Total Proved Undeveloped Reserves: (1)
Oil (Bbls) 0 10,616
Natural Gas (Mcf) 0 1,801,569
Equivalent Bbls (BOE) (2) 0 310,877
Total Proved Developed Reserves: (1)
Oil (Bbls) 21,922 10,235
Natural Gas (Mcf) 747,993 792,640
Equivalent Bbls (BOE) (2) 146,588 142,342
- ----------------------
</TABLE>
(1) Reserves are net to the Company's interest. Applicable royalties have been
deducted from these volumes. No risk factors have been applied to any of
these reserves.
(2) After conversion on the basis of 6 Mcf of natural gas to 1 barrel of crude
oil.
A reason for the substantial difference in total proved reserves of the
Company's Ohio natural gas from 1994 to 1995 is that the Company did not include
any proved undeveloped reserves in its reserve calculations until 1995. In
addition, the Company acquired proved reserves with its Dupont Field acquisition
in 1995.
<TABLE>
<CAPTION>
Company - West Virginia at December 31,
---------------
1994 1995
---- ----
<S> <C> <C>
Total Proved Reserves: (1)
Oil (Bbls) 0 0
Natural Gas (Mcf) 0 970,318
Equivalent Bbls (BOE) (2) 0 161,720
Total Proved Undeveloped Reserves: (1)
Oil (Bbls) 0 0
Natural Gas (Mcf) 0 503,504
Equivalent Bbls (BOE) (2) 0 83,918
Total Proved Developed Reserves: (1)
Oil (Bbls) 0 0
Natural Gas (Mcf) 0 466,814
Equivalent Bbls (BOE) (2) 0 77,802
- ------------------------
</TABLE>
(1) Reserves are net to the Company's interest. Applicable royalties have been
deducted from these volumes. No risk factors have been applied to any of
these reserves.
(2) After conversion on the basis of 6 Mcf of natural gas to 1 barrel of crude
oil.
31
<PAGE>
<TABLE>
<CAPTION>
Company - Oklahoma at December 31,
---------------
1994 1995
------ -------
<S> <C> <C>
Total Proved Reserves: (1)
Oil (Bbls) 0 1,489
Natural Gas (Mcf) 0 0
Equivalent Bbls (BOE) (2) 0 1,489
Total Proved Undeveloped Reserves: (1)
Oil (Bbls) 0 0
Natural Gas (Mcf) 0 0
Equivalent Bbls (BOE) (2) 0 0
Total Proved Developed Reserves: (1)
Oil (Bbls) 0 1,489
Natural Gas (Mcf) 0 0
Equivalent Bbls (BOE) (2) 0 1,489
- ----------------------
</TABLE>
(1) Reserves are net to the Company's interest. Applicable royalties have been
deducted from these volumes. No risk factors have been applied to any of
these reserves.
(2) After conversion on the basis of 6 Mcf of natural gas to 1 barrel of crude
oil.
32
<PAGE>
Discounted Present Value of Future Net Revenues
The following tables represents the estimated future net revenues (SEC
Method) and the present value of the future estimated net reserves from the
proved developed producing, proved developed non-producing and proved
undeveloped reserves of the Company as of December 31, 1994 and as of December
31, 1995, as reviewed and evaluated by Kim A. Walbe, independent certified
geologist. The tables also include the estimated future net revenues (SEC
Method) and the present value of the future estimated net reserves from proved
undeveloped reserves of the Company's Beaver Coal Company Lease only as of
October 1, 1996, as reviewed and evaluated by Kim A. Walbe, independent
certified geologist.
With respect to the tables below, the Estimated Discounted Present Value
of Future Net Cash Flows from Proved Oil and Gas Reserves is computed assuming a
constant price of $3.00 per Mcf. The weighted average price earned by the
Company for gas produced for the calendar year 1995 was $3.22 per Mcf.
ESTIMATED DISCOUNTED PRESENT VALUE OF FUTURE NET CASH FLOWS FROM PROVED OIL AND
GAS RESERVES
<TABLE>
<CAPTION>
Beaver Coal Company Lease Only - West Virginia
(acquired by Company as of July 16, 1996) at October 1, 1996
------------------
<S> <C>
Proved Developed Producing
Oil (Bbl) 0
Natural Gas (Mcf) 0
Proved Developed Non-Producing
Oil (Bbl) 0
Natural Gas (Mcf) 0
Proved Undeveloped
Oil (Bbl) 0
Natural Gas (Mcf) 12,191,855
Estimated Future Net Cash Flows
Before Income Tax
Proved Producing $ 0
Proved Non-Producing 0
Proved Undeveloped 23,231,988
-----------
Total $23,231,988
===========
Estimated Future Net Cash Flows
Before Income Taxes
Discounted at 10%
Proved Producing $ 0
Proved Non-Producing 0
Proved Undeveloped 13,392,565
-----------
Total $13,392,565
===========
</TABLE>
33
<PAGE>
<TABLE>
<CAPTION>
Company - Ohio at December 31,
----------------
1994 1995
---- ----
<S> <C> <C>
Proved Developed Producing
Oil (Bbl) 21,922 6,309
Natural Gas (Mcf) 747,993 579,777
Proved Developed Non-Producing
Oil (Bbl) 0 3,926
Natural Gas (Mcf) 0 212,863
Proved Undeveloped
Oil (Bbl) 0 10,616
Natural Gas (Mcf) 0 1,801,569
Estimated Future Net Cash Flows
Before Income Tax
Proved Producing $1,346,085 $1,166,251
Proved Non-Producing 0 401,898
Proved Undeveloped 0 2,070,351
---------- ----------
Total $1,346,085 $3,638,500
========== ==========
Estimated Future Net Cash Flows
Before Income Taxes
Discounted at 10%
Proved Producing $ 832,924 $ 686,962
Proved Non-Producing 0 247,900
Proved Undeveloped 0 898,053
---------- ----------
Total $ 832,924 $1,832,915
========== ==========
<CAPTION>
Company - West Virginia at December 31,
----------------
1994 1995
---- ----
Proved Developed Producing
Oil (Bbl) 0 0
Natural Gas (Mcf) 0 389,796
Proved Developed Non-Producing
Oil (Bbl) 0 0
Natural Gas (Mcf) 0 77,018
Proved Undeveloped
Oil (Bbl) 0 0
Natural Gas (Mcf) 0 503,504
Estimated Future Net Cash Flows
Before Income Tax
Proved Producing 0 $ 901,119
Proved Non-Producing 0 59,103
Proved Undeveloped 0 637,232
-- ----------
Total $0 $1,597,454
== ==========
Estimated Future Net Cash Flows
Before Income Taxes
Discounted at 10%
Proved Producing $0 $ 503,666
Proved Non-Producing 0 31,847
Proved Undeveloped 0 339,300
-- ----------
Total $0 $ 874,813
== ==========
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
Company - Oklahoma at December 31,
---------------
1994 1995
----- --------
<S> <C> <C>
Proved Developed Producing
Oil (Bbl) 0 1,489
Natural Gas (Mcf) 0 0
Proved Developed Non-Producing
Oil (Bbl) 0 0
Natural Gas (Mcf) 0 0
Proved Undeveloped
Oil (Bbl) 0 0
Natural Gas (Mcf) 0 0
Estimated Future Net Cash Flows
Before Income Tax
Proved Producing $ 0 $21,691
Proved Non-Producing 0 0
Proved Undeveloped 0 0
----- -------
Total $ 0 $21,691
===== =======
Estimated Future Net Cash Flows
Before Income Taxes
Discounted at 10%
Proved Producing $ 0 $12,921
Proved Non-Producing 0 0
Proved Undeveloped 0 0
----- -------
Total $ 0 $12,921
===== =======
</TABLE>
For additional information concerning the discounted future net cash flows
to be derived from the Company's reserves, see the Supplemental Information to
Financial Statements included elsewhere herein.
The Company has filed estimates of its reserves with the United States
Department of Energy, Annual Survey of Domestic Oil and Gas Reserves, for the
year ending December 31, 1995. In this filing the Company reported proved
reserves of 163,232 Bbl of oil and 9,336,403 Mcf of natural gas in gross. The
proved reserve information presented in this Prospectus at 22,340 Bbl of oil and
3,564,527 Mcf for natural gas are reported net to the Company's interest in
accordance with Securities and Exchange Commission guidelines.
There are numerous uncertainties inherent in estimating oil and gas
reserves and their values, including many factors beyond the control of the
producer. The reserve data set forth in this Prospectus represents estimates
only. The meaningfulness of such estimates is highly dependent upon the accuracy
of the assumptions upon which they were based. Reserve engineering and
evaluation is a subjective process of estimating underground accumulations of
oil and gas that cannot be measured in an exact manner. The accuracy of any
reserve estimate is a function of the quality of available data and of
engineering and geological interpretation and judgment. As a result, estimates
of different engineers and geologists often vary. In addition, estimates of
reserves are subject to revision by the results of drilling, testing and
production subsequent to the date of such estimate. Accordingly, reserve
estimates are often different from the quantities of oil and gas that are
ultimately recovered. While the reserve estimate presented herein is believed to
be reasonable, it should be viewed with the understanding that subsequent
reservoir performance, the timing and success of future development drilling and
changes in pricing structure or market demand will affect the reserve estimate.
See "Risk Factors -- Risks Associated with the Company -- Geologist's Estimates
of Reserves and Future Net Revenue."
In general, the volume of production from oil and gas properties declines
as reserves are depleted. Except to the extent the Company acquires properties
containing proven reserves or conducts successful exploration and development
activities, or both, the proven reserves of the Company will decline as reserves
are produced. The Company's future oil and gas production is, therefore, highly
dependent upon its level of success in acquiring or developing additional
reserves.
35
<PAGE>
Producing Wells
The following table sets forth certain information regarding the Company's
ownership, as of December 31, 1995, of productive wells in the areas indicated.
For purposes of this table, productive wells are producing wells and wells
capable of production. A gross well is a well in which a working interest is
owned by the Company. The number of gross wells is the total number of wells in
which the Company owns a working interest. A net well is deemed to exist when
the sum of the fractional ownership interests in gross wells equals one. The
number of net wells is the sum of the fractional working interests owned by the
Company in gross wells expressed as whole numbers and fractions thereof.
PRODUCTIVE WELL SUMMARY
December 31, 1995
<TABLE>
<CAPTION>
Oil Natural Gas Total
--------------- ------------------ ----------------
Gross Net Gross Net Gross Net
----- --- ----- --- ----- ---
<S> <C> <C> <C> <C> <C> <C>
Ohio 10 1.17 147 16.73 157 17.90
West Virginia 2 .29 7 4.44 9 4.73
-- ---- --- ----- --- -----
Total 12 1.46 154 21.17 166 22.63
== ==== === ===== === =====
</TABLE>
As of December 31, 1995, the Company owned four gross wells (.5312906 net
wells) which were either awaiting completion or temporarily shut-in awaiting
rework.
The following table sets forth certain information regarding the Company's
ownership, as of September 30, 1996, of productive wells in the areas indicated.
PRODUCTIVE WELL SUMMARY
September 30, 1996
<TABLE>
<CAPTION>
Oil Natural Gas Total
--------------- ------------------ -----------------
Gross Net Gross Net Gross Net
----- --- ----- --- ----- ---
<S> <C> <C> <C> <C> <C> <C>
Ohio 10 1.17 154 18.11 164 19.28
West Virginia 2 .29 9 4.85 11 5.14
-- ---- --- ----- --- -----
Total 12 1.46 163 22.96 175 24.42
== ==== === ===== === =====
</TABLE>
As of September 30, 1996, the Company owned five gross wells (.706472 net
wells) which were either awaiting completion or temporarily shut-in awaiting
rework.
36
<PAGE>
Production Volumes; Average Prices and Production Costs
The following table sets forth certain information regarding the production
volumes of, average sales prices received for, and average production costs
associated with, the Company's sales of oil and gas for the periods indicated.
<TABLE>
<CAPTION>
at December 31,
---------------
1993 1994 1995
---------- ---------- ----------
<S> <C> <C> <C>
Net Production:
Oil (Bbls) 1,078 1,292 1,166
Natural Gas (Mcf) 140,489 99,587 91,119
Total (BOE) 24,493 17,889.84 16,352.50
Average Sales Price:
Oil ($/Bbl) $ 17.32 $ 15.28 $ 16.48
Natural Gas ($Mcf) $ 2.73 $ 2.75 $ 2.34
Average Production Lifting Cost:
($/BOE) (1) $ 6.05 $ 4.36 $ 4.92
- ---------------------
</TABLE>
(1) Includes direct lifting costs (labor, repairs and maintenance, materials and
supplies) and property and severance taxes.
Development, Exploration and Acquisition Expenditures
The following table sets forth certain information regarding the costs
incurred by the Company in its development, exploration and acquisition
activities on its Ohio, West Virginia and Oklahoma properties during the periods
indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1994 1995
---- ----
<S> <C> <C>
Development Costs $ 885,711 $695,758
Exploration Costs 145,785 31,721
Acquisition Costs
Proved Properties 124,768 195,118
--------- --------
Total Capital
Expenditures $1,156,264 $922,597
========== ========
</TABLE>
Recent Drilling Activities
The Company has drilled or participated in the drilling of wells in its
Ohio, West Virginia and Oklahoma properties as set out in the tables below for
the periods indicated.
<TABLE>
<CAPTION>
Ohio Development Wells
-----------------
Year Ended December 31,
-----------------------
1993 1994 1995
------------------- -------------------- --------------------
Gross Net Gross Net Gross Net
----- ------ ----- --- ----- ---
<S> <C> <C> <C> <C> <C> <C>
Oil 3 .4366 1 .5000 0 0
Natural Gas 20 2.4179 20 3.7182 17 2.741222
Dry 2 .1515 1 .1544 1 .150000
-- ------ -- ------ ---- --------
Total 25 3.0060 22 4.3726 18 2.891222
== ====== == ====== ==== ========
</TABLE>
Exploratory Wells
-----------------
37
<PAGE>
<TABLE>
<CAPTION>
Ohio Year Ended December 31,
-----------------------
1993 1994 1995
----------------- ----------------- ------------------
Gross Net Gross Net Gross Net
----- ---- ----- --- ----- ---
<S> <C> <C> <C> <C> <C> <C>
Oil 0 0 0 0 0 0
Natural Gas 0 0 0 0 0 0
Dry 0 0 1 .25 2 .155
- - - --- - ----
Total 0 0 1 .25 2 .155
= = = === = ====
</TABLE>
Oklahoma Exploratory Wells
-----------------
Year Ended December 31,
-----------------------
<TABLE>
<CAPTION>
1993 1994 1995
----------------- ----------------- ------------------
Gross Net Gross Net Gross Net
----- ---- ----- --- ----- ---
<S> <C> <C> <C> <C> <C> <C>
Oil 0 0 0 0 0 0
Natural Gas 0 0 0 0 0 0
Dry 0 0 0 0 1 .01
- - - - - ---
Total 0 0 0 0 1 .01
= = = = = ===
</TABLE>
The Company has drilled 15 gross wells (2.98 net wells) year to date
through September 30, 1996. Five development wells drilled in 1996 are
producing from the Oriskany sand and eight wells are producing from the
Clinton/Medina sands in southeastern Ohio. The producing wells have proved up
an additional three developmental drilling sites on acreage held by the Company.
This acreage, as of December 31, 1995, was not included as proved undeveloped
reserves. Also in 1996, the Company participated as a non-operator with
industry partners in two exploratory wells drilled to the Knox (Trempeleau)
formation in Ohio. These tests were dry holes.
Properties
Leasehold Acreage. As of December 31, 1995, the Company owned
approximately 25,260 oil and gas leasehold acres located in Washington County,
Ohio, approximately 5,071 acres located in Athens County, Ohio, approximately
4,307 acres located in Meigs County, Ohio, approximately 1,403 acres located in
Wood County, West Virginia, approximately 104 acres located in Noble County,
Ohio, and approximately 43 acres located in Morgan County, Ohio.
In late 1995, the Company acquired approximately 1,403 leasehold acres, all
held by production, in Wood County, West Virginia (the "Dupont Field"), across
the Ohio River from the Company's principal area of operation in southeastern
Ohio. The cost to the Company of acquisition of the Dupont Field was $75,000. An
additional 4,000 undeveloped acres in the area are available for lease and are
in the process of being acquired by the Company.
On July 16, 1996 the Company acquired its largest oil and gas leasehold, a
nearly contiguous 17,000 acre tract located in proximity to major independent
producer fields near Beckley, in Raleigh County, West Virginia (the "Beaver Coal
Company Lease"). The cost to the Company of acquisition of the Beaver Coal
Company Lease was $170,000. This area is proximate to significant producing
wells. In order to hold this acreage, the Company is required to provide a
minimum royalty on the entire tract equal to $5 per acre, subject to reduction
by $1 per acre for every well drilled during the first year; provide that, at
such point as the Company has drilled 20 wells on the lease, the minimum
royalty, while still owed, is not a condition to retaining title to remaining
undrilled acreage.
The following table sets forth certain information regarding the Company's
developed and undeveloped leasehold acreage as of December 31, 1995.
38
<PAGE>
Leasehold Acreage
-----------------
<TABLE>
<CAPTION>
Developed Undeveloped Total
------------------- ------------------ -------------------
Gross Net Gross Net Gross Net
------ ----- ----- --- ----- ---
<S> <C> <C> <C> <C> <C> <C>
Ohio 14,600 2,045 20,185 20,185 34,785 22,230
West Virginia 1,403 1,403 0 0 1,403 1,403
------ ----- ------ ------ ------ ------
Total 16,003 3,448 20,185 20,185 36,188 23,633
====== ===== ====== ====== ====== ======
</TABLE>
Note that the above table does not include the approximately 17,000 acre
Beaver Coal Company Lease in Raleigh County, West Virginia which was acquired
on July 16, 1996 or approximately 4,000 acres acquired during 1996 in
southeastern Ohio and Wood County, West Virginia, thus providing the Company
with current oil and gas leasehold acreage of approxiamtely 55,000 acres.
Substantially all of the Company's Ohio and West Virginia leases are
subject to landowner royalties of 12.5% and, occasionally, subject to additional
overriding royalty interests of 3.125%. Thus, the net revenue interest of the
Company's Ohio and West Virginia leases generally ranges from 87.5% to
84.375%.
Competition
The exploration for and production of oil and natural gas is highly
competitive. In seeking to obtain desirable properties, leases and exploration
prospects, the Company faces competition from both major and independent oil and
natural gas companies, as well as from numerous individuals and drilling
programs. Extensive competition also exists in the market for natural gas
produced by the Company. Many of these competitors have financial and other
resources substantially greater than those available to the Company and,
accordingly, may be better positioned to acquire and exploit prospects, hire
personnel and market production. In addition, many of the Company's larger
competitors may be better able to respond to the factors which affect the demand
for oil and natural gas production such as changes in worldwide oil and natural
gas prices and levels of production, the cost and availability of alternative
fuels and the application of government regulations.
Markets
General. The revenues generated from the Company's oil and gas operations
are highly dependent upon the prices of and the demand for its oil and gas
production. The prices received by the Company for its oil and gas production
depend upon numerous factors beyond the Company's control. Future decreases in
the prices of oil and gas production depend upon numerous factors beyond the
Company's control. Future decreases in the prices of oil and gas would have an
adverse effect on the Company's proved reserves, revenues, profitability and
cash flow. See "Risk Factors -- Risks Associated With Oil and Gas Industry."
Although the Company in the past has not entered into any crude oil or
natural gas price swaps or other similar hedging transactions for the purpose of
reducing its exposure to future price fluctuations, it may engage in such
transactions from time to time in the future as management deems it advisable to
do so.
Gas Sales. Natural gas produced from completed wells must be transported
through pipeline systems in order to get to market. In the Company's primary
fields of operations in southeastern Ohio (the "Bartlett Field" and the "Torch
Field," respectively) substantially all completed wells are connected to the Gas
Gathering System which collects the gas from wells in the field, sends it
through compressor stations to enhance transportability and delivers it to the
East Ohio Company interstate pipeline and to Columbia Gas Company interstate
pipeline. The Gas Gathering System is owned by the Pipeline Operating
Partnership, an affiliate of the Company. The Company, for its own account and
on behalf of the Affiliated Drilling Partnerships it manages, has entered into a
gas servicing agreement (the "Gas Servicing Agreement") with the Pipeline
Operating Company pursuant to which all natural gas produced from wells
connected to the Gas Gathering System is purchased by the Pipeline Operating
Partnership and subsequently resold. The price received by the Company for its
gas is a function of what the Pipeline Operating Company sells it for on the
market (i.e. the "Adjusted Gas Price Spread"). The Gas Servicing Agreement thus
provides for gas purchased from the Company and Affiliated Drilling Partnerships
on a "net back" basis. As of September 30, 1996, the Adjusted Gas Price Spread
with respect to the Gas Servicing Agreement was $0.41 per Mcf in the Company's
Bartlett Field and $0.36 per Mcf in the Company's Torch Field where no
compression is used.
39
<PAGE>
Natural gas produced from the Company's wells is sold by the Pipeline
Operating Partnership pursuant to one or more gas sales contracts to gas
marketers, interstate or intrastate pipelines, local utilities or industrial end
users in the area. Over the twelve month period ended September 30, 1996, gross
natural gas prices received by the Company for its natural gas in Ohio ranged
from $2.28 to $5.32 per Mcf before royalties and gathering and transportation
costs.
The Company did not begin receiving production revenues for its West
Virginia production until August of 1996. Such production revenues related to
April of 1996 production. Prior to that time the Dupont Field in Wood County,
West Virginia, acquired by the Company in late 1995, was undergoing rework. The
gross natural gas prices received by the Company for its natural gas in West
Virginia for production sold in May through August of 1996 (such production
revenues having been received by the Company in August through November of 1996)
ranged from $2.98 to $3.42 per Mcf.
Offices and Employees
The Company's administrative offices are located in Suite 200, 280 Fort
Sanders West Boulevard, Knoxville, Tennessee, 37922. At this office, all
executive management, financial, accounting and general administrative functions
for the Company and its related partnerships are performed. In addition to its
principal executive officers, Messrs. Torrey, Remine and Cooper, the Company has
a full-time controller and two full-time and one part-time administrative
support employees at the Knoxville office.
The Company's field offices are located in Washington County at 106 Front
Street, Marietta, Ohio. Geological, engineering and exploration and production
activities are coordinated at this office. The Company employs one geologist
and one full-time and two part-time administrative support employees at its
field office. In addition, the Company employs five pumpers in the field in
southeastern Ohio. On an as-needed basis, the Company retains consulting
petroleum engineers and geologists. The Company's principal field operations,
its natural gas and oil wells and its Gas Gathering System are located in
Washington, Athens and Meigs Counties in southeastern Ohio and Wood County, West
Virginia.
Regulation
General. Oil and gas exploration, production and related operations are
subject to extensive rules and regulations promulgated by federal and state
agencies. Failure to comply with such rules and regulations can result in
substantial penalties. The regulatory burden on the oil and gas industry will
increase the Company's cost of doing business and will affect its profitability.
Because such rules and regulations are frequently amended or interpreted, the
Company is unable to predict the future cost or impact of complying with such
laws. Many state authorities require permits for drilling operations, drilling
bonds and reports concerning operation and impose other requirements relating to
the exploration and production of oil and gas. Such states also have statutes
or regulations addressing conservation matters, including provisions for the
pooling of oil and gas properties, the establishment of maximum rates of
production from oil and gas wells and the regulation of spacing, plugging and
abandonment of such wells. The statutes and regulations may also limit the rate
at which oil and gas can be produced from certain properties.
Oil and gas operations are regulated by an agency of state government in
every state of the United States. In Ohio and West Virginia, where most of the
Company's oil and gas properties are located, such regulation is by the Ohio
Department of Natural Resources and the West Virginia Division of Environmental
Protection Office of Oil and Gas, respectively. These states, as well as most
other states, each impose a comprehensive statutory and regulatory scheme with
respect to gas and oil operations. Among other things, such regulations involve
(a) a new well permit and well registration requirements, procedures and fees,
(b) minimum well spacing requirements, (c) restrictions on well locations and
underground gas storage, (d) certain well site restoration, groundwater
protection and safety measures, (e) landowner notification requirements, (f)
certain bonding or other security measures, (g) various reporting requirements,
(h) well plugging standards and procedures, and (i) broad enforcement powers.
The Company anticipates that such regulations could in some cases cause delays
in obtaining well permits; however, it does not expect that such delays will
have a material adverse impact upon the proposed operations. The environmental
regulation enforcement agencies of Ohio, West Virginia and other states in which
the Company presently operates, or may operate, have been granted broad
regulatory and enforcement powers which are likely to create additional
financial and operational burdens on gas and oil operations like those of the
Company. Ohio, West Virginia and most other states also have in place other
pollution and environmental control laws which have become increasingly
burdensome in recent years. Enforcement efforts with respect to gas and oil
operations have recently increased and it can be
40
<PAGE>
anticipated that such regulation will expand and have a greater impact on future
gas and oil operations. To the best knowledge of management, the Company has
complied in all material respects with applicable regulatory requirements of the
states in which it operates. To date, the Company has received no material
notice of violation or complaint concerning its compliance with environmental
laws. In the ordinary course of operations, the Company has, on occasion, in the
past, and may in the future, receive notices by environmental regulators of
minor, nonmaterial matters such as the need to post or repair a sign or to
restore a drillsite in a particular manner. When any such notice is received by
the Company, it is immediately dealt with and the situation corrected, if
corrective action is required.
Environmental Regulation. The Company is subject to numerous laws and
regulations governing the discharge of materials into the environment or
otherwise relating to environmental protection. These laws and regulations may
require the acquisition of a permit before drilling commences, restrict the
types, qualities and concentration of various substances that can be released
into the environment in connection with drilling and production activities,
limit or prohibit drilling activities on certain lands lying within wilderness,
wetlands and other protected areas, and impose substantial liabilities for
pollution resulting from the Company's operations. Moreover, the recent trend
toward stricter standards in environmental legislation and regulation is likely
to continue. For instance, legislation has been proposed in Congress from time
to time that would reclassify certain oil and gas production wastes as
"hazardous wastes," which reclassification would make such wastes subject to
much more stringent handling, disposal and clean-up requirements. If such
legislation were to be enacted, it could have a significant impact on the
operating costs of the Company, as well as the oil and gas industry in general.
It is not anticipated that the Company will be required in the near future to
expend amounts that are material in relation to its total capital expenditure
program by reason of environmental laws and regulations, but because such laws
and regulations are frequently changed, the Company is unable to predict the
ultimate cost of such compliance.
The Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), also known as the "Superfund" law, imposes liability, without regard
to fault or the legality of the original conduct, on certain classes of persons
who are considered to have contributed to the release of a "hazardous substance"
into the environment. These persons include the owner or operator of the
disposal site or sites where the release occurred and companies that disposed or
arranged for the disposal of the hazardous substances under CERCLA and may be
subject to joint and several liability for the costs of cleaning up the
hazardous substances that have been released into the environment and for
damages to natural resources. It is not uncommon for neighboring landowners and
other third parties to file claims for personal injury and property damage
allegedly caused by the hazardous substances released into the environment.
Crude Oil Regulation. Effective January 28, 1981, all federal controls of
the price of domestically produced oil were abolished and, therefore, the price
of oil sold after that date is subject only to supply, demand, competitive
factors, the gravity of the crude oil, sulfur content differentials and other
factors. Certain Federal reporting requirements are still in effect under U.S.
Department of Energy regulations.
Federal Gas Regulation. The sale of natural gas is subject to regulation
of production, transportation and pricing by governmental regulatory agencies.
Generally, the regulatory agency in the state where a producing natural gas well
is located supervises production activities and the transportation of natural
gas sold intrastate. The Federal Energy Regulatory Commission ("FERC"), which
has succeeded to the authority of the Federal Power Commission, historically has
regulated the interstate transportation of natural gas and pricing of natural
gas sold for resale interstate; however, under the Natural Gas Policy Act of
1978 ("NGPA"), the price of intrastate, as well as interstate natural gas, is
regulated by FERC.
Price controls for natural gas production from new wells have been
deregulated under the NGPA. Such deregulated gas production may be sold at
market prices determined by supply, demand, BTU content, pressure, location of
the wells, and other factors. The remaining categories of natural gas
production were fully deregulated under the NGPA by January 1992, for existing
wells. However, in the event there may exist a surplus of natural gas, it may
be unlikely that the Company will receive in the near future substantial
benefits from the deregulation of natural gas from new wells of the Company.
Although the transportation and sale of gas in interstate commerce remains
heavily regulated, FERC has recently sought to promote greater competition in
natural gas markets by encouraging open access transportation by interstate
pipelines, with the goal of expanding opportunities for producers to contract
41
<PAGE>
directly with local distribution companies and end-users. This policy,
initially set forth in FERC Order 436, was generally affirmed on appeal by the
United States Court of Appeals for the D.C. Circuit, but modifications were
required by such court principally to the effect of this order on the
significant "take-or-pay" liabilities of the pipeline industry.
In response to the decision of the court, FERC issued Order 500, which
provides that pipelines providing open access transportation service need not
transport gas which a producer owned on June 23, 1987 (subject to certain
exceptions), unless such producer signs a binding offer to credit gas volumes
transported by the pipeline against the pipelines' take-or-pay liability with
such producer under gas sales agreements with the pipelines which were effective
as of June 23, 1987. If a producer seeking to have its gas transported was not
the owner of such gas as of June 23, 1987, offers of take-or-pay credits must be
supplied, in most situations, by the owners of the gas on that date in order for
the gas to qualify for transportation under Order 500. The pipeline may, in its
discretion, apply such credits against its take-or-pay liabilities under any
contract containing a take-or-pay clause as of June 23, 1987, which it has with
the producer who requests transportation. Although this crediting process ended
December 31, 1990, the pipelines may apply credits already taken to offset
future take-or-pay liability on contracts which are still being performed. The
ultimate effect of Order 500 is difficult to assess at present, but it could
adversely impact the ability of natural gas producers to secure transportation
services necessary in connection with the sale of their product in interstate
commerce, the prices which could be obtained in such sales, as well as the
ability of such producers to retain the benefits of existing contracts
containing take-or-pay provisions.
On April 8, 1992, FERC issued Order 636, a comprehensive restructuring of
interstate natural gas pipeline services. Under Order 636 all gas suppliers,
including the interstate pipeline itself (in its role as merchant) will compete
for gas purchases on an equal basis. The long-term objective of Order 636 is to
promote fair competition among suppliers of gas to give consumers an adequate
and reliable supply of natural gas at the lowest reasonable price. Order 636
accomplishes this objective by equalizing the access to and cost of
transportation of gas sold by pipelines and non-pipelines; by providing
pipelines a mechanism to recover reasonable and prudent costs of the
restructuring; and by mandating a new type of pipeline transportation (the no-
notice transportation service) so that non-pipeline gas suppliers can provide
end users with gas supplies as dependably as can pipelines. The principal focus
of the new transportation Order 636 is to provide equal quality service, whether
the transporter is the pipeline as merchant, a non-pipeline seller or the buying
customer.
As a result of Order 636, major producers may have considerable advantages
over smaller producers because of their control over extensive reserves of
natural gas and the ability to give an attractive corporate warranty as an
assurance that long-term supplies will be forthcoming now that no-notice firm
transport service is mandated for firm shippers. A major producer might expect
a premium price for the assured security of supply. Since pipelines may no
longer be aggregating gas supplies for local development corporations ("LDC"s),
major producers will face less competition in the market for large-volume, long-
term supplies at least until other credit-worthy entities step in and fill the
aggregation role.
Order 636 is new and complex. It will be in the process of implementation
over the next several years. Its direct and indirect impact on the industry and
the Company cannot be measured or estimated at this time.
Proposed Regulation. A number of proposals have recently been, and are
being, considered in Congress and in the legislatures and agencies of various
states which, if enacted, may significantly and adversely affect the oil and
natural gas industry. Such proposals involve, among other things, the
imposition of price controls on all categories of natural gas production, the
imposition of land use controls (such as prohibiting drilling activities on
certain Federal and state lands in roadless wilderness areas), the reinstatement
of the windfall profits tax and other measures. At the present time, it is
impossible to accurately predict which proposals, if any, will be enacted by
Congress or the legislatures and agencies of various states and what effect any
proposals which are enacted will have on the activities of the Company.
Insurance
General. For its oil and gas operations, the Company maintains extensive
insurance coverage (exceeding $10 million in the aggregate) to protect the
Company, the Affiliated Drilling Partnerships, the Pipeline Operating
Partnership and the Pipeline Income Partnership from liability and losses that
could arise
42
<PAGE>
in connection with drilling, production or natural gas transportation activities
involving gas or oil.
A brief discussion of the Company's insurance policies is set forth below.
The Company is the primary insured and the Affiliated Drilling Partnerships, the
Pipeline Operating Partnership and the Pipeline Income Partnership are listed as
an additional insured on the policies. Each of the policies are subject to
certain terms, conditions, exclusions and limitations that may preclude the
Company or an Affiliated Drilling Partnership from recovering damages, expenses
and liabilities suffered, including, typically, damages and liabilities from or
caused by (a) the violation of any Federal, state, or local statute, ordinance
or regulation or (b) fines, penalties and punitive and exemplary damages or (c)
war and terrorist acts (d) normal operation, including wear and tear, (e) faulty
design or (f) dishonesty of employees, (g) professional liability, (h) failure
to supply and (i) damage to underground equipment. Certain other exclusions that
are customary in the insurance and oil and gas industries (such as the exclusion
or limitation of coverage for costs related to the loss of diamond drill bits
and in-hole salvage and fishing costs) may also apply. It is possible that the
terms, conditions, exclusions and limitations described above may prevent the
Company or an Affiliated Drilling Partnership from recovering the full amount of
any damages, expenses and liabilities suffered by the Company or an Affiliated
Drilling Partnership which arise from an accident.
Comprehensive General Liability. The Company maintains a comprehensive
general liability policy insured by The Federal Insurance Company with coverage
limits of $1,000,000 per occurrence for bodily injury and property damage and
$2,000,000 in the aggregate. Such policy provides coverage of $2,000,000 per
occurrence and in the aggregate with respect to products and completed
operations, $1,000,000 per occurrence and in the aggregate with respect to
underground resources, and $500,000 stop gap liability coverage. This policy
includes coverage for sudden and accidental seepage and pollution (subject to a
limit of $250,000) care, custody and control, debris removal following a covered
loss, broad form property damage, waiver of subrogation, contractual liability,
non-operator working interest, blow-out and cratering, explosion, collapse and
underground property damage.
Automobile Liability. The Company maintains an automobile liability policy
with coverage limits of $1,000,000 per occurrence for bodily injury and property
damage and $1,000,000 in the aggregate.
Umbrella Liability. The Company maintains an umbrella liability policy
insured by The Federal Insurance Company with coverage limits of $10,000,000 per
occurrence or series of occurrences arising out of one (1) event and, subject to
certain limitations, in the aggregate. Such policy becomes effective only after
underlying coverage limits of $1,000,000 for comprehensive general liability,
$1,000,000 for automotive liability, and $500,000 for stop gap liability.
The Company requires subcontractors to carry liability insurance and
workers' compensation insurance as required by state law.
Since November 1990, when the Company assumed operation of its first oil
and gas wells, there have been no material claims against the Company's
liability insurance policies. In the opinion of the Company's management, the
Company's properties are adequately covered by insurance.
Legal Proceedings
Neither the Company, its properties, nor any of its directors or officers,
is involved in any material litigation or administrative proceedings, nor do any
of them have any knowledge that any such litigation or proceeding may be
contemplated.
43
<PAGE>
MANAGEMENT
Directors and Executive Officers
The following table sets forth certain information regarding the Company's
directors and the executive officers.
<TABLE>
<CAPTION>
Name Age Position Tenure with Company
<S> <C> <C> <C>
Charles P. Torrey, Jr. 49 Chief Executive Officer, Director Since its inception in 1990
Richard S. Cooper 47 President, Director, Legal Counsel Since its inception in 1990
Robert L. Remine 48 Secretary, Treasurer, Director Since its inception in 1990
John M. Johnston 37 Vice President - Exploration/Development Since 1993
</TABLE>
Charles P. Torrey, Jr. - Chief Executive Officer; Director. Mr. Torrey is a
founder, stockholder and director of the Company. Mr. Torrey's primary
responsibilities at the Company include managing gas sales, capital formation
and financial operations. Since 1988, Mr. Torrey has monitored and managed oil
and gas investments for clients both as a fee-based monitor and/or as a managing
general partner in the 1989 Drilling Program, the 1990 Drilling Program, the
1991 Drilling Program, and the 1992 Drilling Program. Mr. Torrey is a
registered securities representative and stockholder, director and president of
Equity Financial Corporation ("EFC"). Equity Financial Corporation is an NASD
member, registered broker-dealer and investment advisor with the Securities
Exchange Commission and is a registered broker-dealer and investment advisor in
the States of Tennessee, Alabama, Georgia, Florida and Kentucky. As president
of EFC, Mr. Torrey has devised and implemented investment plans for individuals,
pension accounts and corporations and has managed over $40,000,000 in assets.
Mr. Torrey received his Bachelor of Arts degree in 1971 from East Carolina
University. In 1986, Mr. Torrey received his certification as a Certified
Financial Planner from the College of Financial Planning, Denver, Colorado.
Richard S. Cooper - President; Director. Mr. Cooper is a founder,
stockholder and director of the Company. Mr. Cooper's primary responsibilities
include all day-to-day management and administration of the Company. Mr. Cooper
is licensed to practice law in the State of Tennessee and, prior to assuming his
present position with the Company, engaged in the private practice of law in
Knoxville, Tennessee. Mr. Cooper currently serves as general counsel to the
Company, Messrs. Torrey and Remine, and EFC. Mr. Cooper serves as co-managing
general partner of the 1991 Drilling Program and the 1992 Drilling Program. Mr.
Cooper received his Bachelor of Science degree in business from the University
of Tennessee in 1971 and his Juris Doctor degree from the University of
Tennessee Law School in 1975.
Robert L. Remine - Secretary and Treasurer; Director. Mr. Remine is a
founder, stockholder and director of the Company. Mr. Remine is responsible for
overview of all financial, tax and accounting matters of the Company. Since
1988, Mr. Remine has monitored and/or managed oil and gas investments for
clients both as a fee-based monitor and as a managing general partner in the
1989 Drilling Program, the 1990 Drilling Program, the 1991 Drilling Program and
the 1992 Drilling Program. Mr. Remine is a registered securities representative
and stockholder, director and secretary and treasurer of EFC. In his position
with EFC, Mr. Remine has developed and implemented investment plans for
individuals, pension accounts and corporations and has managed over $40,000,000
in assets. Mr. Remine is a certified public accountant and received his Bachelor
of Science degree in accounting from the University of Tennessee in 1973.
John M. Johnston - Vice President - Exploration and Development. Mr.
Johnston joined the Company as a petroleum geologist in December 1993 and became
vice president - exploration and development in January of 1996. Mr. Johnston
specializes in subsurface geological analysis, reservoir engineering, wellsite
geology, well completion design and supervision and production maintenance. He
also manages the use of advanced geologic (GeoGraphix) and reservoir engineering
(GEMS) computer programs. Prior to joining the Company, from 1987 through
December of 1993, Mr. Johnston served as manager of geology and reservoir
engineering for Halwell Company, Inc. of Marietta, Ohio and senior geologist and
project manager for Energy Omega, Inc. of Marietta, Ohio, an affiliate of
Halwell Company, Inc. From 1981 through 1986, Mr. Johnston worked as a staff
exploration geologist for Chevron U.S.A. and Gulf Oil Corp. Mr. Johnston earned
his Bachelor of Science degree in geology from the University of Illinois in
1981 and is
44
<PAGE>
presently working on his thesis in connection with a Masters of Science Degree
in Geology at the University of Cincinnati. Mr. Johnston was awarded a Chevron
Fellowship, was a Marathon Oil Scholar and an Edmund J. James Scholar. Mr.
Johnston is currently president of the Ohio Geological Society and a member of
the board of directors of the Southeastern Ohio Oil and Gas Association. He is a
member of the American Association of Petroleum Geologists, the Society of
Professional Well Log Analysts, the Ohio Geological Society, and the Ohio Oil
and Gas Association.
Board of Directors
Number of Directors; Terms. In accordance with the Company's Third Amended
and Restated Charter and Fourth Amended and Restated Bylaws, there are currently
three members of the Board of Directors, each of whom serve annual terms or
until their successors are duly elected and qualified. Upon consummation of this
Offering, there will be five members of the Board of Directors, at least two of
whom must be outside directors. To qualify as an outside director for purposes
of the Fourth Amended and Restated Bylaws, a director must be a "non-employee
director" as defined under Rule 16b-3 under the Securities Exchange Act of 1934,
or any successor provision thereto, and must not currently be or have been
within the past year an officer or regular salaried employee of the Company. The
initial two outside directors will be appointed by the three current directors
(Messrs. Torrey, Remine and Cooper) within sixty days following the closing of
this Offering. Commencing at the first annual meeting of shareholders after
consummation of this Offering, the Board of Directors of the Company shall be
divided into three classes, each class to consist as nearly as possible of one-
third of the directors. The term of office of one class of directors shall
expire each year with the initial term of office of the Class I directors
expiring at the 1998 annual meeting of shareholders; the initial term of office
of the Class II directors expiring at the 1999 annual meeting of the
shareholders; and the initial terms of office of the Class III directors
expiring at the 2000 annual meeting of shareholders. Commencing with the 1998
annual meeting of shareholders, the directors of the class elected at each
annual meeting of shareholders shall hold office for a term of three years.
Director Compensation. As compensation to outside directors, the Company
plans to pay directors' fees not to exceed $2,500 per quarter, plus expenses.
While not presently finalized, the Company is considering a program wherein up
to one - half of directors' fees may, upon agreement between the Company and the
director, be payable in shares of the Company's Common Stock, based on the value
of the stock on the last day of each quarter. Inside directors will not
receive compensation, but may be reimbursed for expenses.
Observer Designated by Representatives. For a period of 24 months following
the completion of this Offering, the Company will allow an observer designated
by the Representatives and acceptable to the Company to attend all meetings of
the Board of Directors. Such observer will have no voting rights, will be
reimbursed for all out-of-pocket expenses incurred in attending meetings, and
will receive compensation equal to that received by outside directors. The
observer will be indemnified by the Company against all claims, liabilities,
damages, costs and expenses arising out of his or her participation at Board of
Directors meetings. The Company has been advised by the Representatives that
Anthony B. Petrelli, senior vice president of Neidiger/Tucker/Bruner, Inc. will
be the initial observer of meetings of the Board of Directors. The Company has
agreed with the Representatives to hold meetings of its Board of Directors at
intervals of not less than 90 days during the 24 month period.
Executive Compensation
The following table sets forth the compensation paid to the Company's chief
executive officer, president and any other executive officers who received
annual compensation in excess of $100,000 (the "Named Executives") for services
rendered in all capacities for the fiscal year ended December 31, 1996. The
Company has written employment contracts (containing, among other things,
confidentiality and noncompetition provisions) with each of the Named
Executives. Pursuant to the employment agreements with the Named Executives,
certain Named Executives will receive compensation in excess of $100,000 in the
event of the resignation, retirement or other termination of employment. See
"Management -- Employment Agreements."
45
<PAGE>
Summary Compensation Table
--------------------------
<TABLE>
<CAPTION>
Long Term
Annual Compensation Compensation
------------------------------------------------- ------------
Securities
Other Annual Underlying
Name/Title Year Salary Bonus Compensation (1) Options (#)
---------- ---- ------ ----- ---------------- -----------
<S> <C> <C> <C> <C> <C>
Richard S. Cooper 1996 $136,000 $66,000 $34,100 75,000\\(2)\\
President 1995 $126,980 $0 $22,100 --
1994 $141,793 $0 $10,000 --
1993 $197,563 $0 $176,000 --
Charles P. Torrey, Jr. 1996 $24,000 $85,000 $34,100 75,000\\(2)\\
CEO 1995 $45,000 $0 $22,100 --
1994 $12,268 $0 $0 --
1993 $113,215 $0 $203,000 --
Robert L. Remine 1996 $24,000 $84,000 $34,100 75,000\\(2)\\
Secretary and Treasury 1995 $45,000 $0 $22,100 --
1994 $4,613 $0 $0 --
1993 $121,354 $0 $122,000 --
</TABLE>
- ---------------------
(1) Represents other annual compensation paid or to be paid to the Named
Executives, including such items as automobile allowance, health, disability
and life insurance, contributions to retirement plans, and certain compensation
assigned to the Named Executives as a stated amount in lieu of their respective
interests in certain Affiliated Drilling Partnership net revenues previously
assigned to them by the Company.
(2) Represents warrants to purchase up to 15,000 shares of Common Stock per
year for five years commencing in 1997. The total number of shares of Common
Stock each person can purchase pursuant to these warrants is 75,000. The
warrants are exercisable at the price to the public of the Units in this
Offering. Immediately prior to closing this Offering, the Common Stock of the
Company will undergo a two-for-one stock split, thereby doubling the number of
shares of Common Stock that can be purchased pursuant to the above-described
warrants.
Employment Agreements
Charles P. Torrey, Jr., Richard S. Cooper and Robert L. Remine. The Company
has entered into employment agreements with each of Charles P. Torrey, Jr., as
chief executive officer, with Richard S. Cooper, as president, and with Robert
L. Remine, as secretary and treasurer. Each of these employment agreements was
effective January 1, 1997, continue for an initial term of five years and is
subject to automatic annual renewal terms of one year each thereafter. Base
salary for each of the employment agreements is $180,000 per year, subject to an
annual increase of at least 6% per year plus any additional amount the Board of
Directors may award. In addition, in each year in which the gross working
interest revenue of the Company increases by at least 20% over its level in the
preceding year, each of the employment agreements provides for a yearly
performance bonus equal to 25% of the executive officer's base salary. Under the
employment agreements, Messrs. Torrey, Cooper and Remine are each entitled to
46
<PAGE>
receive the following: a nonaccountable automobile allowance of $1,000 per month
and reimbursement of itemized fuel, cleaning and related expenses; a life
insurance policy in the face amount of $500,000 (with the employee to name the
beneficiary) provided the employee is insurable at standard rates (and if extra
premiums are incurred in order to insure the life of the employee, the employee
will be responsible for payment of such additional premiums or may accept such
reduced death benefit as may be purchased for the cost of standard premiums);
medical, health and hospitalization insurance as provided to other executive
officers; participation in any bonus or profit sharing plan, profit-sharing
plan, qualified salary deferral plan or pension plan now or in the future
adopted by the Company; three weeks paid vacation; and participation with the
Company in the drilling of Company oil and gas wells by giving the employee the
option to purchase a 1% carried working interest in any well drilled by the
Company (other than in connection with syndicated existing or future Affiliated
Drilling Program) for a price equal to 1% of the completion costs for the well
(thereby being carried by the Company through the drilling and casing point).
In the event of a termination of any of Messrs. Torrey, Cooper or Remine by
the Company with or without cause, the employee shall be entitled to be paid a
severance allowance equal to 24 months' salary (less amounts required to be
withheld and deducted) plus any performance bonus, ratably apportioned. In the
event any of Messrs. Torrey, Cooper or Remine are terminated without cause, such
termination shall be preceded by 120 days advance written notice. No advance
written notice is required to be given by the Company for a termination with
cause.
Messrs. Torrey, Remine and Cooper's employment agreements each contain
confidentiality provisions (generally requiring that all the Company's
confidential and proprietary data be kept confidential) and noncompetition
provisions (generally providing that the employee will not directly or
indirectly compete with the Company during the term of employment or for two
years thereafter) for the benefit of the Company.
John M. Johnston. The Company has entered into an employment agreement with
John M. Johnston as vice president of exploration and development. This
employment agreement is effective January 1, 1997, continues for an initial term
of one year and is subject to automatic annual renewal terms of one year each
thereafter. Base salary for the employment agreement is $72,000 per year. In
addition, in each year in which the gross working interest revenue of the
Company increases by at least 20% over its level in the preceding year, the
employment agreement provides for a yearly performance bonus equal to 25% of Mr.
Johnston's base salary. Under the employment agreement, Mr. Johnston will be
entitled to receive the following: a nonaccountable automobile allowance
including use, maintenance, repair and insurance of an automobile and
reimbursement of itemized fuel, cleaning and related expenses; a life insurance
policy in the face amount of $200,000 (with the employee to name the
beneficiary) provided the employee is insurable at standard rates (and if extra
premiums are incurred in order to insure the life of the employee, the employee
will be responsible for payment of such additional premiums or may accept such
reduced death benefit as may be purchased for the cost of standard premiums);
medical, health and hospitalization insurance as provided to other employees;
participation in any bonus or profit sharing plan, profit-sharing plan,
qualified salary deferral plan or pension plan now or in the future adopted by
the Company; and two weeks paid vacation.
In the event of a termination of Mr. Johnston by the Company with or
without cause, he shall be entitled to be paid a severance allowance equal to
one year's salary (less amounts required to be withheld and deducted) plus any
performance bonus, ratably apportioned. In the event Mr. Johnston is terminated
without cause, such termination shall be preceded by 120 days advance written
notice. No advance written notice is required to be given by the Company for a
termination with cause.
Mr. Johnston's employment agreement contains confidentiality provisions
(generally requiring that all the Company's confidential and proprietary data be
kept confidential) and noncompetition provisions (generally providing that the
employee will not directly or indirectly compete with the Company during the
term of employment or for one year thereafter) for the benefit of the Company.
47
<PAGE>
Benefit Plans
Stock Option Plan. The Company's Stock Option Plan (effective January 1,
1997) was approved by the Board of Directors and stockholders of the Company on
September 18, 1996. The Stock Option Plan provides for the grant of incentive
stock options within the meaning of Section 422 of the Internal Revenue Code of
1986, as amended, and options which do not constitute incentive options to
officers, directors (other than outside directors), employees and advisors of
the Company or a subsidiary of the Company. A total of 300,000 shares of Common
Stock have been authorized and reserved for issuance under the Stock Option
Plan, subject to adjustment to reflect changes in the Company's capitalization
in the case of a stock split, stock dividend or similar event. The Stock Option
Plan will be administered by the Compensation Committee, which will consist of
the Company's two outside directors. The Compensation Committee will have the
sole authority to interpret the Stock Option Plan, to determine the persons to
whom options will be granted (the Compensation Committee may receive
recommendations on this subject from management), to determine the basis upon
which the options will be granted, and to determine the exercise price, duration
and other terms of options to be granted under the Stock Option Plan; provided
that, (i) the exercise price of each option granted under the Stock Option Plan
may not be less than the fair market value (110% of fair market value in the
case of incentive stock options granted to holders of more than 10% of the
voting power of the Company at the time of grant), of the Common Stock on the
day of the grant of the option, (ii) the exercise price must be paid in cash
upon exercise of the option, (iii) no option may be exercisable more than 10
years after the date of grant (5 years in the case of holders of more than 10%
of the voting power of the Company at the time of grant), and (iv) no option is
transferable other than by will or the laws of descent and distribution. No
option is exercisable after an optionee ceases to be employed by the Company or
a subsidiary of the Company, subject to the right of the Compensation Committee
to extend the exercise period for not more than 90 days following the date of
termination of an optionee's employment. An optionee who was a director or
advisor may exercise his option at any time within 90 days after such optionee's
status as a director or advisor terminates to the extent he was entitled to
exercise such option at the date of termination of his status. If an optionee's
employment is terminated by reason of disability, the Compensation Committee has
the authority to extend the exercise period for not more than one year following
the date of termination of the optionee's employment or service as an advisor or
director. If an optionee dies and holds options not fully exercised, such
options may be exercised in whole or in part within one year of the optionee's
death by the executors or administrators of the optionee's estate or by the
optionee's heirs. The vesting period, if any, specified for each option will be
accelerated upon the occurrence of a change of control or threatened change of
control of the Company.
Outside Directors Stock Option Plan. The Outside Directors Stock Option
Plan (effective January 1, 1997) was approved by the Board of Directors and
Stockholders of the Company on September 18, 1996. A total of 50,000 shares of
Common Stock have been authorized and reserved for issuance under the Outside
Directors Stock Option Plan, subject to adjustment to reflect changes in the
Company's capitalization in the case of a stock split, stock dividend or similar
event. The Outside Directors Stock Option Plan will be administered by the Board
of Directors of the Company. The Board of Directors has authority to interpret
the Outside Directors Stock Option Plan, to determine the persons to whom
options will be granted, to determine the basis upon which the options will be
granted, and to determine the exercise price, duration and other terms of
options to be granted under the Outside Directors Stock Option Plan; provided
that, (i) the exercise price of each option granted under the Plan may not be
less than the fair market value of the Common Stock on the day of the grant of
the option, (ii) the exercise price must be paid in cash upon exercise of the
option, (iii) no option may be exercisable more than 10 years after the date of
grant, and (iv) no option is transferable other than by will or the laws of
descent and distribution. If an optionee's status as an outside director is
terminated for any reason other than death, the optionee may exercise his option
at any time within 90 days after such termination to the extent it was then
exercisable. If an optionee dies while an Outside Director and shall not have
fully exercised options granted under the Outside Directors Stock Option Plan,
such options may be exercised in whole or in part within six months of the
optionee's death by the executors or administrators of the optionee's estate or
by the optionee's heirs. The vesting period, if any, specified for each option
will be accelerated upon the occurrence of a change of control or threatened
change of control of the Company.
Options under the Outside Directors Stock Option Plan will be granted only
to "outside directors" selected by the Board of Directors. Outside Directors
shall mean only those directors of the Company or a subsidiary of the Company
who are "non-employee directors" as defined under Rule 16b-3 under the
48
<PAGE>
Securities Exchange Act of 1934 and who are not currently and have not in the
past year been officers or regular salaried employees of the Company.
Restrictions on Options and Warrants to Directors, Officers, Employees, 5%
Shareholders and Affiliates. The Company will not grant options or warrants for
its Common Stock in excess of 15% of the outstanding shares of Common Stock to
officers, directors, employees, 5% shareholders or affiliates for a period of
one year following the Offering.
Indemnification of Officers and Directors
According to the Fourth Amended and Restated Bylaws of the Company, any
director or officer, or his executor or administrator, will be entitled to
indemnification from losses and advancement of expenses incurred personally as a
result of his status as a director or an officer of the Company in accordance
with the Tennessee Business Corporation Act.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Company pursuant to the foregoing provisions, 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 Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Company of expenses incurred or
paid by a director, officer or controlling person of the Company on the
successful defense of any action, suit or proceeding) is asserted by such a
director, officer or controlling person in connection with the securities being
registered, the Company will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
49
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding certain
principal stockholders' beneficial ownership of the Common Stock of the Company
as of the date of this Prospectus and as adjusted to reflect the sale of Units
offered hereby. The beneficial ownership of Common Stock of these principal
stockholders assumes that (a) all 450,000 pre-stock split shares of Preferred
Stock have been converted into Common Stock on a one share - to - one share
basis, (b) certain Common Stock purchase warrants owned by them and vested as of
January 1, 1997 have been exercised, and (c) the two - for - one stock split
intended to occur immediately prior to completion of this Offering has occurred.
The principal stockholders included in the following table are: (i) each person
known by the Company to be the beneficial owner of more than five percent of the
total outstanding shares of Common Stock of the Company, (ii) each director or
executive officer of the Company, (iii) all directors and executive officers of
the Company as a group, (iv) all holders of Preferred Stock. The following table
does not assume that any Series A Warrants or Representatives' Warrants have
been exercised. Except as otherwise indicated all persons listed below have
record and beneficial ownership and sole voting power and investment power with
respect to their shares of Common Stock (except to the extent that authority is
shared by spouses under applicable law).
<TABLE>
<CAPTION>
Amount Amount
Beneficially Percent of Beneficially Percent of
Owned Prior Class Prior to Owned After Class After
Name to Offering Offering Offering Offering
---- ----------- -------- -------- --------
<S> <C> <C> <C> <C>
Charles P. Torrey, Jr.,
CEO and Director 342,498 (1) 16.17% 342,498 10.98%
Richard S. Cooper
President and Director 342,498 (1) 16.17% 342,498 10.98%
Robert L. Remine
Sec/Treas and Director 342,498 (1) 16.17% 342,498 10.98%
John M. Johnston
Vice President Expl. and Dev. 60,000 2.83% 60,000 1.92%
All officers and directors as a
group (four persons) 1,087,494 51.35% 1,087,494 34.88%
Preferred Stockholders as a group,
none of whom individually will
own more than 5% of the Common
Stock upon conversion 900,000 42.49% 900,000 28.87%
</TABLE>
- -------------------------------------------------------
(1) Includes 7,494 post-stock split shares of Common Stock expected to be
acquired by the exercise of presently outstanding Common Stock purchase warrants
owned by Messrs. Torrey, Remine and Cooper. Also includes 30,000 post-stock
split shares of Common Stock per person which may be acquired by the exercise of
presently outstanding Common Stock purchase warrants owned by Messrs. Torrey,
Remine and Cooper to be vested and exercisable as of January 1, 1997. Excludes
360,000 post-stock split shares of Common Stock that may be acquired by the
exercise of presently outstanding Common Stock purchase warrants owned by
Messrs. Torrey, Remine and Cooper to become vested and exercisable in four equal
annual installments of 30,000 post-stock split shares per person as of
January 1, in each of the years 1998, 1999, 2000, and 2001.
The address of the officers and directors shown above is 280 Fort
Sanders West Boulevard, Suite 200, Knoxville, Tennessee, 37922.
50
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Equity Financial Corporation ("EFC") of Knoxville, Tennessee, is a
Tennessee corporation and an NASD-member broker-dealer. EFC is owned and managed
by Messrs. Torrey and Remine, each of whom hold securities licenses as
registered principals. EFC acted as the placement agent for each Affiliated
Drilling Partnership and the Pipeline Income Partnership for which the Company
serves as general partner and operator. Messrs. Torrey and Remine received sales
commissions in connection with the offerings of interests in Affiliated Drilling
Partnerships and the Pipeline Income Partnership. It is anticipated that EFC
will act as placement agent for future Company-sponsored Affiliated Drilling
Programs. Messrs. Torrey and Remine will receive sales commissions for selling
interests in future Affiliated Drilling Programs on behalf of EFC.
Through December 31, 1996, EFC shared its offices and certain office
equipment and facilities with the Company. In consideration for this arrangement
the Company paid EFC approximately $1,000 per month.
Prior to October, 1996, the Company leased an airplane from Charles P.
Torrey, Jr., its chief executive officer and a director, pursuant to an aircraft
lease dated February 1, 1995. The term of the lease was month to month. The
lease required the Company to make payments of base rent of $1,575 per month
payable in advance. The base rent covered the first 12 hours of usage by the
Company. Any excess use was subject to a charge of $100 per hour. Mr. Torrey, as
lessor, was responsible for maintenance of the aircraft. In September of 1996,
Mr. Torrey's airplane was sold and the lease terminated.
The Company is the borrower under promissory notes payable to Charles P.
Torrey, Jr., in the principal amount of $66,773, to Richard S. Cooper, in the
principal amount of $65,000, and to Robert L. Remine, in the principal amount of
$120,000. All of the promissory notes are due on demand and bear interest at the
rate of 10% per annum. The Company plans to pay these notes with the proceeds of
this Offering.
The Company serves as managing general partner in thirteen syndicated
Affiliated Drilling Partnerships, as well as the Pipeline Operating Partnership
and the Pipeline Income Partnership. In connection with each Affiliated Drilling
Partnership, the Company has entered into a JDOA which establishes the terms and
conditions of the Company's participation in the wells and its services as
driller-operator. For a discussion of the Company's relationship to each of
these partnerships see "Business and Properties -- Sponsorship of Affiliated
Drilling Partnerships; Pipeline Operating Partnership and Pipeline Income
Partnership."
The Company has adopted a policy concerning material loans and advances
(for amounts in excess of $1,000 outside the ordinary course of business) to
Company employees, officers and directors which provides that all such loans or
advances must be evidenced by a written loan agreement or promissory note, must
be on terms that are fair and advantageous to the Company, and must be approved
by the Board of Directors. Furthermore, all transactions between the Company and
any affiliate of the Company must be on terms no less favorable than could be
obtained from an unaffiliated third party and must be approved by a majority of
the directors, including a majority of disinterested directors.
51
<PAGE>
DESCRIPTION OF SECURITIES
Capital Stock of the Company
The authorized capital stock of the Company presently consists of
10,000,000 shares of Common Stock, no par value, 216,945 shares of Class A
Preferred Stock, no par value and 450,000 shares of Class B Preferred Stock, no
par value.
Preferred Stock
At the date of this Prospectus, there were 207,700 shares of Class A
Preferred Stock outstanding. Such shares were issued in exchange, on a dollar -
for - dollar basis at $10 per share, for outstanding principal owed on the
Company's Debentures. The Class A Preferred Stock bears a cumulative,
noncompounded dividend at a rate of 5% per annum payable upon the occurrence of
a surrender event, defined below ("Surrender Event").
At the date of this Prospectus, there were 242,300 shares of Class B
Preferred Stock outstanding. Such shares were issued for consideration equal to
$10 per share in cash.
All shares of Class A Preferred Stock and shares of Class B Preferred Stock
(collectively, the "Preferred Stock") were redeemable by the Company, at the
option of the Preferred Stockholder, at $10 per share upon the occurrence of a
Surrender Event (which term includes the undertaking of a registration for an
initial public offering of the Company's Common Stock). Any shares of Preferred
Stock which are not redeemed upon the occurrence of a Surrender Event are
automatically convertible, on a one share-for-one share basis, into shares of
Common Stock. Contemporaneously with the filing of the Registration Statement
for this Offering, management sent notice to all holders of Preferred Stock
announcing the occurrence of an event triggering their option to have their
Preferred Stock redeemed by the Company. Holders of Preferred Stock were
required to provide written notice of election to have their Preferred Stock
redeemed no later than October 26, 1996. Any holders of Preferred Stock who did
not timely elect to have their shares of Preferred Stock redeemed will have
their shares of Preferred Stock automatically converted into shares of Common
Stock on a one share-to-one share basis upon completion of the Offering. As of
the date of this Prospectus, the time period for holders of Preferred Stock to
provide notice of intent to have their shares redeemed has passed and the
Company has received no written notice of intent to redeem. As a result, all
outstanding shares of Class A Preferred Stock and Class B Preferred Stock will
be automatically converted to shares of Common Stock on a one share-for-one
share basis upon completion of this Offering.
Prior to conversion into Common Stock, the Class A Preferred Stock is
entitled to receive a $10 per share, plus accrued and unpaid dividends,
liquidation preference over Class B Preferred Stock and Common Stock. Prior to
conversion into Common Stock, the Class B Preferred Stock is entitled to receive
a $10 per share liquidation preference over Common Stock. After conversion, any
liquidation preference formerly associated with Class A Preferred Stock or
Class B Preferred Stock shall lapse.
For purposes of the Preferred Stock, the term "Surrender Event" is defined
as: (a) the Company merging or consolidating with another company in a
transaction in which the Company is not the survivor; (b) the Company selling or
disposing of all, or substantially all, of its assets; or (c) management of the
Company undertaking a registration and initial public offering of any of its
Common Stock.
The Preferred Shares have no voting rights (other than those prescribed by
Tennessee law) unless and until they are converted into shares of Common Stock.
Tennessee law provides that a vote of the holders of a majority of the
outstanding shares of Preferred Stock is required to change the powers,
preferences, or special rights of the Preferred Stock in a manner adverse to
them. The rule applies to the Preferred Stock on a class-by-class basis.
Following conversion of the Class A Preferred Shares, the Company will have
no authority to issue further Class A Preferred Shares. Following conversion of
the Class B Preferred Shares, the Company will still be authorized to issue up
to 900,000 (post-stock split) shares of Class B Preferred Stock, but presently
has no intention of doing so in the future.
52
<PAGE>
Units
Each Unit consists of one share of Common Stock and one Series A Warrant.
The shares of Common Stock and the Series A Warrants included in the Units may
not be separately traded until July 24, 1997 unless earlier separated upon three
days prior written notice from Neidiger/Tucker/Bruner, Inc. and National
Securities Corporation (the "Representatives") to the Company.
Common Stock
At the date of this Prospectus, there were 550,000 shares of Common Stock
outstanding. In addition, 13,975 shares of Common Stock were reserved for
issuance upon exercise of Common Stock purchase warrants granted under the
Company's existing Common Stock warrant plans, all of which must be exercised,
if at all, within 90 days after the successful completion of this Offering.
Immediately prior to completion of this Offering, the Company will undergo a
two-for-one stock split which will have the effect of doubling the number of
outstanding shares of Common Stock as well as the number of shares of Common
Stock that may be purchased pursuant to currently outstanding Common Stock
purchase warrants.
As of the date of this Prospectus, there were 450,000 shares of Preferred
Stock (including Class A and Class B shares) outstanding which will be converted
into Common Stock on a one share - to - one share (pre-stock split) basis upon
completion of this Offering.
The holders of outstanding shares of Common Stock, as well as the shares of
Common Stock to be received upon conversion of shares of Preferred Stock or
issued upon exercise of existing Common Stock warrants, are entitled to share
ratably in any dividends paid on the Common Stock when, as and if declared by
the Board of Directors out of funds legally available therefor. Each holder of
Common Stock is entitled to one vote for each share held of record. The Common
Stock is not entitled to cumulative voting or preemptive rights and is not
subject to redemption. Upon liquidation, dissolution or winding up of the
Company, the holders of Common Stock are entitled to share ratably in the net
assets legally available for distribution. All outstanding shares of Common
Stock are fully paid and nonassessable.
Series A Warrants
The Board of Directors has authorized the issuance of 1,000,000 Series A
Warrants included in the Units offered hereby, as well as the issuance of
150,000 Series A Warrants which may be issued pursuant to the Underwriters'
Over-allotment Option, and 100,000 Series A Warrants which may be issued
pursuant to the Representatives' Warrants and has authorized and reserved an
equivalent number of shares of Common Stock for issuance upon exercise of such
Series A Warrants. The following statements are brief summaries of certain
provisions of the Warrant Agreement (defined below). Copies of the Warrant
Agreement may be obtained from the Company or the Warrant Agent (defined below)
and have been filed with the Securities and Exchange Commission as an exhibit to
the Registration Statement of which this Prospectus is a part.
The Series A Warrants will be issued in registered form under, governed by,
and subject to the terms of a warrant agreement (the "Warrant Agreement")
between the Company and American Stock Transfer & Trust Company as warrant agent
(the "Warrant Agent"). Each Warrant entitles the holder thereof to purchase one
share of Common Stock at an exercise price of 120% of the offering price per
Unit exercisable at any time commencing on February 28, 1998 until January 30,
2002, unless earlier redeemed by the Company as described below. The Series A
Warrants may not be separately traded until July 24, 1997 unless earlier
separated upon three days prior written notice by the Representative to the
Company at the discretion of the Representative. The Series A Warrants contain
provisions that protect the Warrant holders against dilution by adjustment of
the exercise price in certain events, including, but not limited to stock
dividends, stock splits, reclassifications or mergers. A Warrant holder will not
possess any rights as a shareholder of the Company. Shares of Common Stock, when
issued upon the exercise of the Series A Warrants in accordance with the terms
thereof, will be fully paid and non-assessable. No fractional shares will be
issued upon the exercise of the Series A Warrants. The Company will pay cash in
lieu of fractional shares.
53
<PAGE>
The Series A Warrants are subject to redemption by the Company at a price
of $0.05 per Series A Warrant at any time commencing July 24, 1998, on thirty
days prior written notice, provided that the closing sale price per share for
the Common Stock has equaled or exceeded 200% of the offering price per Unit for
twenty consecutive trading days within the thirty-day period immediately
preceding such notice. If the Series A Warrants are called for redemption, they
must be exercised prior to the close of business on the date of any such
redemption or the right to purchase the applicable shares of Common Stock is
forfeited. See "Risk Factors--Risks Associated with Investment in the
Securities--Potential Adverse Effect of Redemption of Series A Warrants."
At any time when the Series A Warrants are exercisable, the Company has
agreed to have a current registration statement on file with the Commission and
to effect appropriate qualifications under the laws and regulations of the
states in which the holders of the Series A Warrants reside in order to comply
with applicable laws in connection with the exercise of the Series A Warrants
and the resale of the Common Stock issued upon such exercise. So long as the
Series A Warrants are outstanding, the Company has agreed to file all post-
effective amendments to the Registration Statement required to be filed under
the Securities Act, and to take appropriate action under federal law and the
securities laws of those states where the Series A Warrants were initially
offered to permit the issuance and resale of the Common Stock issuable upon
exercise of the Series A Warrants. However, there can be no assurance that the
Company will be in a position to effect such action under the federal and
applicable state securities laws, and the failure of the Company to effect such
action may cause the exercise of the Series A Warrants and the resale or other
disposition of the Common Stock issued upon such exercise to become unlawful.
The Company may amend the terms of the Series A Warrants, but only by extending
the termination date or lowering the exercise price thereof. The Company has no
present intention of amending such terms.
Transfer Agent and Registrar; Warrant Agent
The Transfer Agent and Registrar for the Units, Common Stock and the
Warrant Agent for the Series A Warrants and the Representatives' Warrants will
be American Stock Transfer and Trust Company, 40 Wall Street, New York, NY
10005.
Reports to Shareholders
The Company intends to furnish its shareholders with annual reports
containing audited financial statements and such other periodic reports as the
Company may determine to be appropriate or as may be required by law.
The Company has agreed that no later than the date of this Prospectus, it
will register its Common Stock and Series A Warrants under the provisions of
Section 12(b) and 12(g) of the Securities Exchange Act of 1934, as amended,
(the "Exchange Act"), and that it will use its best efforts to continue to
maintain such registration. Such registration will require the Company to comply
with periodic reporting, proxy solicitation, and certain other requirements of
the Exchange Act.
Boston Stock Exchange and Nasdaq Small-Cap Market
The Units, Common Stock and the Series A Warrants have been approved,
subject to official notice of issuance, for listing on the Boston Stock
Exchange, under the symbols "EYS.U," "EYS," AND "EYS.WS.A," respectively, and on
the Nasdaq Small-Cap Market under the symbol "EGASU," "EGAS," AND "EGASW,"
respectively.
54
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this Offering and conversion of 100% of the outstanding
Preferred Shares to Common Stock, the Company will have 3,000,000 shares of
Common Stock outstanding. In addition, there will be outstanding Common Stock
purchase warrants to purchase 27,950 shares of Common Stock exercisable within
90 days after completion of this Offering. Of the 3,000,000 Common shares to be
outstanding, the 1,000,000 shares to be sold in this Offering (1,150,000 if the
Underwriters' Over-allotment Option is exercised in full) will be tradeable in
the public market without restriction under the Securities Act, except shares
purchased by an "affiliate" (as defined in the Securities Act -- in general, a
person who is in a control relationship with the Company) of the Company. All of
the remaining 2,000,000 shares of Common Stock will be "Restricted Shares"
within the meaning of the Securities Act and may be publicly sold only if
registered under the Securities Act or sold in accordance with an exemption from
registration, such as those provided by Rules 144 and 701 promulgated under the
Securities Act. In addition, to the extent any of the previously outstanding
warrants to purchase 27,950 shares of Common Stock are exercised, such shares
will also be Restricted Shares. The officers and directors who, after completion
of this Offering, will be holders of 997,495 shares of Common Stock, assuming
all outstanding Common Stock purchase warrants held by all of them are
exercised, and further assuming the effect of the two - for - one stock split,
have agreed that they will not, without the prior written consent of the
Representative, offer, sell or otherwise dispose of any shares of Common Stock
or other securities of the Company beneficially owned by them or hereafter
acquired upon the exercise of stock options or otherwise for a period of
24 months after the date of this Prospectus. See "Underwriting."
In general, under Rule 144, as currently in effect, a person (or persons
whose shares are aggregated) is entitled to sell Restricted Shares if at least
two years have passed since the later of the date such shares were acquired from
the Company or any affiliate of the Company. Rule 144 provides that within any
three-month period such person may sell only up to the greater of 1% of the then
outstanding shares of the Company's Common Stock (approximately 30,279 shares
following completion of this Offering) or the average weekly trading volume in
the Company's Common Stock during the four calendar weeks immediately preceding
the date on which the notice of the sale is filed with the Securities and
Exchange Commission. Sales pursuant to Rule 144 are subject to certain other
requirements relating to manner of sale, notice of sale and availability of
current public information. Any person who has not been an affiliate of the
Company for a period of three months preceding a sale of Restricted Shares is
entitled to sell such shares under Rule 144 without regard to such limitations
if at least three years have passed since the later of the date such shares were
acquired from the Company or any affiliate of the Company. Shares held by
persons who are deemed to be affiliates of the Company are subject to such
volume limitations regardless of how long they have been owned or how they were
acquired. The foregoing is a brief summary of certain provisions of Rule 144 and
is not intended to be a complete description thereof.
Without consideration of contractual restrictions described below, an
aggregate of 930,000 post-stock split shares of Common Stock, representing 31.0%
of the outstanding shares of the Common Stock, (29.5% if the Underwriters' Over-
allotment Option is exercised in full) will be eligible for public sales
pursuant to Rule 144 after the completion of this Offering. In addition,
warrants to purchase an aggregate of 21,290 post-stock split shares of Common
Stock are presently outstanding and will be eligible for public sale pursuant to
Rule 144 after completion of this Offering. The Company cannot estimate the
number of shares that may be sold under Rule 144, as the number will depend upon
the market price, trading volume for the Common Stock, personal circumstances of
the sellers and other factors.
After this Offering, executive officers, directors and senior management
will own 990,000 post-stock split shares of the Common Stock. In addition, these
individuals own warrants to purchase 7,494 post-stock split shares of Common
Stock. These individuals, including Messrs. Torrey, Remine, Cooper and Johnston
have agreed with the Representatives, subject to certain limited exceptions, not
to sell or otherwise dispose of any shares of Common Stock or other securities
of the Company now owned or hereafter acquired for a period of 24 months after
the date of this Prospectus without the prior written consent of the
Representatives. See "Underwriting."
Any employee, officer or director of the Company who purchases his or her
shares pursuant to a written compensatory plan or contract is entitled to rely
on the resale provision of Rule 701 under the Securities Act, which permits non-
affiliates to sell those shares without having to comply with the public
information, holding period, volume limitations or notice provisions of Rule 144
and permits affiliates to
55
<PAGE>
sell those shares without having to comply with the holding period restrictions
of Rule 144, in each case commencing 90 days from the date of this Prospectus.
With respect to the Preferred Stock, the Company has agreed that, if it
undertakes to register any shares of Common Stock, it shall use its best efforts
to register all shares of Common Stock into which the Preferred Stock may be
convertible upon the occurrence of a Surrender Event. However, in the event that
the managing underwriter determines not to register the shares of Common Stock
underlying the Preferred Stock, the Company shall have no obligation to do so
and the holder of Preferred Stock is free to undertake the registration of his
or her own shares of underlying Common Stock at his or her own expense. The
Company has requested that the Representative include in this registration and
initial public offering the shares of Common Stock into which the shares of
outstanding Preferred Stock are convertible. The Representative has indicated to
the Company that it believes it is not in the best interest of the Company to
include such shares in this Offering.
Prior to this Offering, there has been no public market for the Common
Stock, and no predictions can be made as to the effect, if any, that public
sales of shares of the Common Stock or the availability of shares for sale will
have on the market price of the shares of Common Stock after this Offering. The
sale, or availability for sale, of substantial amounts of the Common Stock in
the public market following this Offering could adversely affect the prevailing
market price of the Common Stock or the ability of the Company to raise capital
through sales of its equity securities.
56
<PAGE>
UNDERWRITING
Pursuant to the terms and subject to the conditions contained in the
Underwriting Agreement, the Company has agreed to sell on a firm commitment
basis to the Underwriters named below, and each of the Underwriters, for whom
Neidiger/Tucker/Bruner, Inc. and National Securities Corporation (the
"Representatives") are acting as the Representative, have severally agreed to
purchase the number of units set forth opposite their names in the following
table.
Underwriters Number of Units
------------ ---------------
Neidiger/Tucker/Bruner, Inc. 230,000
National Securities Corporation 230,000
Baird, Patrick & Co., Inc. 45,000
Chatfield Dean & Co., Inc. 45,000
Cohig & Associates, Inc. 45,000
Laidlaw Holdings, Inc. 45,000
H. J. Meyers & Co., Inc. 45,000
Paulson Investment Company, Inc. 45,000
Culverwell & Co., Inc. 25,000
Culver-Dyer Securities, Inc. 25,000
Marion Bass Securities Corp. 25,000
First Colonial Securities Group, Inc. 25,000
Fredrick & Company, Inc. 25,000
Kashner Davidson Securities Corporation 25,000
First London Securities Corporation 20,000
Lew Lieberbaum & Co., Inc. 20,000
Nutmeg Securities 20,000
Smith, Moore & Co., Inc. 20,000
Spencer Edwards, Inc. 20,000
Westport Resources Investment Services, Inc. 20,000
----------
TOTAL 1,000,000
==========
The Representatives have advised the Company that the Underwriters propose
to offer the Units to the public at the initial public offering price per share
set forth on the cover page of this Prospectus and to certain dealers at such
price less a concession of not more than $.40 per Unit. After the Offering, the
public offering price and concession may be reduced by the Representatives. No
such reduction will change the amount of proceeds to be received by the Company
as set forth on the cover page of this Prospectus.
The Company has granted to the Underwriters an option, exercisable during
the 45-day period after the date of this Prospectus, to purchase up to 150,000
additional Units to cover over-allotments, if any, at the offering price to the
public of the Units subject to this Prospectus less the Underwriting Discount.
To the extent that the Underwriters exercise such option, each of the
Underwriters will have a firm commitment to purchase approximately the same
percentage of such additional Units that the number of Units to be purchased by
it shown in the above table represents as a percentage of the 1,000,000 Units
offered hereby. If purchased, such additional Units will be sold by the
Underwriters on the same terms as those on which the 1,000,000 Units are being
sold.
Messrs. Torrey, Remine, Cooper and Johnston, who are the Company's
executive officers and largest shareholders, have entered into "lock-up"
agreements with the Representative pursuant to which they have agreed that, for
a period of 24 months after the date of this Prospectus, with certain limited
exceptions, they will not offer, sell, make any short sale of, loan, encumber,
grant any option for the purchase of, or otherwise dispose of any securities of
the Company now owned or hereafter acquired without the prior written consent of
the Representatives. The Company has also agreed, for a period of one year after
the date of this Prospectus, not to issue, sell, contract to sell, transfer,
assign, pledge, encumber, hypothecate or grant any option to purchase any
securities of the Company other than upon the exercise of Series A Warrants or
outstanding options described herein, without the prior written consent of the
Representatives.
The Underwriters will not confirm sales of the offered Units to any
accounts over which they exercise discretionary authority.
The Company has agreed to pay the Representatives a non-accountable expense
allowance of 2.5% of the gross proceeds of the Units sold, which will include
proceeds from the Underwriters' Over-allotment Option to the extent exercised.
The Representatives' expenses in excess of the expense allowance will be paid
by the Representatives. To the extent that the expenses of the underwriting are
less than such amount, such excess will be deemed to be additional compensation
to the Representatives.
In the event the Series A Warrant components of the offered Units are
exercised (commencing thirteen months from the date of closing of this
Offering), and subject to the applicable rules of the NASD, the Company will pay
to the Representative soliciting such exercise a fee of 5% of the purchase price
of the Series A Warrants exercised. In connection with such solicitation of
Series A Warrant exercises, unless granted an exemption by the Securities and
Exchange Commission from Rule 10b-6 under the Exchange Act, a Representative and
any other soliciting broker-dealer will be prohibited from engaging in any
market making activities or solicited brokerage activities with regard to the
Company's securities for a period of two to nine days, whichever is applicable,
prior to any solicitation of the exercise of the Series A Warrants and until the
later of the termination of such solicitation activity or the termination (by
waiver or otherwise) of any right that the Representatives or any other
soliciting broker-dealer may have to receive a fee for the exercise of the
Series A Warrants. As a result, the Representatives, or either of them, or any
other soliciting broker-dealers, as the case may be, may be unable to provide a
market for the Company's securities, should they desire to do so, during certain
periods while the Series A Warrants are exercisable.
57
<PAGE>
For a period of 24 months following the completion of this Offering, the
Company will allow an observer designated by the Representatives and acceptable
to the Company to attend all meetings of the Board of Directors. Such observer
will have no voting rights, will be reimbursed for all out-of-pocket expenses
incurred in attending meetings and will receive compensation equal to that
received by outside directors. The observer will be indemnified by the Company
against all claims, liabilities, damages, costs and expenses arising out of his
or her participation at board of directors meetings. The Company has been
advised by the Representatives that Anthony B. Petrelli, senior vice president
of Neidiger/Tucker/Bruner, Inc., will be the initial observer of meetings of
the Board of Directors. The Company has agreed with the Representatives to hold
meetings of its Board of Directors at intervals of not less than 90 days during
the 24 month period.
The Underwriting Agreement provides for indemnification between the Company
and the Underwriters against certain civil liabilities, including liabilities
under the federal securities laws. If such indemnifications are unavailable or
are insufficient, the Company and the Underwriters have agreed to damage
contribution arrangements between them based upon the relative benefits received
from this Offering and relative fault resulting in such damages. In addition,
the Representatives' Warrants provide for indemnification between the Company
and the holders of the Representatives' Warrants and underlying securities
against certain civil liabilities, including liabilities under the federal
securities laws.
Representatives' Warrants
Upon the closing of this Offering, the Company has agreed to sell to the
Underwriters, for nominal consideration, warrants to purchase 100,000 Units
offered hereunder (the "Representatives' Warrants"). The Representatives'
Warrants are exercisable at 125% of the public offering price per Unit for a
four-year period commencing one year from the date of this Prospectus. The
Representatives' Warrants will be nontransferable for a period of two years from
the date of this Prospectus except (in the Representatives' sole discretion) to
officers of the Representatives or members of the selling group or their
respective officers or partners. The Representatives' Warrants may be exercised
in a cashless transaction whereby the Representatives' Warrants themselves, at
the holders' option, may be exchanged, in whole or in part, for the underlying
Common Stock and Series A Warrants. Such cashless exercise will be permitted
commencing one year after the issue date of the Representatives' Warrants and
only if the Company's Common Stock is listed or approved for trading on an
exchange, inter-dealer communication system or a national quotation bureau. In
such cashless exercise, the Company shall issue to the holder of the exchanged
Representatives' Warrant (i) the number of shares of the Company's Common Stock
which is determined by dividing the imputed warrant value (which is the current
market value of the shares less the exercise price of the Representatives'
Warrants exchanged) by the current market value of the shares and (ii) the same
number of Series A Warrants as shares of Common Stock issued in such exchange.
The holders of the Representatives' Warrants will have no voting, dividend or
other rights as shareholders of the Company with respect to the underlying
shares until the Representatives' Warrants have been exercised.
The Representatives' Warrants and the securities issuable thereunder have
been registered under the Securities Act in connection with this Offering;
however, such securities may not be offered for sale except in compliance with
the applicable provisions of the Securities Act. The Company has agreed that,
if, at any time after the first anniversary of the date if this Prospectus but
prior to the fifth anniversary of the date of this Prospectus, it shall cause a
Post-Effective Amendment or a new Registration to be filed with the Securities
and Exchange Commission, the holders of the Representatives' Warrants shall have
the right to include in such Post-Effective Amendment or new Registration
Statement the Representatives' Warrants or the securities issuable upon their
exercise at the Company's expense. Additionally, the Company has agreed, for a
period of four years commencing one year from the date of this Prospectus, on
demand of the holders of a majority of the Representatives' Warrants or the
securities issued thereunder, to register the Representatives' Warrants and the
securities issuable thereunder one time at the Company's expense. Such
registration rights may be transferred to any subsequent holder of the
Representatives' Warrants and the securities issuable thereunder.
For the exercise period during which the Representatives' Warrants are
exercisable, the holder or holders will have the opportunity to profit from a
rise in the market value of the Common Stock, with a resulting dilution in the
interest of the other stockholders of the Company. The holder or holders of the
Representatives' Warrants can be expected to exercise them at a time when the
Company would, in all likelihood, be able to obtain any needed capital from an
offering of its unissued Common Stock on terms more favorable to the Company
than those provided for in the Representatives' Warrants. Such factors may
adversely affect the terms on which the Company can obtain additional financing.
To the extent that the holders of the Representatives' Warrants realize any gain
from the resale of the Representatives' Warrants or the securities issuable
thereunder, such gain may be deemed additional underwriting compensation under
the federal securities laws.
Determination of Offering Price
Prior to this Offering, there has been no public market for the securities
offered and there can be no assurance that a regular trading market will develop
upon completion of the Offering. Consequently, purchasers of the Units may not
find a ready market for the sale of their securities. The initial public
offering price for the Units has been determined by negotiation between the
Company and the Representatives. The factors considered in determining the
initial public offering price include the Company's revenue growth since its
organization, the industry in which it operates, the Company's business
potential and earnings prospects and the general condition of the securities
markets at the time of the Offering. The initial public offering price does not
necessarily bear any relationship to the Company's assets, book value, net worth
or other recognized objective value.
LEGAL MATTERS
58
<PAGE>
Certain matters with respect to the validity of the securities offered
hereby will be passed upon for the Company by Patrick R. Sughroue, P.C., 3777
Sparks Drive, S.E., Suite 130, Grand Rapids, Michigan, 49546. Certain legal
matters will be passed upon for the Underwriters by Winstead Sechrest & Minick
P.C., 5400 Renaissance Tower, 1201 Elm Street, Dallas, Texas 75270.
EXPERTS
The financial statements of the Company at December 31, 1995 and December
31, 1994, and for the respective periods then ended, included in this Prospectus
and Registration Statement, have been audited by Ronald D. Cameron, C.P.A.,
independent auditor, as set forth in his report thereon appearing elsewhere
herein, and are included in reliance upon such report given on the authority of
such person as an expert in auditing and accounting.
The reserve report of Kim A. Walbe, certified geologist, of the proved
reserves and future net revenues attributable to the Company's properties has
been relied upon as a basis for information contained herein in reliance upon
the authority of such person as an expert in geology and oil and gas reservoirs.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission"), a Registration Statement on Form SB-2 under the Securities Act
with respect to the Units. This Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits. For
further information with respect to the Company and the Units, reference is made
to the Registration Statement and the exhibits filed as a part thereof.
Statements made in this Prospectus as to the contents of any contract or any
other document referred to are not necessarily complete, and, in each instance,
reference is made to the copy of such contract or document filed as an exhibit
to the Registration Statement, each such statement being qualified in all
respects by such reference to such exhibit. The Registration Statement,
including exhibits thereto, may be inspected without charge at the public
reference facilities maintained by the Commission at Room 1024, Judiciary Plaza,
450 Fifth Street, NW, Washington, DC 20549 and at the regional offices of the
Commission at 7 World Trade Center, 13th Floor, New York, New York 10048 and at
500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of the
Registration Statement and the exhibits thereto may be obtained from the
Commission at such offices upon payment of prescribed rates.
The Company is not presently a reporting company. As a result of the
Offering, the Company will become subject to the information and periodic
reporting requirements of the Securities Exchange Act of 1934, as amended, and
in accordance therewith, will file periodic reports, proxy statements and other
information with the Commission. Such periodic reports, proxy statements and
other information will be available for inspection and copying at the public
reference facilities and regional offices referred to above.
The Company intends to furnish its stockholders with annual reports
containing audited financial statements and such other periodic reports as the
Company may determine to be appropriate or as may be required by law.
59
<PAGE>
GLOSSARY
AFFILIATE. "Affiliate" shall mean with respect to another person, (i) any
person directly or indirectly owning, controlling or holding with power to vote
10% or more of the outstanding voting securities of or equity interests in such
other person, (ii) any person 10% or more of whose outstanding voting securities
or equity interest are directly or indirectly controlling, controlled or held
with power to vote by such other person, (iii) any person directly or indirectly
controlling, controlled by or under common control with such other person, (iv)
any officer or director of such other person, and (v) any company for which any
such officer or director acts in any such capacity.
AFFILIATED DRILLING PARTNERSHIP(S). The limited partnership(s) formerly or in
the future sponsored by the Company or its affiliates and marketed by EFC for
the purpose of raising drilling capital for the Company.
BOARD OF DIRECTORS. The board of directors of the Company.
BbL. "Bbl" means barrel. "MBbl" means thousand barrels. "MMBbl" means million
barrels.
B/O. "B/O" means barrels of oil.
BOE. "BOE" means barrel of oil equivalent, which are determined using the ratio
of one barrel of crude oil, condensate or natural gas liquids to 6 Mcf of
natural gas so that 6 Mcf of natural gas is referred to as one barrel of oil
equivalent or "BOE". "MBOE" means thousands of barrels of oil equivalent.
"MMBOE" means millions of barrels of oil equivalent.
B/C. "B/C" means barrels of condensate.
BOPD. "BOPD" means barrels of oil per day.
CARRIED INTEREST. A fractional interest in an oil and gas lease or property,
the holder of which has no personal obligation for drilling costs, which are
paid by the owners of the remaining fraction, i.e. the working interest owners,
who reimburse themselves therefor out of production, if any.
CLASS A PREFERRED STOCK. The convertible Class A Preferred Stock, no par value,
accruing a 5% per annum cumulative, noncompounded dividend, which shares are
redeemable or automatically convertible to Common Stock upon completion of this
Offering.
CLASS B PREFERRED STOCK. The convertible Class B Preferred Stock, no par value,
which shares are redeemable or automatically convertible to Common Stock upon
completion of this Offering.
COMMERCIAL WELL. A well that will make a profit over the cost of drilling,
completing and operating the well.
COMMON SHARE(S). The shares of common stock of the Company.
COMPLETION. The installation of permanent equipment for the production of oil
and gas. Completion costs are the costs incurred for the equipment and labor
required therefor.
DEVELOPMENTAL WELL. "Developmental Well" shall mean a well drilled to a known
producing oil or natural gas horizon in a previously discovered field or in an
area where known producing horizons reasonably believed by the operator, based
on experience and known geological, production and other data, to be
geologically continuous.
EFC. "EFC" shall mean Equity Financial Corporation of Knoxville, Tennessee.
EXPLORATORY WELL. 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 and gas in another reservoir, or to extend a known reservoir.
60
<PAGE>
GAS GATHERING SYSTEM. The natural gas gathering and pipeline system owned by
the Pipeline Operating Partnership and managed by the Company servicing wells in
the principal area of the Company's operations in southeastern Ohio.
GAS SERVICING AGREEMENT. The agreement between the Pipeline Operating
Partnership and the Company, for its own account and on behalf of Affiliated
Drilling Partnerships, for the gathering, transportation and marketing of
natural gas through the Gas Gathering System.
GAS WELL. A gas well is a well drilled for producing only gas as its primary
product and not producing oil or condensate.
GROSS ACRES. The total acres in which an entity has an interest, either
directly or through an affiliate.
JDOA. "JDOA" shall mean a Joint Drilling and Operating Agreement between the
Company and an Affiliated Drilling Partnership.
MCF AND MCFPD. "Mcf" means one thousand cubic feet of gas, and "Mcfpd" means
one thousand cubic feet of gas per day.
NET ACRES. Calculated by multiplying the number of gross acres in which that
party has an interest by the fractional interest of the party in each such acre.
NET REVENUE INTEREST. The share of revenues from oil and/or gas production net
of all other interest burdening the gross revenues such as landowner's royalty
and overriding royalties, etc.
NON-ECONOMIC PROPERTY. A well or lease that may or may not be producing. Such
production, if any, is not sufficient enough to exceed the operational costs of
such property, i.e., operating at a loss.
PIPELINE INCOME PARTNERSHIP. "Pipeline Operating Partnership" shall mean Energy
Search Natural Gas Pipeline Income, L.p., a Tennessee Limited Partnership, which
is the sole limited partner of the Pipeline Operating Partnership.
PIPELINE OPERATING PARTNERSHIP. "Pipeline Operating Partnership" shall mean
Pipeline Operating, L.P., a Tennessee Limited Partnership, the limited partner
of the Pipeline Operating Partnership, of which the Company is the managing
general partner.
PREFERRED SHARE(S). The Class A Preferred Shares and/or the Class B Preferred
Shares of the Company currently outstanding.
PLUGGING LIABILITY. A liability or exposure to the costs and hazards of
plugging and abandoning oil/gas well.
PLUGGING OF A WELL. The sealing off of the fluids in the strata penetrated by a
well, so that the fluid from one stratum will not escape into another or to the
surface. This is usually accomplished by introducing cement and mud into the
hole. Regulations in many states require the plugging of abandoned wells.
PROVED RESERVES. Those quantities of crude oil, natural gas, and natural gas
liquids which, upon analysis of geologic and engineering data, appear with
reasonable certainty to be recoverable in the future from known oil and gas
reservoirs under existing economic and operating conditions. Proved reserves
are limited to those quantities of oil and gas which can be expected, with
little doubt, to be recoverable commercially at current prices and costs, under
existing regulatory practices and with existing conventional equipment and
operating methods. Depending upon their status of development, such Proved
Reserves shall be subdivided into the following classifications:
(a) PROVED DEVELOPED RESERVES. These are Proved reserves which can be
expected to be recovered through existing wells with existing equipment and
operating methods. This classification shall include:
61
<PAGE>
(1) PROVED DEVELOPED PRODUCING RESERVES. These are proved developed
reserves which are expected to be produced from existing completion
interval(s) now open for production in existing wells; and
(2) PROVED DEVELOPED NON-PRODUCING RESERVES. These are proved developed
reserves which exist behind the casing of existing wells, (but not below
the depths of the present bottom of such wells) which are expected to be
produced through these wells in the predictable future, where the cost of
making such oil and gas available for production should be relatively small
compared to the cost of a new well.
Additional oil and gas expected to be obtained through the application of
fluid injection or other improved recovery techniques of supplementing the
natural forces and mechanisms of primary recovery shall be included as "proved
developed reserves" only after testing by a pilot project or after the operation
of an installed program has confirmed through production response that increased
recovery will be achieved.
(B) PROVED UNDEVELOPED RESERVES. These are proved reserves which are
expected to be recovered from new wells on undrilled acreage, or from
existing wells at depths below the present bottom of the wells.
RESERVES. Crude oil and natural gas, condensate and natural gas liquids, are
net of leasehold burdens, stated on a net revenue interest basis, and found to
be commercially recoverable.
Royalty Interest or Overriding Royalty Interest. An interest in an oil and gas
property entitling the owner to a share of oil and gas production (or the
proceeds of the sale thereof) free of the costs of production.
SEC METHOD. The SEC method is a method of determining the present value of
proved reserves. Under the SEC method, the future net revenues from proved
reserves are estimated assuming that oil and gas prices and production costs
remain constant. The resulting stream of revenues is then discounted at the
rate of 10% per year to obtain a present value.
UNDEVELOPED ACREAGE. Is oil and gas acreage (including, in applicable
instances, rights in one or more horizons which may be penetrated by existing
well bores but which have not been tested) to which proved reserves have not
been assigned by independent petroleum engineers.
WORKING INTEREST. The operating interest under an oil and gas lease which gives
the owner the right to drill, produce and conduct operating activities on the
property and a share of production, subject to all royalties, overriding
royalties and other burdens and to all costs of exploration, development and
operations and all risks in connection therewith.
62
<PAGE>
ENERGY SEARCH, INCORPORATED
INDEX TO FINANCIAL STATEMENTS
AUDITED FINANCIAL STATEMENTS
as of and for the periods ended
December 31, 1995 and 1994
Independent Auditor's Report F-2
Balance Sheets F-3
Statements of Operations F-5
Statements of Shareholders' Equity (Deficit) F-6
Statements of Cash Flows F-7
Notes to Financial Statements F-8
Supplementary Information (Unaudited)
as of December 31, 1995
Independent Auditor's Report on Supplementary Information F-16
Costs Incurred in Oil and Gas Producing Activities F-17
Estimates of Natural Gas and Oil Reserves F-17
FINANCIAL STATEMENTS (UNAUDITED)
as of and for the periods ended
September 30, 1996 and 1995
Balance Sheets (Unaudited) F-20
Statements of Operations (Unaudited) F-22
Statements of Cash Flows (Unaudited) F-24
Notes to Unaudited Financial Statements F-26
F-1
<PAGE>
INDEPENDENT AUDITOR'S REPORT
----------------------------
To the Shareholders of
Energy Search, Incorporated:
I have audited the accompanying balance sheets of Energy Search, Incorporated
(the Company) as of December 31, 1995 and 1994 and the related statements of
operations, shareholders' equity (deficit) and cash flows for the years then
ended. These financial statements are the responsibility of the Company's
management. My responsibility is to express an opinion on these financial
statements based on my audits.
I conducted my audits in accordance with generally accepted auditing standards.
Those standards require that I plan and perform the audits 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.
I believe that my audits provide a reasonable basis for my opinion.
In my opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Energy Search, Incorporated as of
December 31, 1995 and 1994 and the results of its operations and its cash flows
for the years then ended in conformity with generally accepted accounting
principles.
Ronald D. Cameron
Knoxville, Tennessee
January 30, 1996,
except Note J
which is dated November 4, 1996
F-2
<PAGE>
BALANCE SHEETS
ENERGY SEARCH, INCORPORATED
<TABLE>
<CAPTION>
December 31
1995 1994
---------------------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash $ 105,978 $ 136,939
Accounts receivable 78,439 63,989
Due from related partnerships, net of $102,468
allowance for uncollectible accounts in 1995
and $60,178 in 1994 1,114,828 863,930
Inventory 62,165 37,989
----------- -----------
TOTAL CURRENT ASSETS 1,361,410 1,102,847
OIL AND GAS PROPERTIES, USING SUCCESSFUL
EFFORTS ACCOUNTING
Proved properties 487,313 292,195
Wells and related equipment 4,920,839 4,383,546
Less accumulated depreciation, depletion and
amortization (2,447,439) (1,957,119)
----------- -----------
NET OIL AND GAS PROPERTIES 2,960,713 2,718,622
OTHER ASSETS
Other property and equipment less accumulated
depreciation of $337,333 in 1995 and $394,358 in
1994 76,267 212,592
Investments in related partnerships 1,223,928 993,758
Debenture issue costs, less accumulated
amortization of $15,078 in 1995 129,256 72,573
Other assets 60,232 81,645
----------- -----------
1,489,683 1,360,568
----------- -----------
$5,811,806 $ 5,182,037
=========== ===========
</TABLE>
F-3
<PAGE>
<TABLE>
<CAPTION>
December 31
1995 1994
----------- -----------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Current portion of long-term debt $ 783,254 $ 289,405
Accounts payable and accrued expenses 692,803 594,170
Drilling advances 2,415,120 3,265,996
---------- ----------
TOTAL CURRENT LIABILITIES 3,891,177 4,149,571
LONG-TERM DEBT, LESS CURRENT PORTION 2,285,592 1,665,771
COMMITMENTS AND CONTINGENCIES -- NOTE G
SHAREHOLDERS' EQUITY (DEFICIT)
Common stock, par value $1; 2,000 shares
authorized; 1,200 shares issued and outstanding 1,200 1,200
Retained earnings (deficit) (366,163) (634,505)
---------- ----------
(364,963) (633,305)
$5,811,806 $5,182,037
=========== ===========
</TABLE>
See notes to financial statements.
F-4
<PAGE>
STATEMENTS OF OPERATIONS
ENERGY SEARCH, INCORPORATED
<TABLE>
<CAPTION>
<S> <C> <C>
Year Ended December 31
1995 1994
------------------------
NET REVENUE
Turnkey revenue, net of drilling expenses $2,025,078 $ 807,405
Oil and gas sales 173,162 213,744
Management fees 175,350 203,290
Other revenue 118,473 233,725
---------- -----------
TOTAL NET REVENUE 2,492,063 1,458,164
OPERATING EXPENSES
Production costs 432,714 702,254
Exploration costs 31,721 145,785
Depreciation, depletion and amortization 574,239 706,346
Interest 234,820 88,373
General and administrative 934,988 975,040
---------- -----------
TOTAL OPERATING EXPENSES 2,208,482 2,617,798
---------- -----------
NET INCOME (LOSS) FROM OPERATIONS 283,581 (1,159,634)
OTHER INCOME (EXPENSES)
Gain (loss) on the sale of assets 73,540 (5,244)
Equity in losses of related partnerships (88,779) (37,692)
---------- -----------
(15,239) (42,936)
---------- -----------
NET INCOME (LOSS) $ 268,342 $(1,202,570)
========== ===========
PRO FORMA FINANCIAL INFORMATION
Pro forma information assuming change in tax status
since inception - Note J
Pro forma net income before pro forma income tax expense 268,342
Pro forma income tax expense -0-
----------
PRO FORMA NET INCOME $ 268,342
----------
PRO FORMA EARNINGS PER SHARE $ 224.00
----------
</TABLE>
See notes to financial statements.
F-5
<PAGE>
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
ENERGY SEARCH, INCORPORATED
Years Ended December 31, 1995 and 1994
<TABLE>
<CAPTION>
Retained
Common Earnings
Stock (Deficit) Total
------- ------------ ------------
<S> <C> <C> <C>
Balance at January 1, 1994 $1,200 $ 568,065 $ 569,265
Net loss for the year ended
December 31, 1994 -0- (1,202,570) (1,202,570)
------ ----------- -----------
BALANCE AT DECEMBER 31, 1994 1,200 (634,505) (633,305)
Net income for the year ended
December 31, 1995 -0- 268,342 268,342
------ ----------- -----------
BALANCE AT DECEMBER 31, 1995 $1,200 $ (366,163) $ (364,963)
====== =========== ===========
</TABLE>
See notes to financial statements.
F-6
<PAGE>
STATEMENTS OF CASH FLOWS
ENERGY SEARCH, INCORPORATED
<TABLE>
<CAPTION>
Year Ended December 31
1995 1994
--------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 268,342 $(1,202,570)
Adjustments to reconcile net income
(loss) to net cash used in operating
activities:
Depreciation, depletion and
amortization 574,239 706,346
(Gain) loss on sale of assets (73,540) 5,244
Equity in losses of related
partnerships 88,779 37,692
Increase in accounts receivable and
due from partnerships (265,348) (488,666)
(Increase) decrease in inventory (24,176) 7,650
Decrease in other assets 21,413 27,712
Increase in accounts payable and
accrued expenses 98,633 71,779
Increase (decrease) in drilling
advances (850,876) 24,499
---------- -----------
(430,876) 392,256
---------- -----------
NET CASH USED IN OPERATING
ACTIVITIES (162,534) (810,314)
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in proved properties (195,118) (124,768)
Proceeds from sale of other property
and equipment 152,000 -0-
Capital expenditures, net (548,269) (656,549)
Distributions from related
partnerships 71,077 137,132
Contributions to related partnerships (390,026) (358,908)
Payments received on notes receivable -0- 17,500
---------- -----------
NET CASH USED IN INVESTING
ACTIVITIES (910,336) (985,593)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt 1,427,000 1,587,282
Payments on long-term debt (313,330) (405,842)
Payments of debenture issue costs (71,761) (72,573)
---------- -----------
NET CASH PROVIDED BY FINANCING
ACTIVITIES 1,041,909 1,108,867
---------- -----------
NET DECREASE IN CASH (30,961) (687,040)
CASH AT BEGINNING OF YEAR 136,939 823,979
---------- -----------
CASH AT END OF YEAR $ 105,978 $ 136,939
========== ===========
SUPPLEMENTAL DISCLOSURE:
Cash paid for interest during the year $ 229,264 $ 76,454
========== ===========
</TABLE>
See notes to financial statements.
F-7
<PAGE>
NOTES TO FINANCIAL STATEMENTS
ENERGY SEARCH, INCORPORATED
December 31, 1995 and 1994
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations: Energy Search, Inc. (ESI) is engaged in the exploration,
development, production and marketing of oil and natural gas in the Appalachian
Basin area. ESI's revenue is primarily derived from the drilling of oil and gas
wells on a contract basis, the sale of natural gas and crude oil from wells in
which it has working interests, the transmission of natural gas through a
pipeline and gathering system owned by an affiliated partnership in which ESI
has an ownership interest, the management and operation of oil and gas wells,
and the formation and management of oil and gas partnerships. All ESI oil and
gas wells and the majority of its market for oil and gas produced are located
primarily in Washington County, Ohio, and the counties contiguous thereto.
Because of the nature of ESI's business, a significant number of transactions
are with related parties. For affiliated oil and gas partnerships in which ESI
has an interest, its proportionate share of revenue and expenses is recorded in
the income statement as oil and gas sales and lease operating expenses,
respectively.
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 reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Inventory: Materials and supplies inventory, consisting primarily of tubular
goods and field materials, is stated at the lower of average cost or market.
Oil and Gas Properties: ESI uses the successful efforts method of accounting
for oil and gas producing activities, as set forth in the Statement of Financial
Accounting Standards No. 19, as amended. ESI does not capitalize intangible
drilling costs since under the terms of the drilling contracts, these costs are
the responsibility of the contracting parties. ESI does capitalize all tangible
drilling costs when incurred, as they retain ownership of the well equipment
under the drilling contracts. ESI's policy is to expense the cost of any non-
salvageable tangible equipment on exploratory wells that do not result in proven
reserves. Oil and gas properties are periodically assessed for impairment of
value, and a loss is recognized at time of impairment.
Proved properties represent purchased working interests in producing oil and gas
wells, as well as oil and gas leases. Proved properties and wells and related
equipment are depreciated and depleted by the units-of-production method using
estimates of proven reserves. Because of inherent uncertainties in estimating
proven reserves, estimates of depletion and depreciation could change
significantly.
F-8
<PAGE>
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
ESI has acquired certain oil and gas leases providing rights for exploration,
development, extraction and sale of oil and gas from the land covered by such
leases. Upon contribution of the oil and gas lease to the partnership or upon
abandonment of lease, the cost of the lease is charged to expense.
Other Property and Equipment: Other property and equipment is recorded at
cost. Major additions and improvements are capitalized while repairs,
replacements and maintenance which do not improve or extend the life of the
respective assets are expensed. Depreciation is computed under the double-
declining balance method over the estimated useful lives.
Investments in Related Partnerships: Investments in related partnerships are
accounted for by the equity method. ESI, as the managing general partner of the
oil and gas partnerships, makes initial capital contributions to the
partnerships in accordance with provisions in the respective placement
memorandum governing the activities of the particular partnership. Income or
losses are allocated to the investments according to ESI's ownership interest in
the partnerships and distributions or withdrawals are deducted from the
investments.
Drilling Revenue: ESI enters into contracts with the affiliated oil and gas
partnerships to drill oil and gas wells under turnkey agreements. Under the
terms of the contracts, ESI provides all tangible well equipment and receives
working interests in the completed wells. The partnerships pay all intangible
drilling costs and receive working interests in the wells. The partnerships
advance funds to ESI in order to finance the drilling activity. ESI initially
defers the full amount of the drilling advances and recognizes drilling revenue
as the wells are completed. Drilling expenses are netted against turnkey
drilling revenue and include $1,675,499 and $1,950,446 in 1995 and 1994,
respectively.
Management Fees and Other Revenue: In connection with the sponsorship of
natural gas partnerships in 1995 and 1994, ESI received reimbursement for the
organization and offering expenses in an amount equal to 1% of the investors'
subscriptions. In its role as operator of the oil and gas wells owned by
various related partnerships, ESI charges a wellhead fee of between $100 and
$200 per month for each producing well. In its role as general partner of the
partnership which owns the gas pipeline and gathering system, ESI charges the
partnership a management fee of $5,000 per month.
Income Taxes: ESI is a subchapter S corporation by election under the
provisions of the Internal Revenue Code. As such, all income, losses and
credits of ESI are reported for inclusion in the individual Federal income tax
returns of the shareholders. As a result, there is no provision for federal
income taxes in the accompanying financial statements. ESI is subject to state
franchise and excise taxes.
Reclassifications: Certain reclassifications have been made to 1994 amounts to
conform to 1995 presentation.
F-9
<PAGE>
NOTE B--AFFILIATED OIL AND GAS PARTNERSHIPS
Since 1989, ESI has sponsored the formation of partnerships for the purpose of
conducting oil and gas exploration, development, and production activities on
certain oil and gas properties. Such partnerships include the Natural Gas/Tax
Credit 1989 L.P., the Natural Gas/Tax Credit 1990 L.P., the Natural Gas/Tax
Credit 1991 L.P., the Natural Gas/Tax Credit 1992 L.P., the Natural Gas/Tax
Credit 1992A L.P., the Natural Gas 1993 L.P. and the Energy Search Natural Gas
1993-A L.P., the Energy Search Natural Gas 1994 L.P. and Energy Search Natural
Gas 1994-A L.P., and the Energy Search Natural Gas 1995 L.P. and Energy Search
Natural Gas 1995-A L.P. ESI serves as managing general partner of these
partnerships and, as such, has full and exclusive discretion in the management
and control of the partnerships. The turnkey drilling and operating agreements
that ESI enters into with the partnerships provide that the partnerships pay for
the intangible drilling costs of the wells at an agreed-upon price per well.
ESI provides all tangible equipment required in the drilling, equipping,
completing and operation of the properties. Revenues from the partnership oil
and gas properties are allocated based upon the working interest ownership
percentage of the properties. The partnerships' working interests in the
properties range from 63% to 70% at both December 31, 1995 and 1994. ESI's
working interests in the properties range from 8% to 16% and 8% to 13% at
December 31, 1995 and 1994, respectively.
In 1993, ESI sponsored the formation of the ESI Pipeline Operating L.P. (the
Operating Partnership), which purchased a portion of ESI's gas pipeline and
gathering system. ESI contributed its remaining interest in the pipeline system
to the new partnership in exchange for an ownership interest in the Operating
Partnership.
Also, in 1993, ESI sponsored the formation of the ESI Natural Gas Pipeline
Income L.P. (the Pipeline Partnership). The Pipeline Partnership made a capital
contribution to the Operating Partnership to finance the initial purchase of
ESI's pipeline system. In turn, the Pipeline Partnership received an ownership
interest in the Operating Partnership. ESI serves as managing general partner
for both of these partnerships and, as such, has full and exclusive discretion
in the management of and control of the partnerships. The Operating Partnership
earns revenues by charging gas wells a transportation fee based upon the volume
of gas moved through the pipeline system. Substantially all these gas wells are
operated by ESI. The Operating Partnership nets these transportation revenues
against the pipeline system operating expenses and remits net transportation
revenues to the partners based upon their respective ownership percentage. As
of December 31, 1995 and 1994, the Pipeline Partnership owned approximately 62%
and 64% of the Operating Partnership with ESI owning the remaining 38% and 36%
respectively.
F-10
<PAGE>
NOTE B--AFFILIATED OIL AND GAS PARTNERSHIPS - Continued
In 1993, a partnership comprised of the shareholders of ESI entered into a
turnkey drilling agreement with ESI that called for ESI to drill wells at a
contract price of ESI's cost plus ten percent. ESI received drilling advances
of $180,000 from the partnership. In 1995 and 1994, ESI recognized drilling
revenues of $11,505 and $79,323, respectively, under this contract. Unearned
drilling revenue at December 31, 1995 and 1994 includes $27,145 and $38,650
which will be recognized as revenue as drilling costs are incurred and the wells
are completed in subsequent years.
Total assets and equity of the related partnerships in the aggregate were
approximately $4,430,000 and $4,412,000, respectively, at December 31, 1995 and
$4,689,000 and $4,675,000, respectively, at December 31, 1994.
NOTE C--REIMBURSEMENT OF PARTNERSHIP EXPENSES
During 1995 and 1994, ESI reimbursed the various partnerships or paid on their
behalf $188,072 and $418,671, respectively, which represents a portion of the
lease operating expenses allocated to the partnerships and is included in
production costs in the accompanying statements of operations. ESI is under no
legal or contractual obligation to reimburse partnership lease operating
expenses, and there is no expectation that this reimbursement will continue in
future years.
NOTE D--LONG-TERM DEBT
Long-term debt consisted of the following at December 31:
<TABLE>
<CAPTION>
1995 1994
---------- -----------
<S> <C> <C>
Variable Rate Subordinated Debentures; unsecured $2,169,500 $1,282,500
Note payable to bank, secured by equipment and
guaranties of shareholders, payable in monthly
installments of $842 plus interest at prime plus
1.22% which was 9.72% at December 31, 1994 -0- 131,159
Note payable to bank, secured by vehicles and
guaranties of shareholders, payable in monthly
installments of $5,250, including interest at
prime plus 0.50% which was 9% at December
31, 1995 and 1994 through May 10, 1998 137,296 184,847
</TABLE>
F-11
<PAGE>
NOTE D--LONG-TERM DEBT - Continued
<TABLE>
<CAPTION>
1995 1994
---------- -----------
<S> <C> <C>
Line of credit at bank, secured by lien on oil and
gas property, with interest at prime plus 2.0%,
which was 10.5% at December 31, 1995 400,000 -0-
Note payable to related entity, unsecured, payable
in monthly installments of $5,005, including
interest at 12%, through October 1, 1996 42,873 94,379
Note payable to related entity, unsecured, payable
in monthly installments of $3,612, including
interest at 10%, through October 1, 1997 69,321 103,835
Note payable to related entity, unsecured, payable
in monthly installments of $4,449, including
interest at 12%, through April 1, 1996 13,083 61,683
Notes payable to shareholders, due on demand 236,773 96,773
---------- ----------
3,068,846 1,955,176
Less current portion 783,254 289,405
---------- ----------
$2,285,592 $1,665,771
========== ==========
</TABLE>
During 1994, ESI issued $1,282,500 in variable rate subordinated debentures
under terms of a $2,000,000 private placement memorandum. In 1995, a supplement
was made to the private placement memorandum to increase the maximum amount of
debentures to $2,500,000 and an additional $887,000 in debentures were issued.
All the debentures bear interest at a stated interest rate of 9% per annum
through December 31, 1997 and 10% per annum from January 1, 1998 through
maturity. The debentures also provide for the payment of additional interest at
maturity as described in the private placement memorandum. The debentures shall
mature at the earlier of December 31, 2001, upon sale or disposition of all or
substantially all qualifying oil and gas assets, or upon merger or combination
of ESI with another entity such that ESI is not the surviving entity.
F-12
<PAGE>
NOTE D--LONG-TERM DEBT - Continued
The three notes payable to related entities represent promissory notes payable
to affiliated partnerships. The shareholders of ESI serve as the general
partners of these partnerships and have full and exclusive discretion in the
management and control of the partnerships. The sole and limited purpose of the
affiliated partnerships is the provision of loans to ESI.
Principal maturities of long-term debt at December 31, 1995 are as follows:
<TABLE>
<CAPTION>
<S> <C>
Year Ending December 31, 1996 $ 783,254
1997 88,505
1998 27,587
1999 -0-
2000 -0-
Thereafter 2,169,500
----------
$3,068,846
==========
</TABLE>
The estimate of the fair value of the long-term debt at December 31, 1995 is
$3,267,125 based on the current rates available to ESI for debt of the same
remaining maturities and risk. This estimate does not give effect to any
additional interest related to the variable rate subordinated debentures.
NOTE E--DRILLING ADVANCES
During 1995 and 1994, ESI received drilling advances from two affiliated oil and
gas partnerships in the amount of $2,935,000 and $2,915,400, respectively.
Drilling advances from affiliated oil and gas partnerships of $2,387,975 and
$3,227,346 as of December 31, 1995 and 1994, respectively, relate to advances in
1995 and 1994 and preceding years and will be earned as drilling costs are
incurred and the wells are completed in subsequent years.
NOTE F--PENSION PLAN
ESI sponsors a Simplified Employee Pension Plan (SEP) for qualifying employees.
Employee contributions to individual retirement plans may not exceed the greater
of 15% of employee earnings or $22,500 per year per employee. ESI contributed
$12,235 and $10,195 to the SEP during 1995 and 1994, respectively.
F-13
<PAGE>
NOTE G--COMMITMENTS AND CONTINGENCIES
The nature of the independent oil and gas industry involves a dependence on
drilling capital from outside investors and involves a concentration of oil and
gas sales to a few customers.
As general partner in various affiliated oil and gas partnerships, ESI is
subject to contingencies that may arise in the normal course of business of
these partnerships. Management is of the opinion that liabilities, if any,
related to such contingencies that may arise would not be material to the
financial statements.
ESI entered into exploration, drilling and development agreements with an oil
and gas company in Ohio. Under the agreement, ESI is obligated to pay its
proportionate shares of any charges for seismic lines run on the lease acreage.
If ESI elects to participate in the drilling of wells, ESI is obligated to pay a
percentage of total costs to the casing point and a percentage of all costs
relative to the completion of the wells, if so elected, in accordance with ESI's
working interest. As of December 31, 1995, ESI's share of the estimated costs
to the casing point for the exploratory well is approximately $24,000.
ESI is contingently liable with respect to a $50,000 letter of credit issued as
a performance bonding commitment related to well activities and operations.
Subsequent to yearend, ESI began the process of issuing preferred stock to
selected investors through private placement. Proceeds of the sale of the
preferred stock is to be used for retirement of the variable rate subordinated
debentures and any remaining proceeds will be used for operational and
administrative working capital needs of the Company. The terms of the offering
have not been finalized.
NOTE H--OTHER RELATED PARTY TRANSACTIONS
As the managing general partner of the Energy Search Natural Gas 1995 and 1995-A
L.P.'s, ESI paid $250,800 in 1995 to the placement agent, Equity Financial
Corporation (EFC), a related party owned by two shareholders, as management fees
and sales commission for managing the offering of the programs to investors.
Similarly, ESI paid $229,500 in 1994 to EFC related to the Energy Search Natural
Gas 1994 and 1994-A L.P.'s. In addition, four percent of the proceeds from
issuance of the variable rate subordinated debentures were paid to EFC as sales
commissions which totaled approximately $41,000 and $57,000 in 1995 and 1994,
respectively.
ESI also paid $36,000 and $57,000 in rent and management fees during 1995 and
1994, respectively, to EFC under a monthly shared service arrangement.
As of December 31, 1995, amounts due from EFC for prepaid commissions related to
sales of the Energy Search Natural Gas 1995 L.P. and 1995-A L.P. totaled
$27,200.
F-14
<PAGE>
<PAGE>
NOTE I--CASH CONCENTRATIONS
Financial instruments that potentially subject ESI to concentrations of credit
risk consist principally of cash. ESI has cash deposits with a financial
institution. The balances are insured by the Federal Deposit Insurance
Corporation up to $100,000. At December 31, 1995, ESI's uninsured cash balances
as reflected by the financial institution were $144,444.
NOTE J--CHANGE IN TAX STATUS
Effective January 1, 1996, ESI was granted by the Internal Revenue Service
approval to change its tax status from an S corporation to a C corporation under
provisions of the Internal Revenue Code. Pro forma income tax and earnings per
share information has been presented in the statement of operations for the year
ended December 31, 1995 as if ESI had been a C corporation since inception.
Current pro forma income tax expense of $100,400 was offset by a pro forma tax
benefit recognized from a net pro forma operating loss carryforward.
F-15
<PAGE>
INDEPENDENT AUDITOR'S REPORT
ON SUPPLEMENTARY INFORMATION
To the Shareholders of
Energy Search, Incorporated:
The Costs incurred in Oil and Gas Producing Activities and Estimates of Natural
Gas and Oil Reserves on pages F-17 through F-19 is not a required part of the
basic financial statements of Energy Search, Incorporated, but is supplementary
information required by the Financial Accounting Standards Board. I have
applied certain limited procedures, which consisted principally of inquiries of
management regarding the methods of measurement and presentation of the
supplementary information. However, I did not audit the information and express
no opinion on it.
Ronald D. Cameron
Knoxville, Tennessee
January 30, 1996
F-16
<PAGE>
SUPPLEMENTARY INFORMATION (UNAUDITED)
ENERGY SEARCH, INCORPORATED
December 31, 1995
COSTS INCURRED IN OIL AND GAS PRODUCING ACTIVITIES
<TABLE>
<CAPTION>
Year Ended December 31
1995 1994
---------- ----------
<S> <C> <C>
Property acquisition costs - proved $195,118 $124,768
Exploration costs 31,721 145,785
Development costs 695,758 885,711
</TABLE>
ESTIMATES OF NATURAL GAS AND OIL RESERVES
The following estimates of proved developed natural gas and oil reserve
quantities and related standardized measure of discounted net cash flow are
estimates prepared by ESI's engineer as of December 31, 1995 and 1994. They do
not purport to reflect realizable values or fair market values of ESI's
reserves. ESI emphasizes that reserve estimates are inherently imprecise and
that estimates of new discoveries are more imprecise than those of producing oil
and gas properties. Accordingly, these estimates are expected to change as
future information becomes available. All of ESI's reserves are located in
southeastern Ohio.
Proved reserves are estimated reserves of crude oil (including condensate and
natural gas liquids) and natural gas that geological and engineering data
demonstrate with reasonable certainty to be recoverable in future years from
known reservoirs under existing economic and operating conditions. Proved
developed reserves are those expected to be recovered through existing wells,
equipment and operating methods.
The standardized measure of discounted future net cash flows is computed by
applying year-end prices of oil and gas to the estimated future production of
proved oil and gas reserves, less estimated future expenditures (based on year-
end costs) to be incurred in developing and producing the proved reserves, less
estimated future severance tax expenses and assuming continuation of existing
economic conditions. The estimated future net cash flows are then discounted
using a rate of ten percent a year to reflect the estimated timing of the future
cash flows.
F-17
<PAGE>
SUPPLEMENTARY INFORMATION (UNAUDITED)
ENERGY SEARCH, INCORPORATED
December 31, 1995
ESTIMATES OF NATURAL GAS AND OIL RESERVES - Continued
<TABLE>
<CAPTION>
Oil Gas
(Bbl) (Mcf)
-------- ----------
<S> <C> <C>
Proved developed and undeveloped reserves
January 1, 1994 4,678 786,227
Revisions and other changes 542 (236,867)
Extensions and discoveries 17,994 298,220
Purchases of reserves -0- -0-
Production (1,292) (99,587)
------- ---------
December 31, 1994 21,922 747,993
Revisions and other changes (15,302) (153,948)
Extensions and discoveries 16,886 2,594,786
Purchases of reserves -0- 466,815
Production (1,166) (91,119)
------- ---------
December 31, 1995 22,340 3,564,527
======= =========
Proved developed reserves
December 31, 1994 21,922 747,993
December 31, 1995 11,723 1,259,454
Equity interest in proved reserves
December 31, 1994 162 84,559
December 31, 1995 2,392 169,023
</TABLE>
F-18
<PAGE>
SUPPLEMENTARY INFORMATION (UNAUDITED)
ENERGY SEARCH, INCORPORATED
December 31, 1995
ESTIMATES OF NATURAL GAS AND OIL RESERVES - Continued
<TABLE>
<CAPTION>
December 31
1995 1994
------------ -----------
<S> <C> <C>
Standardized measure of discounted
future net cash flows
Future cash inflows $10,097,118 $1,884,133
Future production costs (2,385,183) (538,048)
Future development costs (2,454,290) -0-
----------- ----------
Future net cash flows 5,257,645 1,346,085
10% annual discount for estimated
timing of cash flows (2,536,994) (513,161)
----------- ----------
Standardized measure of discounted
future net cash flows relating to
proved oil and gas reserves $ 2,720,651 $ 832,924
=========== ==========
ESI's share of equity method investors'
standardized measure of discounted
future cash flows $ 26,387 $ 9,841
=========== ==========
<CAPTION>
The following reconciles the change in the standardized measure of discounted
future net cash flow for the year ended December 31,
1995 1994
----------- ----------
<S> <C> <C>
Beginning of year $ 832,924 $1,115,912
Sales of oil and gas produced, net of production costs (219,464) (281,518)
Extensions, discoveries, and improved recovery,
less related costs 1,603,198 635,486
Revisions of previous quantity estimates (253,575) (476,905)
Net change from purchases and sales of minerals in place 535,514 -0-
Other 222,054 (160,051)
---------- ----------
End of year $2,720,651 $ 832,924
========== ==========
</TABLE>
F-19
<PAGE>
BALANCE SHEETS (UNAUDITED)
ENERGY SEARCH, INCORPORATED
<TABLE>
<CAPTION>
September 30
1996 1995
------------ -------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash $ 107,666 $ 60,934
Accounts receivable 59,806 33,239
Due from related partnerships, net 166,475 178,628
Inventory 89,984 57,344
----------- -----------
TOTAL CURRENT ASSETS 423,931 330,145
OIL AND GAS PROPERTIES, USING SUCCESSFUL
EFFORTS ACCOUNTING
Proved properties 702,098 363,595
Wells and related equipment 5,363,243 4,784,595
Less accumulated depreciation, depletion and
amortization (2,868,405) (2,378,085)
----------- -----------
NET OIL AND GAS PROPERTIES 3,196,936 2,770,105
OTHER ASSETS
Other property and equipment less accumulated
depreciation of $222,155 and $329,949,
respectively 74,356 82,170
Investments in affiliated partnerships 1,564,127 1,254,185
Deferred state income taxes 90,412 -0-
Deferred federal income taxes 407,607 -0-
Loan issue costs, net 23,500 229,067
Other assets 140,331 65,499
----------- -----------
2,300,333 1,630,921
----------- -----------
$ 5,921,200 $ 4,731,171
=========== ===========
</TABLE>
F-20
<PAGE>
<TABLE>
<CAPTION>
September 30
1996 1995
---------- ----------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Line of credit $ 400,000 $ 400,000
Current portion of long-term debt 307,606 258,792
Accounts payable and accrued expenses 622,171 379,263
Drilling advances 1,375,995 1,807,336
---------- ----------
TOTAL CURRENT LIABILITIES 2,705,772 2,845,391
LONG-TERM DEBT, less current portion 46,716 2,056,422
SHAREHOLDERS' EQUITY (DEFICIT)
Class A Convertible Preferred Stock (no par value;
5% cumulative; 216,945 shares authorized,
shares issued and outstanding at $10 per share) 2,077,000 -0-
Class B Convertible Preferred Stock (no par value;
no dividend preference, 450,000 shares authorized
242,300 shares issued and outstanding at $10
per share) 2,423,000 -0-
Common stock (no stated value, 10,000,000 shares
authorized, 550,000 shares issued and outstanding as
of September 30, 1996 and $1 par value, 2,000
shares authorized, 1,200 shares issued and outstanding 1,200 1,200
as of September 30, 1995) (1,308,488) (171,842)
Retained earnings (deficit) (24,000) -0-
---------- ---------
Distribution to shareholders 3,168,712 (170,642)
---------- ---------
$5,921,200 $4,731,171
</TABLE>
F-21
<PAGE>
STATEMENTS OF OPERATIONS (UNAUDITED)
ENERGY SEARCH, INCORPORATED
<TABLE>
<CAPTION>
Nine Months Ended September 30
1996 1995
--------------- --------------
<S> <C> <C>
NET REVENUE
Turnkey revenue $ 582,879 $1,533,278
Oil & gas sales 159,730 149,127
Management fees 152,890 120,800
Other revenue 42,399 98,483
----------- ----------
TOTAL NET REVENUE 937,898 1,901,688
OPERATING EXPENSES
Lease operating 198,662 159,288
Field management 240,239 197,483
Depreciation, depletion & amortization 460,791 462,807
Interest 196,037 57,240
General and administrative 922,053 652,335
----------- ----------
TOTAL OPERATING EXPENSES 2,017,782 1,529,153
TOTAL INCOME (LOSS) FROM OPERATIONS (1,079,884) 372,535
OTHER INCOME (EXPENSE)
Stock issuance expense (83,080) -0-
Gain on sale of assets 53,096 53,924
Equity in income of related partnerships 2,269 36,204
----------- ----------
(27,715) 90,128
NET INCOME (LOSS) BEFORE INCOME TAXES
AND EXTRAORDINARY ITEM (1,107,599) 462,663
Income tax benefit 438,366 -0-
----------- ----------
NET INCOME (LOSS) BEFORE
EXTRAORDINARY ITEM (669,233) 462,663
Extraordinary item - loss on early
extinguishment of debt
(net of income tax benefit of $50,669) ( 79,251) -0-
----------- ----------
NET INCOME (LOSS) $ ( 748,484) $ 462,663
=========== ==========
</TABLE>
F-22
<PAGE>
STATEMENTS OF OPERATIONS (UNAUDITED) - Continued
ENERGY SEARCH, INCORPORATED
PRO FORMA INFORMATION
Pro forma information presents results of operations and earnings per share as
if the Company had been a C corporation since inception ( Note E ).
<TABLE>
<CAPTION>
Nine Months Ended September 30
1996 1995
----------------------------
<S> <C> <C>
Net income (loss) before pro forma income taxes and $(1,107,599) $462,663
extraordinary item
Pro forma income tax benefit (expense) 438,366 (45,800)
----------- --------
Pro forma net income (loss) before extraordinary
item (669,233) 416,863
Extraordinary item (79,251) -0-
----------- --------
PRO FORMA NET INCOME (LOSS) $ (748,484) $416,863
=========== ========
Pro forma earnings (loss) per common share:
Pro forma net income (loss) before extraordinary item $ (1.22) $ 347.39
Extraordinary item ( .14) -0-
----------- --------
PRO FORMA NET INCOME (LOSS) PER COMMON SHARE $ ( 1.36) $ 347.39
=========== ========
</TABLE>
F-23
<PAGE>
STATEMENTS OF CASH FLOWS (UNAUDITED)
ENERGY SEARCH, INCORPORATED
<TABLE>
<CAPTION>
Nine Months Ended September 30
1996 1995
---------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ ( 748,484) $ 462,663
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation, depletion and amortization 460,791 462,807
Loss on early extinguishment of debt 129,920 -0-
Gain on sale of assets (53,096) (53,924)
Equity in income of related partnerships (2,269) (36,204)
Decrease in accounts receivable and due from partnerships 966,986 716,052
Increase in inventory (27,819) (19,355)
Increase (decrease) in other assets (80,099) 16,146
Increase in deferred income taxes (498,019) -0-
Increase (decrease) in accounts payable and
accrued expenses (70,632) (214,907)
Decrease in drilling advances (1,039,125) (1,458,660)
----------- -----------
Total adjustments (213,362) (588,045)
----------- -----------
NET CASH USED IN OPERATING ACTIVITIES (961,846) (125,382)
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in proved properties (214,785) (71,400)
Proceeds from sale of other property and equipment 48,379 152,000
Capital expenditures (499,602) (410,544)
Contributions to related partnerships, net (337,930) (224,223)
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES (1,003,938) (554,167)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of Class B preferred stock 2,229,160 -0-
Proceeds from issuance of debt 15,000 1,021,850
Payments on long-term debt (252,524) (261,812)
Payments of loan issue costs (24,164) (156,494)
----------- -----------
NET CASH PROVIDED
BY FINANCING ACTIVITIES 1,967,472 603,544
----------- -----------
</TABLE>
F-24
<PAGE>
STATEMENTS OF CASH FLOWS (UNAUDITED) - Continued
ENERGY SEARCH, INCORPORATED
<TABLE>
<CAPTION>
Nine Months Ended September 30
1996 1995
-------------- ---------------
<S> <C> <C>
NET INCREASE (DECREASE) IN CASH $ 1,688 $(76,005)
CASH AT BEGINNING OF PERIOD 105,978 136,939
---------- --------
CASH AT END OF PERIOD $ 107,666 $ 60,934
========== ========
<CAPTION>
SUPPLEMENTAL DISCLOSURES:
Cash paid for interest during the period $ 207,956 $ 69,159
---------- --------
Redemption of variable rate subordinated debentures
through issuance of class A convertible preferred stock $2,077,000 -0-
---------- ---
</TABLE>
F-25
<PAGE>
SELECTED INFORMATION (UNAUDITED) -- Substantially All Disclosures Required By
Generally Accepted Accounting Principles Are Not Included
ENERGY SEARCH, INCORPORATED
September 30, 1996 and 1995
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations: Energy Search, Inc. (ESI) is engaged in the exploration,
development, production and marketing of oil and natural gas in the Appalachian
Basin area. ESI's revenue is primarily derived from the drilling of oil and gas
wells on a contract basis, the sale of natural gas and crude oil from wells in
which it has working interests, the transmission of natural gas through a
pipeline and gathering system owned by an affiliated partnership in which ESI
has an ownership interest, the management and operation of oil and gas wells,
and the formation and management of oil and gas partnerships. All ESI oil and
gas wells and the majority of its market for oil and gas produced are located
primarily in Washington County, Ohio, and southern West Virginia and the
counties contiguous thereto. Because of the nature of ESI's business, a
significant number of transactions are with related parties. For affiliated oil
and gas partnerships in which ESI has an interest, its proportionate share of
revenue and expenses is recorded in the income statement as oil and gas sales
and lease operating expenses, respectively.
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 reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Inventory: Materials and supplies inventory, consisting primarily of tubular
goods and field materials, is stated at the lower of average cost or market.
Oil and Gas Properties: ESI uses the successful efforts method of accounting
for oil and gas producing activities, as set forth in the Statement of Financial
Accounting Standards No. 19, as amended. ESI does not capitalize intangible
drilling costs since under the terms of the drilling contracts, these costs are
the responsibility of the contracting parties. ESI does capitalize all tangible
drilling costs when incurred, as they retain ownership of the well equipment
under the drilling contracts. ESI's policy is to expense the cost of any non-
salvageable tangible equipment on exploratory wells that do not result in proven
reserves. Oil and gas properties are periodically assessed for impairment of
value, and a loss is recognized at time of impairment.
Proved properties represent purchased working interests in producing oil and gas
wells, as well as oil and gas leases. Proved properties and wells and related
equipment are depreciated and depleted by the units-of-production method using
estimates of proven reserves. Because of inherent uncertainties in estimating
proven reserves, estimates of depletion and depreciation could change
significantly.
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
F-26
<PAGE>
ESI has acquired certain oil and gas leases providing rights for exploration,
development, extraction and sale of oil and gas from the land covered by such
leases. Upon contribution of the oil and gas lease to a partnership or upon
abandonment of lease, the cost of the lease is charged to expense. Included in
the Company's oil and gas leases, is the largest acquisition to date for
property in southern West Virginia (the "Beaver Coal Company Lease"). The cost
of acquisition of the Beaver Coal lease was $170,000 and was paid in cash during
the third quarter of 1996.
Other Property and Equipment: Other property and equipment is recorded at
cost. Major additions and improvements are capitalized while repairs,
replacements and maintenance which do not improve or extend the life of the
respective assets are expensed. Depreciation is computed under the double-
declining balance method over the estimated useful lives.
Investments in Related Partnerships: Investments in related partnerships are
accounted for by the equity method. ESI is the managing general partner or
manager of each related partnership and thereby has the ability to exercise
significant influence over each of the related partnerships. ESI, as the
managing general partner of the oil and gas partnerships, makes initial capital
contributions to the partnerships in accordance with provisions in the
respective placement memorandum governing the activities of the particular
partnership. Income or losses are allocated to the investments according to
ESI's ownership interest in the partnerships and distributions or withdrawals
are deducted from the investments.
Due to the loss from continuing operations for the nine months ended September
30, 1996, certain equity investees represent twenty percent or more of ESI's
income from continuing operations. See Note H for related disclosure.
Turnkey Drilling Revenue: ESI enters into contracts with the affiliated oil and
gas partnerships to drill oil and gas wells under turnkey agreements. Under
the terms of the contracts, ESI provides all tangible well equipment and
receives working interests in the completed wells. The partnerships pay all
intangible drilling costs and receive working interests in the wells. The
partnerships advance funds to ESI in order to finance the drilling activity.
ESI initially defers the full amount of the drilling advances and recognizes
drilling revenue as the wells are completed. Drilling expenses of $1,197,246
and $1,279,132 are netted against turnkey drilling revenue in a nine month
period ended September 30, 1996 and 1995, respectively.
Management Fees and Other Revenue: In connection with the sponsorship of
natural gas partnerships in a nine month period ended September 30, 1996 and
1995, ESI received reimbursement for the organization and offering expenses in
an amount equal to 1% of the investors' subscriptions. In its role as operator
of the oil and gas wells owned by various related partnerships, ESI charges a
wellhead fee of between $100 and $200 per month for each producing well. In its
role as general partner of
F-27
<PAGE>
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
the partnership which owns the gas pipeline and gathering system, ESI charges
the partnership a management fee of $5,000 per month.
Income Taxes: ESI accounts for income taxes under the provisions of Statement
of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income
Taxes". These provisions were not applicable to the financial statements at
September 30, 1995 due to ESI's tax status as a Subchapter "S" corporation
under provisions of the Internal Revenue Code. See Note E for further
discussion.
Earnings Per Share: Earnings (loss) per share of common and common equivalent
stock is based on the weighted average common shares outstanding. The
convertible preferred stock is considered to be the equivalent of common stock
from the time of its issuance in 1996; however, conversion has not been assumed
due to the net loss for 1996.
NOTE B--UNAUDITED FINANCIAL STATEMENTS
These interim financial statements are prepared without audit and reflect all
adjustments which, in the opinion of management, are necessary to present fairly
the financial position of ESI at September 30, 1996 and 1995 and its results of
operations and its cash flows for the periods presented. All such adjustments
are of a normal recurring nature.
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and Item 310 of Regulation S-B. Accordingly, footnote disclosure,
which would substantially duplicate the disclosure contained in the most
recent audited financial statements, has been substantially omitted. The
accompanying unaudited financial statements should be read in conjunction with
the notes to financial statements contained in the December 31, 1995
financial statements.
NOTE C--PREFERRED STOCK ISSUANCE
During the nine months ended September 30, 1996, ESI issued 207,700 shares of
Class A convertible preferred stock with a $10 stated value in exchange for and
to retire the outstanding principle on its variable rate subordinated
debentures. Of the $2,169,500 debentures payable outstanding at December 31,
1995, a total of $2,077,000 was converted to Class A convertible preferred stock
with the remaining $92,500 in debentures being paid from cash. The write-off of
the deferred loan costs related to the debentures has been reflected as a loss
on early extinguishment of the debt. In addition, ESI issued 242,300 shares of
Class B convertible preferred stock with a $10 stated value during this period.
Issue costs of $193,840 related to the Class B preferred stock were charged
directly to retained earnings (deficit).
Both the Class A and the Class B preferred stock is redeemable by the Company,
at the option of the holder, at $10 per share or, if not redeemed, is
automatically convertible on a share-by-share basis into common stock upon the
occurrence of a certain event. Such event includes merger or consolidation with
another company in which ESI is not the survivor; sale or disposition of all, or
substantially all, assets; or the undertaking of a registration and initial
F-28
<PAGE>
NOTE C--PREFERRED STOCK ISSUANCE - Continued
public offering of any of ESI's common stock. As the Company is in the process
of a registration and initial public offering, the preferred stock has been
reflected in shareholders' equity at September 30, 1996 in the accompanying
financial statements.
NOTE D--RECAPITALIZATION OF COMMON STOCK
On July 1, 1996, all of the existing Shareholders surrendered 1,200 shares of
common stock outstanding as of June 30, 1996 in exchange for 550,000 shares of
common stock from the Company for no additional consideration.
NOTE E--CHANGE IN TAX STATUS
Effective January 1, 1996, ESI obtained permission from the Internal Revenue
Service to change its tax status from a Subchapter S corporation to a C
corporation under the provisions of the Internal Revenue Code. As a Subchapter S
corporation, earnings and losses are allocated to shareholders and, accordingly,
the financial statements for 1995 do not reflect a provision for federal income
taxes. Under the provisions of SFAS No. 109, "Accounting for Income Taxes",
deferred income taxes are recognized for the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. The effect of
the election for the change in tax status and the resulting recognition of the
deferred tax assets and tax benefits is included in the accompanying statement
of operations for the nine months ended September 30, 1996.
Net income or loss for the nine months ended September 30, 1996 and 1995 has
also been presented on a pro forma basis as if the Company had been a C
corporation since inception. The pro forma income tax benefit (expense) is
calculated using an effective tax rate of 35% for federal tax purposes and 6%
for state tax purposes. The net pro forma income tax expense as of September
30, 1995 of $45,800 resulted from netting a tax benefit of $149,600 recognized
from pro forma net operating loss carryforwards with income tax expense of
$195,400. The pro forma income tax benefit of $438,366 as of September 30, 1996
resulted from net operating losses generated in 1996. As a result, the pro
forma tax information is determined on the same basis as the historical tax
information as of September 30, 1996.
NOTE F--OTHER CHANGES TO SHAREHOLDERS' EQUITY
In addition to the net loss and net income for the nine months ended September
30, 1996 and 1995, respectively, and to the charge for stock issuance costs in
1996 as discussed in Note C, ESI declared and distributed a property dividend of
$24,000 during the nine-months ended September 30, 1996.
F-29
<PAGE>
NOTE G--ACCOUNTING STANDARDS IMPLEMENTED IN 1996
In March 1995, the Financial Accounting Standards Board (FASB) issued SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of." SFAS No. 121 establishes accounting standards for the
impairment of long-lived assets, certain identifiable intangibles, and goodwill
related to those assets to be held and used, and for long-lived assets and
certain identifiable intangibles held for disposal. The Statement requires the
long-lived assets to be held and used by an entity be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Measurement of an impairment loss for long-
lived assets and identifiable intangibles that an entity expects to hold and use
should be based on the fair value of the asset.
The Statement is effective for fiscal years beginning after December 15, 1995.
ESI has adopted the Statement effective January 1, 1996; however, the adoption
had no material effect on ESI's financial position or results of
operations.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation". The Statement establishes a fair value based method of accounting
for stock-based compensation plans. It encourages entities to adopt that method
for all arrangements under which employees receive shares of stock or other
equity instruments of the employer or the employer incurs liabilities to
employees in amounts based on the price of its stocks. As ESI does not have any
stock-based compensation arrangements with employees or others, implementation
of the Statement had no effect on the financial statements.
NOTE H--SIGNIFICANT EQUITY INVESTEES
Sales, gross profit, net income (loss) from continuing operations and net income
for ESI's share of such items of the following equity investees for the period
ending December 31, 1995 are as follows. In the case of each equity investee
the sales equals the gross profit and the net income (loss) from continuing
operations equals the net income (loss).
<TABLE>
<CAPTION>
NET INCOME (LOSS)
SALES; FROM CONTINUING
EQUITY INVESTEE GROSS PROFIT OPEATIONS
--------------- ------------ ---------
<S> <C> <C>
Energy Search Natural Gas Pipeline Income, L.P. ($360) ($150)
ESI Pipeline Operating L.P. 94,039 (18,024)
Energy Search Natural Gas 1993 L.P. 9,797 6,488
Energy Search Natural Gas 1993-A L.P. 15,304 10,534
Energy Search Natural Gas 1994 L.P. 3,055 (906)
Energy Search Natural Gas 1994-A L.P. 956 678
Energy Search Natural Gas 1995 L.P. 0 0
Energy Search Natural Gas 1995-A L.P. (225) (225)
Energy Search Natural Gas 1996 L.P. N/A N/A
</TABLE>
F-30
<PAGE>
NARRATIVE DESCRIPTION OF IMAGE FOUND ON THE INSIDE BACK COVER OF THE
PROSPECTUS
The inside back cover contains a map depicting regional setting of the
Company's area of operations in the Appalachian Basin. As shown on the map,
the Appalachian Basin includes the state of West Virginia and parts of the
states of Pennsylvania, New York, Ohio, Kentucky, Tennessee, Alabama, Georgia,
North Carolina, Virginia, Maryland and New Jersey. A grey color-shaded square
in the southeastern section of the state of Ohio depicts the general location
Company's current producing area. An irregular shaped grey color-shaded area
in the south-central part of the state of West Virginia depicts the
approximate location of the Company's Beaver Coal Company Lease.
The title of this map is "ENERGY SEARCH, INCORPORATED - Area of Operations -
Ohio & West Virginia."
Language in lower right hand corner of this map states: "REGIONAL SETTING -
ENERGY SEARCH, INCORPORATED."
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATION IN CONNECTION WITH THIS 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 ANY
UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY SECURITY OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS
UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCE, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE
INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
HEADING PAGE
- ------- ----
<S> <C>
Prospectus Summary........................................................ 1
Risk Factors.............................................................. 8
Use of Proceeds........................................................... 17
Dividend Policy........................................................... 18
Dilution.................................................................. 18
Capitalization............................................................ 20
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 21
Business and Properties................................................... 26
Management................................................................ 45
Principal Stockholders.................................................... 51
Certain Relationships and Related Transactions............................ 52
Description of Securities................................................. 53
Shares Eligible for Future Sale........................................... 56
Underwriting.............................................................. 58
Legal Matters............................................................. 60
Experts................................................................... 61
Additional Information.................................................... 61
Glossary.................................................................. 62
Index to Financial Statements............................................. F-1
</TABLE>
----------------
UNTIL FEBRUARY 18, 1997 (25 DAYS FROM THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
1,000,000 UNITS
EACH UNIT CONSISTING OF
ONE SHARE OF COMMON STOCK
AND
ONE REDEEMABLE SERIES A
COMMON STOCK
PURCHASE WARRANT
OFFERING PRICE
$8.00
PER UNIT
[LOGO OF ENERGY SEARCH INCORPORATED APPEARS HERE]
PROSPECTUS
JANUARY 24, 1997
NEIDIGER/TUCKER/BRUNER, INC.
NATIONAL SECURITIES CORPORATION
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
