<PAGE>
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U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB/A
(AMENDMENT NO. 1)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________ to ___________
Commission File Number: 001-12679
ENERGY SEARCH, INCORPORATED
(Name of Small Business Issuer in Its Charter)
TENNESSEE 62-1423071
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
280 FORT SANDERS WEST BLVD., SUITE 200
KNOXVILLE, TENNESSEE 37922
(Address of Principal Executive Offices) (Zip Code)
(800) 551-5810
(Issuer's Telephone Number, Including Area Code)
Securities registered Pursuant to Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, NO PAR VALUE
Check whether the issuer has: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes __X__ No ______
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. [ ]
<PAGE>
The Registrant's total revenues for the year ended December 31, 1998, were
$3,527,854.
As of March 24, 1999, the aggregate market value of the voting and non-
voting common equity held by non-affiliates of the Registrant was
approximately $15,265,904. This amount is based on the sale price of
$5.125 per share for the registrant's stock as of such date.
As of March 24, 1999, the Registrant had outstanding 4,019,308 shares of
Common Stock, no par value.
Portions of the Registrant's definitive proxy statement to be filed no
later than April 30, 1999 for the Registrant's annual meeting of
shareholders are incorporated by reference into Part III of this Report.
Transitional Small Business Disclosure Format (check one): Yes _____
No __X__
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<PAGE>
This Form 10-KSB/A (Amendment No. 1) of Energy Search, Incorporated is
filed solely for the purpose of correcting a number contained in the
Consolidated Statement of Cash Flows for the year ended December 31, 1998.
The "Net cash provided by (used in) operating activities" line item for
December 31, 1998 was listed as $224,823. The correct number for the "Net cash
provided by (used in) operating activities" line item for December 31,1998 is
$244,823. This Form 10-KSB/A (Amendment No. 1) contains no other changes to
the Form 10-KSB filed with the Securities and Exchange Commission on March 31,
1999.
ITEM 7. FINANCIAL STATEMENTS.
The response to this Item is set forth herein in a separate section to this
Form 10-KSB/A (Amendment No. 1), beginning on Page F-1.
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ENERGY SEARCH, INCORPORATED
Date: April 15, 1999 /s/Richard S. Cooper
Richard S. Cooper
2
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
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CONTENTS
REPORT LETTER F-2
FINANCIAL STATEMENTS
Consolidated Balance Sheet F-3
Consolidated Statement of Operations F-4
Consolidated Statement of Stockholders' Equity F-5
Consolidated Statement of Cash Flows F-6-7
Notes to Consolidated Financial Statements F-8-25
REPORT LETTER F-27
ADDITIONAL INFORMATION
Cost Incurred in Oil and Gas Property Acquisition,
Exploration and Development Activities F-28
Estimates of Natural Gas and Oil Reserves F-28-31
F-1
<PAGE>
Independent Auditor's Report
To the Stockholders of
Energy Search, Incorporated and Subsidiary
We have audited the accompanying balance sheet of Energy Search,
Incorporated and Subsidiary, (the Company) as of December 31, 1998 and 1997
and the related statements of operations, stockholders' equity, and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the 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. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Energy Search,
Incorporated and Subsidiary, as of December 31, 1998 and 1997 and the results
of its operations and its cash flows for the years then ended, in
conformity with generally accepted accounting principles.
/s/ Plante & Moran, LLP
Grand Rapids, Michigan
March 12, 1999
F-2
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ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
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<TABLE>
CONSOLIDATED BALANCE SHEET
<CAPTION>
DECEMBER 31,
-----------------------------
1998 1997
----------- -----------
ASSETS
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 595,749 $ 2,252,316
Accounts receivable (Note I) 980,881 976,065
Other current assets 90,226 91,670
----------- -----------
Total current assets 1,666,856 3,320,051
OIL AND GAS PROPERTIES
Proven properties 13,165,858 4,546,833
Unproven properties 209,616 193,965
Wells and related equipment 11,357,198 8,100,764
Less accumulated depreciation, depletion and amortization (4,467,912) (3,140,678)
----------- -----------
Net oil and gas properties 20,264,760 9,700,884
OTHER ASSETS
Other property and equipment - Net (Note C) 287,746 363,180
Investments in related partnerships (Note B) 1,713,267 1,863,095
Deferred tax asset (Note D) 886,000 650,400
Other 204,780 223,090
----------- -----------
Total other assets 3,091,793 3,099,765
----------- -----------
Total assets $25,023,409 $16,120,700
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt (Note E) $ 546,407 $ 679,868
Accounts payable and accrued liabilities 632,677 1,356,748
----------- -----------
Total current liabilities 1,179,084 2,036,616
LONG-TERM DEBT - less current portion (Note E) 7,703,369 137,595
F-3
<PAGE>
STOCKHOLDERS' EQUITY (Notes F, G, H and J)
Preferred stock (no par value, 5,000,000 shares authorized;
issued and outstanding: 175,547 shares of 9%
redeemable convertible) 847,707 --
Common stock (no par value, 25,000,000 shares
authorized; 4,017,308 and 3,768,241 shares issued
and outstanding at December 31, 1998 and 1997,
respectively) 17,206,862 15,448,073
Accumulated deficit (1,913,613) (1,501,584)
----------- -----------
Total stockholders' equity 16,140,956 13,946,489
----------- -----------
Total liabilities and stockholders' equity $25,023,409 $16,120,700
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
F-4
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
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<TABLE>
CONSOLIDATED STATEMENT OF OPERATIONS
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1998 1997
---------- ----------
<S> <C> <C>
REVENUE
Oil and gas sales $2,597,875 $ 798,956
Management fees (Note I) 145,586 264,590
Net turnkey revenue 67,312 475,936
Other revenue (Note L) 609,725 693,188
---------- ----------
Total revenue 3,420,498 2,232,670
OPERATING EXPENSES
Production costs 661,036 274,571
Exploration costs 202,718 76,810
Depreciation, depletion and amortization 1,551,685 557,167
Interest 392,716 105,735
General and administrative 1,156,890 1,816,163
---------- ----------
Total operating expenses 3,965,045 2,830,446
---------- ----------
NET (LOSS) FROM OPERATIONS (544,547) (597,776)
OTHER INCOME (EXPENSE)
Program subsidies (Note I) (192,837) (80,384)
Gain on sale of assets -- 4,785
Equity in income of related partnerships (Note B) 107,356 123,794
---------- ----------
Total other income (expense) (85,481) 48,195
---------- ----------
NET (LOSS) BEFORE INCOME TAXES (630,028) (549,581)
INCOME TAX BENEFIT (Note D) 235,600 182,300
---------- ----------
NET (LOSS) $ (394,428) $ (367,281)
========== ==========
F-5
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BASIC NET (LOSS) PER COMMON SHARE $ (0.11) $ (0.14)
========== ==========
DILUTED NET (LOSS) PER COMMON SHARE $ (0.11) $ (0.14)
========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
F-6
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
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<TABLE>
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<CAPTION>
PREFERRED STOCK COMMON STOCK
----------------------- ---------------------
ACCUMULATED
SHARES AMOUNT SHARES AMOUNT DEFICIT TOTAL
------ --------- ---------- ------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE-January 1, 1997 450,000 $ 4,246,160 1,100,000 $ 1,200 $(1,074,554) $ 3,172,806
Issuance of common stock (Note G) -- -- 1,755,761 11,178,273 -- 11,178,273
Conversion of preferred stock A and B to
common stock (Note F) (450,000) (4,246,160) 900,000 4,246,160 -- --
Exercise of pre-IPO warrants -- -- 12,480 22,440 -- 22,440
Dividends on preferred stock A -- -- -- -- (59,749) (59,749)
Net loss for the year ended December 31,
1997 -- -- -- -- (367,281) (367,281)
--------- ----------- ---------- ----------- ----------- -----------
BALANCE - December 31, 1997 -- -- 3,768,241 15,448,073 (1,501,584) 13,946,489
Issuance of common stock (Note G) -- -- 249,067 1,758,789 -- 1,758,789
Issuance of preferred stock (Note F) 175,547 847,707 -- -- -- 847,707
Dividends on redeemable convertible
preferred stock -- -- -- -- (17,601) (17,601)
Net loss for the year ended December 31,
1998 -- -- -- -- (394,428) (394,428)
--------- ----------- ---------- ----------- ----------- -----------
BALANCE - December 31, 1998 175,547 $ 847,707 4,017,308 $17,206,862 $(1,913,613) $16,140,956
========= =========== ========== =========== =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
F-7
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
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<TABLE>
CONSOLIDATED STATEMENT OF CASH FLOWS
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (394,428) $ (367,281)
Adjustments to reconcile net loss to net cash from (used in)
operating activities:
Depreciation, depletion and amortization expense 1,551,685 557,167
Dry holes and abandonments of previously
capitalized oil and gas properties 43,033 2,865
Gain on sale of assets -- (4,785)
Equity in income of related partnerships (107,356) (123,794)
Increase in deferred taxes (235,600) (182,300)
(Increase) decrease in assets:
Accounts receivable and due from partnerships 139,876 (456,070)
Other current assets 1,444 (25,603)
Other assets (29,760) (167,123)
Increase (decrease) in liabilities:
Accounts payable and accrued liabilities (724,071) 323,286
Drilling advances -- (1,335,124)
----------- -----------
Net cash provided by (used in) operating
activities 244,823 (1,778,762)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of proven properties (6,839,114) (4,129,663)
Proceeds from sale of other property and equipment -- 10,054
Purchase of wells and related equipment (3,256,434) (2,513,051)
Purchase of other property and equipment (30,951) (251,244)
Distributions from affiliated partnerships 77,006 92,426
Contributions to affiliated partnerships (34,510) (318,100)
Purchase of oil and gas leases (15,651) (7,806)
----------- -----------
Net cash used in investing activities (10,099,654) (7,117,384)
</TABLE>
See Notes to Consolidated Financial Statements.
F-8
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
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<TABLE>
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Gross proceeds from issuance of common stock -- $13,249,727
Gross proceeds from issuance of preferred stock $ 956,500 --
Payments on stock issuance costs - common stock (64,155) (1,783,066)
Payments on stock issuance costs - preferred stock (117,793) --
Proceeds from issuance of long-term debt 7,599,093 129,874
Payment of dividends on preferred stock (17,601) (59,749)
Payments on long-term debt (166,780) (439,391)
----------- -----------
Net cash provided by financing activities 8,198,264 11,097,395
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,656,567) 2,201,249
CASH AND CASH EQUIVALENTS - Beginning of year 2,252,316 51,067
----------- -----------
CASH AND CASH EQUIVALENTS - End of year $ 595,749 $ 2,252,316
=========== ===========
SUPPLEMENTAL CASH FLOW DISCLOSURE
Cash paid for interest $ 392,716 $ 120,017
Cash paid for income taxes $ 100,370 $ 20,391
Significant noncash activities:
Issuance of common stock for purchase of properties $ 1,822,944 $ --
Conversion of preferred to common stock (Note F) $ -- $ 4,246,160
</TABLE>
See Notes to Consolidated Financial Statements.
F-9
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS - Energy Search, Incorporated and Subsidiary (the
"Company") consists of Energy Search, Incorporated ("ESI") and Equity
Financial Corporation ("EFC"), a wholly owned subsidiary acquired May 1,
1997.
ESI is engaged in the exploration, development, production and
marketing of oil and natural gas in the Appalachian Basin area
including southeastern Ohio and southern West Virginia. ESI's revenue
is primarily derived from: the sale of natural gas and crude oil from
wells in which it has working interest; 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 to a lesser extent the drilling
of oil and gas wells on a contract basis, and the formation and
management of oil and gas partnerships (Affiliated Drilling
Partnerships).
In 1997, ESI transitioned from being primarily a driller-operator for
syndicated Affiliated Drilling Partnerships to an energy company
developing reserves for its own account. The shift of its primary
operational focus was financed from public funds raised through an
initial public offering (Note G) and funds raised through a private
placement. While the Company anticipates the continued sponsoring of
Affiliated Drilling Partnerships on a limited basis, management's
primary focus will be the development of its own reserves and
acquisition of primarily proved undeveloped properties for
exploitation.
EFC is engaged in the operations of providing investment advice and
brokering and dealing in stocks, bonds, and other securities in the
east Tennessee region. EFC uses a clearing broker on a fully
disclosed basis to execute trades.
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
include the accounts of ESI and its wholly owned subsidiary, EFC,
since the date of acquisition. All significant inter-company balances
and transactions have been eliminated in consolidation.
ESTIMATES - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
F-10
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
OIL AND GAS PROPERTIES - ESI uses the successful efforts method of
accounting for oil and gas producing activities. Acquisition costs
for proved and unproved properties are capitalized when incurred.
Costs of unproved properties are transferred to proved properties when
proved reserves are discovered. Exploration costs, including
geological and geophysical costs and costs of carrying and retaining
unproved properties, are charged to expense as incurred.
Exploratory drilling costs are capitalized initially; however, if it
is determined that an exploratory well does not contain proved
reserves, such capitalized costs are charged to expense, as dry hole
costs, at that time.
Prior to 1997, wells were drilled with capital raised primarily
through limited partnerships. Under the terms of the partnership and
drilling contracts, ESI did not capitalize intangible drilling costs
since these costs were the responsibility of the contracting parties.
Intangible drilling costs are the expense for labor, fuel, repair,
hauling, rig rental and supplies used in the drilling of a well. ESI
does capitalize all tangible drilling costs when incurred, since they
retain ownership of the well equipment. Tangible costs are equipment
such as casing, tubing, pumps, tanks and other equipment installed on
a well.
Prior to 1997, the Company incurred certain lease acquisition
costs (e.g. landman expenses), which were part of the costs of
acquiring and developing leases for the Affiliated Drilling
Partnerships, that were offset against turnkey revenues. In 1998, the
Company has incurred similar costs; however, some of these costs have
been incurred and capitalized in connection with properties acquired
by the Company for its own portfolio. These costs include indirect
costs that management believes are related to the acquisition,
exploration and development of oil and gas properties. In 1998 and
1997, the Company capitalized approximately $1,353,000 and $437,000 of
F-11
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ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
indirect costs, respectively, and in 1998 $166,000 of interest costs
were capitalized to proven properties.
For 1997 and future years, all intangible and tangible drilling costs
for successful development wells drilled with the Company's capital
will be capitalized. Costs incurred to operate and maintain wells and
equipment and to lift oil and gas to the surface are generally expensed.
Oil and gas properties that are individually significant are
periodically assessed for impairment of value, and a loss is
recognized at time of impairment. Because the individual wells are
generally insignificant and the Company's business is primarily
drilling development wells, the impairment test is performed on a
field basis. Proved properties represent purchased working interests
in producing oil and gas wells, costs to acquire oil and gas leases
and intangible well development costs. Oil and gas properties 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.
OTHER PROPERTY AND EQUIPMENT - Other property and equipment are
recorded at cost. Major additions and improvements are capitalized,
while repairs, replacements and maintenance that 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 (see Note B for additional partnership information).
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
F-12
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ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 were $47,888 in 1998 and
$2,209,872 in 1997.
INCOME TAXES - The Company accounts for income taxes following the
liability method. A current tax liability or asset is recognized for
the estimated taxes payable or refundable on tax returns. Deferred
tax liabilities or assets are recognized for the estimated future tax
effect of temporary differences between book and tax accounting and
operating loss and tax credit carryforwards. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount
expected to be realized.
FAIR VALUE OF FINANCIAL INSTRUMENTS - A summary of the methods and
significant assumptions used to estimate the fair value of financial
instruments is as follows:
- SHORT-TERM FINANCIAL INSTRUMENTS - The fair value of short-term
financial instruments, including cash, trade accounts receivable
and trade accounts payable, approximate their carrying amounts in
the financial statements due to the short maturity of such
instruments.
- NOTES PAYABLE AND LONG-TERM DEBT - Based on interest rates
currently available to the Company for debt instruments with
similar terms and remaining maturities, the fair values of notes
payable and long-term debt approximate their carrying amounts in
the financial statements.
STOCK OPTIONS AND WARRANTS - The Company has stock option and stock
warrant plans (Notes H and J). Options and warrants granted to employees
are accounted for using the intrinsic value method, under which
compensation expense is recorded at the amount by which the market
price of the underlying stock at the grant date exceeds the exercise
price of an option. Options and warrants granted to non-employees are
accounted for using the fair value method.
F-13
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BASIC NET (LOSS) PER COMMON SHARE - Basic net (loss) per common share
is based on net (loss) available to common stockholders (net income
less preferred stock dividends) divided by the weighted average number
of common shares outstanding during the period.
DILUTED NET (LOSS) PER COMMON SHARE - Diluted net (loss) per common
share is based on net (loss) before dividends divided by the weighted
average number of common shares outstanding plus dilutive potential
common shares, outstanding during the period. Potential dilutive
shares, consisting of stock options (Note J), warrants (Note H), and
convertible preferred stock (Note F), were not included in the
computation of diluted net (loss) per common share in 1998 or 1997
because to do so would have been antidilutive.
CASH EQUIVALENTS - The Company considers all highly liquid investments
with a maturity of three months or less when purchased to be cash
equivalents.
RECLASSIFICATIONS - Certain reclassifications have been made to 1997
amounts to conform to 1998 presentations.
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 included 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., and the Natural Gas/Tax
Credit 1992-A L.P., all of which were liquidated in 1998 through the
Company's acquisition of the affiliated partnership working interests
(Note G).
ESI has also sponsored the following partnerships: the Natural Gas
1993 L.P., the Energy Search Natural Gas 1993-A L.P., the Energy
Search Natural Gas 1994 L.P., the Energy Search Natural Gas 1994-A
L.P., the Energy Search Natural Gas 1995 L.P., the Energy Search
Natural Gas 1995-A L.P., the Energy Search Natural Gas 1996 L.P., the
Energy Search Natural Gas 1996-A L.P., the Energy Search Natural Gas
F-14
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE B - AFFILIATED OIL AND GAS PARTNERSHIPS (CONTINUED)
1997 L.P., the Energy Search Natural Gas 1997-A L.P., and the Energy
Search Natural Gas 1998 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 operating of the properties. Revenue from the
partnership oil and gas properties is allocated based on the working
interest ownership percentage of the properties. ESI's interests in
the limited partnerships ranges from 1 percent to 9 percent at
December 31, 1998 and from 0.5 percent to 9 percent at December
31,1997.
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. ESI has advanced
funds to the Operating Partnership for each extension of the pipeline.
ESI has no legal obligation to continue to advance funds in the
future. ESI provided a guaranteed 10 percent return to pipeline
investors through 1997. Operations of the pipeline have been
sufficient to fund the preferential return through 1997. After
preferential returns, all cash is used to repay advances used to fund
pipeline extensions.
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 the Operating Partnership and Pipeline Partnership and, as such,
has full and exclusive discretion in the management of and control of
the partnerships. The Operating Partnership earns revenue by charging
gas wells a transportation fee based on the volume of gas moved through
the pipeline system. Substantially all of these gas wells are operated by
F-15
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE B - AFFILIATED OIL AND GAS PARTNERSHIPS (CONTINUED)
ESI. As of December 31, 1998 and 1997, the Pipeline Partnership owned
approximately 51 percent of the Operating Partnership, with ESI owning
the remaining 49 percent.
Total assets and equity of the related partnerships in the aggregate
were approximately $4,779,900 and $4,737,051, respectively, at
December 31, 1998, and $5,813,197 and $5,772,464, respectively, at
December 31, 1997.
ESI's share of revenue and net income for its equity investees for
the years ended December 31, 1998 and 1997, are given below. In
the case of each equity investee, the net income (loss) from
continuing operations equals the net income (loss).
F-16
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
<TABLE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE B - AFFILIATED OIL AND GAS PARTNERSHIPS (CONTINUED)
<CAPTION>
NET INCOME (LOSS) FROM
REVENUE CONTINUING OPERATIONS
------------------------------- -----------------------------
EQUITY INVESTEE 1998 1997 1998 1997
- ------------------------------------ ------------- ------------ -------------- -------------
<S> <C> <C> <C> <C>
Energy Search Natural Gas
Pipeline Income, L.P. $ 4,673 $ 75 $ 4,673 $ (79)
ESI Pipeline Operating L.P. 86,059 117,357 78,978 86,290
Energy Search Natural Gas
1993 L.P. 2,604 4,572 2,596 4,375
Energy Search Natural Gas
1993-A L.P. 5,338 8,931 5,338 8,541
Energy Search Natural Gas
1994 L.P. 5,695 10,684 5,677 10,387
Energy Search Natural Gas
1994-A L.P. 502 656 502 617
Energy Search Natural Gas
1995 L.P. 3,741 6,921 3,741 6,642
Energy Search Natural Gas
1995-A L.P. 3,272 6,454 3,272 6,287
Energy Search Natural Gas
1996 L.P. 1,247 536 1,247 510
Energy Search Natural Gas
1996-A L.P. 360 123 360 105
Energy Search Natural Gas
1997 L.P. 668 118 668 117
F-17
<PAGE>
Energy Search Natural Gas
1997-A L.P. 318 -- 304 --
Energy Search Natural Gas
1998 L.P. -- -- -- --
</TABLE>
F-18
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE C - PROPERTY AND EQUIPMENT
The principal categories of property and equipment are as follows:
<TABLE>
<CAPTION>
DEPRECIABLE
1998 1997 LIFE-YEARS
--------------- -------------- ---------------
<S> <C> <C> <C> <C>
Machinery and equipment $ 41,005 $ 39,941 5
Office furniture, equipment
and software 311,657 281,770 5
Airplane 165,932 165,932 5
Vehicles 218,645 218,645 5
---------- ----------
Total cost 737,239 706,288
Less accumulated depreciation 449,493 343,108
---------- ----------
Net carrying amount $ 287,746 $ 363,180
========== ==========
</TABLE>
Depreciation expense totaled $106,385 and $74,750 for the years ended
December 31, 1998 and 1997, respectively.
NOTE D - INCOME TAXES
ESI and its subsidiary file a consolidated federal income tax return.
The following is a summary of the provisions for income taxes for
years ended December 31:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C> <C>
Deferred tax benefit $235,600 $182,300
======== ========
</TABLE>
F-19
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE D - INCOME TAXES (CONTINUED)
The following is a reconciliation of the statutory federal income tax
rate to the Company's effective tax rate:
<TABLE>
<CAPTION>
1998 1997
------ ------
<S> <C> <C> <C>
Income tax at federal statutory rate 34.0% 34.0%
State income tax, net of federal benefit 6.0% 6.0%
Other (2.6)% (6.8)%
----- -----
Actual effective tax rate 37.4% 33.2%
===== =====
</TABLE>
The significant components of ESI's deferred tax assets and
liabilities are as follows:
F-20
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE D - INCOME TAXES (CONTINUED)
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C> <C>
Deferred tax assets:
Allowance for uncollectible accounts -- $ 59,000
Accounting for equity investments $ 128,900 177,000
Federal net operating loss 1,771,100 2,213,800
State net operating loss 99,600 125,800
Geological and engineering costs 106,900 --
---------- ----------
Total deferred tax asset 2,106,500 2,575,600
Valuation allowance for deferred tax assets -- --
Deferred tax liabilities:
Depreciation and pooling of capital 832,900 784,200
Intangible drilling costs 349,200 1,126,000
Other 38,400 15,000
---------- ----------
Total deferred tax liabilities 1,220,500 1,925,200
---------- ----------
Net deferred tax asset $ 886,000 $ 650,400
========== ==========
</TABLE>
At December 31, 1998, the Company has federal and state operating
loss carryforwards of approximately $5,200,000 and $1,700,000
respectively, that expire in the years 2005 to 2018. These
carryforwards are available to offset future taxable income.
F-21
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE E - LONG-TERM DEBT
Long-term debt consisted of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
---------- --------
<S> <C> <C> <C>
Line of credit at bank, available balance of
$7,800,000 and $920,000 at December 31, 1998 and
1997, respectively. Collateralized by lien on oil
and gas property, interest payable at prime plus
1.25% and 1.75% at December 31, 1998 and 1997
(a 9.0% and 10.25% effective rate, respectively).
Principal payments begin September 30, 1999, payable
in 48 equal monthly payments of principal plus interest $7,749,776 $650,684
Note payable to bank, collateralized by equipment,
payable in monthly installments of $3,600, including
interest at prime plus 0.5%, which was 9% at
December 31, 1997. This note was refinanced in 1998 -- 166,779
Note payable to bank, collateralized by equipment,
payable in monthly installments of $8,400, including
interest at 7.75%, with any unpaid principal
balance due December 5, 2003. 500,000 --
---------- --------
Total 8,249,776 817,463
Less current portion 546,407 679,868
---------- --------
Total long-term debt $7,703,369 $137,595
========== ========
</TABLE>
The Company is subject to various loan covenants in connection with
bank notes payable described above including requirements on its
tangible net worth, debt to tangible net worth, limits on partnership
subsidies, restrictions on payment of dividends and general and
administrative costs.
F-22
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE E - LONG-TERM DEBT (CONTINUED)
Principal maturities of long-term debt at December 31, 1998 are as
follows:
<TABLE>
<CAPTION>
<S> <C> <C>
1999 $ 546,407
2000 2,006,182
2001 2,011,880
2002 2,017,944
2003 1,667,363
----------
Total $8,249,776
==========
</TABLE>
NOTE F - PREFERRED STOCK
CLASS A AND B PREFERRED STOCK - Class A and B preferred stock was
converted to common stock in 1997 in conjunction with the successful
initial public offering of ESI's common stock.
REDEEMABLE CONVERTIBLE PREFERRED STOCK - In 1998, the Company
initiated a private placement offering of up to 800,000 shares of 9%
redeemable convertible preferred stock. The offering was terminated
on December 18, 1998, and the issue price of the preferred stock was
adjusted to $5.50 per share according to the terms of the offering.
The Company raised $847,707, net of issue costs of $117,793, and sold
175,547 shares of preferred stock under the offering.
The preferred shares enjoy a liquidation and dividend preference over
the Company's common stock and are convertible to common stock at the
option of the holder at any time at a rate of 1.0 common share for
each preferred share converted. Conversion of the preferred shares to
common stock will automatically occur in the event the Company is
acquired or is the subject of a business combination in which
substantially all assets of the Company are acquired by unaffiliated
F-23
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE F - PREFERRED STOCK (CONTINUED)
purchasers or greater than 50% of the outstanding beneficial interest
of the Company's common stock is acquired by unaffiliated purchasers.
The holders of preferred shares may require the Company to redeem the
preferred shares if, at any time prior to October 1, 1999, the Company
publicly announces that it will be acquired or is the subject of a
business combination, as defined above. The redemption price in such
an event will be 100% of the issue price of the preferred shares plus
accrued and unpaid dividends.
The preferred shares are redeemable at the sole option of the Company
any time after September 30, 1999, provided the average trading
closing price for the Company's common stock exceeds 130% of the issue
price of the preferred shares over any 5 consecutive trading day
period commencing after September 30, 1999. The redemption price for
the preferred shares will be 100% of the issue price for the preferred
shares, plus accrued but unpaid dividends. The Company will provide
the holders of preferred shares 30 days written notice of its intent
to redeem the preferred shares during which time the holders may, at
their option, convert their preferred shares to common stock.
NOTE G - COMMON STOCK
INITIAL PUBLIC OFFERING - In January 1997, the Company registered its
stock in a public offering of 1,000,000 common shares and raised
$6,501,491 net of $1,498,509 for underwriter fees, professional fees,
and various other costs associated with this stock offering.
REGULATION D OFFERING - On October 27, 1997, the Company completed a
private offering of 749,961 shares of common stock and raised
$4,620,867, net of $628,900 for underwriter fees, professional fees,
and various other costs associated with this stock offering.
AFFILIATED PARTNERSHIP ROLL-UP - Effective June 30, 1998, the Company
closed the acquisition of working interests (the "Subject Interests")
in a total of 145 gross natural gas or oil wells that were being operated
by the Company. The Subject Interests were owned by the following
affiliated partnerships: the Natural Gas/Tax Credit 1989 L.P., the
Natural Gas/Tax Credit 1990 L.P., the Natural Gas/Tax Credit 1991
F-24
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE G - COMMON STOCK (CONTINUED)
L.P., the Natural Gas/Tax Credit 1992 L.P., and the Natural Gas/Tax
Credit 1992-A L.P. The Company paid aggregate purchase consideration
amounting to $2,223,941 for the Subject Interests, which was comprised
of $1,716,748 in Company common stock (221,453 shares) and $507,193 in
cash.
The Company's acquisition of the Subject Interests from affiliated
partnerships followed a group of smaller transactions (the "Minor
Interest Acquisitions") pursuant to which the Company acquired minor
working interests and overriding royalty interests in the wells from
nine individuals. The Minor Interest Acquisitions had an effective
date of April 16, 1998. The Company paid aggregate purchase
consideration amounting to $227,740 for the Minor Interest
Acquisitions, which was comprised of $106,197 in Company common stock
(10,114 shares) and $121,543 in cash.
NOTE H - STOCK WARRANT PLANS
SERIES A WARRANTS - As part of ESI's public offering, the Board of
Directors issued 1,000,000 Series A warrants included in units that
consist of one share of common stock and one Series A warrant. The
Board issued additional Series A warrants consisting of 100,000 units
pursuant to the Underwriters' over-allotment option, and 100,000
"representative's" warrants pursuant to Underwriters' compensation.
An equivalent number of shares of common stock has been authorized and
reserved for issuance upon exercise of such Series A warrants.
Each Series A warrant entitles the holder to purchase one share of
common stock at an exercise price of $9.60 per unit exercisable at any
time after February 28, 1998, until January 30, 2002. The Series A
warrants could not be traded separately until July 24, 1997. The
warrants are subject to redemption by the Company at a price of $.05
per Series A warrant on 30 days written notice at any time after July
24, 1998, provided that the closing sale price per share for the
common stock has equaled or exceeded 200 percent of the offering price
per unit for 20 consecutive trading days within the 30-day period
immediately preceding such notice.
F-25
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE H - STOCK WARRANT PLANS (CONTINUED)
REGULATION D WARRANTS - As part of ESI's private offering of common
stock that took place in October 1997, 74,996 warrants were issued to
unaffiliated parties pursuant to the Placement Agent Agreement. The
warrants entitle each holder to purchase one share of common stock and
are exercisable at $7 per share at any time up to October 27, 2002.
The number, type of security and the exercise price is subject to
adjustment upon occurrence of certain events including consolidation,
merger, subdivision or combination of shares and issuance of stock
dividends. None of these warrants have been exercised at December 31,
1998.
The following is a summary of stock warrant activity:
<TABLE>
<CAPTION>
NUMBER OF EXERCISE
WARRANTS PRICE EXPIRATION DATE
------------------------------------------
<S> <C> <C> <C> <C>
Outstanding - January 1, 1997 - $ -
Granted 1,200,000 9.60 January 30, 2002
Granted 74,996 7.00 October 27, 2002
---------
Outstanding - December 31, 1997 and 1998 1,274,996
---------
</TABLE>
None of the consideration received in the above stock offerings
was specifically allocated to the warrants.
NOTE I - RELATED-PARTY TRANSACTIONS
Because of the nature of ESI's business, a significant number of
transactions are with related parties.
F-26
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE I - RELATED PARTY TRANSACTIONS (CONTINUED)
During 1998 and 1997, ESI received $115,200 and $1,156,800, respectively,
from affiliated oil and gas partnerships for drilling costs which were
the responsibility of the affiliated oil and gas partnerships. Included
in accounts receivable at December 31, 1998 and 1997 is $59,002 and
$781,553 respectively, due from affiliated partnerships.
In its role as operator of the oil and gas wells owned by various
related partnerships, ESI charges a monthly wellhead and
administrative fee of between $100 and $300 for each producing well.
These fees totaled $110,856 and $239,433 for 1998 and 1997,
respectively. In its role as general partner of the Operating
Partnership (Note B), ESI charges the partnership a management fee of
$2,500 and $5,000 per month for 1998 and 1997, respectively. These fees
totaled $35,000 and $60,000 for 1998 and 1997, respectively.
Subsequent to December 31, 1998 the Company issued a note totaling
$225,000 to three officers for their interests in various properties
and their rights to invest in future properties.
The Company, in its discretion and given the business environment
existing at the time, chose not to collect certain amounts due from
partnerships and also paid certain expenses due to others on behalf of
partnerships. ESI is under no legal or contractual obligation to
continue this activity, and there is no expectation that it will
continue in future years.
F-27
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE I - RELATED PARTY TRANSACTIONS (CONTINUED)
The following is a summary of expenses paid on behalf of the
partnerships and advances forgiven for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C> <C>
Expenses paid on behalf of partnership $192,837 $ 80,384
======== ========
Advances forgiven $ 820 $ 11,728
======== ========
</TABLE>
ESI has the contractual right to charge partnership administrative
fees and production operating fees in excess of the aggregate amounts
charged to the partnerships during 1998 and 1997.
NOTE J - EMPLOYEE BENEFIT AND STOCK-BASED COMPENSATION PLANS
EMPLOYEE BENEFIT PLAN - The Company sponsors a simplified employee
pension plan (SEP) for qualifying employees. Employee contributions to
individual retirement plans may not exceed the greater of 15 percent of
employee earnings or $22,500 per year per employee. The Company
contributed $38,792 and $25,370 to the SEP during 1998 and 1997,
respectively.
NON-EMPLOYEE OPTIONS - The Company issued 2,500 options each to the
two outside directors during both 1998 and 1997. Options issued in
1998 and 1997 entitle the holder to purchase one share of common
stock at an exercise price of $5.25 and $6.50, respectively, and the
options expire January 30, 2002. The Company also issued 2,500
options to an outside consultant in 1998 for past services rendered.
The options entitle the holder to purchase one share of common stock
at an exercise price of $6.50 and expire January 30, 2002. During
1998 and 1997, $6,700 and $2,400, was charged to expense related to
these non-employee options, respectively.
F-28
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE J - EMPLOYEE BENEFIT AND STOCK-BASED COMPENSATION PLANS (CONTINUED)
EMPLOYEE OPTION PLAN - The Company has a fixed employee stock-based
compensation plan under which the Company granted options for 55,650
shares of restricted common stock in 1997. The exercise price of
each option is $6.50 per share. The options expire January 30, 2002
and vest immediately upon grant.
In addition, the Company has granted options for 22,500 shares of
restricted common stock under the fixed employee stock-based
compensation plan in 1998. The exercise price of each option is
$8.00 per share. The term of the options is five years starting in
1998 and the warrants vest at 4,500 shares per year.
OFFICER WARRANT PLAN - The Company also has a fixed executive officer
stock-based compensation plan under which executive officers have
been granted warrants for the purchase of up to 450,000 shares of
restricted common stock. The exercise price of each warrant is $8.00
per share, which equaled the market price of the Company's stock on
the date of grant. The term of the warrants is five years starting in
1997 and the warrants vest at 30,000 shares per officer per year.
The Company applies intrinsic value accounting to its fixed stock-
based compensation plans. Accordingly, no compensation cost has been
recognized for the fixed plans in 1998 and 1997. Had compensation
cost been determined using the fair value method, net loss would have
been $(551,517) and $(476,563) for 1998 and 1997, respectively, and
basic and fully diluted loss per share would have been $(.15) and $(.18)
for 1998 and 1997, respectively. The fair value of the warrants and
options was determined using the Black-Scholes model with application
of an additional 30 percent discount due to the fact that the shares are
restricted. Assumptions made in estimating the fair value include:
risk-free interest rate of 6 percent, expected expiration of the
warrants of January 30, 2002, expected price volatility of 20 percent
and dividend yield of 0 percent.
F-29
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE J - EMPLOYEE BENEFIT AND STOCK-BASED COMPENSATION PLANS (CONTINUED)
The following is a summary of the status of the fixed stock-based
compensation plans during 1998.
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF SHARES EXERCISE PRICE
------------------ --------------
<S> <C> <C> <C>
Outstanding at January 1, 1997 27,950 $ 3.57
Granted 505,650 7.84
Expired (15,470) 10.00
Exercised (12,480) 3.59
-------- ------
Outstanding - December 31, 1997 505,650 7.84
Granted 22,500 8.00
-------- ------
Outstanding - December 31, 1998 $528,150 $ 7.84
======== ======
Exercisable at December 31, 1998 $240,150 $ 7.65
======== ======
Weighted average per share fair value
of options granted during 1998 $ 1.66
========
</TABLE>
F-30
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE J - EMPLOYEE BENEFIT AND STOCK-BASED COMPENSATION PLANS (CONTINUED)
The following is a summary of the status of the fixed options
outstanding at December 31, 1998.
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
------------------------------------------------ ---------------------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE REMAINING EXERCISE REMAINING
PRICE NUMBER CONTRACTUAL LIFE PRICE NUMBER CONTRACTUAL LIFE
-------- ------ ---------------- -------- ------ ----------------
<S> <C> <C> <C> <C> <C> <C>
$6.50 55,650 4 $6.50 55,650 4
$8.00 472,500 4 $8.00 184,500 4
</TABLE>
NOTE K - COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS
As general partner in various affiliated oil and gas partnerships, the
Company 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.
CONCENTRATIONS OF CREDIT RISK - The Company extends credit to
affiliated partnerships in the normal course of business. Within this
industry, certain concentrations of credit risk exist. ESI, in its
role as operator of co-owned properties, assumes responsibility for
payment to vendors for goods and services related to joint operations
and extends credit to these partnerships as co-owners of these
properties.
This concentration of credit risk may be similarly affected by changes
in economic or other conditions and may, accordingly, impact the
Company's overall credit risk. However, management believes that its
accounts receivable are well diversified, thereby reducing potential
risk to the Company.
F-31
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE K - COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS (CONTINUED)
GEOGRAPHIC CONCENTRATION - The Company plans to increase its oil and
gas reserves by continued developmental drilling in southeastern Ohio
in the area serviced by its gas gathering system, its Dupont Field and
its Beaver Coal Company Lease in Wood and Raleigh counties, West
Virginia, respectively. 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.
NOTE L - BUSINESS SEGMENTS
The Company adopted SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION, in 1997 which changes the way the
Company reports information about its operating segments. The
information for 1997 has been restated from the prior year's
presentation in order to conform to the 1998 presentation.
The Company's operations are classified into two principal industry
segments. Oil and gas operations and brokerage services. The oil and
gas operations are conducted entirely through Energy Search, Incorporated
which is the primary industry segment. The brokerage services are
conducted exclusively through Equity Financial Corporation. See Note A
for a description of the operations and accounting policies of each
Company. The following is a summary of segment information for 1998
and 1997.
F-32
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE L - BUSINESS SEGMENTS (CONTINUED)
<TABLE>
<CAPTION>
OIL & GAS BROKERAGE
1998 OPERATIONS SERVICES TOTALS
-------------------------------- ----------- -------- -----------
<S> <C> <C> <C> <C>
Revenues $ 2,956,832 $463,666 $ 3,420,498
Segment profit (loss) (387,043) (7,385) (394,428)
Intersegment revenue -- 9,600 9,600
Total assets 24,888,353 135,056 25,023,409
Capital expenditures 10,142,150 -- 10,142,150
Equity method income 107,356 -- 107,356
Interest expense 392,716 -- 392,716
Depreciation, depletion
and amortization 1,545,631 6,054 1,551,685
</TABLE>
F-33
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 (CONTINUED)
NOTE L - BUSINESS SEGMENTS (CONTINUED)
<TABLE>
<CAPTION>
OIL & GAS BROKERAGE
1997 OPERATIONS SERVICES TOTALS
-------------------------------- ----------- -------- -----------
<S> <C> <C> <C> <C>
Revenues $ 1,640,139 $592,531 $ 2,232,670
Segment profit (loss) (494,371) 127,090 (367,281)
Intersegment revenue -- 92,400 92,400
Total assets 15,810,516 310,184 16,120,700
Capital expenditures 6,901,159 605 6,901,764
Equity method income 123,794 -- 123,794
Interest expense 105,735 -- 105,735
Depreciation, depletion
and amortization 552,471 4,696 557,167
</TABLE>
F-34
<PAGE>
ADDITIONAL INFORMATION
===========================================================================
F-35
<PAGE>
To the Stockholders of
Energy Search, Incorporated and Subsidiary
We have audited the financial statements of Energy Search, Incorporated and
Subsidiary for the years ended December 31, 1998 and 1997. The accompanying
schedules of Costs Incurred in Oil and Gas Producing Activities and Estimates
of Natural Gas and Oil Reserves on pages F-28 through F-31 are not a
required part of the basic financial statements of Energy Search, Incorporated,
but constitute additional supplementary information required by the
Financial Accounting Standards Board. We have applied certain limited
procedures, which consisted principally of inquiries of management regarding
the methods of measurement and presentation of the supplementary information.
However, we did not audit the information and express no opinion on it.
/s/ Plante & Moran, LLP
Grand Rapids, Michigan
March 12, 1999
F-36
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
SUPPLEMENTARY INFORMATION (UNAUDITED)
COST INCURRED IN OIL AND GAS PROPERTY ACQUISITION, EXPLORATION AND
DEVELOPMENT ACTIVITIES
The following costs are comprised of both capitalized and expensed costs
included in the balance sheet and income statement.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1998 1997
---------- ----------
<S> <C> <C>
Property acquisition costs $4,560,556 $1,535,173
========== ==========
Exploration costs $ 218,369 $ 84,616
========== ==========
Developments costs $6,607,991 $5,683,356
========== ==========
</TABLE>
ESTIMATES OF NATURAL GAS AND OIL RESERVES
The following estimates of proven developed natural gas and oil reserve
quantities and related standardized measure of discounted net cash flow are
estimates prepared by an independent petroleum engineer on behalf of the
Company's engineer as of December 31, 1998 and 1997. 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.
Proven 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. Proven developed reserves are those expected to be recovered
through existing wells, equipment and operating methods.
F-37
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
SUPPLEMENTARY INFORMATION (UNAUDITED)
ESTIMATES OF NATURAL GAS AND OIL RESERVES (CONTINUED)
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 proven oil and gas reserves, less estimated future expenditures (based
on year-end costs) to be incurred in developing and producing the proven
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 10 percent per year to
reflect the estimated timing of the future cash flows.
<TABLE>
<CAPTION>
OIL (BBL) GAS (MCF)
--------- ------------
<S> <C> <C>
Proven, developed and undeveloped reserves:
January 1, 1997 16,736 15,692,300
Revisions and other changes (12,583) (1,608,121)
Extensions and discoveries -- 4,649,023
Purchases and sales of reserves 20,600 12,099,800
Production (1,129) (223,025)
-------- ------------
December 31, 1997 23,624 30,609,977
-------- ------------
Revisions and other changes 3,576 (3,450,274)
Extensions and discoveries -- 11,606,732
Purchases and sales of reserves 24,585 5,788,007
Production (7,231) (1,061,388)
-------- ------------
December 31, 1998 44,554 43,493,054
======== ============
Proven developed reserves <F1>:
December 31, 1997 23,624 11,192,017
December 31, 1998 44,554 15,990,954
Equity interest in proven reserves <F2>:
December 31, 1997 268 138,228
December 31, 1998 103 124,326
- -------------------------
F-38
<PAGE>
<FN>
<F1> These reserves are owned directly by the Company.
<F2> These are reserves owned indirectly by the Company through its interests
in affiliated partnerships.
</FN>
</TABLE>
F-39
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
SUPPLEMENTARY INFORMATION (UNAUDITED)
ESTIMATES OF NATURAL GAS AND OIL RESERVES (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1998 1997
------------ ------------
<S> <C> <C>
STANDARDIZED MEASURE OF DISCOUNTED FUTURE PRETAX NET CASH FLOWS
Future cash inflows $121,902,800 $105,929,500
Future production costs (23,279,515) (18,076,980)
Future development costs (21,171,030) (16,710,350)
------------ ------------
Future pretax net cash flows 77,452,255 71,142,170
10% annual discount for estimated timing of cash flows (46,690,672) (38,780,970)
------------ ------------
Standardized measure of discounted future pretax net
cash flows relating to proven oil and gas reserves $ 30,761,583 $ 32,361,200
============ ============
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
Future cash inflows $121,902,800 $105,929,500
Future production costs (23,279,515) (18,076,980)
Future development costs (21,171,030) (16,710,350)
Future income taxes (23,610,860) (22,149,426)
------------ ------------
Future net cash flows 53,841,395 48,992,744
10% annual discount for estimated timing of cash flows (29,975,411) (24,897,377)
------------ ------------
Standardized measure of discounted future net cash flows
relating to proven oil and gas reserves $ 23,865,984 $ 24,095,367
============ ============
ESI's share of equity method investors' standardized measure
of discounted future cash flows $ 124,376 $ 181,570
============ ============
</TABLE>
F-40
<PAGE>
ENERGY SEARCH, INCORPORATED AND SUBSIDIARY
- ---------------------------------------------------------------------------
SUPPLEMENTARY INFORMATION (UNAUDITED)
ESTIMATES OF NATURAL GAS AND OIL RESERVES (CONTINUED)
The following reconciles the change in the standardized measure of
discounted future net cash flows for the year ended December 31,
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Beginning of year $ 24,095,367 $ 15,172,758
Sales of oil and gas produced, net of production costs (2,444,574) (524,385)
Extensions, discoveries, and improved recovery -
Less related costs 9,806,445 4,853,796
Revisions of previous quantity estimates (2,632,622) (394,343)
Changes in prices (12,778,261) 1,231,832
Net change from purchases and sales of minerals in place 6,498,274 10,716,000
Net change in income taxes (1,461,434) (11,258,007)
Accretion of discount (2,409,537) (1,517,276)
Other 5,192,326 5,814,992
------------ ------------
End of year $ 23,865,984 $ 24,095,367
============ ============
</TABLE>
F-41
