-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, L9TkxawzsL7PRflYHavPvrYqc8n301eA8W++1pgWUV8rv6RuCjOnlKZ7Wnqc+NzH BhCbJSE7xmTt8qstLppooQ== 0001193805-07-002544.txt : 20071005 0001193805-07-002544.hdr.sgml : 20071005 20071005093608 ACCESSION NUMBER: 0001193805-07-002544 CONFORMED SUBMISSION TYPE: 424B3 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 20071005 DATE AS OF CHANGE: 20071005 FILER: COMPANY DATA: COMPANY CONFORMED NAME: Baseline Oil & Gas Corp. CENTRAL INDEX KEY: 0001291983 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 300226902 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 424B3 SEC ACT: 1933 Act SEC FILE NUMBER: 333-134978 FILM NUMBER: 071158197 BUSINESS ADDRESS: STREET 1: 16161 COLLEGE OAK, SUITE 101 CITY: SAN ANTONIO STATE: TX ZIP: 78249 BUSINESS PHONE: 210-408-6019 EXT 2 MAIL ADDRESS: STREET 1: 16161 COLLEGE OAK, SUITE 101 CITY: SAN ANTONIO STATE: TX ZIP: 78249 FORMER COMPANY: FORMER CONFORMED NAME: College Oak Investments, Inc. DATE OF NAME CHANGE: 20040527 424B3 1 e602679_424b3-baseline.txt Filed pursuant to Rule 424(b)(3) Registration number 333-134978 BASELINE OIL & GAS CORP. 10,486,828 Shares Common Stock This prospectus relates to the resale of up to 10,486,828 shares of our common stock, par value $.001 per share (the "Common Stock"), by the selling security holders listed in the prospectus commencing on page 15, consisting of (i) 8,627,738 shares of Common Stock presently outstanding and held by selling security holders and (ii) up to 1,859,090 shares of our Common Stock that are issuable upon exercise of stock options and common stock purchase warrants. The transactions in which the selling security holders acquired the shares of Common Stock covered by this prospectus are described in the section of this prospectus entitled "Selling Security Holders." The selling security holders, by themselves or through brokers and dealers, may offer and sell the shares at prevailing market prices or in transactions at negotiated prices. We will not receive any proceeds from the selling security holders' resale of the shares of Common Stock. The selling security holders will receive all proceeds from such sales. We will, in the ordinary course of business, receive proceeds from the issuance of our Common Stock upon exercise of the stock options and common stock purchase warrants. It is not possible to determine the price to the public in any sale of the shares of Common Stock by the selling security holders and the selling security holders reserve the right to accept or reject, in whole or in part, any proposed purchase of shares. Accordingly, the selling security holders will determine the public offering price, the amount of any applicable underwriting discounts and commissions and the net proceeds at the time of any sale. The selling security holders will pay any underwriting discounts and commissions. The selling security holders, and the brokers through whom sales of the securities are made, will be "underwriters" within the meaning of Section 2(11) of the Securities Act of 1933, as amended, referred to herein as the "Securities Act". Our Common Stock is traded on the OTC Bulletin Board under the symbol "BOGA". On September 18, 2007 the reported closing prices of our Common Stock on the OTC Bulletin Board was $0.63. INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" BEGINNING ON PAGE 3. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. The selling security holders are offering to sell and seeking offers to buy shares of our Common Stock only in jurisdictions where offers and sales are permitted. You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with different information from that contained in this prospectus. No person is authorized in connection with this prospectus to give any information or to make any representations about us, the selling security holders, the securities or any matter discussed in this prospectus, other than the information and representations contained in this prospectus. If any other information or representation is given or made, such information or representation may not be relied upon as having been authorized by us or any selling security holder. This prospectus does not constitute an offer to sell, or a solicitation of an offer to buy the securities in any circumstances under which the offer or solicitation is unlawful. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our Common Stock. Neither the delivery of this prospectus nor any distribution of securities in accordance with this prospectus shall, under any circumstances, imply that there has been no change in our affairs since the date of this prospectus. The date of this prospectus is October 5, 2007 TABLE OF CONTENTS Page ---- Prospectus Summary .................................................... 1 Risk Factors .......................................................... 3 Cautionary Note Regarding Forwarding-Looking Statements ............... 13 Use of Proceeds ....................................................... 14 Determination of Offering Price ....................................... 14 Selling Security Holders .............................................. 15 Plan of Distribution .................................................. 24 Legal Proceedings ..................................................... 26 Directors, Executive Officers, Promoters and Control Persons .......... 27 Security Ownership of Certain Beneficial Owners and Management ........ 29 Description of Securities ............................................. 31 Interest of Named Experts and Counsel ................................. 32 Disclosure of Commission Position on Indemnification for Securities Act 32 Certain Relationships and Transactions and Corporate Governance ....... 33 Description of Business ............................................... 34 Plan of Operation ..................................................... 38 Description of Property ............................................... 45 Market for Common Equity and Related Stockholder Matters .............. 46 Executive Compensation ................................................ 49 Financial Statements .................................................. 52 (i) PROSPECTUS SUMMARY This summary highlights information contained elsewhere in this prospectus. This summary does not contain all of the information you should consider before investing in our Common Stock. You should read the entire prospectus, including "Risk Factors" and our consolidated financial statements and the related notes before making an investment decision. In this prospectus, the "Company" and terms such as "we," "us" and "our," refer to Baseline Oil & Gas Corp., a Nevada corporation. Our Company We were incorporated in the State of Nevada on February 3, 2004 as College Oak Investments, Inc. We changed our name on January 17, 2006 to Baseline Oil & Gas Corp. On April 6, 2005, we entered into a merger transaction with Coastal Energy Services, Inc., a Delaware corporation ("Coastal"), as described elsewhere in this prospectus under "Business - General" which resulted in a change in control of our Company. Coastal was formed to engage in the energy business, and following the merger transaction, we focused on business opportunities in the oil and gas industries. Our efforts resulted in our acquisition of (1) a working interest in approximately 171,000 gross acres in the southern Indiana New Albany Shale formation, with its long life, natural gas potential, and (2) a working interest in approximately 4600 gross acres located in Stephens County, north Texas, with its long life oil reserves. Our principal offices are located at 1811 N. Freeway (I-45), Suite 200, Houston, TX 77060. Our telephone number is (281) 591-6100. Recent Developments Proposed Acquisition of DSX Properties We entered into an Asset Purchase and Sale Agreement dated as of August 7, 2007 with DSX Energy Limited, LLP, Kebo Oil & Gas, Inc., Sanchez Oil & Gas Corp., Sue Ann Operating, L.L.C., and 23 other individuals, trusts, and companies (collectively, "Sellers"), whereby we agreed, subject to the satisfaction of various terms and conditions, to acquire, effective June 1, 2007, certain oil and gas properties located in the Blessing Field in Matagorda County onshore along the Texas Gulf Coast (the "DSX Properties"), all as previously disclosed by us in our Current Report on Form 8-K filed with the Securities and Exchange Commission on August 15, 2007. Included elsewhere in this prospectus are financial statements for the DSX Properties. The closing of the purchase is scheduled to occur on October 30, 2007, or such earlier date as we and the Sellers may determine (the "Closing Date"). The purchase price we agreed to pay for the DSX Properties at the Closing Date is $100.0 million in cash, subject to certain adjustments set forth in the purchase agreement. We also agreed to assume certain obligations related to the DSX Properties On August 13, 2007, we paid a performance deposit of $2.5 million to the Sellers (the "Performance Deposit"), which will be credited against the purchase price paid at the Closing Date. We obtained the Performance Deposit from our senior lenders pursuant to the terms of a letter agreement dated August 9, 2007. Either the Sellers or we may terminate the purchase agreement if the sum of the aggregate values of all uncured title defects (including preferential rights and required consents to assignment that result in exclusion of one or more properties), plus the aggregate amounts to remediate all unremedied environmental defects, plus the amounts of any damage to the DSX Properties prior to the closing, all as finally agreed upon by the Sellers and us or determined by arbitration, would result in reductions to the Purchase Price, without regard to deductibles, equal to or in excess of $15.0 million. If the purchase agreement is thus terminated, we will be entitled to the return of the full amount of the Performance Deposit. Although we anticipate closing on this proposed acquisition in October 2007, there can be no assurance that the various closing conditions can be satisfied to enable us to close timely, if at all. In particular, there is no assurance that financing, whether in the form of equity, debt or some combination thereof, will be available to us to the extent required, on terms acceptable to us, or at all. Likewise, there is no assurance that favorable results will be obtained from our on-going due diligence inquiries or, in the event we proceed with the transaction following such inquiries, whether we will be successful in achieving the intended integration of business operations following such acquisition. We plan to finance the proposed acquisition of the DSX Properties through the private issuance of debt securities in our company, consisting of (i) $115 million aggregate principal amount of 12.5% Senior Secured Notes due 2012 and (ii) $50 million aggregate principal amount of 14% Senior Subordinated Convertible Secured Notes due 2013, as previously reported by us in our Current Report on Form 8-K filed with the SEC on September 18, 2007 (the "DSX Financing"). Neither of these notes will have been registered under the Securities Act of 1933, as amended, or any state securities laws at the time of their offer and sale, and are intended to be offered and sold under applicable exemptions from the registration requirements. The notes are intended to be secured, in part, by a lien on the DSX Properties. We expect that the DSX Financing will close concurrently with the acquisition of the DSX Properties in early October 2007, although there can be no assurances in that regard. Engagement of new Chief Financial Officer On August 3, 2007, we entered into an employment agreement with Patrick H. McGarey, whereby we hired Mr. McGarey as our Chief Financial Officer, effective August 16, 2007. Mr. McGarey succeeds Richard M. Cohen, who stepped down on August 15, 2007 after having served as our Chief Financial Officer since inception. Mr. McGarey's employment agreement provides for an initial term of two years, unless earlier terminated or extended, at an annual salary of $165,000 and, provided that he remains in our employ, a performance bonus of $33,000 upon completion of the initial year of his term. As additional consideration, we granted Mr. McGarey five-year, non-qualified stock options to purchase up to an aggregate of 1,500,000 shares of our common stock, upon the terms and subject to the conditions set forth in stock option agreements, each dated as of August 3, 2007, between us and Mr. McGarey. We previously filed the employment agreement and the form of option agreements as exhibits to our Current Report on Form 8-K filed by us with the Securities and Exchange Commission on August 6, 2007. A fuller description of the terms and conditions of his employment and option grants is contained elsewhere in this prospectus under "Management - Employment Agreements." The Offering This prospectus relates to the resale of up to 10,486,828 shares of our common stock, par value $.001 per share (the "Common Stock"), by the selling security holders listed in the prospectus commencing on page 15, consisting of (i) 8,627,738 shares of Common Stock presently outstanding and held by selling security holders and (ii) up to 1,859,090 shares of our Common Stock that are issuable upon exercise of stock options and common stock purchase warrants. The issuances of such securities to the selling security holders was made in reliance upon exemptions from the registration requirements provided by Section 4(2) of the Securities Act for private transactions. Additional information concerning the transactions in which the rights to acquire the shares covered by this prospectus were obtained by the selling security holders are set forth in the section of this prospectus entitled "Selling Security Holders." Sales By Selling Security Holders The selling security holders may offer the Common Stock pursuant to this prospectus in varying amounts and transactions so long as this prospectus is then current under the rules of the Securities and Exchange Commission ("SEC") and we have not withdrawn the registration statement. The offering of Common Stock may be through the facilities of the OTC Bulletin Board or such other 1 exchange or reporting system where the Common Stock may be traded. Brokerage commissions may be paid or discounts allowed in connection with such sales; however, it is anticipated that the discounts allowed or commissions paid will be no more than the ordinary brokerage commissions paid on sales effected through brokers or dealers. To our knowledge, as of the date hereof, no one has made any arrangements with a broker or dealer concerning the offer or sale of the Common Stock. See "Plan of Distribution." Outstanding Securities As of September 18, 2007, there were 33,363,173 shares of our Common Stock outstanding. On a fully-diluted basis, giving effect to and assuming the exercise or conversion of all of our options, warrants and derivative securities, we would have had outstanding an aggregate of approximately 55 million shares of Common Stock at September 18, 2007. Risks An investment in the shares of our Company is subject to a number of risks. We have set forth these risk factors below under the heading "Risk Factors" which you should carefully review. 2 RISK FACTORS The reader should carefully consider each of the risks described below. If any of the following risks develop into actual events, our business, financial condition or results of operations could be materially adversely affected and the trading price of the Common Stock could decline significantly. Risks Relating to Our Business and the Oil and Natural Gas Industry. A substantial or extended decline in oil and natural gas prices may adversely affect our business, financial condition or results of operations and our ability to meet our capital expenditure obligations and financial commitments. The prices we receive for our oil and natural gas production heavily influence our revenue, profitability, access to capital and future rate of growth. Oil and natural gas are commodities and, therefore, their prices are subject to wide fluctuations in response to relatively minor changes in supply and demand. Historically, the markets for oil and natural gas have been volatile. These markets will likely continue to be volatile in the future. The prices we receive for our production, and the levels of our production, depend on numerous factors beyond our control. These factors include, but are not limited to, the following: o changes in global supply and demand for oil and natural gas; o the actions of certain foreign states, such as the governments of Venezuela or Iran; o the price and quantity of imports of foreign oil and natural gas; o political conditions, including embargoes, in or affecting other oil producing activities; o the level of global oil and natural gas exploration and production activity; o the level of global oil and natural gas inventories; production or pricing decisions made by the Organization of Petroleum Exporting Countries (OPEC); o weather conditions; o technological advances affecting energy consumption; and o the price and availability of alternative fuels. Lower oil and natural gas prices may not only decrease our revenues on a per unit basis but also may reduce the amount of oil and natural gas that we can produce economically. Lower prices will also negatively impact the value of our proved reserves. A substantial or extended decline in oil or natural gas prices may materially and adversely affect our future business, financial condition, results of operations, liquidity or ability to finance planned capital expenditures. Drilling for and producing oil and natural gas are high risk activities with many uncertainties that could adversely affect our business, financial condition or results of operations. Our future success will depend on the success of our exploitation, exploration, development and production activities. Our oil and natural gas exploration and production activities are subject to numerous risks beyond our control, including the risk that drilling will not result in commercially viable oil or natural gas production. Our decisions to purchase, explore, develop or otherwise exploit prospects or properties will depend in part on the evaluation of data obtained through geophysical and geological analyses, production data and engineering studies, the results of which are often inconclusive or subject to varying interpretations. Please read "- Reserve estimates depend on many assumptions that may turn out to be inaccurate" (below) for a discussion of the uncertainties involved in these processes. Our costs of drilling, completing and operating wells is often uncertain before drilling commences. Overruns in budgeted expenditures are common risks that can make a particular project uneconomical. Further, many factors may curtail, delay or cancel drilling, including the following: 3 o delays imposed by or resulting from compliance with regulatory requirements; o pressure or irregularities in geological formations; o shortages of or delays in obtaining equipment and qualified personnel; o equipment failures or accidents; o adverse weather conditions; o reductions in oil and natural gas prices; o oil and natural gas property title problems; and o market limitations for oil and natural gas. If oil and natural gas prices decrease, we may be required to take write-downs of the carrying values of our oil and natural gas properties, potentially triggering earlier-than-anticipated repayments of any outstanding debt obligations and negatively impacting the trading value of our securities. Accounting rules require that we review periodically the carrying value of our oil and natural gas properties for possible impairment. Based on specific market factors and circumstances at the time of prospective impairment reviews, and the continuing evaluation of development plans, production data, economics and other factors, we may be required to write down the carrying value of our oil and natural gas properties. Because our properties will likely serve as collateral for advances under our future credit facilities, a write-down in the carrying values of our properties could require us to repay debt earlier than we would otherwise be required. A write-down would also constitute a non-cash charge to earnings. It is likely that the cumulative effect of such a write-down could also negatively impact the trading price of our securities. We account for our oil and gas properties using the successful efforts method of accounting. Under this method, all development costs and acquisition costs of proved properties are capitalized and amortized on a units-of-production basis over the remaining life of proved developed reserves and proved reserves, respectively. Costs of drilling exploratory wells are initially capitalized, but charged to expense if and when a well is determined to be unsuccessful. We evaluate impairment of its proved oil and gas properties whenever events or changes in circumstances indicate an asset's carrying amount may not be recoverable. The risk that the company will be required to write down the carrying value of its oil and natural gas properties increases when oil and gas prices are low or volatile. In addition, write-downs would occur if we were to experience sufficient downward adjustments to our estimated proved reserves or the present value of estimated future net revenues. Reserve estimates depend on many assumptions that may turn out to be inaccurate. Any material inaccuracies in these reserve estimates or underlying assumptions will materially affect the quantities and present value of our reserves. The process of estimating oil and natural gas reserves is complex. It requires interpretations of available technical data and many assumptions, including assumptions relating to economic factors. Any significant inaccuracies in these interpretations or assumptions could materially affect the estimated quantities and present value of our reported reserves. In order to prepare our estimates, we must project production rates and timing of development expenditures. We must also analyze available geological, geophysical, production and engineering data. The extent, quality and reliability of this data can vary. The process also requires economic assumptions about matters such as oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. Therefore, estimates of oil and natural gas reserves are inherently imprecise. 4 Actual future production, oil and natural gas prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable oil and natural gas reserves most likely will vary from our estimates. Any significant variance could materially affect the estimated quantities and present value of our reported reserves. In addition, we may adjust estimates of proved reserves to reflect production history, results of exploration and development, prevailing oil and natural gas prices and other factors, many of which are beyond our control. Prospects that we decide to drill may not yield oil or natural gas in commercially viable quantities. Our prospects are in various stages of evaluation. There is no way to predict in advance of drilling and testing whether any particular prospect will yield oil or natural gas in sufficient quantities to recover drilling or completion costs or to be economically viable. The use of seismic data and other technologies and the study of producing fields in the same area will not enable us to know conclusively prior to drilling whether oil or natural gas will be present or, if present, whether oil or natural gas will be present in commercial quantities. We cannot assure you that the analogies we draw from available data from other wells, more fully explored prospects or producing fields will be applicable to our drilling prospects. Special geological characteristics of the New Albany Shale area will require us to use less-common drilling technologies in order for our development efforts to be economically viable. The near-term focus of our development activities will be concentrated to a large degree in the New Albany Shale area, which exposes us to risks associated with prospect concentration. Except for our proposed development and production activities in the 4600 acres of the north Texas asset region acquired in the Stephens County Transaction in April 2007, our development activities are largely concentrated in the 171,000 acre New Albany Shale area. New Albany Shale reservoirs are complex, often containing unusual features that are not well understood by drillers and producers. Successful operations in this area require specialized technical staff expertise in horizontal drilling, with respect to which we have limited experience. The New Albany Shale contains vertical fractures. Results of past drilling in the New Albany Shale have been mixed and are generally believed to be related to whether or not a particular well bore intersects a vertical fracture. While wells have been drilled into the New Albany Shale for years, most of those wells have been drilled vertically. Where vertical fractures have been encountered, production has been better. It is expected that horizontal drilling will allow us to encounter more fractures by drilling perpendicular to the fracture planes. While it is believed that the New Albany Shale is subject to some level of vertical fracturing throughout the Illinois Basin, certain areas will be more heavily fractured than others. If our area of interest is not subject to the level of vertical fracturing that we expect, then our plan for horizontal drilling might not yield our expected results. Gas and water are produced together from the New Albany Shale. Water is often produced in significant quantities, especially early in the producing life of a well. We plan to dispose of this produced water by means of injecting it into other porous and permeable formations via disposal wells located adjacent to producing wells. If we are unable to find such porous and permeable reservoirs into which to inject this produced water or if we are prohibited from injecting because of governmental regulation, then our cost to dispose of produced water could increase significantly, thereby affecting the economic viability of producing the New Albany Shale wells. The relative concentration of our near-term activities in the New Albany Shale means that any impairments or material reductions in the expected size of the reserves attributable to the Company's wells, any material harm to the 5 producing reservoirs from which these wells produce or any significant governmental regulation with respect to any of these wells, including curtailment of production or interruption of transportation of production, could have a material adverse effect on the Company's financial condition and results of operations. We cannot control activities on properties that we do not operate and are unable to ensure their proper operation and profitability. We will not operate all of the properties in which we will own an interest. As a result, we have limited ability to exercise influence over, and control the risks associated with, the operations of these properties. The failure of an operator of our wells to adequately perform operations, an operator's breach of the applicable agreements or an operator's failure to act in ways that are in our best interests could reduce our production and revenues. The success and timing of our drilling and development activities on properties operated by others therefore depend upon a number of factors outside of our control, including the operator's o timing and amount of capital expenditures; o expertise and financial resources; o inclusion of other participants in drilling wells; and o use of technology. The marketability of our natural gas production depends on facilities that we typically do not own or control, which could result in a curtailment of production and revenues. The marketability of our production will depend in part upon the availability, proximity and capacity of natural gas gathering systems, pipelines and processing facilities. We generally deliver natural gas through gas gathering systems and gas pipelines that we do not own under interruptible or short-term transportation agreements. Under the interruptible transportation agreements, the transportation of our gas may be interrupted due to capacity constraints on the applicable system, for maintenance or repair of the system, or for other reasons as dictated by the particular agreements. Our ability to produce and market natural gas on a commercial basis could be harmed by any significant change in the cost or availability of such markets, systems or pipelines. Our future acquisitions may yield revenues or production that vary significantly from our projections. In acquiring producing properties, we will assess the recoverable reserves, future natural gas and oil prices, operating costs, potential liabilities and other factors relating to the properties. Our assessments are necessarily inexact and their accuracy is inherently uncertain. Our review of a subject property in connection with our acquisition assessment will not reveal all existing or potential problems or permit us to become sufficiently familiar with the property to assess fully its deficiencies and capabilities. We may not inspect every well, and we may not be able to observe structural and environmental problems even when we do inspect a well. If problems are identified, the seller may be unwilling or unable to provide effective contractual protection against all or part of those problems. Any acquisition of property interests may not be economically successful, and unsuccessful acquisitions may have a material adverse effect on our financial condition and future results of operations. Our business may suffer if we lose our Chief Executive Officer. Our success will be dependent on our ability to continue to employ and retain experienced skilled personnel. We depend to a large extent on the services of Thomas Kaetzer, our Chief Executive Officer and Chairman, the loss of whom could have a material adverse effect on our operations. Although we have 6 an employment agreement with Mr. Kaetzer which provides for notice before he may resign and contains non-competition and non-solicitation provisions, we do not, and likely will not, maintain key-man life insurance with respect to him or any of our employees. Hedging activities we engage in may prevent us from benefiting from price increases and may expose us to other risks. Following our entry into a credit facility in April 2007, we executed an arrangement to use derivative instruments to hedge the impact of market fluctuations on crude oil and natural gas prices. To the extent that we engage in hedging activities, it may be prevented from realizing the benefits of price increases above the levels of the hedges. In addition, we will be subject to risks associated with differences in prices at different locations, particularly where transportation constraints restrict our ability to deliver oil and gas volumes to the delivery point to which the hedging transaction is indexed. We have had a history of operating losses and we may have losses in the future. Since our inception in June 2004, we have had limited operations and nominal revenues. While we intend to increase our revenues through the New Albany properties and the Stephens County Transaction properties and other possible acquisitions, there can be no assurance that we will be successful. Our ability to generate net income will be strongly affected by, among other factors, our ability to successfully drill undeveloped reserves as well as the market price of crude oil and natural gas. If we are unsuccessful in drilling productive wells or the market price of crude oil and natural gas declines, we may report additional losses in the future. Consequently, future losses may adversely affect our business, prospects, financial condition, results of operations and cash flows. Our common stock is listed on the OTC Bulletin Board. Our common stock is not quoted on the NASDAQ National Market System or listed on a national securities exchange. The NASDAQ National Market System and national securities exchanges require companies to fulfill certain requirements in order for their shares to be listed and to continue to be listed. The securities of a company may be ineligible for listing or, if listed, may be considered for delisting if the company fails to meet certain financial thresholds, including if the company has sustained losses from continuing operations and/or net losses in recent fiscal years. There can be no assurance that we will not report additional losses in the future or that we will be able to list or have quoted our common stock on the NASDAQ National Market or a national securities exchange. An inability to list our common stock could adversely affect our ability to raise capital in the future by issuing common stock or securities convertible into or exercisable for our common stock. Continuing losses may mean that additional funding may not be available on acceptable terms, if at all. If adequate funds are unavailable from our operations or additional sources of financing, we might be forced to reduce or delay acquisitions or capital expenditures, sell assets, reduce operating expenses, refinance all or a portion of our debt, or delay or reduce important drilling or enhanced production initiatives. In addition, in that instance, we may seek to raise any necessary additional funds through equity or debt financings, convertible debt financing, joint ventures with corporate partners or other sources, which may be dilutive to our existing shareholders and may cause the price of our common stock to decline. 7 Our anticipated debt service obligations and cash requirements to fund our operations could harm our ability to operate our business. In April 2007 we entered into term and revolving line of credit facilities and borrowed approximately $30 million as part of the purchase price for the Stephens County Transaction completed on April 12, 2007. The line of credit is be available for borrowings to fund our working capital requirements and capital requirements, and is secured by substantially all of our oil and natural gas properties. Our degree of leverage may have important consequences to you, including the following: o we may have difficulty satisfying our obligations under our indebtedness and, if we fail to comply with these requirements, an event of default could result; o we may be required to dedicate a substantial portion of our cash flow from operations to required payments on indebtedness, thereby reducing the availability of cash flow for working capital, capital expenditures and other general corporate activities; o covenants relating to future debt may limit our ability to obtain additional financing for working capital, capital expenditures and other general corporate activities; o covenants relating to future debt may limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; o we may be more vulnerable to the impact of economic downturns and adverse developments in our business; and o we may be placed at a competitive disadvantage against any less leveraged competitors. The occurrence of any one of these events could have a material adverse effect on our business, financial condition, results of operations and future business prospects. The unavailability or high cost of drilling rigs, equipment, supplies, personnel and oil field services could adversely affect our ability to execute on a timely basis our exploration and development plans within our budget. With the increase in the prices of oil and natural gas, we have encountered an increase in the cost of securing drilling rigs, equipment and supplies. Shortages or the high cost of drilling rigs, equipment, supplies and personnel are expected to continue in the near-term. In addition, larger producers may be more likely to secure access to such equipment by virtue of offering drilling companies more lucrative terms. If we are unable to acquire access to such resources, or can obtain access only at higher prices, not only would this potentially delay our ability to convert our reserves into cash flow, but it could also significantly increase the cost of producing those reserves, thereby negatively impacting anticipated net income. We may incur substantial losses and be subject to substantial liability claims as a result of our oil and natural gas operations. We are not insured against all risks. Losses and liabilities arising from uninsured and underinsured events could materially and adversely affect our business, financial condition or results of operations. Our oil and natural gas exploration and production activities are subject to all of the 8 operating risks associated with drilling for and producing oil and natural gas, including the possibility of: o environmental hazards, such as uncontrollable flows of oil, natural gas, brine, well fluids, toxic gas or other pollution into the environment, including groundwater and shoreline contamination; o abnormally pressured formations; o mechanical difficulties, such as stuck oil field drilling and service tools and casing collapses; o fires and explosions; o personal injuries and death; and o natural disasters. Any of these risks could adversely affect our ability to conduct operations or result in substantial losses to the Company. We may elect not to obtain insurance if we believe that the cost of available insurance is excessive relative to the risks presented. In addition, pollution and environmental risks generally are not fully insurable. If a significant accident or other event occurs and is not fully covered by insurance, then that accident or other event could adversely affect our results of operations, financial condition and cash flows. We may not have enough insurance to cover all of the risks that we face. In accordance with customary industry practices, we maintain insurance coverage against some, but not all, potential losses in order to protect against the risks we face. We do not carry business interruption insurance. We may elect not to carry insurance if our management believes that the cost of available insurance is excessive relative to the risks presented. In addition, we cannot insure fully against pollution and environmental risks. The occurrence of an event not fully covered by insurance could have a material adverse effect on our financial condition and results of operations. We are subject to complex laws that can affect the cost, manner or feasibility of doing business. Exploration, development, production and sale of oil and natural gas are subject to extensive federal, state, local and international regulation. We may be required to make large expenditures to comply with governmental regulations. Matters subject to regulation include: o discharge permits for drilling operations; o drilling bonds; o reports concerning operations; o the spacing of wells; o unitization and pooling of properties; and o taxation. Under these laws, we could be liable for personal injuries, property damage and other damages. Failure to comply with these laws also may result in the suspension or termination of our operations and subject us to administrative, civil and criminal penalties. Moreover, these laws could change in ways that substantially increase our costs. Any such liabilities, penalties, suspensions, terminations or regulatory changes could materially adversely affect our financial condition and results of operations. 9 Our operations may cause us to incur substantial liabilities for failure to comply with environmental laws and regulations. Our oil and natural gas operations are subject to stringent federal, state and local laws and regulations relating to the release or disposal 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, quantities and concentration of 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 our operations. Failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, incurrence of investigatory or remedial obligations or the imposition of injunctive relief. Changes in environmental laws and regulations occur frequently, and any changes that result in more stringent or costly waste handling, storage, transport, disposal or cleanup requirements could require us to make significant expenditures to maintain compliance, and may otherwise have a material adverse effect on our results of operations, competitive position or financial condition as well as the industry in general. Under these environmental laws and regulations, we could be held strictly liable for the removal or remediation of previously released materials or property contamination regardless of whether we were responsible for the release or if our operations were standard in the industry at the time they were performed. We anticipate having substantial capital requirements that, if not met, may hinder our operations. We expect to experience substantial capital needs as a result of our planned development and acquisition programs. We expect that additional external financing will be required in the future to fund our growth. We may not be able to obtain additional financing, and financing under a new credit facility on acceptable terms may not be available in the future. Without adequate capital resources, we may be forced to limit our planned oil and natural gas acquisition and development activities and thereby adversely affect the recoverability and ultimate value of our oil and natural gas properties. This, in turn, would negatively affect our business, financial condition and results of operations. Competition in the oil and natural gas industry is intense, which may adversely affect our ability to compete. We operate in a highly competitive environment for acquiring properties, marketing oil and natural gas and securing trained personnel. Many of our competitors possess and employ financial, technical and personnel resources substantially greater than ours, which can be particularly important in the areas in which we operate. Those companies may be able to pay more for productive oil and natural gas properties and exploratory prospects and to evaluate, bid for and purchase a greater number of properties and prospects than our financial or personnel resources permit. Our ability to acquire additional prospects and to find and develop reserves in the future will depend on our ability to evaluate and select suitable properties and to consummate transactions in a highly competitive environment. We may not be able to compete successfully in the future in acquiring prospective reserves, developing reserves, marketing hydrocarbons, attracting and retaining quality personnel and raising additional capital. 10 If our access to markets is restricted, it could negatively impact our production, our income and ultimately our ability to retain our leases. Market conditions or the unavailability of satisfactory oil and natural gas transportation arrangements may hinder our access to oil and natural gas markets or delay our production. The availability of a ready market for our oil and natural gas production depends on a number of factors, including the demand for and supply of oil and natural gas and the proximity of reserves to pipelines and terminal facilities. Our ability to market our production depends in substantial part on the availability and capacity of gathering systems, pipelines and processing facilities owned and operated by third parties. Our failure to obtain such services on acceptable terms could materially harm our business. Our productive properties may be located in areas with limited or no access to pipelines, thereby necessitating delivery by other means, such as trucking, or requiring compression facilities. Such restrictions on our ability to sell our oil or natural gas have several adverse affects, including higher transportation costs, fewer potential purchasers (thereby potentially resulting in a lower selling price) or, in the event we were unable to market and sustain production from a particular lease for an extended time, possibly causing us to lose a lease due to lack of production. Risks Relating to Our Common Stock You may experience dilution of your ownership interests due to the future issuance of additional shares of the Company's common stock The Company may in the future issue its previously authorized and unissued securities, which will result in the dilution of the ownership interests of its present stockholders. The Company is currently authorized to issue 140,000,000 shares of common stock and 10,000,000 shares of preferred stock with such designations, preferences and rights as determined by our Board of Directors. As of September 18, 2007, we have issued 33,363,173 shares of our common stock. In addition, we have outstanding options, warrants and convertible promissory notes to purchase up to an approximate additional 21.6 million shares of the Company's common stock. Issuance of additional shares of common stock may substantially dilute the ownership interests of the Company's existing stockholders. The potential issuance of such additional shares of common stock may create downward pressure on the trading price of our common stock that in turn will require it to issue additional shares to raise funds through sales of its securities. The Company may also issue additional shares of its stock in connection with the hiring of personnel, future acquisitions, future private placements of its securities for capital raising purposes, or for other business purposes. This will further dilute the interests of the Company's existing holders. The market price of our common stock may be affected by low volume float. While there has been a public market for our common stock on the OTC Bulletin Board, our common stock is very thinly traded. Substantial sales of our common stock, including shares issued upon the exercise of outstanding options and warrants, in the public market, or the perception that these sales could occur, may have a depressive effect on the market price of our common stock. Such sales or the perception of such sales could also impair our ability to raise capital or make acquisitions through the issuance of our common stock. 11 We have no plans to, and are currently unable to, pay dividends on our common stock. You may not receive funds without selling your stock. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. We currently intend to retain future earnings, if any, to finance the expansion of our business. Our future dividend policy is within the discretion of our Board of Directors and will depend upon various factors, including our business, financial condition, results of operations, capital requirements and investment opportunities. Our accumulated losses and stockholders' deficits prevent us from being able to declare and pay dividends. In addition, our proposed credit facility will prohibit us from paying dividends. We may issue shares of preferred stock having greater rights than our common stock. Although we have no current plans, arrangements, understandings or agreements to issue any preferred stock, our certificate of incorporation authorizes our Board of Directors to issue one or more series of preferred stock and set the terms of the preferred stock without seeking any further approval from our shareholders. Any preferred stock that is issued may rank ahead of our common stock, with respect to dividends, liquidation rights and voting rights, among other things. Provisions under Nevada law could delay or prevent a change in control of our company, which could adversely affect the price of our common stock. While we do not believe that we currently have any provisions in our organizational documents that could prevent or delay a change in control of our company (such as provisions calling for a staggered Board of Directors, or the issuance of stock with super-majority voting rights), the existence of some provisions under Nevada law could delay or prevent a change in control of our Company, which could adversely affect the price of our common stock. Nevada law imposes some restrictions on mergers and other business combinations between us and any holder of 10% or more of our outstanding common stock. Conflicts of interests for certain members of the present management exist with regards to their obligations to the Company and their obligations to businesses in which they continue to own interests and manage. The officers and directors of the Company are subject to the certain duties imposed on them under the Nevada law, including a general requirement that certain opportunities within the scope of the Company's proposed business operations which come to their attention may be considered opportunities that should be made available to the Company and the companies that they are affiliated with on an equal basis. A breach of this requirement will be a breach of the fiduciary duties of the officer and director. If the Company or any of the other companies with which that officer or director is affiliated both desire to take advantage of an opportunity, then those officers and directors would abstain from negotiating and voting upon the business opportunity. Even in the event these procedures are followed, we cannot assure you that conflicts of interests among the Company, its officers and directors and Dune will not develop. 12 CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS Our disclosure and analysis in this prospectus contain some forward-looking statements. Certain of the matters discussed concerning our operations, cash flows, financial position, economic performance and financial condition, including, in particular, future sales, product demand, competition and the effect of economic conditions include forward-looking statements within the meaning of section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, referred to herein as the Exchange Act. Statements that are predictive in nature, that depend upon or refer to future events or conditions or that include words such as "expects," "anticipates," "intends," "plans," "believes," "estimates" and similar expressions are forward-looking statements. Although we believe that these statements are based upon reasonable assumptions, including projections of orders, sales, operating margins, earnings, cash flow, research and development costs, working capital, capital expenditures, distribution channels, profitability, new products, adequacy of funds from operations, these statements and other projections and statements contained herein expressing general optimism about future operating results and non-historical information, are subject to several risks and uncertainties, and therefore, we can give no assurance that these statements will be achieved. Investors are cautioned that our forward-looking statements are not guarantees of future performance and actual results or developments may differ materially from the expectations expressed in the forward-looking statements. As for the forward-looking statements that relate to future financial results and other projections, actual results will be different due to the inherent uncertainty of estimates, forecasts and projections and may be better or worse than projected. Given these uncertainties, you should not place any reliance on these forward-looking statements. These forward-looking statements also represent our estimates and assumptions only as of the date that they were made. We expressly disclaim a duty to provide updates to these forward-looking statements, and the estimates and assumptions associated with them, after the date of this filing to reflect events or changes in circumstances or changes in expectations or the occurrence of anticipated events. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise. You are advised, however, to consult any additional disclosures we make in our Form 10-KSB, Form 10-QSB and Form 8-K reports to the SEC. Also note that we provide a cautionary discussion of risk and uncertainties under the caption "Risk Factors" in this prospectus. These are factors that we think could cause our actual results to differ materially from expected results. Other factors besides those listed here could also adversely affect us. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995. 13 USE OF PROCEEDS We will not receive any of the proceeds from the selling stockholders' sale of the shares offered under this prospectus. DETERMINATION OF OFFERING PRICE We are not selling any of the Common Stock that we are registering. The Common Stock will be sold by the selling security holders listed in this prospectus. The selling security holders may sell the Common Stock at the market price as of the date of sale or a price negotiated in a private sale. Our Common Stock is traded on the OTC Bulletin Board under the symbol "BOGA". On September 18, 2007 the reported closing price for our Common Stock on the OTC Bulletin Board was $0.63. We have agreed to pay certain expenses in connection with the registration of the securities offered by the selling security holders for resale pursuant to this prospectus. 14 SELLING SECURITY HOLDERS Based on information provided by the selling security holders, the table below sets forth certain information, as of September 18, 2007 unless otherwise noted, regarding the selling security holders. Certain of the selling security holders (identified by more than one footnote reference after their name) are listed more than once in the following table because they fall into multiple categories of selling security holders. However, their shares are counted only once in arriving at the total number of shares beneficially owned and being offered by the selling stockholders. Percentage ownership of common stock is based on 33,363,173 shares of our Common Stock outstanding as of September 18, 2007. For purposes of calculating the post-offering ownership of each selling security holder, the table also assumes the sale of all of the securities being offered by such selling security holder. Next to the name of each selling stockholder listed below that is not a natural person (or the name of which is not identified with a natural person), we have set forth in parentheses the name of the natural person who has the power to exercise voting and/or investment power over the shares owned by such selling stockholder. Except for C.K Cooper & Company and Gilford Securities, Inc., who served as placement agents in our private offerings, no selling stockholder is a registered broker-dealer. The second column from the left in the table below lists the number of shares of Common Stock beneficially owned by each selling stockholder, based on his/her ownership of the shares of our Common Stock. The third column from the left lists the shares of Common Stock being offered pursuant to this prospectus by the selling stockholders. The fourth column from the left assumes the sale of all of the shares offered by the selling stockholders pursuant to this prospectus. The selling stockholders may sell all, some or none of their shares in this offering. See "Plan of Distribution."
Common stock beneficially owned after the offering Number of ---------------------------------- shares of common stock Percentage beneficially of owned prior to Number of shares Outstanding Name of selling security holders the offering (+) being offered Number of shares shares - -------------------------------- ---------------- ------------- ---------------- ----------- Certain Holders of April 2005 Stock Options (1): R. Scott Barter (2005 Defined Contribution Plan)(1a) 500,000 500,000 0 0 Steven Barrenechea (1b) 250,000 250,000 0 0
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Common stock beneficially owned after the offering Number of --------------------------------- shares of common stock Percentage beneficially of owned prior to Number of shares Outstanding Name of selling security holders the offering (+) being offered Number of shares shares - -------------------------------- ---------------- ------------- ---------------- ----------- Wayne Brannan 630,000 250,000 380,000 1.2 % Carey Birmingham (1c) 508,000 100,000 408,000 1.3 % David Loev (1d) 125,000 100,000 25,000 *
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Common stock beneficially owned after the offering Number of --------------------------------- shares of common stock Percentage beneficially of owned prior to Number of shares Outstanding Name of selling security holders the offering (+) being offered Number of shares shares - -------------------------------- ---------------- ------------- ---------------- ----------- Placement Agent in November 2005 Financing: Gilford Securities, Inc.(A)(C)(2) 475,000 475,000 0 0 Holder of December 2005 Stock Option: Richard M. Cohen (3) 475,000 175,000 300,000 * Investors in February 2006 Financing (4): Pemigewasset Partners L.P. 91,742 91,742 0 0 Pemigewasset Offshore Ltd. 13,709 13,709 0 0 Stephen Taylor 52,725 52,725 0 0 Dr. Steven Rosenberg and Robin Rosenberg JT WROS 47,932 47,932 0 0 Jack Jankovic 47,932 47,932 0 0 James R. Stevens (B)(D)(E) 47,932 47,932 0 0 Ruth Winkle and William Winkle JT WROS 47,932 47,932 0 0 Neil Breslau 47,932 47,932 0 RFJM Partners LLC (Jeffrey Markowitz) 95,864 95,864 0 0 BRU Holding Co., LLC (Bruce Toll) 143,795 143,795 0 0 Kevin T. Tolbert 47,932 47,932 0 0 Leonidas Group LLC 47,932 47,932 0 0 Stephen Weingrow 47,932 47,932 0 0 Larry Schmalz 47,932 47,932 0 0 Scott M. Wallace 47,932 47,932 0 0 Loretta Diamond 47,932 47,932 0 0
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Common stock beneficially owned after the offering Number of ---------------------------------- shares of common stock Percentage beneficially of owned prior to Number of shares Outstanding Name of selling security holders the offering (+) being offered Number of shares shares - -------------------------------- ---------------- ------------- ---------------- ----------- Girdhar Korlipara 47,932 47,932 0 0 Frommer Investment Partners LP (Sachin Shah) (B)(D)(E) 95,864 95,864 0 0 Mark Abrams 52,725 52,725 0 0 Michael Vandemaele 52,725 52,725 0 0 Tiedemann Trust Company TTEE Trust B U/W Edward Burke Ross FBO Amory L. Ross I/M 47,932 47,932 0 0 Bruce C. Conway 52,725 52,725 0 0 Kurt Eichler 47,932 47,932 0 0 Lawrence Antonucci 47,932 47,932 0 0 Saleh Alamoudi 47,932 47,932 0 0 Robert Holmes TTEE The Holmes Family Trust UA DTD 4/24/87 52,725 52,725 0 0 Gus Blass II 210,900 210,900 0 0 Richard M. Dearnley 210,900 210,900 0 0 RCB Securities Profit Sharing Plan (Robert Bedford) 52,725 52,725 0 0 Jay R. Kuhne 52,725 52,725 0 0 Howard Malman 36,908 36,908 0 0 Gerald Zeitz 52,725 52,725 0 0 Goldstein Family Associates, LLP (Barry Goldstein) 26,363 26,363 0 0 Ronald Shear 52,725 52,725 0 0 Hwang Community Property Trust (Li-San Hwang Trustee) 242,540 242,540 0 0 George H. Robinette III 68,543 68,543 0 0 Phil Frey Living Trust of 3/20/96 (Phil Frey Trustee) 71,706 71,706 0 0 Henry Bedinger Mitchell III 31,635 31,635 0 0
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Common stock beneficially owned after the offering Number of ---------------------------------- shares of common stock Percentage beneficially of owned prior to Number of shares Outstanding Name of selling security holders the offering (+) being offered Number of shares shares - -------------------------------- ---------------- ------------- ---------------- ----------- Janis Salin 52,725 52,725 0 0 Gary Brennglass 52,725 52,725 0 0 Cordillera Fund, L.P. (Stephen Carter) 418,637 418,637 0 0 Enable Growth Partners LP (Mitch Levine) (B)(D)(E) 305,605 305,605 0 0 Enable Opportunity Partners LP (Mitch Levine) (B)(D)(E) 50,236 50,236 0 0 Pierce Diversified Strategy Master Fund LLC (Mitch Levine) (B)(D)(E) 62,796 62,796 0 0 Kaia Offshore Partners, LP (Jack Alfandary) 104,715 104,715 0 0 Kaia Partners I LP (Jack Alfandary) 44,008 44,008 0 0 Vladimir Vagin 527,251 527,251 0 0 Fribourg Enterprises, Inc. 527,251 527,251 0 0 Israel Braunstein 105,450 105,450 0 0 Moses & Yetta Braunstein Trust (Israel Braunstein) 105,450 105,450 0 0 Rachel B. Blass 105,450 105,450 0 0 Nicola Dimonda 52,725 52,725 0 0 Jodi Kirsch 47,932 47,932 0 0 Fountainhead Investments, Inc. (Peter Zachariou) 47,932 47,932 0 0 David Cantor 23,937 23,937 0 0 Philip Clark 26,363 26,363 0 0 CMS Capital 94,905 94,905 0 0 Howard Weiss 63,270 63,270 0 0 Superius Securities Group Inc. Profit Sharing Plan (James Hudgins) 958,637 958,637 0 0 Stanford S. Warshawsky 101,232 101,232 0 0 Ronald Koenig 52,725 52,725 0 0
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Common stock beneficially owned after the offering Number of ---------------------------------- shares of common stock Percentage beneficially of owned prior to Number of shares Outstanding Name of selling security holders the offering (+) being offered Number of shares shares - -------------------------------- ---------------- ------------- ---------------- ----------- Peter D. Burack 21,090 21,090 0 0 Larry Lomrantz & Merle Robin Lomrantz, Joint Tenants 10,545 10,545 0 0 Diamondback Master Fund, Ltd. (Chad Loweth) 771,884 771,884 0 0 Daniel A. Burack 42,180 42,180 0 0 Bayberrie Partners (Elliott Jaffe) 101,232 101,232 0 0 Avedis Movsesian 21,090 21,090 0 0 Arthur & Marylin B. Levitt 95,865 95,865 0 0 Amiel David 68,543 68,543 0 0 Gerald Parselle Wilton 37,962 37,962 0 0 Milton Dressner 95,865 95,865 0 0 Gavin Scotti 95,865 95,865 0 0 Chris Engel 101,232 101,232 0 0 Louisa Ramsay 42,180 42,180 0 0 Henry D'Abo 95,855 95,855 0 0 Blair Harrison 52,725 52,725 0 0 Stiletto Capital Partners, LP (Jonathan Sorensen) (B)(D)(E) 105,450 105,450 0 0 MLC Management Company 210,900 210,900 0 0 Tembo Associates LLC, Series C (Jeffrey Tweedy) 143,412 143,412 0 0 Holders of Warrants Issued in February 2006 Financing (5): C.K. Cooper & Company (Otilia Chen)(A)(C)(5a) 122,728 122,728 0 0 Gilford Securities, Inc. (Robert Malley) 1A)(C)(5b) 81,818 81,818 0 0 The Altitude Group LLC (Michael Kreizman)(5c) 45,454 45,454 0 0 Matthew Toboroff (5d) 4,545 4,545 0 0
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Common stock beneficially owned after the offering Number of ---------------------------------- shares of common stock Percentage beneficially of owned prior to Number of shares Outstanding Name of selling security holders the offering (+) being offered Number of shares shares - -------------------------------- ---------------- ------------- ---------------- ----------- Jacqueline Toboroff (5d) 4,545 4,545 0 0 ---------- ---------- --------- Totals: 11,599,828 10,486,828 1,113,000
- ---------- (*) Less than one percent. (+) A person is deemed to be the beneficial owner of securities that can be acquired within 60 days from August 1, 2007. Each beneficial owner's percentage is determined by assuming that options and warrants that are held by such person (but not any other person), and which are exercisable within 60 days from August 1, 2007, have been exercised. (A) Is a registered broker dealer. (B) Is an affiliate of a registered broker dealer. (C) Is deemed to be an underwriter. (D) Is not deemed to be an underwriter. (E) Acquired its shares of common stock in the ordinary course of business and, at the time of the acquisition, did not have any arrangements or understandings with any person to distribute the securities. (1) The individuals listed under this heading (except R. Scott Barter) are among those who received stock options from us on April 29, 2005, exercisable for an aggregate of 12,950,000 shares of our Common Stock at the exercise price of $.05 per share (the "April Options"), which April Options will expire on April 28, 2010. (1a) Represents option granted on April 1, 2005, exercisable for 500,000 shares of our Common Stock at the exercise price of $0.30 per share, which option expires on April 1, 2010 and provides for "cashless exercise." (1b) Includes April Options exercisable for 250,000 shares of our Common Stock. Mr. Barrenechea was previously one of our Board members. (1c) Includes April Options exercisable for 100,000 shares of our Common Stock. Also includes option granted on October 20, 2006, exercisable for up to 75,000 shares of our Common Stock at an exercise price of $0.50 per share, which option expires on October 20, 2011. Mr. Birmingham previously served as our President. (1d) Includes April Options exercisable for 100,000 shares of our Common Stock. Also includes option granted on October 20, 2006, exercisable for up to 25,000 shares of our Common Stock, at an exercise price of $0.50 per share, which option expires on October 20, 2011. [NOTE OMITTED] 21 [NOTE OMITTED] 22 (2) As the placement agent in our November 2005 Financing, Gilford Securities, Inc. received from us warrants immediately exercisable into an aggregate of 475,000 shares of our Common Stock at the exercise price of $0.50 per share. Such warrants expire in November 2010 and have "cashless" exercise provisions. 475,000 of the shares listed as beneficially owned by Gilford Securities represent the shares issuable upon exercise of such warrants. (3) Represents (i) option granted on December 27, 2005, exercisable for up to 175,000 shares of our Common Stock at an exercise price of $0.94 per share, which option expires on December 27, 2010 and (ii) option granted on January 4, 2007, exercisable for up to 100,000 shares of our Common Stock at an exercise price of $0.56 per share, which option expires on January 4, 2012. Mr. Cohen previously served as our Chief Financial Officer. (4) The investors from our February 2006 Financing (defined herein) are listed below under this heading. We raised an aggregate gross amount of $9,000,000 by issuing to investors 8,181,818 shares of our Common Stock at the price of $1.10 per share (the "February 2006 Financing"). We are registering for each of the investors in our February 2006 Financing the number of shares of Common Stock which they acquired from us in such financing (which number is listed in the second column to the right of each investor's name), plus certain additional shares issuable pro rata to each such investor, pursuant to a Registration Rights Agreement between us and such investor, as a result of our not filing a registration statement under the Securities Act with respect to such investor's shares by April 2, 2006 and not attaining effectiveness of such registration statement by June 2, 2006. Such amounts are to be pro-rated for partial months. We elected to pay our penalty in shares of additional Common Stock and, in the registration statement originally filed with the SEC on June 13, 2006, we listed additional shares, in the estimated aggregate amount of 673,920, separately under the heading "Shares Issuable as Penalty". Such share amount was calculated by taking the sum of (i) 1% of such investors' investment ($90,000) divided by $2.94 (the closing price of the Common Stock on April 2, 2006), plus (ii) $90,000 divided by $3.10 (the closing price of the Common Stock on May 2, 2006), plus (iii) $90,000 divided by $2.43 (the closing price of the Common Stock on June 1, 2006), plus (iv) $90,000 divided by $1.19 (the closing price of the Common Stock on July 3, 2006, plus (v) $90,000 divided by $1.01 (the closing price of the Common Stock on August 2, 2006, plus (vi) $90,000 divided by $0.80 (the closing price of the Common Stock on September 1, 2006, plus (vii) an additional estimated 300,000 shares to cover additional delay beyond October 2, 2006. The original registration statement was declared effective by the SEC on October 20, 2006, reducing to 445,920 the total number of shares actually issued as a penalty in the February 2006 Financing, based upon the sum of (A) that number of shares for the six preceding months, as calculated above PLUS (B) $90,000 divided by $0.75 (the closing price of the Common Stock on October 2, 2006) pro rated through October 20, 2006. This penalty amount is allocated among the investors in the Post-effective Amendment No. 2 to our registration statement. (5) C.K. Cooper & Company and Gilford Securities, Inc. were the placement agents in our February 2006 Financing and, in connection therewith, received warrants to purchase 122,728 and 81,818 shares, respectively, of our Common Stock. In addition, for their assistance in the February 2006 Financing, we issued warrants to purchase 45,454 shares of our Common Stock to the Altitude Group LLC and warrants to purchase 4,545 shares to each of Matthew Toboroff and Jacqueline Toboroff. Such warrants are immediately exercisable at the price of $1.32 per share, expire in February 2009, and have "cashless exercise" provisions. (5a) The shares of Common Stock listed as beneficially owned by C.K. Cooper & Company are the shares issuable upon its exercise of such warrants issued to C.K. Cooper in connection with the February 2006 Financing. (5b) Of the shares of Common Stock listed as beneficially owned by Gilford Securities, Inc., 81,818 of the shares are the shares issuable upon exercise of such warrants issued to Gilford Securities in connection with the February 2006 Financing. (5c) The shares of Common Stock listed as beneficially owned by The Altitude Group LLC are the shares issuable upon its exercise of the warrants which we issued to it in connection with the February 2006 Financing. (5d) The shares of Common Stock listed as beneficially owned by each of Matthew Toboroff and Jacqueline Toboroff are the shares issuable upon each of his/her exercise of the warrants which we issued to him or her in connection with the February 2006 Financing. 23 PLAN OF DISTRIBUTION All fees, costs, expenses and fees in connection with the registration of the Common Stock offered by this prospectus will be borne by us. Brokerage commissions, if any, attributable to the sale of the Common Stock will be borne by the selling security holders. The selling security holders may sell the Common Stock directly or through brokers, dealers or underwriters who may act solely as agents or may acquire Common Stock as principals. The selling stockholders may distribute the Common Stock in one or more of the following methods: o ordinary brokers transactions, which may include long or short sales; o transactions involving cross or block trades or otherwise on the open market; o purchases by brokers, dealers or underwriters as principal and resale by these purchasers for their own accounts under this prospectus; o "at the market" to or through market makers or into an existing market for the Common Stock; o in other ways not involving market makers or established trading markets, including direct sales to purchasers or sales made through agents; o through transactions in options, swaps or other derivatives (whether exchange listed or otherwise); or o any combination of the above, or by any other legally available means. Selling security holders will not be restricted as to the price or prices at which the selling security holders may sell their Common Stock. Sales of Common Stock by the selling security holders may depress the market price of our Common Stock since the number of shares which may be sold by the selling security holders is very large compared to the historical average weekly trading volume of our Common Stock, which has been quite low. Accordingly, if the selling security holders were to sell, or attempt to sell, all of such securities at once or during a short time period, we believe such a transaction would dramatically adversely affect the market price of our Common Stock. From time to time a selling security holder may pledge its Common Stock under margin provisions of customer agreements with its brokers or under loans with third parties. Upon a default by the selling security holder, the broker or such third party may offer and sell any pledged securities from time to time. In effecting sales, brokers and dealers engaged by a selling security holder may arrange for other brokers or dealers to participate in the sales as agents or principals. Brokers or dealers may receive commissions or discounts from the selling security holder or, if the broker-dealer acts as agent for the purchaser of such Common Stock, from the purchaser in amounts to be negotiated, which compensation as to a particular broker dealer might be in excess of customary commissions customary in the types of transactions involved. Broker-dealers may agree with the selling security holders to sell a specified number of shares of Common Stock at a stipulated price, and to the extent the broker-dealer is unable to do so acting as agent for the selling security holders, to purchase as principal any unsold securities at the price required to fulfill the broker-dealer commitment to the selling security holder. Broker-dealers who acquire securities as principal may then resell those 24 securities from time to time in transactions: in the over-the counter market or otherwise; at prices and on terms prevailing at the time of sale; at prices related to the then-current market price; or in negotiated transactions. These resales may involve block transactions or sales to and through other broker-dealers, including any of the transactions described above. In connection with these sales, these broker-dealers may pay to or receive from the purchasers of the Common Stock commissions as described above. The selling security holders may also sell the Common Stock in open market transactions under Rule 144 under the Securities Act, rather than under this prospectus. The selling security holders and any broker-dealers or agents that participate with the selling security holders in sales of the Common Stock may be deemed to be "underwriters" within the meaning of the Securities Act in connection with these sales. In this event, any commissions received by these broker-dealers or agents and any profit on the resale of the Common Stock purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act. The selling security holders may agree to indemnify any agent, dealer or broker-dealer that participates in transactions involving sales of the Common Stock against certain liabilities, including liabilities arising under the Securities Act. NASD Notice to Members 88-101 states that in the event a selling shareholder intends to sell any of the shares registered for resale in this Prospectus through a member of the NASD participating in a distribution of our securities, such member is responsible for insuring that a timely filing is first made with the Corporate Finance Department of the NASD and disclosing to the NASD the following: o it intends to take possession of the registered securities or to facilitate the transfer of such certificates; o the complete details of how the selling shareholders shares are and will be held, including location of the particular accounts; o whether the member firm or any direct or indirect affiliates thereof have entered into, will facilitate or otherwise participate in any type of payment transaction with the selling shareholders, including details regarding any such transactions; and o in the event any of the securities offered by the selling shareholders are sold, transferred, assigned or hypothecated by any selling shareholder in a transaction that directly or indirectly involves a member firm of the NASD or any affiliates thereof, that prior to or at the time of said transaction the member firm will timely file all relevant documents with respect to such transaction(s) with the Corporate Finance Department of the NASD for review. The selling security holders are subject to applicable provisions of the Securities Exchange Act of 1934 (the "Exchange Act") and the SEC's rules and regulations, including Regulation M, which provisions may limit the timing of purchases and sales of the securities by the selling security holders. We have advised the selling shareholders that the anti-manipulation rules of Regulation M under the Exchange Act may apply to sales of shares in the market and to the activities of the selling shareholders and their affiliates. In addition, we will make copies of this Prospectus available to the selling shareholders for the purpose of satisfying the Prospectus delivery requirements of the Securities Act. The selling security holders may agree to indemnify any 25 agent, dealer or broker-dealer that participates in transactions involving sales of the Common Stock against certain liabilities, including liabilities arising under the Securities Act. In order to comply with certain states' securities laws, if applicable, the Common Stock may be sold in those jurisdictions only through registered or licensed brokers or dealers. In certain states the securities may not be sold unless they have been registered or qualified for sale in such state, or unless an exemption from registration or qualification is available and is obtained. We have agreed to indemnify each selling stockholder whose shares we are registering from all liability and losses resulting from any misrepresentations we make in connection with the registration statement. LEGAL PROCEEDINGS The Company is not currently involved in any litigation. 26 DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS The following table sets forth information as of August 1, 2007 with respect to the current directors and executive officers of the Company: Name Age Position with the Company ------------------- --------- ------------------------------------- Thomas Kaetzer 47 Chairman, Chief Executive Officer (1) Patrick H. McGarey 49 Chief Financial Officer Alan Gaines 51 Director Richard d'Abo 51 Director - ---------- (1) Effective March 21, 2007, Barrie Damson resigned as Chairman and Chief Executive Officer, as a result of which Mr. Kaetzer was promoted from President/COO to Chairman/CEO. The business experience of each director and named executive officer of the Company is set forth below: Mr. Thomas Kaetzer. Mr. Kaetzer was promoted to our chairman and chief executive officer on March 21, 2007. He previously was our president and chief operating officer, titles he held since December 2006. He brings 25 years of experience in the oil and gas industry. Mr. Kaetzer began his career with Texaco Inc., where, from 1981 to 1995, he held various positions of increasing responsibility. Such positions provided him with a solid foundation in the evaluation, exploitation and management of oil and gas assets. He has both onshore and offshore experience in operations and production management, asset acquisition, asset rationalization, development, drilling and workovers in the continental U.S., Gulf of Mexico, North Sea, Colombia, Saudi Arabia, China and West Africa. In 1995, Mr. Kaetzer left Texaco and formed Southwest Texas Oil & Gas Co., which subsequently merged into GulfWest Energy Inc. in 1998. Mr. Kaetzer served as President/Chief Operating Officer of GulfWest from 1999 to 2004, and as Vice President of Operations for its successor, Crimson Exploration Inc., from 2005 to July 2006. Since August 2006, Mr. Kaetzer has worked as a consultant to several companies in the oil and gas industry. Mr. Kaetzer earned his B.S. from the University of Illinois in 1981 and his M.S. in petroleum engineering from Tulane University in 1988. Mr. Patrick McGarey. Mr. McGarey has served as Chief Financial Officer since August 16, 2007. From 2004 until May 2007, he served as Executive Vice President - Finance, Planning and Corporate Development at Goldking Energy Corporation, a private exploration and production company which he co-owned and co-founded along with Natural Gas Partners and another minority owner. During 2003, Mr. McGarey was principal of his own firm, Energy Growth & Value, LLC, which specialized in sourcing debt and equity capital for energy projects. From 1998 through 2002, he served in a variety of managerial roles within the Energy Capital and Structured Finance business units of The Williams Companies, in Houston, Texas. Prior to 1998, Mr. McGarey worked in commercial and investment banking, focusing on the energy industry. He began his career as a petroleum engineer with Texaco. Mr. McGarey has a Bachelor of Science degree in Civil Engineering from Virginia Polytechnic Institute and State University and an MBA degree from Loyola Marymount University in Los Angeles. Mr. Alan Gaines. Mr. Gaines has served as a director of the Company since April 2005. Mr. Gaines resigned as vice chairman of the Company on August 31, 2007. He is currently the Chairman of Dune Energy, Inc., an independent, publicly traded oil and gas company engaged in the development, exploration and acquisition of oil and gas properties, with operations presently concentrated onshore at the Louisiana/Texas Gulf Coast as well as the Fort Worth Basin Barnett Shale. Mr. Gaines also currently serves as the Chairman of ABC Funding, Inc., a publicly traded company with no current assets or operations. Mr. Gaines has 25 years of experience as an energy investment and merchant banker. In 1983, he co-founded Gaines, Berland Inc., an investment bank and brokerage firm, specializing in global energy markets, with particular emphasis given to small to medium capitalization companies involved in exploration and production, pipelines, refining and marketing, and oilfield services. Mr. Gaines holds a BBA in Finance from Baruch College, and an MBA in Finance (with distinction) from Zarb School, Hofstra University School of Graduate Management. 27 Mr. Richard d'Abo. Mr. d'Abo has served as a Director of the Company since January 17, 2006. He is presently a transaction partner at The Yucaipa Companies, a private equity firm focused on consolidating companies within the supermarket industry. From 1995 through 2003, Mr. d'Abo was a private investor, and served as a consultant to numerous companies both public and private regarding acquisitions and related financings. From 1988 to 1994, Mr. d'Abo was a partner at The Yucaipa Companies and was instrumental in the creation of financing structures for a number of acquisitions. Audit Committee. We do not have an audit committee or another committee performing similar functions. We are currently seeking to add two new "independent" directors to our board and we intend to establish various committees as soon as reasonably practicable. Certain Matters Involving Promoters Immediately prior to our merger with Coastal in April 2005, 47.3% of the Company's then outstanding shares of Common Stock were held by Mr. David Loev. Mr. Loev is an attorney residing in the State of Texas who performed legal services for the Company prior to its merger with Coastal. At no time was Mr. Loev an officer or a director of the Company. In November 2005, the SEC filed a civil lawsuit in the Houston federal district court against certain parties unrelated to the Company and sued Mr. Loev for allegedly violating certain registration provisions of the federal securities laws (SEC Litigation Release No. 19476; November 29, 2005). Mr. Loev settled the lawsuit with the SEC by consenting to the entry of an order permanently enjoining him from violating the securities registration provisions, ordering him to disgorge $25,785.50, plus interest, and imposing a $25,000 civil penalty. The order also prohibits Mr. Loev from issuing any legal opinions that the securities of any issuer are exempt from the securities registration provisions of the federal securities laws pursuant to Rule 504 of Regulation D and from accepting securities of any issuer whose securities are quoted on the Pink Sheets in consideration for legal or consulting services rendered. As previously stated, since April of 2005, Mr. Loev has had no dealings with the Company. 28 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT As of September 18, 2007, we had 33,363,173 shares of Common Stock outstanding. The following table sets forth certain information regarding the beneficial ownership of our Common Stock as of that date by (i) each person who, to our knowledge, beneficially owns more than 5% of our Common Stock; (ii) each of our current directors and executive officers; and (iii) all of our current directors and executive officers as a group:
Name and Address Amount and Nature of Percent of of Beneficial Owner (1) Beneficial Ownership (2) Outstanding Shares (2) - --------------------------------------- ------------------------ ---------------------- Thomas Kaetzer 666,665 (3) 1.9 % (Chairman and Chief Executive Officer) Patrick H. McGarey 499,998 (4) 1.3 % (Chief Financial Officer) Alan Gaines 7,624,250 (5) 21.7 % (Director) Richard d'Abo 1,336,000 (6) 3.9 % (Director) Barrie Damson 6,849,250 (7) 21.9 % 37 Franklin Street Westport, CT 06880 Lakewood Group LLC 3,000,000 (8) 8.3 % 242 4th Street Lakewood, NJ 08701 All Officers & Directors as a Group (4 10,126,913 (3)(4)(5)(6) 27.6 % persons)
- ---------- (1) Unless otherwise indicated, the address of each beneficial owner reported above is 11811 N. Freeway (I-45), Suite 200, Houston, Texas 77060. (2) A person is deemed to be the beneficial owner of securities that can be acquired within 60 days from September 18, 2007. Each beneficial owner's percentage is determined by assuming that options and warrants that are held by such person (but not any other person), and which are exercisable within 60 days from September 14, 2007, have been exercised. (3) Refers to options to purchase (i) up to 1,000,000 shares of Common Stock at an exercise price of $0.50 per share, of which 333,333 underlying shares are currently vested, (ii) up to 500,000 shares of Common Stock at an exercise price of $0.60 per share, of which 166,666 shares are currently vested, and (iii) up to 500,000 shares of Common Stock at an exercise price of $1.00 per share, of which 166,666 shares are currently vested. Each option is subject to a vesting schedule, as follows: (i) up to 1/3rd of the underlying Common Stock exercisable at any time from and after December 20, 2006, (ii) up to an additional 1/3rd of the underlying Common Stock exercisable at any time from and after December 20, 2007, and (iii) up to the remaining 1/3rd of the underlying Common Stock exercisable at any time from and after December 20, 2008; provided, that Mr. Kaetzer's employment has not been terminated by us for cause or by Mr. Kaetzer without good reason. 29 (4) Refers to options to purchase (i) up to 500,000 shares of our common stock at an exercise price of $0.55 per share, of which 166,666 underlying shares are currently vested, (ii) up to 500,000 shares of our common stock at an exercise price of $0.825 per share, of which 166,666 shares are currently vested, and (iii) up to 500,000 shares of our common stock at an exercise price of $1.10 per share, of which 166,666 shares are currently vested. Each option is subject to a vesting schedule, as follows: (i) up to one-third of the underlying common stock exercisable at any time from and after August 3, 2007, (ii) up to an additional one-third of the underlying common stock exercisable at any time from and after August 3, 2008, and (iii) up to the remaining one-third of the underlying common stock exercisable at any time from and after August 3, 2008; provided, that Mr. McGarey's employment has not been terminated by us for cause or by Mr. McGarey without good reason. (5) Includes options currently exercisable to purchase up to 1,730,000 shares of Common Stock at an exercise price of $0.05 per share. (6) Includes 250,000 shares underlying a stock option exercisable at $.05 per share. (7) Includes options currently exercisable to purchase up to 1,730,000 shares of Common Stock at an exercise price of $0.05 per share. (8) Represents 3,000,000 shares of Common Stock underlying warrants exercisable at $0.50 per share granted in connection with our March 2007 Bridge Financing. 30 DESCRIPTION OF SECURITIES The authorized capital stock of the Company consists of 140,000,000 shares of Common Stock and 10,000,000 shares of preferred stock. As of September 18, 2007, there are a total of 33,363,173 shares of Common Stock issued and outstanding and no shares of preferred stock that are issued and outstanding. In addition to the foregoing, as of September 18, 2007 there are (i) approximately 9.5 million shares of Common Stock issuable pursuant to outstanding stock options, (ii) approximately 4.3 million shares of Common Stock that are issuable upon conversion of $2,125,000 principal amount of convertible promissory notes and (iii) approximately 7.8 million shares of Common Stock issuable pursuant to outstanding warrants. Common Stock Holders of outstanding shares of Common Stock are entitled to one vote for each share of stock in his or her name on the records of the Company on all matters submitted to a vote of stockholders, including the election of directors. The holders of Common Stock do not have cumulative voting rights. Dividends may be paid to holders of Common Stock when, as and if declared by the board of directors out of funds legally available therefore. Holders of Common Stock have no conversion, redemption or preemptive rights. All shares of commons stock, when validly issued and fully paid, will be non-assessable. In the event of any liquidation, dissolution or winding up of the Company, holders of Common Stock are entitled to share ratably in the assets of the Company remaining after provision for payment of creditors and after the liquidation preference, if any, of any preferred stock outstanding at the time. Preferred Stock We are authorized to issue up to a total of 10,000,000 shares of "blank check" preferred stock, $0.001 par value. No shares of preferred stock are currently issued or outstanding. In accordance with the Company's Articles of Incorporation, the board of directors may, by resolution, issue preferred stock in one or more series at such time or times and for such consideration as the board of directors may determine. The board of directors is expressly authorized to provide for such designations, preferences, voting power (or no voting power), relative, participating, optional or other special rights and privileges, and such qualifications, limitations or restrictions thereof, as it determines in the resolutions providing for the issue of such class or series of preferred stock prior to the issuance of any shares thereof. The Company may issue preferred stock to effect a business combination, to raise capital or for other reasons. In addition, preferred stock could be utilized as a method of discouraging, delaying or preventing a change in control of the Company. Restrictions on Ownership - Nevada law The Nevada statutory law applicable to private corporations such as the Company contains provisions that impose certain restrictions on the ability of stockholders owning a specific percentage or more of shares of a Nevada corporation's voting stock to engage in a combination transaction with that corporation, and on the ability to certain persons or entities to acquire a controlling interest in a Nevada corporation. Because the Company's Articles of Incorporation and Bylaws do not prohibit the application of these provisions, these laws may have the effect of inhibiting the acquisition of shares of Common Stock or any combination transaction with the Company. 31 INTERESTS OF NAMED EXPERTS AND COUNSEL Included in this registration statement are the reports of Malone & Bailey, PC, independent registered public accountants, located in Houston, Texas, with respect to its audits of (i) our balance sheet as of December 31, 2006, and the related statements of expenses, cash flows and changes in stockholders' equity (deficit) for the two year period then ended and for the period from June 29, 2004 (Inception) through December 31, 2006; (ii) the Statements of Combined Revenues and Direct Operating Expenses of the Oil and Gas Properties purchased by us from Statex Petroleum I, L.P. and Charles W. Gleason, L.P. for the years ended December 31, 2006 and 2005; and (iii) the Statements of Combined Revenues and Direct Operating Expenses of Oil and Gas Properties purchased from DSX Energy Limited, LLP for the years ended December 31, 2005 and 2006. respectively. We have relied upon such report, given upon the authority of such firm as an expert in accounting and auditing. Our counsel, Eaton & Van Winkle LLP, located in New York, New York, passed upon the validity of the issuance of the shares of Common Stock that are being offered pursuant this prospectus. DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT Our Articles of Incorporation and by-laws provide that we will indemnify to the fullest extent permitted by the Nevada General Corporation Law any person made or threatened to be made a party to any action, suit or proceeding, whether civil, criminal, administrative or investigative, by reason of the fact that such person or such person's testator or intestate is or was a director, officer, employee or agent of our Company or serves or served at our request as a director, officer or employee of another corporation or entity. We may enter into agreements to indemnify our directors and officers, in addition to the indemnification provided for in our articles of incorporation and by-laws. These agreements, among other things, would indemnify our directors and officers for certain expenses (including advancing expenses for attorneys' fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person's services as a director or officer of our Company, any subsidiary of ours or any other company or enterprise to which the person provides services at our request. We maintain a Directors, Officers and Company Liability Policy. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers and controlling persons pursuant to the foregoing provisions, or otherwise, we have been advised that, in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. 32 CERTAIN RELATIONSHIPS AND TRANSACTIONS AND CORPORATE GOVERNANCE Relationships and Related Transactions. As previously disclosed on our Current Report on Form 8-K filed with the Commission on January 29, 2007, on January 26, 2007 then Chairman and Chief Executive Officer Barrie Damson and then vice chairman and director Alan Gaines each made a loan of $50,000 to us to be used for our short-term working capital needs and evidenced by promissory notes. The notes bear interest at an annual rate of six percent (6%) and matures, as extended by amendment dated April 10, 2007, on the earlier to occur of (i) the date on which we close an equity offering in which we obtain gross proceeds in excess of three million dollars ($3,000,000) or (ii) October 13, 2010. During our fiscal year 2006, we granted stock options to certain of our affiliates as described elsewhere in this prospectus under "Executive Compensation - Option Grants in Last Fiscal Year". Director Independence. The OTC Bulletin Board, on which our common stock is currently traded, does not maintain director independence standards. 33 DESCRIPTION OF BUSINESS General. We were incorporated as a Nevada corporation in February 2004 under the name of College Oak Investments, Inc., and changed our name to Baseline Oil & Gas Corp. on January 17, 2006. We are the surviving corporation of a merger transaction with Coastal Energy Services, Inc. ("Coastal") that was effective on April 6, 2005. Under the Plan and Agreement of Merger, Coastal was merged with and into our company in exchange for 17,206,000 shares of our Common Stock issued to the former Coastal stockholders. In addition, all stock options and other rights to purchase shares of common stock of Coastal were converted into options or rights to purchase an equal number of shares of our Common Stock. As of the effective date of the merger, options to acquire up to 500,000 shares of Coastal common stock were converted into options to acquire 500,000 shares of our Common Stock. Under the merger agreement, we assumed all of the obligations and liabilities of Coastal, including Coastal's obligations to repay outstanding indebtedness under its $350,000 original principal amount of 10% convertible promissory notes. These notes were convertible into shares of our Common Stock at a rate of $0.25 per share and matured on April 6, 2006. Each holder of these notes was entitled to receive an additional number of shares equal to 20% of the face amount of holder's note. Effective April 6, 2006, the holders of such notes converted such notes into an aggregate of 1,820,000 shares of our Common Stock. In addition, on the effective date of the merger, Coastal delivered the sum of $125,000 to the Company to discharge amounts owed by us for prior legal services rendered to us and for expenses incurred by us in connection with the merger transaction. As a result of the merger, Coastal Energy Services, Inc. was treated as the "acquiring" company and the historical financial statements of our company were restated to be those of Coastal for financial accounting and reporting purposes. Coastal was formed to engage in the energy business, and following the merger, we began pursuing opportunities in the energy industry and particularly, in the oil and gas industries. Our efforts most recently culminated in the following two transactions causing us, when taken together, to cease being a shell company: o our redemption on March 16, 2007 of our prior membership interest in a joint venture for a direct working interest in approximately 171,000 acres in the Illinois Basin located in southern Indiana known to contain New Albany Shale, as more particularly described below under the heading "-Southern Indiana Oil, Gas and Mineral Rights in New Albany Shale" and elsewhere in our Current Report on Form 8-K previously filed with the SEC on March 19, 2007; and o our purchase on April 12, 2007 of the Statex Assets, including those wells and properties located on approximately 4600 acres in north Texas (the "Stephens County Acquisition"), as more particularly described below under the heading "- Northern Texas Oil, Gas and Mineral Rights - Stephens County Acquisition" and elsewhere in our Current Report on Form 8-K previously filed with the SEC on April 18, 2007. Prior to the Stephens County Acquisition, and for our fiscal year ended December 31, 2006, we were still a "shell company" and as such, had only conducted nominal operations and had only nominal assets. 34 As discussed below, our business activities will focus on the continued development of our Indiana (long life, natural gas reserves) and Texas (long life, oil and gas reserves) asset base regions. We expect significant 'organic growth potential' based upon the drilling and workover opportunities in these two regions. Southern Indiana Oil, Gas and Mineral Rights - New Albany Shale. From November 25, 2005 until March 16, 2007, we held a 50% economic and voting membership interest in New Albany-Indiana, LLC, a Delaware limited liability company ("New Albany"), a joint venture with Rex Energy Operating Corp. ("Rex Energy"), a privately held Delaware corporation, and since January 20, 2006, certain of Rex Energy's affiliates and assigns, formed for the purpose of acquiring working interests in leasehold interests in leasehold acreage in the Illinois Basin located in Southern Indiana known to contain New Albany Shale formations. Rex Energy Wabash, LLC, an affiliate of Rex Energy is the managing member of New Albany and responsible for its day-to-day operations. On March 16, 2007, pursuant to that certain Membership Interest Redemption Agreement of even date between us and New Albany, we redeemed our membership interest in New Albany for a direct assignment to us of an undivided 40.423% working interest in and to all oil and gas properties, rights, and assets of New Albany (collectively, the "New Albany Assets"). The reduction in our interest from 50% to a 40.423% reflected an adjustment of our membership interest in New Albany at the time of the redemption, as a result of outstanding capital calls owned by us but assumed by the affiliates and/or assigns of Rex Energy, the other joint venture partner. The New Albany Assets represented the following working interests acquired by New Albany during our 2006 fiscal year: o By that Purchase and Sale Agreement dated November 15, 2005 between New Albany and Aurora Energy Ltd., a Nevada corporation ("Aurora"), New Albany purchased on February 1, 2006 an undivided 48.75% working interest (40.7% net revenue interest) in (i) certain oil, gas and mineral leases covering approximately 80,000 acres in several counties in Indiana and (ii) all of Aurora's rights under a certain Farmout and Participation Agreement with a third party. The total purchase price to New Albany for the acquisition of the working interests, together with the grant of an option to acquire a 50% working interest in any and all acreage leased or acquired by Aurora or its affiliates within certain other counties located in Indiana (estimated to be 68,000 acres), at a fixed price of $25 per net acre, was $10,500,000. Of the total purchase price, we paid an aggregate of $5,250,000. Subsequent to February 1, 2006, New Albany acquired leases covering an additional 42,000 acres. We obtained funding to pay our share of New Albany's purchase price for this acquisition through private placements of (i) our convertible notes and stock in November 2005 and (ii) shares of our common stock in February 2006, as discussed in this Item 5.06 below under the headings "Part I - Item 6 "Management's Discussion and Analysis or Plan of Operations" and "Part II - Item 4 "Recent Sales of Unregistered Securities". o On March 6, 2006, New Albany purchased from Source Rock Resources, Inc. ("Source Rock") a 45% working interest in certain oil, gas and mineral leases covering approximately 21,000 acres in Knox and Sullivan Counties in Indiana, which we believe contain New Albany Shale formation stratum. The purchase price paid by New Albany was $735,000, of which we paid half. Subsequently, New Albany acquired a working interest in approximately 20,000 additional acres in this region. Rex Energy operates the wells drilled on this acreage. 35 o In June 2006, New Albany entered into a Joint Operating Agreement with El Paso Exploration & Development Corp., Pogo Producing Company and Aurora Energy Ltd., pursuant to which New Albany contributed certain of its acreage in exchange for a 17% working interest in a new area of mutual interest covering 8,700 acres, targeting the New Albany Shale formation in Greene County, Indiana. Under this joint operating agreement, El Paso serves as operator. After redeeming our membership interest in New Albany on March 16, 2007, we now own the following assets: o 19.7% working interest in the Aurora/Wabash Area of Mutual Interest (AMI), consisting of approximately 122,000 gross acres (approximately 24,400 acres net to us), seven New Albany natural gas pilot wells (four horizontal and three vertical wells), one natural gas compression/treating facility, two salt water disposal wells, three Devonian Reef gas wells (5% working interest to us) and three horizontal wells currently scheduled to be drilled in 2007; o 18.2% working interest in the Rex Knox County AMI, consisting of approximately 41,000 total acres (approximately 7,380 acres net to us) acquired from Source Rock, and five horizontal wells currently scheduled to be drilled in 2007; and o 6.9% working interest in the El Paso AMI, consisting of approximately 8,000 acres (560 acres net to us) and one or two horizontal wells currently scheduled to be drilled in 2007. The name "New Albany Shale" refers to brownish-black shale exposed along the Ohio River at New Albany in Floyd County, Indiana, and is present in the subsurface throughout much of the Illinois Basin. The Illinois Basin covers approximately 60,000 square miles in parts of Illinois, southwestern Indiana and western Kentucky. The New Albany Shale has produced natural gas since 1858, mostly from wells located in southwestern Indiana and western Kentucky (at least 40 fields in Kentucky and 19 in Indiana). As is the case with other organic shale reservoirs, the gas is stored both as free gas in fractures and as absorbed gas on kerogen and clay surfaces within the shale matrix. Wells typically begin producing high volumes of water and low volumes of gas when first beginning to produce in a new area. As more and more wells are drilled in an area, the formation becomes dewatered and the gas continues to desorb from the shale. An initially high level of water is a positive indicator of natural fracturing in the New Albany Shale. Prior to 1994, according to industry sources, over 600 New Albany Shale wells had produced commercially in the Illinois Basin. Horizontal drilling may be able to exploit the anisotropic nature of the New Albany Shale natural fracture systems. Vertical fractures are dominant in the New Albany Shale and the fracture system contains water. Historically, the potential for wells in this area was limited by the efficiency of water disposal methods. Improved technology for pumping and disposal of water may allow for better rates of gas production. Prior to redeeming our membership interest, we had explored acquiring the 50% membership interest in New Albany not owned by us, together with all rights of New Albany in the Aurora Agreement and certain assets directly from Rex Energy and its affiliates, including working and royalty interests in oil and gas leases as operator and non-operator, located in Illinois, Indiana, Pennsylvania, West Virginia, Texas, New Mexico, Virginia and New York, that contain approximately 2,028 gross producing oil and natural gas wells. As previously disclosed in our Current Reports on Forms 8-K filed with the Commission on January 17, 2006, we entered into a purchase agreement dated January 16, 2006 (the "Rex Purchase Agreement") to purchase these assets for approximately $73.2 million in cash and shares of our Common Stock and, in accordance therewith issued a total of 12,069,250 shares of our Common Stock to certain designees of the selling parties who were designated to become part of our management. By that Mutual Termination Agreement (the "Termination 36 Agreement") dated June 8, 2006, the parties mutually terminated the transactions contemplated by the Rex Purchase Agreement and also entered into a mutual release and non-disparagement agreement. In exchange for the earlier termination of the Rex Purchase Agreement and our release of the selling parties from any liability thereunder, the 12,069,250 shares of our Common Stock previously issued in January 2006 to [Rex Parties] were surrendered and cancelled. Nothing in the Termination Agreement, the release or the non-disparagement agreement affected our rights with respect to New Albany. As a result of the termination of the Rex Purchase Agreement, none of the additional anticipated changes (including changes to management, our board of directors or the relocation of our headquarters) previously disclosed in our Annual Report on Form 10-KSB for the year ended December 31, 2005 transpired. North Texas Oil, Gas and Mineral Rights - Stephens County Acquisition On April 12, 2007, we acquired effective as of February 1, 2007 certain oil and gas assets, consisting of working interests in approximately 4600 acres known as the Eliasville field (also called the Stephens County Regular Field) located in Stephens County in north Texas or roughly ninety miles west of Fort Worth. Under the purchase and sale agreement dated December 20, 2006 with Statex Petroleum I, L.P. and Charles W Gleeson LP, we paid approximately $28,600,000 (including interest from January 15, 2007 until date of closing) for various: (i) leasehold interests, royalty interests, net profit interests, production payments, operating rights, and similar interests attributable to identified oil, gas and mineral leases, and the leasehold interest created thereby; (ii) all wells thereon or lands pooled, unitized or communitized therewith and all oil, gas, minerals or substances produced therefrom; (iii) all agreements relating thereto; (iv) surface and subsurface machinery and equipment, supplies, facilities or other personal property thereon or thereunder that relate to production, treatment, storage, or transportation of hydrocarbons; and (v) all records relating to the foregoing. The Stephens County Regular Field was discovered in the 1920's and produces primarily from the Caddo Lime oil formation at a depth of 3300 feet. Currently the field produces 660 bopd and 100 mcfpd, resulting in 520 boepd of net production, with an average net revenue interest of 77%. There are 81 oil wells producing in the field, and it is an active waterflood with 54 injection wells. There are eight leases which total approximately 4600 acres and there are two central operating facilities and three tank batteries. After the waterflood was initiated in the 1980's, oil production peaked at 1500 bopd from the central six leases which have produced 18 to 22 million barrels of oil and recovered 25% to 30% of the original oil in place. The two western leases have not been incorporated into the waterflood of the central leases and the western leases have recovered only 12% to 18% of the original oil in place. Anticipated development programs include 21 idle wells which are workover candidates as future Caddo oil producers and there is significant infill drilling potential on the acreage. The eastern and central leases have not been fully developed on well spacing down to 15 to 20 acres and we anticipate twelve wells to be initially planned on these leases. The western leases are developed on 80 acre spacing or greater and 42 infill locations and eight re-entries have been identified on the western leases. Proposed Acquisition of DSX Properties We entered into the Asset Purchase and Sale Agreement dated as of August 7, 2007 with DSX Energy Limited, LLP, Kebo Oil & Gas, Inc., Sanchez Oil & Gas Corp., Sue Ann Operating, L.L.C., and 23 other individuals, trusts, and companies (collectively, "Sellers"), whereby we agreed, subject to the satisfaction of various terms and conditions, to acquire certain oil and gas properties located in the Blessing Field in Matagorda County onshore along the Texas Gulf Coast (the "DSX Properties"), all as previously disclosed by us in our Current Report on Form 8-K filed with the Securities and Exchange Commission on August 15, 2007. The closing of the purchase is scheduled to occur on October 30, 2007, or such earlier date as we and the Sellers may determine (the "Closing Date"). Although the transfer of ownership of the DSX Properties will occur at the Closing Date, it will be effective as of June 1, 2007 (the "Effective Date"). The purchase price we agreed to pay for the DSX Properties at the Closing Date is $100.0 million in cash, subject to certain adjustments set forth in the purchase agreement. We also agreed to assume certain obligations related to the DSX Properties, including, without limitation: (i) obligations related to the ownership and operation of the DSX Properties and the production and marketing of hydrocarbons allocable thereto, in each case accruing on or after the Effective Date; (ii) obligations accruing after the Effective Date under the terms of all oil and gas leases, contracts, and agreements affecting the DSX Properties and in existence on the Effective Date; and (iii) obligations related to the plugging, abandonment, removal, disposal, site clearance, and similar activities with respect to the wells located on the DSX Properties. We have also agreed to assume all environmental obligations and liabilities relating to the DSX Properties (except for certain liabilities related to the off-site disposal of hazardous substances, if any), regardless of when the act, omission, or event that gives rise to the environmental liability or obligation occurred. On August 13, 2007, we paid a performance deposit of $2.5 million to the Sellers (the "Performance Deposit"), which will be credited against the purchase price paid at the Closing Date. We obtained the Performance Deposit from our senior lenders pursuant to the terms of a letter agreement dated August 9, 2007. If the Sellers terminate the purchase agreement prior to the closing due to our breach of or failure to perform under the purchase agreement, or our failure to satisfy certain pre-closing conditions, the Sellers will be entitled to retain as liquidated damages the Performance Deposit. If we terminate the purchase agreement prior to the closing due to the Sellers' breach of or failure to perform as required by the purchase agreement, or the Sellers' failure to satisfy certain pre-closing conditions, we will be entitled to the return of the full amount of the Performance Deposit, and we will be entitled to seek damages from the Sellers not to exceed $2.5 million. Either the Sellers or we may terminate the purchase agreement if the sum of the aggregate values of all uncured title defects (including preferential rights and required consents to assignment that result in exclusion of one or more properties), plus the aggregate amounts to remediate all unremedied environmental defects, plus the amounts of any damage to the DSX Properties prior to the closing, all as finally agreed upon by the Sellers and us or determined by arbitration, would result in reductions to the Purchase Price, without regard to deductibles, equal to or in excess of $15.0 million. If the purchase agreement is thus terminated, we will be entitled to the return of the full amount of the Performance Deposit. There can be no assurance that the various closing conditions can be satisfied to enable us to close timely, if at all. In particular, there is no assurance that financing, whether in the form of equity, debt or some combination thereof, will be available to us to the extent required, on terms acceptable to us, or at all. Likewise, there is no assurance that favorable results will be obtained from our on-going due diligence inquiries or, in the event we proceed with the transaction following such inquiries, whether we will be successful in achieving the intended integration of business operations following such acquisition. Proposed Sale of Debt Securities to Finance Acquisition of DSX Properties We plan to finance the proposed acquisition of the DSX Properties through the private issuance of debt securities in our company, consisting of (i) $115 million aggregate principal amount of 12.5% Senior Secured Notes due 2012 and (ii) $50 million aggregate principal amount of 14% Senior Subordinated Convertible Secured Notes due 2013 (the "DSX Financing"), as previously reported by us in our Current Report on Form 8-K filed with the SEC on September 18, 2007. Neither of the notes under the DSX Financing will have been registered under the Securities Act of 1933, as amended, or any state securities laws at the time of their offer and sale, and are intended to be offered and sold under applicable exemptions from the registration requirements. The notes are intended to be secured, in part, by a lien on the DSX Properties. We expect that the DSX Financing will close concurrently with the acquisition of the DSX Properties in early October 2007, although there can be no assurances in that regard. Employees. In addition to Thomas Kaetzer, our Chairman and Chief Executive Officer, and Patrick McGarey, our Chief Financial Officer, as of September 14, 2007 we had seven additional full-time employees and four part-time consultants. 37 MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION The following discussion is meant to assist you in understanding our plan of operations and financial position and should be read in conjunction with our financial statements and the pro forma financial information, together with the notes to our financial statements and pro forma financial information, set forth in this Prospectus. To the extent our discussion contains forward-looking information, we desire to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. See "Cautionary Note Regarding Forward-Looking Statements" at page 13 of this Prospectus. We have not had any revenues from operations in each of the last two fiscal years, as our business operations have consisted principally of oil and gas exploration activities through our participation in the New Albany joint venture. We have no operating history upon which our operations plan or future prospects can be evaluated. Prior to the Stephens County Acquisition, with its expected production revenue, our operating revenue did not cover our operating expenses. Our ability to generate future revenue, if any, will depend upon whether we can successfully develop and implement our plan of operation. As disclosed in our Current Report on Form 8-K filed with the Commission on April 18, 2007, we exited from "shell company" status, as that term is defined in Rule 405 promulgated under the Securities Act and Rule 12b-2 promulgated under the Exchange Act, upon completing our acquisition of a number of oil and gas producing properties located in Stephens County in north Texas from Statex Petroleum I, L.P. and Charles W Gleeson LP (the "Stephens County Transaction"). Our business and prospects must be also considered in light of the risks and uncertainties frequently encountered by companies in the oil & gas industry. The successful development of oil and gas fields is highly uncertain and we cannot reasonably estimate or know the nature, timing and estimated expenses of the efforts necessary to complete the development of, or the period in which material net cash inflows are expected to commence from, any oil and gas production from our existing fields or other fields, if any, acquired in the future. Risks and uncertainties associated with oil & gas production include: o reservoir performance and natural field decline; o changes in operating conditions and costs, including costs of third party equipment or services such as drilling rigs and shipping; o the occurrence of unforeseen technical difficulties, including technical problems that may delay start-up or interrupt production; o the outcome of negotiations with co-venturers, governments, suppliers, or other third party operators; o our ability to manage expenses successfully; o regulatory developments, such as de-regulation of certain energy markets or restrictions on exploration and production under laws and regulations related to environmental or energy security matters; and 38 o changes in oil, gas and petrochemical prices and changes in margins on gasoline and other refined products based upon supply and demand for oil and gas affected by general economic growth rates and conditions, supply disruptions, new supply sources and the competitiveness of alternative hydrocarbon or other energy sources. Plan of Operation With our completion of the April 2007 Credit Facility, as discussed elsewhere in this prospectus under "- Liquidity and Source of Capital - April 2007 Credit Facility", we believe that we now have adequate funds available under our revolving line of credit to focus on exploratory and production activities at each of our southern Indiana recently acquired north Texas holdings. Our intended strategy is to focus on the development of these two asset bases, with the expectation that the north Texas waterflood can provide us with long life oil reserves and the southern Indiana resource lay can provide us with long life, natural gas potential, together with a substantial upside potential. We also believe that these two fields provide us with significant organic growth potential. We will manage our operations and evaluate our fields from our new office location in Houston, Texas. While the majority of the effort will be spent on developing these two properties, we will continue to look for additional incremental acquisitions to make in the vicinity of our current fields. Stephens County Regular field/Eliasville Field. The Stephens County Regular field (also called the Eliasville Field) is located in Stephens County, in north Texas, roughly ninety miles west of Fort Worth. The field was discovered in the 1920's and produces primarily from the Caddo Lime oil formation at a depth of 3300 feet. Currently the field produces 640 bopd and 100 mcfpd, resulting in 510 boepd of net production, with an average net revenue interest of 77%. In addition to the expected cash flow from the existing production from the Stephens County Acquisition, we expect that the existing waterflood on the central acreage can be further developed and that the waterflood can be expanded to the western acreage. There are 81 oil wells producing in the field, and it is an active waterflood with 54 injection wells. There are eight leases which total approximately 4600 acres and there are two central operating facilities and three tank batteries. After the waterflood was initiated in the 1980's, oil production peaked at 1500 bopd from the central six leases which have produced 18 to 22 million barrels of oil and recovered 25% to 30% of the original oil in place. The two western leases have not been incorporated into the waterflood of the central leases and it is planned to expand the waterflood to the western leases. Stephens County provides immediate development opportunities. There are 21 idle wells which are workover candidates as future Caddo oil producers and there is significant infill drilling potential on the acreage. We anticipate developing the 21 workovers and initially drilling five wells in this area during 2007. The eastern and central leases have not been fully developed on well spacing down to 15 to 20 acres and twelve wells are initially planned on these leases. The western leases are developed on 80 acre spacing or greater and 42 infill locations and eight re-entries have been identified on the western leases. Proved reserves have been estimated by a third party engineering firm to be 3.6 million boe (net) with a pre-tax PV10 value of $49.9 million at $59/bbl and $1.77/mcf. Of the proved reserves, 70% are PDP, 10% PDNP and 20% are PUD 39 reserves. In addition, another 1.7 mmboe (net) reserves are classified as probable/possible reserves for expanding the waterflood to the west (approximate $25 million of additional PV10 potential). In addition to the waterflood expansion, we intend to investigate the full development potential on the 4600 acre lease-hold. We believe the Caddo Lime oil formation is a good candidate for an Alkaline Surfactant Polymer (ASP) flood, and this enhanced oil recovery technique will be evaluated in 2007. There also is shallow gas production in this region, and the natural gas potential for the Marble Falls and Duffer gas formations will be evaluated during 2007, together with the identification of additional leases which may be attractive in the area. In addition, the Barnett Shale is located at approximately 4900 feet in this area, and the production potential of the Barnett Shale in this region has not been evaluated. New Albany Shale. We currently have a direct working interest in the development of 171,000 gross acres in the five county southern Indiana New Albany Shale formation in southern Indiana. We own an 18% to 19% working interest in approximately 163,000 acres in five counties in southern Indiana, of which the remaining 41,000 acres and 122,000 acres are operated under an Area of Mutual Interest, or AMI, covering this acreage by Rex Energy and Aurora, respectively (plus an option on an additional 68,000 gross acres). These companies currently plan to drill eight horizontal wells (in which we have a 18-19% working interest) and one vertical Devonian Reef well (in which we have a 4-5% working interest) during 2007 in the 163,000 acre AMIs. Additional wells may be drilled, depending on rig availability, results of wells drilled, and agreement with our partners. Four pilot test wells drilled in 2006 are also planned to be tested during 2007. We also participate in an 8700 acre AMI which is in the same area of the New Albany Shale. El Paso Energy Inc., is operator of this AMI and Rex Energy, Aurora and other partners participate with us. Currently one well is drilling, in which we have just under a 7% working interest in this AMI. To date, we have invested $8.1 million in the acquisition of our interest in the 171,000 acres and the drilling of seven New Albany pilot test wells and four Devonian Reef wells. As mentioned above, ten new wells are planned for 2007. Of the wells already drilled, the seven New Albany Shale wells are to be tested for natural gas and water rates, and then tied in for sales. The New Albany Shale wells produce some water initially and have to be pumped off in order to achieve steady gas production. Of the four Devonian Reef wells drilled, two have tested gas and two were dry holes. We intend to continue to participate in the New Albany Shale development, and based on the results of the ten wells to be drilled during 2007, will work with our partners to evaluate and prioritize future drilling. We anticipate that as many as 500 to 1,000 horizontal wells could be eventually drilled on the current leasehold, depending on success and drainage areas of the horizontal wells. The industry has reported a range of natural gas production rate reserve potential in the New Albany Shale Play; however, because there is not extensive production history from horizontal wells completed in the New Albany Shale, we have no proven reserves booked to its acreage position. Currently available public information indicates that each horizontal well should drain 160 to 320 acres at a depth of 1500 to 2500 feet. Estimated reserves are in the range of 0.7 bcf to nearly 2 bcf per well, depending on initial production rates. Wells have had reported test rates of 50 mcfpd to 1,000 mcfpd, and 'typical' wells are currently expected to produce 300 mcfpd or more. 40 The ability to better predict production rates and reserves per well, as well as establishing the best methodology to drill and complete the horizontal wells, will allow us and our partners to better understand the economics of each well, and the overall play in general. We believe that a more complete understanding and longer term production histories will drive the future drilling activity and accelerated development potential of the New Albany Shale play, as well as will influence our continuing participation and funding needs in 2008 and beyond. Liquidity and Source of Capital We currently believe, based upon our forecasts and our liquidity and capital requirements for the near-term future, that the combination of our expected internally-generated cash, the borrowings under the April 2007 Credit Facility and our working capital, will be adequate to fund our anticipated capital and liquidity requirements for the next twelve months in connection with our above plan of operations. As discussed below, on April 12, 2007 we entered into a $75 million revolving credit commitment and term loan under the April 2007 Credit Facility, of which approximately $45 million remains available to be drawn down by us at June 26, 2007, subject to and only in the event that we satisfy various financial and other covenants contained in the credit agreement. On April 12, 2007 we drew down approximately $9.7 million as a Revolving Loan and $20.3 million as a Term Loan in connection with the Stephens County Transaction and our repayment of the March 2007 Bridge Financing discussed elsewhere in this prospectus under "- Liquidity and Source of Capital - March 2007 Bridge Financing". We also expect to receive proceeds from production associated with those wells operating in north Texas we purchased as part of the Stephen County Acquisition. At May 15, 2007, we had received approximate net proceeds of $500,000 attributable to production from these wells. Included elsewhere in this prospectus under the heading "Financial Statements" are pro forma financial information and related notes that give pro forma effect as of December 31, 2006 of the Stephens County Acquisition. This pro forma financial information is derived from and should be read in conjunction with our audited financial statements and the Statements of Combined Revenues and Direct Operating Expenses relating to the Stephens County Acquisition as of and for the period ended December 31, 2006, contained elsewhere in this prospectus under the heading "Financial Statements and Exhibits". Accordingly, we currently believe, based upon our forecasts and our liquidity and capital requirements for the near-term future, that the combination of our expected internally-generated cash, the borrowings under our credit facility and our working capital, will be adequate to meet our anticipated capital and liquidity requirements for the next twelve months. Should our estimated capital needs be erroneous and our costs and expenses prove to be greater than we currently anticipate, or should we change our current operations plan in a manner that will increase or accelerate our anticipated costs and expenses, the depletion of our working capital would be accelerated. Although we anticipate that adequate funds will remain available to us under the Loan Transaction, if we were unable to access such funding by reason of our failure to satisfy borrowing covenants under the Credit Agreement we would have to use other alternative resources. To the extent it becomes necessary to raise additional cash in the future if our current cash and working capital resources are depleted, we will seek to raise it through the public or private sale of debt or our equity securities, funding from joint venture or strategic partners, or a combination of the foregoing. We may also seek to satisfy indebtedness without any cash outlay through the private issuance of debt or equity securities. The sale of additional equity securities or convertible debt securities would result in dilution to our shareholders. We 41 cannot give you any assurance that we will be able to secure the additional cash or working capital we may require to continue our operations in such circumstances. April 2007 Credit Facility. Our Credit Agreement executed April 12, 2007 provides for a revolving credit commitment of up to $54.7 million and a Term Loan Commitment of $20.3 million. Unless earlier payment is required under the Credit Agreement, Revolving Loans must be paid on or before April 12, 2010 and Term Loans on or before October 12, 2010. Interest on Revolving Loans accrues at the Prime Rate that is in effect from time to time, while interest on Term Loans accrues at the Prime Rate (that is in effect from time to time) or 7.5%, whichever is greater, plus 3%. Funds available to us are subject to our satisfaction of a Borrowing Base formula and a number of standard industry conditions precedent and covenants. As security under the Credit Agreement, we have granted lenders a security interest in and a first lien on, all of our existing and after-acquired assets including, without limitation, the Statex Assets that we acquired in the Stephens County Acquisition. In addition to the foregoing, we granted the Lenders an overriding royalty interest ranging between 2% and 3% in (i) our existing Oil and Gas Properties and (ii) Oil and Gas Properties that we acquire after the date hereof until the Credit Agreement is terminated. In accordance with a requirement of the Credit Agreement, we also entered into a Swap Agreement ("Swap Agreement") with Macquarie Bank Limited, which Swap Agreement provides that we put in place, for each month through the third anniversary of April 12, 2007, separate swap hedges, as adjusted from time to time as specified therein, with respect to notional volumes which are approximately 75% of the reasonably anticipated projected production from Proved Developed Producing Reserves (as defined in the credit agreement) for each of crude oil and natural gas, calculated separately pursuant to the requirements of the credit agreement. Immediately subsequent to the April 2007 Credit Facility, we entered into a hedging arrangement under the Swap Agreement with Macquarie Bank Limited, providing for a fixed price of $68.20 per barrel for a three year period, commencing June 1, 2007. The hedging arrangement is based upon a minimum of 11,000 barrels in the first year. Private Placement of Equity and Debt Previously, we have financed current expenses and our business operations chiefly through private placements of equity and debt securities issued by our Company, as follows: November 2005 Placement. In November 2005, we completed the offering and sale of $2.375 million in units of consisting of 10% convertible promissory note and shares of common stock in privately negotiated transactions with accredited investors. The holder of a note may elect to receive interest on the note in cash or in shares of common stock valued at $0.50 per share. At any time prior to maturity, holders may convert the principal and accrued but unpaid interest on their note into such number of shares of common stock equal to the outstanding principal amount plus accrued but unpaid interest, divided by $0.50, or a total of 4,750,000 shares, excluding interest. Each note initially matured on May 15, 2007 and accrued interest at the rate of 10% per annum. On May 31, 2007 we entered into Extension Agreements with the holders of the notes extending the maturity date until the earlier of (i) November 15, 2007 or the date of consummation by us of a merger, combination or 42 sale of substantially all of our Company's assets or the purchase by a single entity or person or group of affiliated entities or persons of more than fifty (50%) percent of the voting stock of our Company. In consideration for the note holders' agreement to extend the maturity date, we agreed to (i) increase the interest payable on the outstanding principal under the notes from 10% to 12%, effective as of May 16, 2007, and (ii) issue to the note holders an aggregate of 380,000 shares of our Common Stock. None of the shares underlying the notes, issued as interest on the notes, or issued in connection with the extension of the notes are being registered in this prospectus. Furthermore, by virtue of the modification to the notes, we have determined that 6,412,500 shares of our common stock previously registered for resale and relating to shares of common stock issued or issuable upon conversion of the notes, are no longer eligible for resale under this prospectus. Thus, none of the shares of common stock underlying notes issued in the November 2005 Placement are being registered hereby. February 2006 Placement. On February 1, 2006, we completed a private placement to accredited investors in which we received gross proceeds of $9 million by selling an aggregate of 8,181,819 shares of our newly-issued Common Stock at $1.10 per share. We paid aggregate placement agent commissions of $675,000 (or 7.5% of the gross proceeds) and issued three-year warrants to our placement agents to purchase an aggregate of 259,090 shares of Common Stock at an exercise price of $1.32 per share. C.K. Cooper & Company and Gilford Securities, Incorporated acted as our placement agents. Approximately $4 million of the net proceeds were used to fund our portion of the Aurora and Source Rock acquisitions by New Albany. These shares are among the shares of our Common Stock being registered under the registration statement to which this prospectus is a part. January 2007 Interim Funding. As previously disclosed on our Current Report on Form 8-K filed with the SEC on January 29, 2007, on January 26, 2007 then Chairman and Chief Executive Officer Barrie Damson and then vice chairman and director Alan Gaines each made a loan of $50,000 to us to be used for our short-term working capital needs and evidenced by promissory notes. The notes bear interest at an annual rate of six percent (6%) and mature, as extended by amendment dated April 10, 2007, on the earlier to occur of (i) the date on which we close an equity offering in which we obtain gross proceeds in excess of three million dollars ($3,000,000) or (ii) October 13, 2010. March 2007 Bridge Financing. On March 15, 2007, we borrowed $1.7 million from a single accredited investor in the form of a Senior Secured Debenture, due September 15, 2007, in the principal amount of $1.7 million, bearing interest at a rate of 16% per annum (the "Debenture"). The investor also received a common stock purchase warrant to purchase up to 3,000,000 shares of our common stock at an exercise price of $0.50 per share any time prior to September 15, 2012. Our obligations under the Debenture were secured by a mortgage and security interest in the properties located in the New Albany Shale area of Indiana in which we hold any leasehold and/or working interests and a continuing security interest in certain of our assets and properties other than the mortgaged property. The Debenture became payable in full upon our consummation of an equity or debt financing of $15 million or more and, following the Loan Transaction, we repaid the Debenture in full on April 12, 2007. We also paid a closing fee of $170,000 on the date on which the outstanding principal amount plus accrued interest was repaid. In connection with the March 2007 Bridge Financing, we delivered to Casimir Capital LP, a placement fee of $170,000 and warrants to purchase up to 340,000 shares of our Common Stock at an exercise price of $0.50 per share. Contractual Obligations Except for (i) our lease payments of approximately $6,600 per month for use of our corporate headquarters, (ii) our hedging arrangement entered into under the Swap Agreement, as discussed elsewhere in this prospectus , which hedging arrangement is to be settled on a monthly basis, commencing June 1, 2007 and (iii) those convertible notes issued under the November 2005 Placement, which provide for us to make quarterly interest payments of approximately $59,000, payable either in cash or shares of our Common Stock, we do not currently have any contractual obligations. 43 Off-Balance-Sheet Arrangements. We have no off balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to any investor in our securities. 44 DESCRIPTION OF PROPERTY Corporate Headquarters. We lease approximately 2500 square feet of office space in Houston, Texas to house our corporate offices. Our lease arrangement is month-to-month and provides for rent of $2,600 per month. Southern Indiana - New Albany Shale. As of March 16, 2007, the date we redeemed our membership interest in New Albany to acquire a direct working interest in the oil and gas leases and other properties held by New Albany, we acquired tracts of land covering approximately 171,000 surface acres in southern Indiana. Prior to our redemption, we had only an indirect contractual right (pursuant to our interest in New Albany), in those oil and gas leases and other rights acquired by New Albany during 2006 in the New Albany Shale area in Indiana. Although the industry has reported a range of natural gas production rate reserve potential in the New Albany Shale Play, there is not extensive production history from horizontal wells completed in the New Albany Shale and we have no proven reserves booked to its acreage position. Currently available public information indicates that each horizontal well should drain 160 to 320 acres at a depth of 1500 to 2500 feet. Estimated reserves are in the range of 0.7 bcf to nearly 2 bcf per well, depending on initial production rates. Wells have had reported test rates of 50 mcfpd to 1,000 mcfpd, and 'typical' wells are expected to produce 300 mcfpd or more. North Texas - Stephens County Acquisition. As of April 12, 2007, the date of the Stephens County Acquisition, we acquired tracts of land covering approximately 4600 surface acres in north Texas. The Eliasville field (also called the Stephens County Regular Field) produces primarily from the Caddo Lime oil formation at a depth of 3300 feet. Currently the field produces 640 bopd and 100 mcfpd, resulting in 510 boepd of net production, with an average net revenue interest of 77%. There are 81 oil wells producing in the field, and it is an active waterflood with 54 injection wells. There are eight leases which total approximately 4600 acres and there are two central operating facilities and three tank batteries. After the waterflood was initiated in the 1980's, oil production peaked at 1500 bopd from the central six leases which have produced 18 to 22 million barrels of oil and recovered 25% to 30% of the original oil in place. The two western leases have not been incorporated into the waterflood of the central leases and the western leases have recovered only 12% to 18% of the original oil in place. Proved reserves have been estimated by a third party engineering firm to be 3.6 million boe (net) with a pre-tax PV10 value of $49.9 million at $59/bbl and $1.77/mcf. Of the proved reserves, 70% are PDP, 10% PDNP and 20% are PUD reserves. In addition, another 1.7 mmboe (net) reserves are classified as probable/possible reserves for expanding the waterflood to the west (approximate $25 million of additional PV10 potential). Additional disclosure of the oil and gas estimated and proven reserves is included in the notes to the financial statements and the pro forma financial information, giving effect as of January 1, 2005 to our acquisition of the Stephens County assets, contained elsewhere in this prospectus under "Financial Statements - (b) Financial Statements of Business Acquired - Notes to Financial Statements, Note 5" and "Financial Statements - (c) Pro Forma Financial Information of Baseline Oil & Gas Corp. - Pro Forma Supplemental Oil and Gas Disclosures." 45 MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information. Our Common Stock is quoted on the OTC Bulletin Board under the trading symbol "BOGA." Prior to January 17, 2006, our name was College Oak Investments, Inc. and our symbol was "COKV." The table below sets forth the high and low bid information for our Common Stock for the last two fiscal years and the interim quarterly period ended June 30, 2007. These quotations reflect inter-dealer prices, without retail markup, markdown or commission and may not represent actual transactions. There were no trades of our securities on the OTC Bulletin Board prior to March 3, 2005. 2007 Quarter Ended High Bid Price Low Bid Price ------------------ -------------- ------------- 6/30/2007 $ 0.71 $ 0.32 3/31/2007 $ 0.65 $ 0.37 2006 Quarter Ended High Bid Price Low Bid Price ------------------ -------------- ------------- 12/31/2006 $ 0.75 $ 0.35 9/30/2006 1.19 0.67 6/30/2006 3.25 1.10 3/31/2006 3.25 0.85 2005 Quarter Ended High Bid Price Low Bid Price ------------------ -------------- ------------- 12/31/2005 $ 1.40 $ 0.60 9/30/2005 0.90 0.60 6/30/2005 1.01 0.20 3/31/2005 0.90 0.10 As of September 18, 2007, we have outstanding options to purchase up to approximately 9.5 million shares of Common Stock, warrants to purchase up to approximately 7.8 million shares of Common Stock and notes convertible into up to approximately 4.3 million shares of Common Stock, excluding interest. Holders of Securities. As of September 18, 2007, there were approximately 171 holders of record of our Common Stock. Our Common Stock is covered by a SEC rule that imposes additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors, which are generally institutions with assets in excess of $5,000,000 or individuals with net worth in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their spouse. For transactions covered by the rule, the broker-dealer must make a special suitability determination for the purchaser and transaction prior to the sale. Consequently, the rule may affect the ability of broker-dealers to sell our securities and also may affect the ability of purchasers of our Common Stock to sell their shares in the secondary market. It may also cause fewer broker-dealers to be willing to make a market in our Common Stock, and it may affect the level of news coverage we receive. 46 Dividends. We have not declared or paid any cash dividends on our Common Stock since our inception, and our board of directors currently intends to retain all earnings for use in the business for the foreseeable future. Any future payment of dividends will depend upon our results of operations, financial condition, cash requirements and other factors deemed relevant by our board of directors. Pursuant to the convertible notes we issued in November 2005, as long as there is outstanding indebtedness thereunder, we may not declare or pay a cash dividend on our Common Stock without the consent of the agent to such holders of the notes. No equity securities of our Company were purchased by us or any "affiliated purchaser" of ours during fiscal years 2005 or 2006. Securities Authorized for Issuance Under Equity Compensation Plans. The following table provides information as of December 31, 2006 about our equity compensation arrangements:
Number of securities Number of securities remaining available for to be issued upon Weighted-average future issuance under equity exercise of exercise price of compensation plans outstanding options, outstanding options, (excluding securities Plan Category warrants and rights warrants and rights reflected in column (a) - ----------------------------- ---------------------- -------------------- ---------------------------- Equity compensation plans 0 0 n/a approved by security holders Equity compensation plans not 13,985,000 $ 0.18 n/a approved by security holders (1) Total (1) 13,985,000 $ 0.18 n/a
- ---------- (1) Consists of warrants and options granted to our employees, officers, directors and consultants, to the extent vested and exercisable (within the meaning of Rule 13d-3(d)(1) promulgated by the Commission under the Securities and Exchange Act of 1934, as amended) as of December 31, 2006. Set forth below is a description of the individual compensation arrangements or equity compensation plans not currently approved by our security holders pursuant to which the 14,719,090 shares of our Common Stock included in the chart above were issuable as of December 31, 2006: o Option granted April 1, 2005 to a consultant in consideration of services performed on our behalf, which option expires five years from grant date and is currently exercisable to purchase up to 500,000 shares of our Common Stock at an exercise price of $0.30 per share; o Options granted April 29, 2005 to directors, officers and consultants in consideration of services performed on our behalf, which options expire five years from grant date and, after adjusting for the cancellation of an aggregate of 8,540,000 shares of Common Stock underlying certain of the option grants, are currently exercisable to purchase up to an aggregate of 4,160,000 shares of our Common Stock at an exercise price of $0.05 per share; 47 o Options granted December 20, 2005 to third parties in connection with potential acquisition transaction, which options expire five years from grant date and are currently exercisable to purchase up to 50,000 shares of our Common Stock at an exercise price of $1.00 per share; o Option granted December 27, 2005 to an officer in consideration of services performed on our behalf, which option expires five years from grant date and is currently exercisable to purchase up to 175,000 shares of our Common Stock at an exercise price of $0.94 per share; o Option granted August 15, 2006 to a consultant in consideration of services performed on our behalf, which option expires five years from grant date and is currently exercisable to purchase up to 100,000 shares of our Common Stock at an exercise price of $1.01 per share; o Option granted October 20, 2006 to a consultant in consideration of services performed on our behalf, which option expires five years from grant date and is currently exercisable to purchase up to 100,000 shares of our Common Stock at an exercise price of $0.50 per share; o Option granted November 14, 2006 to a consultant in consideration of services performed on our behalf, which option expires five years from grant date and is currently exercisable to purchase up to 360,000 shares of our Common Stock at an exercise price of $0.50 per share; o Option granted December 20, 2006 to an officer in consideration of services to be performed on our behalf, which option expires five years from grant date and, subject to a vesting schedule, is currently exercisable with respect to 333,333 shares of our Common Stock at an exercise price of $0.50 per share; o Option granted December 20, 2006 to an officer in consideration of services to be performed on our behalf, which option expires five years from grant date and, subject to a vesting schedule, is currently exercisable with respect to 166,666 shares of our Common Stock at an exercise price of $0.60 per share; and o Option granted December 20, 2006 to an officer in consideration of services to be performed on our behalf, which option expires five years from grant date and, subject to a vesting schedule, is currently exercisable with respect to 166,666 shares of our Common Stock at an exercise price of $1.00 per share. 48 EXECUTIVE COMPENSATION Prior to hiring Thomas Kaetzer as our President and Chief Operating Officer, the Company had not paid salaries to any individual, although in December 2005 we began to pay to Richard M. Cohen, Inc., a company of which Richard M. Cohen, our then Chief Financial Officer, is sole shareholder, officer and director, a monthly consulting fee of $7,500. In connection with our employment of Mr. Kaetzer in December 2006, we agreed to pay him a salary and other compensation pursuant to his employment agreement with us, as described in more detail below in the Summary Compensation Table and elsewhere in this prospectus under "- Employment Contracts." The following table shows the compensation of our executive officers for the fiscal years ended December 31, 2006 and December 31, 2005: Summary Compensation Table
Long-Term Compensation ---------------------------- Annual Awards Compensation -------------------------------------------------------- Name and Securities Underlying All Other Principal Position Year Salary ($) Options (#) Compensation - ----------------------------------------------------------------------------------------------------------------- Barrie Damson (Chief Executive 2006 $0 None n/a Officer) (1) Thomas Kaetzer (President and Chief 2006 $15,833 (2) 2,000,000 shares of Common n/a Operating Officer) (2) Stock Richard Cohen 2006 $90,000 None n/a (Chief Financial Officer) (3) 2005 $7,500 (3) 175,000 shares of Common n/a Stock
- ---------- (1) Mr. Damson joined our board of directors and became our Chairman and Chief Executive Officer as of February 1, 2006. Mr. Damson resigned as Chairman and Chief Executive Officer, effective March 21, 2007 (2) Mr. Kaetzer became our President and Chief Operating Officer as of December 5, 2006. In 2006 he was paid an amount equal to one month's salary at an annualized salary of $190,000 as provided for in his employment agreement. See the subsection below entitled "Employment Contracts". Mr. Kaetzer was promoted to Chairman and Chief Executive Officer on March 21, 2007, upon the resignation of Mr. Damson. (3) Mr. Cohen became our Chief Financial Officer in December 2005, at which time he received a salary of $7,500 per month. Mr. Cohen stepped down as Chief Financial Officer August 15, 2007 upon our hiring of Patrick H. McGarey. Option Grants in the Last Fiscal Year As shown in the below table, during fiscal year ended December 31, 2006, the Company granted stock options to our named executive officers, as follows: 49 Option Grants In Last Fiscal Year (2006)
No. of % of Total Securities Options Underlying Granted to Options Employees in Exercise Name Year Granted (1) Fiscal Year Price Expiration Date - ------------------------- ---- ------------ ------------ -------- --------------- Barrie Damson (Chief Executive Officer)(2) 2006 0 0% N/A N/A Thomas Kaetzer 2006 1,000,000 (1) 50% $0.50 12/20/2011 (President and Chief 2006 500,000 (1) 25% $0.60 12/20/2011 Operating Officer)(3) 2006 500,000 (1) 25% $1.00 12/20/2011 Richard Cohen (Chief Financial Officer)(4) 2006 0 0% N/A N/A
- ---------- (1) Each option shall vest and be exercised in whole or in part, as follows: (i) up to 1/3rd of the underlying Common Stock at any time from and after December 20, 2006, (ii) up to an additional 1/3rd of the underlying Common Stock at any time from and after December 20, 2007, and (iii) up to the remaining 1/3rd of the underlying Common Stock at any time from and after December 20, 2008; provided, that Mr. Kaetzer's employment has not been terminated by us for cause or by Mr. Kaetzer without good reason. (2) Mr. Damson joined our board of directors and became our Chairman and Chief Executive Officer as of February 1, 2006. He resigned as Chairman and Chief Executive Officer, effective March 21, 2007 (3) Mr. Kaetzer became our President and Chief Operating Officer as of December 5, 2006. He was promoted to Chairman and Chief Executive Officer on March 21, 2007, upon the resignation of Mr. Damson. (4) Mr. Cohen became our Chief Financial Officer in December 2005. He stepped down as Chief Financial Officer August 15, 2007 upon our hiring of Patrick H. McGarey. Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values During 2006, none of our named executive officers or directors exercised any options to purchase shares of Common Stock. The following table sets forth, for each of our named executive officers and directors, the number and value of vested and unvested options held as of December 31, 2006 and the value of any in-the-money stock options, vested and unvested, as of such date.
No. of Securities Value of Unexercised In-The-Money Options Name Underlying Options Granted at December 31, 2006 (1) - -------------- ---------------------------------- ----------------------------------------- Exercisable Unexercisable Exercisable Unexercisable ----------- ------------- -------------- --------------- Barrie Damson(2) 5,000,000 (3) 0 $ 2,800,000 -- Alan Gaines 5,000,000 (3) 0 $ 2,800,000 -- Thomas Kaetzer 666,665 1,333,335 $ 38,333 $ 76,667 Richard d'Abo 250,000 0 $ 140,000 -- Richard Cohen(4) 175,000 0 -- --
- ---------- (1) The last sale price of the Common Stock on December 29, 2006 (the last trading date of the fiscal year) was $0.61. (2) Mr. Damson joined our board of directors and became our Chairman and Chief Executive Officer as of February 1, 2006. He resigned as Chairman and Chief Executive Officer, effective March 21, 2007 (3) In 2005, we awarded options to purchase up to 6,000,000 shares of our Common Stock at an exercise price per share of $0.05 to each of Barrie Damson and Alan Gaines. However, in connection with our grant of options to Thomas Kaetzer pursuant to hiring him as our President and Chief Operating Officer in December 2006, Mr. Gaines and Mr. Damson each agreed to the cancellation of options to acquire 1,000,000 shares of our Common Stock. (4) Mr. Cohen became our Chief Financial Officer in December 2005. He stepped down as Chief Financial Officer August 15, 2007 upon our hiring of Patrick H. McGarey. 50 Employment Contracts. Thomas Kaetzer Employment Agreement. Our employment agreement, dated December 20, 2006, with Thomas Kaetzer, provides that Mr. Kaetzer shall serve as our President and Chief Operating Officer effective as of December 5, 2006 and ending on December 30, 2008, unless earlier terminated or extended under the terms of such agreement. In consideration for such employment, the Company shall, among other things, pay Mr. Kaetzer an annual salary of $190,000. In addition to his annual salary, if Mr. Kaetzer remains in our employ on December 5, 2007 he shall be entitled to a performance bonus of $50,000. In addition, during the second year of his employment and thereafter (if his employment is extended), he may be entitled to a performance bonus, solely at the discretion of our board of directors. Mr. Kaetzer is further eligible under his employment agreement to participate, subject to any eligibility, co-payment and waiting period requirements, in all employee health and/or benefit plans offered or made available to our executive officers. Upon termination by Mr. Kaetzer for specified good reasons in the event of a merger or acquisition resulting in a diminution of his authority and duties, the relocation of his offices outside Houston, Texas of residence, or his termination by us other than for cause, the terminating executive officer will be entitled to receive from us: (i) a severance payment equal to 12-months of his then-current base salary plus pro rata bonus and fringe benefits otherwise due at time of termination; (ii) any unpaid bonus from preceding year of employment; and (iii) accrued but unused vacation days during the year such termination occurs. In addition, his employment agreement provides for us to issue to him three non-qualified stock options to purchase up to an aggregate of 2 million shares of our Common Stock pursuant to three stock option agreements, as described in more detail elsewhere in this prospectus. Each Option is exercisable as to one third of the optioned shares on each of the grant date and the first and second anniversary dates thereafter, and each such agreement provides that if Mr. Kaetzer's employment is terminated by the Company for cause or by Mr. Kaetzer without good reason, unvested Options shall immediately be forfeited, and that if his employment is terminated by the Company without cause or voluntarily by Mr. Kaetzer with good reason, optioned shares that would have vested on the next vesting date will immediately vest and become exercisable in proportion to the number of months he was employed during the 12-month period following the immediately preceding vesting date. Mr. Kaetzer has further agreed under his employment agreement that, during the respective term of his employment and for a one-year period after his termination (other than its termination by him for good reason or by us without cause), not to engage, directly or indirectly, as an owner, employee, consultant or otherwise, in any business engaged in the exploration, drilling or production of natural gas or oil within a ten (10) mile radius from any property that we then have an ownership, leasehold or participation interest. He is further prohibited during the above time period from soliciting or inducing, directly or indirectly, any of our then-current employees or customers, or any customers of ours during the one year preceding the termination of his employment. Mr. Kaetzer was promoted to Chairman and Chief Executive Officer on March 21, 2007 and, except for his title, his employment agreement continues to govern the terms of his employment. Patrick McGarey Employment Agreement. On August 3, 2007, we entered into an employment agreement with Patrick H. McGarey, whereby the Company hired Mr. McGarey as our Chief Financial Officer, effective August 16, 2007. Pursuant to the employment agreement, Mr. McGarey, shall serve as our Chief Financial Officer for an initial term of two years, unless earlier terminated or extended under the terms of the employment agreement. In consideration for such employment, Mr. McGarey shall receive an annual salary of $165,000. In addition, provided that Mr. McGarey remains in our employ, he will be entitled to a performance bonus of $33,000 for the first year of his term and a discretionary bonus each year thereafter. Mr. McGarey is further eligible under his employment agreement to participate, subject to any eligibility, co-payment and waiting period requirements, in all employee health and/or benefit plans offered or made available to our executive officers. The employment agreement provides that in the event Mr. McGarey is terminated without "Cause" (as defined in the employment agreement), he will receive a severance payment equal to 12 months' base salary. His employment agreement also contains covenants restricting him from participating in any business which is then engaged in the drilling, exploration or production of natural gas or oil, within a 10 mile radius of any area leased by us or in which we hold a working interest. As additional consideration for the hiring of Mr. McGarey, we granted Mr. McGarey non-qualified stock options to purchase up to an aggregate of 1,500,000 shares of our common stock under three separate stock option agreements, each dated as of August 3, 2007 and exercisable with respect to 500,000 shares at an exercise price of $0.55 per share, $0.825 per share and $1.10 per share, respectively. Each such option shall vest and become exercisable as to one third of the optioned shares on each of the grant date and the first and second anniversary dates thereafter, provided that Mr. McGarey remains in our employ. If his employment is terminated by us for cause or by Mr. McGarey without good reason, unvested options shall immediately be forfeited, and if his employment is terminated by us without cause or voluntarily by Mr. McGarey with good reason, shares that would have vested on the next vesting date will immediately vest and become exercisable in proportion to the number of months he was employed during the 12-month period following the immediately preceding vesting date. Upon a "change of control," unvested optioned shares shall be accelerated and become immediately exercisable. We have no other employment agreements with any of our other named executive officers. Director Compensation. Directors of the Company are not compensated in cash for their services but are reimbursed for out-of-pocket expenses incurred in furtherance of our business. 51 FINANCIAL STATEMENTS Index
Page No. (a) Annual Financial Statements of Baseline Oil & Gas Corp. Report of Independent Registered Public Accounting Firm ........................ F-1 Balance Sheet at December 31, 2006 ............................................. F-2 Statement of Expenses for years ended December 31, 2006 and 2005 and for the period from June 29, 2004 (Inception) through December 31, 2006 ........ F-3 Statement of Cash Flows for years ended December 31, 2006 and 2005 and for the period from June 29, 2004 (Inception) through December 31, 2006 .... F-4 Statement of Changes in Stockholders' Equity (Deficit) for the period from June 29, 2004 (Inception) through December 31, 2006 ........................... F-5 Notes to Financial Statements .................................................. F-6 (b) Quarterly Financial Statements of Baseline Oil & Gas Corp. Unaudited Balance Sheet at June 30, 2007 and December 31, 2006 ................. F-17 Unaudited Statements of Operations for three months ended June 30, 2007 and 2006 ........................................................................... F-19 Unaudited Statement of Operations for six months ended June 30, 2007 and June 30, 2006 ..................................................................... F-20 Unaudited Statement of Cash Flows for six months ended June 30, 2007 and 2006 ........................................................................... F-21 Notes to Financial Statements .................................................. F-22 (c) Financial Statements of Businesses Acquired. Report of Independent Registered Public Accounting Firm ........................ F-29 Statements of Combined Reserves and Direct Operating Expenses Oil and Gas Properties Purchased From Statex Petroleum I, L.P. and Charles W. Gleason, L.P. F-30 Notes to Financial Statements .................................................. F-31 (d) Pro Forma Financial Information of Baseline Oil & Gas Corp., giving effect to our acquisition of Statex Petroleum I, L.P. Introductory Comments - Unaudited Pro Forma Condensed Financial Statements ..................................................................... F-36 Unaudited Pro Forma Condensed Statement of Operations for the Year Ended December 31, 2006 ................................................... F-37 Unaudited Pro Forma Condensed Statement of Operations for the Year Ended December 31, 2005 ................................................... F-38 Unaudited Pro Forma Condensed Balance Sheet as of December 31, 2006 ........... F-39 Notes to Unaudited Pro Forma Condensed Financial Statements .................... F-40 Pro Forma Supplemental Oil and Gas Disclosures ................................. F-41 (e) Financial Statements of Business To Be Acquired. Report of Independent Registered Public Accounting Firm......................... F-45 Statements of Combined Revenues and Direct Operating Expenses of Oil and Gas Properties Purchased From DSX Energy Limited, LLP............................... F-46 Notes to Financial Statements................................................... F-47 (f) Pro Forma Financial Information of Baseline Oil & Gas Corp., giving effect to our proposed acquisition of DSX Energy Limited, LLP Unaudited Pro Forma Combined Balance Sheet as of June 30, 2007, with related footnotes.......................................................... F-52 Unaudited Pro Forma Combined Statement of Operations for the Six Months Ended June 30, 2007, with related footnotes.......................... F-53 Unaudited Pro Forma Combined Statement of Operations for the Six Months Ended June 30, 2006, with related footnotes.......................... F-54 Unaudited Pro Forma Combined Statement of Operations for the Fiscal Year Ended December 31, 2006, with related footnotes..................... F-55
52 (a) Annual Financial Statements of Baseline Oil & Gas Corp. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors Baseline Oil & Gas Corp. (A Development Stage Company) Houston, Texas We have audited the accompanying balance sheet of Baseline Oil & Gas Corp. ("Baseline") as of December 31, 2006, and the related statements of expenses, cash flows and changes in stockholders' equity (deficit) for the two year period then ended and for the period from June 29, 2004 (Inception) through December 31, 2006. These financial statements are the responsibility of Baseline's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). 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 Baseline, as of December 31, 2006, and the results of its operations and its cash flows for the periods described in conformity with accounting principles generally accepted in the United States of America. /s/ Malone & Bailey, PC Malone & Bailey, PC www.malone-bailey.com Houston, Texas April 12, 2007 F-1 BASELINE OIL & GAS CORP. (A Development Stage Company) BALANCE SHEET December 31, 2006 ASSETS Cash and marketable securities $ 123,678 Prepaid and other current assets 125,000 ------------ Total current assets 248,678 Deferred debt issuance costs, net of amortization of $237,192 88,947 Deferred financing costs 99,631 Property acquisition - deposit 1,000,000 Unproven leasehold acquisition costs 7,810,135 ------------ Total assets $ 9,247,391 ============ LIABILITIES & STOCKHOLDERS' EQUITY Accounts payable $ 82,873 Other payables 50,029 Accrued liabilities 171,471 Derivative liability 104,896 Short term debt and current portion of long term debt, net of discount 1,948,001 ------------ Total current liabilities 2,357,270 Commitments and contingencies -- STOCKHOLDERS' EQUITY Preferred stock, $.001 par value, 10,000,000 shares authorized, none issued and outstanding -- Common stock, $.001 par value, 140,000,000 shares authorized, 31,342,738 shares issued and outstanding 31,343 Additional paid-in-capital 28,423,418 Deficit accumulated during the development stage (21,564,640) ------------ Total stockholders' equity 6,890,121 ------------ Total liabilities & stockholders' equity $ 9,247,391 ============ See accompanying summary of accounting policies and notes to financial statements. F-2 BASELINE OIL & GAS CORP. (A Development Stage Company) STATEMENTS OF EXPENSES Years Ended December 31, 2006 and 2005 and the Period from June 29, 2004 (Inception) through December 31, 2006
Inception Year Ended Year Ended Through December 31, December 31, December 31, 2006 2005 2006 ----------------------------------------------------------- Selling, general and administrative $ 2,386,364 $ 17,305,279 $ 19,781,452 Interest (income) (117,630) -- (117,630) Interest expense 1,691,788 392,565 2,085,197 (Gain) on derivative liability (400,775) -- (400,775) Other expense 213,137 1,605 216,396 ----------------------------------------------------------- Total expense 3,772,884 17,699,449 21,564,640 ----------------------------------------------------------- Net loss $ (3,772,884) $ (17,699,449) $ (21,564,640) =========================================================== Basic and diluted loss per share $ (0.11) $ (1.20) Weighted average common shares outstanding 33,989,119 14,777,299
See accompanying summary of accounting policies and notes to financial statements. F-3 BASELINE OIL & GAS CORP. (A Development Stage Company) STATEMENTS OF CASH FLOWS Years Ended December 31, 2006 and 2005 and the Period from June 29, 2004 (Inception) through December 31, 2006
Year Year Inception Ended Ended Through December 31, December 31, December 31, 2006 2005 2006 ---------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (3,772,884) $(17,699,449) $(21,564,640) Adjustments to reconcile net loss to cash used in operating activities: Share based compensation 720,874 16,499,670 17,220,544 Unrealized gain on derivative liability (400,775) -- (400,775) Amortization of debt discount 1,206,577 305,825 1,512,402 Stock issued as penalty for delayed registration 594,000 -- 594,000 Stock issued in lieu of cash interest 187,500 -- 187,500 Amortization of debt issuance costs 237,192 29,649 266,841 Changes in: Prepaid and other assets (125,000) -- (125,000) Accounts payable and accruals 158,467 79,204 313,482 ------------ ------------ ------------ NET CASH USED IN OPERATING ACTIVITIES (1,194,049) (785,101) (1,995,646) ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Deposit on acquisition (1,000,000) -- (1,000,000) Deferred acquisition costs (99,631) -- (99,631) Property acquisition costs (6,060,135) (1,750,000) (7,810,135) ------------ ------------ ------------ NET CASH FLOWS USED IN INVESTING ACTIVITIES (7,159,766) (1,750,000) (8,909,766) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Payment of note payable (16,496) -- (16,496) Proceeds from sale of common stock, net 8,275,000 16,590 8,291,590 Proceeds from exercise of options 12,500 -- 12,500 Proceeds from convertible notes -- 2,725,000 2,741,496 ------------ ------------ ------------ NET CASH PROVIDED BY FINANCING ACTIVITIES 8,271,004 2,741,590 11,029,090 ------------ ------------ ------------ NET CHANGE IN CASH (82,811) 206,489 123,678 Cash balance, beginning of period 206,489 -- -- ------------ ------------ ------------ Cash balance, end of period $ 123,678 $ 206,489 $ 123,678 ============ ============ ============ SUPPLEMENTAL DISCLOSURES: Cash paid for interest $ 50,000 $ -- $ 50,000 Cash paid for income taxes $ -- $ -- $ -- NON-CASH INVESTING AND FINANCING ACTIVITIES: Warrants issued in connection with issuance of stock $ 505,671 $ -- $ 505,671
See accompanying summary of accounting policies and notes to financial statements. F-4 BASELINE OIL & GAS CORP. (A Development Stage Company) STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY/(DEFICIT) For the Period from June 29, 2004 (Inception) through December 31, 2006
Deficit Accumulated Additional During the Common Paid In Development Shares Stock Capital Stage Totals ------------------------------------------------------------------------------- Balances, June 29, 2004 -- $ -- $ -- $ -- $ -- Shares issued to founders at inception for $0.00 per share 200,000 200 (200) -- -- Net loss (92,307) (92,307) ------------------------------------------------------------------------------- Balances, December 31, 2004 (92,307) 200,000 200 (200) (92,307) Proceeds from issuance of common stock 17,006,000 17,006 -- -- 17,006 Debt discount related to shares issued with convertible notes 950,000 950 -- -- 950 Shares issued in connection with merger 2,114,000 2,114 (3,480) -- (1,366) Stock based compensation -- -- 16,499,670 -- 16,499,670 ount -- -- 1,939,401 -- 1,939,401 Debt Debt issuance cost -- -- 355,788 -- 355,788 Net loss -- -- -- (17,699,449) (17,699,449) ------------------------------------------------------------------------------- Balances, December 31, 2005 20,270,000 20,270 18,791,179 (17,791,756) 1,019,693 Shares issued in connection with merger 12,069,250 12,069 1,194,856 -- 1,206,925 Proceeds from issuance of common stock 8,181,818 8,182 8,991,818 -- 9,000,000 Equity issuance costs -- -- (1,230,671) -- (1,230,671) Shares issued on conversion of debt 1,820,000 1,820 357,289 -- 359,109 Return of shares issued in connection with merger (12,069,250) (12,069) (1,194,856) -- (1,206,925) Shares issued to pay interest 375,000 375 187,125 -- 187,500 Shares based compensation -- -- 720,874 -- 720,874 Shares issued as penalty for delayed registration 445,920 446 593,554 -- 594,000 Option exercise 250,000 250 12,250 -- 12,500 Net loss -- -- -- (3,772,884) (3,772,884) ------------------------------------------------------------------------------- Balances, December 31, 2006 31,342,738 $ 31,343 $ 28,423,418 $(21,564,640) $ 6,890,121 ===============================================================================
See accompanying summary of accounting policies and notes to financial statements. F-5 BASELINE OIL & GAS CORP. (A Development Stage Company) NOTES TO FINANCIAL STATEMENTS NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations and Organization Baseline Oil & Gas Corp. ("Baseline" or the "Company") is an independent exploration and production company, with operations presently focused in the Illinois Basin New Albany Shale play. Pursuant to a definitive purchase agreement and subject to the satisfaction of certain terms and conditions, on April 12, 2007 Baseline acquired significant oil and natural gas assets from Statex Petroleum I, L.P. and Charles W. Gleeson LP. Such assets consist of operated and non-operated working interests in leases located in Stephens County Texas, and approximately 81 gross producing oil and natural gas wells. Use of Estimates The preparation of these financial statements is in conformity with accounting principles generally accepted in the United States of America and requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents For purposes of the statement of cash flows, Baseline considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. There were no cash equivalents as of December 31, 2006. Properties and Equipment The Company uses the successful efforts method of accounting for oil and gas producing activities. Under this method, acquisition costs for proved and unproved properties are capitalized when incurred. Exploration costs, including geological and geophysical costs, the costs of carrying and retaining unproved properties and exploratory dry hole drilling costs, are expensed. Development costs, including the costs to drill and equip development wells, and successful exploratory drilling costs to locate proved reserves are capitalized. Exploratory drilling costs are capitalized when incurred pending the determination of whether a well has found proved reserves. A determination of whether a well has found proved reserves is made shortly after drilling is completed. The determination is based on a process that relies on interpretations of available geologic, geophysic, and engineering data. If a well is determined to be successful, the capitalized drilling costs will be reclassified as part of the cost of the well. If a well is determined to be unsuccessful, the capitalized drilling costs will be charged to expense in the period the determination is made. If an exploratory well requires a major capital expenditure before production can begin, the cost of drilling the exploratory well will continue to be carried as an asset pending determination of whether proved reserves have been found only as long as: i) the well has F-6 found a sufficient quantity of reserves to justify its completion as a producing well if the required capital expenditure is made and ii) drilling of the additional exploratory wells is under way or firmly planned for the near future. If drilling in the area is not under way or firmly planned, or if the well has not found a commercially producible quantity of reserves, the exploratory well is assumed to be impaired, and its costs are charged to expense. In the absence of a determination as to whether the reserves that have been found can be classified as proved, the costs of drilling such an exploratory well is not carried as an asset for more than one year following completion of drilling. If, after that year has passed, a determination that proved reserves exist cannot be made, the well is assumed to be impaired, and its costs are charged to expense. Its costs can, however, continue to be capitalized if a sufficient quantity of reserves are discovered in the well to justify its completion as a producing well and sufficient progress is made in assessing the reserves and the well's economic and operating feasibility. The impairment of unamortized capital costs is measured at a lease level and is reduced to fair value if it is determined that the sum of expected future net cash flows is less than the net book value. The Company determines if impairment has occurred through either adverse changes or as a result of the annual review of all fields. Development costs of proved oil and gas properties, including estimated dismantlement, restoration and abandonment costs and acquisition costs, are depreciated and depleted on a field basis by the units-of-production method using proved developed and proved reserves, respectively. The costs of unproved oil and gas properties are generally combined and impaired over a period that is based on the average holding period for such properties and the Company's experience of successful drilling. Investments in Oil and Gas Joint Ventures The Company accounts for its investments in oil and gas joint ventures pursuant to the provisions of AICPA Accounting Interpretation No. 2 to APB No. 18. As such, the Company includes in its financial statements its pro rata share of the assets, liabilities, revenues, and expenses of the venture. Loss Per Share The basic net loss per common share is computed by dividing the net loss by the weighted average number of common shares outstanding. Diluted net loss per common share is computed by dividing the net loss adjusted on an "as if converted" basis, by the weighted average number of common shares outstanding plus potential dilutive securities. For the years ended December 31, 2006 and 2005, there were no dilutive securities outstanding. Income Taxes Baseline recognizes deferred tax assets and liabilities based on differences between the financial reporting and tax bases of assets and liabilities using the enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered. Baseline provides a valuation allowance for deferred tax assets for which it does not consider realization of such assets to be more likely than not. Stock Compensation F-7 On January 1, 2006, Baseline adopted SFAS No. 123 (R), "Share-Based Payment." SFAS 123(R) replaced SFAS No. 123 and supersedes APB Opinion No. 25. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS 123 are no longer an alternative to financial statement recognition. Baseline adopted SFAS 123(R) using the modified prospective method which requires the application of the accounting standard as of January 1, 2006. The consolidated financial statements as of and for the year ended December 31, 2006 reflect the impact of adopting SFAS 123(R). In accordance with the modified prospective method, the consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). During the fiscal year ended December 31, 2005, Baseline granted 13,675,000 options to purchase common stock to employees. All options are currently vested, have a weighted average exercise price of $0.07 per share and expire 5 years from the date of grant. Baseline recorded compensation expense of $10,080,000 under the intrinsic value method during the fiscal year ended December 31, 2005. The following table illustrates the effect on net loss and net loss per share if Baseline had applied the fair value provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation. - -------------------------------------------------------------------------------- Year Ended December 31, 2005 - -------------------------------------------------------------------------------- Net loss as reported $(17,699,449) Add: stock based compensation determined under intrinsic value based method 10,080,000 Less: stock based compensation determined under fair value based method (10,874,173) ------------ Pro forma net loss $(18,493,622) ============ Basic and diluted net loss per common share: As reported $ (1.20) ============ Pro forma $ (1.25) ============ - -------------------------------------------------------------------------------- The weighted average fair value of the stock options granted during 2005 was $0.77. Variables used in the Black-Scholes option-pricing model include (1) a range of 3.9% - 4.41% for the risk-free interest rate, (2) expected option life is the actual remaining life of the options as of each period end, (3) expected volatility was 274% - 672%, and (4) zero expected dividends. F-8 NOTE 2 - INCOME TAXES Deferred tax assets - NOLs $ 969,241 Less: valuation allowance (969,241) --------- Net deferred tax asset $ -- ========= Baseline has net operating loss carry-forwards of approximately $2,850,000 at December 31, 2006, which begin expiring in 2024. NOTE 3 - CONVERTIBLE NOTES On April 6, 2005 (the effective date), Baseline acquired Coastal in exchange for 17,206,000 shares of Baseline common stock. Coastal was merged with and into Baseline with Baseline continuing as the surviving entity. Upon the effective date of the Coastal merger, Baseline assumed the obligations with respect to $350,000 of convertible promissory notes. The notes, issued in April 2005, were convertible at any time into shares of Baseline's common stock at a rate of $0.25 per share, accrued interest at the rate of 10% per annum and matured in April 2006 (twelve months from the date of issuance). Upon conversion, each holder of these convertible promissory notes is entitled to receive an additional number of shares equal to 20% of the face amount of the convertible promissory notes. The impact of these additional shares results in an effective conversion rate of $0.21 per share. Based on the effective conversion rate of $0.21 per share, Baseline has recognized a beneficial conversion feature on the notes of $231,401 which was recorded as a debt discount. The discount was amortized over the life of the notes. On April 6, 2006, holders of Baseline's convertible promissory notes issued in April of 2005 in the aggregate principal amount of $350,000, converted all of such notes plus accrued interest into 1,820,000 shares of Baseline's common stock. During November of 2005, Baseline sold $2,375,000 in aggregate of its units. Each Unit consisted of (i) a $50,000 principal amount in an 18 month 10% convertible promissory note ("November Note"), and (ii) such number of shares of common stock equal to the quotient of (1) the aggregate principal amount of each Note purchased, multiplied by 20% and (2) $0.50. The notes are convertible at any time at a conversion price of $0.50 per share. Interest is payable in cash or shares (at the conversion price) at the option of the Company. Purchasers of the Units received in the aggregate 950,000 shares and, upon conversion of the Notes, will receive an additional 4,750,000 Shares. Each quarter Baseline pays interest of $59,380 to the holders in the form of $12,500 in cash and 93,750 shares of Baseline common. Baseline recorded a debt discount of $680,500 in connection with the initial issuance 950,000 shares based on the stock prices of $0.71 and $0.75 on the dates of issuance. Based on the effective conversion rate of $0.50, Baseline recognized a beneficial conversion feature of $1,027,500 as a debt discount on the additional 4,750,000 shares to be issued upon conversion of the principal amount of the note. The total discount, $1,708,000, is being amortized over the life of the November Note using the effective interest method. As of December 31, 2006, $1,281,001 of the discount had been amortized resulting in a net balance for the November Note of $1,948,001. In connection with the note issuance, Baseline granted to Gilford Securities, the placement agent, a five year warrant to purchase 475,000 shares of Common Stock at an exercise of $0.50 per share. F-9 Baseline evaluated the application of Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" and Emerging Issues Task Force ("EITF") 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock" for the 10% convertible promissory notes and the warrants issued in connection with the note issuance. Based on the guidance of SFAS No. 133 and EITF 00-19, Baseline concluded that these instruments were not required to be accounted for as derivatives. NOTE 4 - ISSUANCE OF COMMON STOCK On March 28, 2005, Baseline issued 17,006,000 shares as follows: o 100,000 shares of common stock for services valued at $35,000 and is included in share based compensation; and o 16,906,000 shares of common stock valued at $5,917,100 for cash proceeds of $16,590. The $5,900,194 of value in excess of the cash proceeds received has been charged to expense as share based compensation; The services were provided by the founders in connection with non-specific research into oil and gas business opportunities. The value of the shares issued was determined by reference to the closing price of Baseline's stock on the date of issuance. On January 16, 2006, Baseline entered into a definitive Purchase Agreement ("Purchase Agreement") to purchase certain assets from Rex Energy Operating Corp. ("Rex Energy") and its affiliates (collectively the "Rex Parties"), and the 50% membership in the New Albany -Indiana, LLC ("New Albany") that we did not already own. Concurrently with the execution of the Purchase Agreement, we entered into a Stock Agreement with certain individuals designated by Rex Energy, pursuant to which we issued a total of 12,069,250 common shares of our Common Stock valued at $1,206,925 or $0.10 per share. The issuance of such shares was subject to our right of first refusal to repurchase all such shares at a price $ 1.00 below any bona fide purchase offer for such shares made by a third party. We accounted for the aforementioned shares as a stock subscription receivable. On June 8, 2006, Baseline entered into a Mutual Termination Agreement ("Termination Agreement") and Mutual Release Agreement ("Release Agreement") with the Rex Parties pursuant to which we and the Rex Parties mutually terminated (i) that certain purchase agreement between us dated January 16, 2006 and (ii) that certain stock agreement dated January 16, 2006 (as amended on March 10, 2006). Pursuant to the termination agreement, the Rex Parties surrendered for cancellation of the aforementioned, 12,069,250 shares of our common stock, previously issued to them pursuant to the Stock Agreement. In connection with the surrender of these shares, the $1,206,925 of stock subscription receivable relating to the shares was eliminated as an adjustment to equity. After giving effect to the cancellation of such shares, we have 31,342,730 shares of common stock and options, warrants and convertible promissory notes to purchase up to an additional 19,562,840 shares of common stock outstanding as of December 31, 2006. Pursuant to the Release Agreement, we and the Rex Parties have agreed to release and hold each other harmless from all Claims stemming from Controversies (each as defined in the Release Agreement) arising out of our dealings with one another. F-10 On February 1, 2006 Baseline completed a private placement of $9,000,000 by selling an aggregate of 8,181,818 shares of newly-issued Common Stock at $ 1.10 per share. As part of the transaction, Baseline issued warrants to the placement agents ("Placement Warrants") to purchase an aggregate of 204,546 shares of Common Stock at an exercise price of $1.32 per share. These warrants have a three year term. Baseline agreed to register the resale of the shares of common stock issuable upon exercise of the Placement Warrants. Based on the guidance in SFAS 133 "Accounting for Derivative Instruments and Hedging Activities" and EITF 00-19 "Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Company's Own Stock", Baseline concluded the Placement Warrants qualified for derivative accounting. Baseline determined the Placement Warrants had the attributes of a liability and therefore recorded the fair value of the Placement Warrants on day one as a current liability and a reduction of additional paid in capital as a cost of equity issuance. Baseline is required to record the unrealized changes in fair value in subsequent periods of the Placement Warrants as an adjustment to the current liability with unrealized changes in the fair value of the derivative reflected in the statement of expenses as "(Gain)/loss on derivative liability." The fair value of the Placement Warrants was $505,671 at February 1, 2006. The fair value of the Placement Warrants was determined utilizing the Black-Scholes stock option valuation model. The significant assumptions used in the valuation were: the exercise price as noted above; the market value of Baseline's common stock on February 1, 2006, $2.50; expected volatility of 268%; risk free interest rate of approximately 4.54%; and a term of three years. The fair value of the Placement Warrants was $104,896 at December 31, 2006. The fair value of the Placement Warrants was determined utilizing the Black-Scholes stock option valuation model. The significant assumptions used in the valuation were: the exercise price as noted above; the market value of Baseline's common stock on December 31, 2006, $0.761 expected volatility of 224%; risk free interest rate of approximately 4.82%; and a term of two years and four months. The resulting unrealized change in fair value of $400,775 from February 1, 2006 was recorded in the statement of expenses as a gain on derivative liability. On April 6, 2006, holders of Baseline's convertible promissory notes issued in April of 2005 in the aggregate principal amount of $350,000, converted all of such notes into 1,820,000 shares of Baseline's common stock. On October 20, 2006, Baseline's registration statement was declared effective. In November 2006, Baseline issued an aggregate of 445,920 shares of Common Stock with a value of $594,000 to investors in our February 2006 private offering. Such shares were issued as a result of Baseline's failure to timely register the shares purchased in the private offering. On November 15, 2006, Baseline issued an aggregate of 375,000 shares of Common Stock with a value of $187,500 to holders of November Notes in payment of accrued interest through November 15, 2006. On November 16, 2006, Wayne Brannan exercised an option to purchase 250,000 shares of Common Stock at $0.05 per share. Baseline issued 250,000 shares to Mr. Brannan in exchange for $12,500. NOTE 5 - STOCK OPTION GRANTS On April 1, 2005, Baseline granted a stock option to a non-employee consultant to purchase up to 500,000 shares of common stock at an exercise price of $0.30 per share. The option shall terminate no later than March 31, 2010 and may be exercised in whole or in part, at any time from and after October 1, 2005. The F-11 fair value of the option was $150,000 and has been fully expensed as share based compensation. As of the effective date of the Coastal merger noted above, see Note 3, the shares available in connection with the option converted into an equal number of Baseline shares. On April 29, 2005, Baseline granted stock options to seven persons, five of which are company directors and/or officers and two of which are non-employees, to acquire up to 12,950,000 shares of Baseline's common stock. The options are immediately exercisable at $0.05 per share and will expire on April 28, 2010. The options were granted as an inducement to retain management and for services rendered to Baseline. The intrinsic value of the options granted to the employees was $10,080,000 and has been expensed as share based compensation. The fair value of the options granted to the non-employees was $297,500 and has been expensed as share based compensation. Mr. Alan Gaines ("Gaines") and Mr. Barrie Damson ("Damson"), two of the seven persons mentioned above, have options which are cancelable under certain conditions. Specifically, the agreement with Rex Energy Operating Corp. (see Note 4) provides that each of Damson and Gaines, who presently each beneficially owns 5,894,250 shares of our outstanding Common Stock and options to acquire an additional 6,000,000 shares of Common Stock, will, upon the earlier to occur of (i) the Closing Date or, (ii) if the Closing shall not have occurred as a result of the Baseline's breach of a material provision of the Purchase Agreement, June 30, 2006, cancel such number of shares underlying their respective stock options, such that on such date, each of Messrs. Gaines and Damson shall beneficially own no more than 9.99% of the Company's outstanding shares of Common Stock on a fully-diluted basis. As is discussed in Note 4, on June 8, 2006, Baseline terminated the Purchase Agreement with Rex Energy. On December 20, 2005, Baseline issued to six Rex Management designees as described in stock options, exercisable for up to an aggregate of 50,000 shares of common stock at an exercise price of $1.00 per share. The options are fully vested, immediately exercisable and will expire on December 20, 2008. On December 27, 2005, Baseline issued to Mr. Richard Cohen, CFO, a stock option, exercisable for up to 175,000 shares of common stock at an exercise price of $0.94 per share. The option is fully vested, immediately exercisable and will expire on December 26, 2010. During 2006, Baseline's Board of Directors granted the following stock options, which are immediately exercisable with the exception of the options issued to Thomas Kaetzer as detailed below: On August 15, 2006, Baseline granted a stock option to The Wall Street Group, a consultant, exercisable for up to 100,000 shares of Common Stock at an exercise price of $1.01 per share. On October 20, 2006, Baseline granted a stock option to Carey Birmingham, its former president, exercisable for up to 75,000 shares of Common Stock at an exercise price of $0.50 per share. On October 20, 2006, Baseline granted a stock option to David Loev, exercisable for up to 25,000 shares of Common Stock at an exercise price of $0.50 per share. On November 14, 2006, Baseline granted a stock option to Masstar Inc., a consultant, exercisable for up to 360,000 shares of Common Stock at an exercise price of $0.50 per share. F-12 On November 16, 2006 Wayne Brannan exercised an option to purchase 250,000 shares at $0.05 share. On December 16, 2006, Baseline granted stock options to Thomas Kaetzer, then COO, now CEO, exercisable for up to 1,000,000, 500,000 and 500,000 shares of Common Stock exercisable at $0.50, $0.60 and $1.00 per share respectively. Mr. Kaetzer's options vest in three equal parts on; 1) the date of grant, 2) the 1st anniversary the date of grant, and 3) 2nd anniversary of the date of grant. Coinciding with the issue of Mr. Kaetzer's options, Messrs. Gaines and Damson agreed to cancel in aggregate options to purchase 2,000,000 shares with an exercise price of $0.05 per share. The following table summarizes stock option activity: Weighted Average Options Price Outstanding as of January 1, 2004 -- $ -- Granted during 2004 -- -- Cancelled or expired -- -- Exercised -- -- ---------- Outstanding as of December 31, 2004 -- -- Granted during 2005 13,675,000 $ 0.07 Cancelled or expired -- -- Exercised -- -- ---------- Outstanding as of December 31, 2005 13,675,000 $ 0.07 Granted during 2006 2,560,000 $ 0.64 Cancelled or expired (2,000,000) 0.05 Exercised (250,000) 0.05 ---------- Outstanding as of December 31, 2006 13,985,000 $ 0.18 ---------- Exercisable as of December 31, 2006 13,985,000 $ 0.18 ========== Options Outstanding and exercisable at December 31, 2006: Exercisable Number Remaining Number of Exercise Price of Shares Life Shares ---------------------------------------------- $0.05 10,700,000 3.3 10,700,000 $0.30 500,000 3.3 500,000 0.50 - $1.01 2,785,000 4.8 1,451,667 ---------- ---------- 13,985,000 12,651,667 ========== ========== F-13 NOTE 6 - INVESTMENT IN JOINT VENTURE On November 25, 2005, Baseline entered into a joint venture with Rex Energy, a privately held company, for the purpose of acquiring a working interest in certain leasehold interests located in the Illinois Basin, Indiana. The joint venture will be conducted through New Albany, a Delaware limited liability company. Pursuant to a Limited Liability Company Agreement, Baseline has a 50% economic/voting interest in New Albany and Rex Energy and its affiliates has a 50% economic/voting interest in New Albany. Rex Energy Wabash, LLC, an affiliate of Rex, is the Managing Member of New Albany and manages the day to day operations of New Albany. On November 15, 2005, New Albany entered into a Purchase and Sale Agreement with Aurora Energy Ltd ("Aurora"), pursuant to which New Albany has agreed to purchase from Aurora an undivided 48.75% working interest (40.7% net revenue interest) in (i) certain oil, gas and mineral leases covering acreage in several counties in Indiana and (ii) all of Aurora's rights under a certain Farmout and Participation Agreement with a third party ("Farmout Agreement"). In addition, at the closing of the transaction, New Albany was granted an option from Aurora, exercisable by New Albany for a period of eighteen (18) months thereafter, to acquire a fifty percent (50%) working interest in any and all acreage leased or acquired by Aurora or its affiliates within certain other counties located in Indiana, at a fixed price per acre. On February 1, 2006, New Albany completed its acquisition of certain oil and gas leases and other rights from Aurora pursuant to the November 15, 2005 Purchase and Sale Agreement mentioned above. The total purchase price under the Aurora Purchase Agreement and the grant of the Aurora Option was $10,500,000 of which Baseline paid $5,250,000. On February 28, 2006, New Albany acquired a 45% working interest (37.125% net revenue interest) in certain oil, gas and mineral leases covering approximately 21,000 acres of prospective New Albany Shale acreage in Knox and Sullivan Counties, Indiana. New Albany acquired its 45% working interest from Source Rock Resources, Inc., for a total consideration of $735,000 (of which Baseline paid half). On July 21, 2006 Baseline transferred $88,714 to New Albany to fund the purchase of working interests in additional acreage acquired from Source Rock Resources, Inc. On July 31, 2006 Baseline transferred $200,938 to New Albany to fund the purchase of working interests in additional acreage acquired from Aurora. On October 26, 2006, Baseline transferred $680,643 to New Albany to fund its share of the pilot drilling program on the acreage acquired from Aurora and the acquisition of additional acreage from Source Rock Resources, Inc. On November 8, 2006 Baseline transferred $250,105 to New Albany to fund its share of the pilot drilling program on the acreage acquired from Aurora On November 17, 2006 Baseline transferred $175,013 to New Albany to fund its share of the pilot drilling program on the acreage acquired from Aurora F-14 NOTE 7 - REGISTRATION STATEMENT-PENALTY INTEREST SHARES As part of its Common Stock Offering in February 2006 (see Note 4), Baseline was subject to a Registration Rights Agreement requiring it to file a registration statement under the Securities Act by April 2, 2006. The company did not file by April 2, but did so on June 13, 2006. As a result, Baseline incurred a $540,000 penalty, which was paid by issuing 445,920 common shares in November 2006. NOTE 8 - SUBSEQUENT EVENTS On December 20, 2006, Baseline Oil & Gas entered into a Purchase and Sale Agreement ( "agreement") with Statex Petroleum I, L.P. and Charles W Gleeson LP for a number of oil and gas producing properties in Stephens County in West Texas. The purchase price was $ 28,000,000 plus interest from January 15, 2007 until date of closing. Upon execution of the agreement we paid a $1,000,000 non-refundable deposit to be credited against the purchase price at the closing scheduled to take place on or before March 9, 2007. On March 9, 2007 we entered into an amendment to the agreement whereby for an additional deposit of $300,000 paid by March 16, 2007 the deadline to close on the purchase of the Stephens County assets was extended until April 16, 2007 and the effective date for the transfer of the assets was changed from December 1, 2006 to February 1, 2007. Baseline closed this acquisition on April 12, 2007. On January 4, 2007, Baseline granted a stock option to Richard Cohen, CFO, exercisable for up to 100,000 shares of Common Stock at an exercise price of $0.56 per share. On January 26, 2007, Barrie Damson our Chairman and CEO and Alan Gaines our Vice Chairman and a director each made a loan of $50,000 to the Company to be used for short term working capital needs. The loans, in the form of promissory notes, bear interest at an annual rate of 6% and mature on the earlier to occur of (i) the date on which we close a financing transaction in which we obtain proceeds in excess of $5,000,000 or (ii) July 26, 2007. On February 15, 2007, Baseline issued an aggregate of 93,750 shares of Common Stock to holders of November Notes in payment of interest for the three months ended February 15, 2007. On March 15, 2007, Baseline closed a private bridge financing whereby we borrowed $1,700,000 from a single accredited investor, Lakewood Capital ("Lakewood"). The Company issued to Lakewood a Senior Secured Debenture ("Debenture") bearing interest at 16%, a common stock purchase warrant to purchase up to 3,000,000 shares of our common stock at an exercise price of $0.50 per share, and entered into a security agreement collateralized by the assets of the New Albany LLC. In addition we are required to pay Lakewood a closing fee of $170,000 on the date when the outstanding principal and accrued interest are paid. If Baseline consummates a debt or equity financing of $15,000,000 or more the Debenture must be paid in full. The proceeds from the Lakewood financing were used to pay the additional deposit of $300,000 on the Stephens County property, satisfy a capital call of $300,000 payable to Rex to maintain an interest in the New Albany LLC, pay existing payables on Stephens County, and pay a $170,000 fee to Casamir Capital, the placement agent. Additionally, The Company issued Casamir Capital a warrant exercisable for up to 340,000 shares of Common Stock at an exercise price of $0.50 per share. Concurrently with the closing of the Lakewood financing, Barrie Damson and Alan Gaines each cancelled stock options to purchase 1,670,000 shares of the company's common stock at an exercise of $0.05. On March 16, 2007 we delivered $300,000 to New Albany-Indiana LLC ( "New Albany ") to pay a portion of the outstanding capital calls that we, as a member of New Albany, were required to make. Pursuant to a Membership Interest Redemption F-15 Agreement between the Company and New Albany, we then redeemed our membership interest in the New Albany for the direct assignment to the Company of an undivided 40.423% working interest in and to all oil and gas properties, rights, and assets of New Albany. The New Albany assets have been pledged to Lakewood under a mortgage to secure the assets of Lakewood Debenture. Effective March 21, 2007, Barrie Damson resigned as Chairman and CEO of Baseline Oil and Gas Corp. As a result of Mr. Damson's departure, the Company appointed Mr. Thomas Kaetzer to fill the vacancy on the Board and promoted Mr. Kaetzer from President/COO to Chairman/CEO. F-16 BASELINE OIL & GAS CORP. BALANCE SHEETS (Unaudited)
June 30, December 31, 2007 2006 ---- ---- ASSETS CURRENT ASSETS Cash and marketable securities $ 156,396 $ 123,678 Cash - restricted 1,131,107 -- Accounts receivable, trade 1,175,289 -- Prepaid and other current assets 123,661 125,000 ------------ ------------ Total current assets 2,586,453 248,678 ------------ ------------ OIL AND NATURAL GAS PROPERTIES - using successful efforts method of accounting Proved properties 27,416,424 -- Unproved properties 8,092,302 7,810,135 Less accumulated depletion, depreciation and amortization (514,580) -- ------------ ------------ Oil and natural gas properties, net 34,994,146 7,810,135 ------------ ------------ OTHER ASSETS Deferred acquisition costs -- 99,631 Property acquisition - deposit -- 1,000,000 Deferred loan costs, net of accumulated amortization of $2,141,832 and $237,192, respectively 3,767,604 88,947 Other property and equipment, net of accumulated depreciation of $3,125 at June 30, 2007 37,635 -- ------------ ------------ Total other assets 3,805,239 1,188,578 ------------ ------------ TOTAL ASSETS $ 41,385,838 $ 9,247,391 ============ ============
The accompanying notes are an integral part of the financial statements. F-17 BASELINE OIL & GAS CORP. BALANCE SHEETS (Unaudited)
June 30, December 31, 2007 2006 ---- ---- LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable - trade 599,074 82,873 Accrued expenses 417,575 172,750 Royalties payable 508,440 -- Short term notes to related parties 100,000 -- Short term debt and current portion of long-term debt 2,257,450 1,996,751 Derivative liability - short term 956,463 104,896 ------------ ------------ Total current liabilities 4,839,002 2,357,270 ------------ ------------ NONCURRENT LIABILITIES Long-term debt 30,218,224 -- Asset retirement obligations 450,779 -- Derivative liability - long term 834,490 -- ------------ ------------ Total noncurrent liabilities 31,503,493 -- ------------ ------------ Total liabilities 36,342,495 2,357,270 ------------ ------------ COMMITMENTS AND CONTINGENCIES -- -- STOCKHOLDERS' EQUITY Common stock, $0.001 par value per share; 140,000,000 shares authorized; 32,210,238 and 31,342,738 shares issued and outstanding, respectively 32,211 31,343 Additional paid-in capital 31,629,156 28,423,418 Accumulated other comprehensive income (1,691,686) -- Accumulated deficit (24,926,338) (21,564,640) ------------ ------------ Total stockholders' equity 5,043,343 6,890,121 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 41,385,838 $ 9,247,391 ============ ============
The accompanying notes are an integral part of the financial statements. F-18 BASELINE OIL & GAS CORP. STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended June 30, ----------------------------- 2007 2006 ---- ---- REVENUES Oil and gas sales $ 2,819,739 $ -- ------------ ------------ OPERATING EXPENSES Production 1,309,387 -- General and administrative 563,823 839,019 Depreciation, depletion and amortization 517,705 -- Accretion expense 12,332 -- ------------ ------------ Total operating expenses 2,403,247 839,019 ------------ ------------ Net income (loss) from operations 416,492 (839,019) OTHER INCOME (EXPENSE) Other income 23,366 -- Interest income 102 37,513 Interest expense (2,954,872) (354,418) Unrealized gain (loss) on derivative instruments (40,806) 433,650 ------------ ------------ Total other expense, net (2,972,210) 116,745 ------------ ------------ NET LOSS $ (2,555,718) $ 722,274 ============ ============ OTHER COMPREHENSIVE INCOME (LOSS) Unrealized gain (loss) on derivative instruments (1,691,686) -- ------------ ------------ Total comprehensive loss $ (4,247,404) $ (722,274) ============ ============ NET LOSS PER SHARE - Basic and Diluted $ (0.08) $ (0.02) ============ ============ WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING BASIC AND DILUTED 31,641,960 39,303,227 ============ ============
The accompanying notes are an integral part of the financial statements. F-19 BASELINE OIL & GAS CORP. STATEMENTS OF OPERATIONS (Unaudited)
Six Months Ended June 30, ----------------------------- 2007 2006 ---- ---- REVENUES Oil and gas sales $ 2,819,739 $ -- ------------ ------------ OPERATING EXPENSES Production 1,309,387 -- General and administrative 851,929 1,265,274 Depreciation, depletion and amortization 517,705 -- Accretion expense 12,332 -- ------------ ------------ Total operating expenses 2,691,353 1,265,274 ------------ ------------ Net income (loss) from operations 128,386 (1,265,274) OTHER INCOME (EXPENSE) Other income 23,366 -- Interest income 860 59,543 Interest expense (3,519,939) (764,257) Unrealized gain on derivative instruments 5,629 333,677 ------------ ------------ Total other expense, net (3,490,084) (371,037) ------------ ------------ NET LOSS $ (3,361,698) $ (1,636,311) ============ ============ OTHER COMPREHENSIVE INCOME (LOSS) Unrealized gain (loss) on derivative instruments (1,691,686) -- ------------ ------------ Total comprehensive loss $ (5,053,384) $ (1,636,311) ============ ============ NET LOSS PER SHARE - Basic and Diluted $ (0.11) $ (0.04) ============ ============ WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING BASIC AND DILUTED 31,514,831 37,440,583 ============ ============
The accompanying notes are an integral part of the financial statements. F-20 BASELINE OIL & GAS CORP. STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended June 30, ----------------------------- 2007 2006 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (3,361,698) $ (1,636,311) Adjustments to reconcile net loss to net cash provided by operating activities Share based compensation 55,371 -- Common stock issued for consulting fees 150,000 -- Depreciation, depletion and amortization expense 517,705 -- Amortization of debt discount 426,999 118,596 Amortization of deferred loan costs 2,047,140 637,243 Derivative gain (loss) (5,629) (333,677) Accretion expense 12,332 -- Changes in operating assets and liabilities Cash - restricted (1,131,107) -- Accounts receivable, trade (1,175,289) -- Prepaid and other current assets 101,050 (37,500) Accounts payable - trade 516,201 (27,486) Accrued liabilities 368,263 387,774 Royalties payable 508,440 -- ------------ ------------ Net cash used in operating activities (970,222) (891,361) ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Acquisition of proved oil and gas properties (28,195,001) -- Development costs incurred (361,345) -- Additions to unproved properties (282,167) (4,664,723) Purchase of property and equipment, other (40,760) -- ------------ ------------ Net cash used in investing activities (28,879,273) (4,664,723) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from long-term debt 30,013,224 -- Proceeds from short term debt 1,700,000 -- Proceeds from short tern notes to related parties 100,000 -- Repayments of short term debt (1,761,011) (16,496) Proceeds from common stock sales, net -- 8,284,109 Deferred loan costs incurred (170,000) -- ------------ ------------ Net cash provided by financing activities 29,882,213 8,267,613 ------------ ------------ NET INCREASE IN CASH AND CASH EQUIVALENTS 32,718 2,711,529 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 123,678 206,489 ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $ 156,396 $ 2,918,018 ============ ============ SUPPLEMENTAL DISCLOSURES: Cash paid for interest $ 474,641 $ -- Cash paid for income taxes -- -- NON-CASH ACTIVITIES Unrealized gain/(loss) on derivative liability (1,686,057) 333,677 Warrants issued in conjunction with debt 2,687,797 -- Stock issued for note extension 190,000 -- Asset retirement obligation incurred 400,298 -- Warrants issued in conjunction with stock issuance -- 505,671 Stock issued on conversion of debt -- 350,000 Stock issued in lieu of cash interest 93,750 --
The accompanying notes are an integral part of the financial statements. F-21 Baseline Oil & Gas Corp. Notes to Unaudited Financial Statements June 30, 2007 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations and Organization Baseline Oil & Gas Corp. ("Baseline" or the "Company") is an independent exploration and production company primarily engaged in the acquisition, development, production and exploration of oil and natural gas properties onshore in the United States. Basis of Presentation The accompanying unaudited interim financial statements of Baseline have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission (the "SEC"), and should be read in conjunction with Baseline's audited financial statements for the year ended December 31, 2006, and notes thereto, which are included in the Company's annual report on Form 10-KSB filed with the SEC on April 17, 2007. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the financial statements, which would substantially duplicate the disclosure required in Baseline's 2006 annual financial statements have been omitted. Use of Estimates The preparation of these financial statements is in conformity with accounting principles generally accepted in the United States of America and requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. Oil and Natural Gas Properties Baseline uses the successful efforts method of accounting for oil and gas producing activities. Costs to acquire mineral interests in oil and gas properties, to drill and equip exploratory wells that find proved reserves, to drill and equip development wells and related asset retirement costs are capitalized. Costs to drill exploratory wells that do not find proved reserves, geological and geophysical costs, and costs of carrying and retaining unproved properties are expensed. Unproved oil and gas properties that are individually significant are periodically assessed for impairment of value, and a loss is recognized at the time of the impairment by providing an impairment allowance. Capitalized costs of producing oil and gas properties, after considering estimated residual salvage values, are depreciated and depleted by the unit-of-production method. Support equipment and other property and equipment are depreciated over their estimated useful lives. On the sale or retirement of a complete unit of proved property, the cost and related accumulated depreciation, depletion, and amortization are eliminated from the property accounts, and the resultant gain or loss is recognized. On the retirement or sale of a partial unit of proved property, the cost is charged to accumulated depreciation, depletion, and amortization with a resulting gain or loss recognized in income. F-22 On the sale of an entire interest in an unproved property for cash or cash equivalent, gain or loss on the sale is recognized, taking into consideration the amount of any recorded impairment if the property had been assessed individually. If a partial interest in an unproved property is sold, the amount received is treated as a reduction of the cost of the interest retained. Asset Retirement Obligations The Company records a liability for legal obligations associated with the retirement of tangible long-lived assets in the period in which they are incurred in accordance with Statement of Financial Accounting Standards ("SFAS") No. 143 "Accounting for Asset Retirement Obligations." Under this method, when liabilities for dismantlement and abandonment costs, excluding salvage values, are initially recorded the carrying amount of the related oil and natural gas properties are increased. Accretion of the liability is recognized each period using the interest method of allocation, and the capitalized cost is depleted over the useful life of the related asset. Revisions to such estimates are recorded as adjustments to the ARO, capitalized asset retirement costs and charges to operations during the periods in which they become known. At the time the abandonment cost is incurred, the Company will be required to recognize a gain or loss if the actual costs do not equal the estimated costs included in ARO. Revenue and Cost Recognition The Company uses the sales method of accounting for natural gas and oil revenues. Under this method, revenues are recognized based on the actual volumes of gas and oil sold to purchasers. The volume sold may differ from the volumes to which the Company is entitled based on our interest in the properties. Costs associated with production are expensed in the period incurred. NOTE 2 - CONCENTRATION OF RISK At June 30, 2007, Baseline's cash in financial institutions exceeded the federally insured deposits limit by $1,087,503. Restricted cash in the amount of $1,131,107 represents cash in a bank account controlled by an administrative agent under a credit agreement (see NOTE 4). NOTE 3 - ACQUISITION OF NORTH TEXAS PROPERTIES On April 12, 2007, Baseline acquired an interest in producing oil and gas properties from Statex Petroleum I, L.P. and Charles W. Gleeson LP. The properties consist of a 100% working interest in approximately 4,600 acres in Stephens County in North Texas (the "North Texas Assets"). The purchase price was $28,000,000, plus interest from January 15, 2007 until the date of closing and an adjustment for cash flow from the properties from the effective date until the date of closing. In addition, Baseline has capitalized $1,551,106 in costs associated with the transaction and $438,447 related to the asset retirement obligations associated with the properties. Upon execution of the Purchase and Sale Agreement Baseline paid a $1,000,000 non-refundable deposit to be credited against the purchase price. Baseline entered into an amendment to the agreement, whereby for an additional deposit of $300,000, the deadline to close on the purchase was extended. The effective date for the transfer of the assets was February 1, 2007. Baseline funded the adjusted purchase price, less the deposits previously paid, and a portion of the costs associated with the transaction through borrowings under a newly created credit agreement (see Note 4). F-23 NOTE 4 - DEBT Total debt at June 30, 2007 and December 31, 2006 consisted of the following: June 30, 2007 December 31, 2006 ------------- ----------------- Short term notes to related parties $ 100,000 $ -- Other short term notes 87,450 48,750 Convertible notes, net of discount of $0 and $426,999 2,375,000 1,948,001 Term loans under credit agreement 9,713,224 -- Revolving loans under credit agreement 20,300,000 -- ------------ ------------ 32,575,674 1,996,751 Less short term debt and current portion of long-term debt (2,357,450) (1,996,751) ------------ ------------ Long-term debt $ 30,218,224 $ -- ============ ============ Long-term Debt On April 12, 2007, Baseline entered into a $75 million Credit Agreement (the "Credit Agreement") with Drawbridge Special Opportunities Fund LP ("Drawbridge"), as Administrative Agent and various named lenders (the "Lenders"). The Credit Agreement provides for a revolving credit commitment of up to $54.7 million and a Term Loan Commitment of $20.3 million. Revolving Loans must be paid on or before April 12, 2010 and Term Loans on or before October 12, 2010. The Revolving Loans accrue interest at the Prime Rate and the Term Loans accrue interest at the Prime Rate or 7.5%, whichever is greater, plus 3%. Additionally, Baseline granted the Lenders an overriding royalty interest ranging between 2% and 3% in its existing oil and gas properties and any properties that it acquires while the Credit Agreement is in effect. The Credit Agreement requires Baseline's revenues to be deposited into a lockbox account controlled by the Administrative agent. Funds in the lockbox account on the last business day of the month are utilized, in order of priority, to pay any amounts due for the overriding royalty interest granted under the Credit Agreement, amounts due to third parties under swap agreements, lease operating costs approved by the Administrative agent, interest due on the Term Loans and Revolving loans and general and administrative expenses up to $225,000 per quarter. Any amounts remaining in the lockbox account in excess of $250,000 are to be used to repay outstanding principal, to be applied first to the Term Loans. Baseline's obligations under the Credit Agreement are secured by a first lien on all of its existing oil and gas properties, including the North Texas Assets, and any properties acquired while the Credit Agreement is in effect. On April 12, 2007 Baseline drew down $9.7 million as a Revolving Loan. In addition, Baseline drew down $20.3 million as a Term Loan. The funds were utilized to repay the bridge loan financing, including accrued interest and fees, and to fund the adjusted purchase price and a portion of the capitalized transaction costs for the acquisition of the North Texas Assets. The Company recorded a discount of $2,678,000 related to the conveyance of the overriding royalty interest to the Lenders as discussed above. As of June 30, 2007, $44,633 of this discount has been amortized as a component of interest expense. This discount is being amortized over the expected term of the Credit Agreement using the effective interest method. On May 30, 2007 holders of Baseline's 10% convertible notes unanimously agreed to extend the maturity date of the notes from May 15, 2007 to November 15, 2007. As consideration for the extension of the notes, Baseline issued 380,000 shares in aggregate to the holders of the notes and increased the coupon rate on the notes from 10% to 12% per annum effective May 16, 2007. Bridge Loan Financing On March 15, 2007, Baseline borrowed $1,700,000 from a single accredited investor, Lakewood Group, LLC ("Lakewood"). Baseline issued to Lakewood a Senior Secured Debenture ("Debenture") bearing interest at 16%, a common stock purchase warrant to purchase up to 3,000,000 shares of Common Stock at an exercise price F-24 of $0.50 per share, and entered into a security agreement collateralized by the assets of Baseline. In addition Baseline was required to pay Lakewood a closing fee of $170,000 on April 12, 2007, when the outstanding principal and accrued interest were paid. The proceeds from the Lakewood financing were used to pay an additional deposit of $300,000 on the North Texas Assets (see NOTE 3), to partially satisfy a capital call in the New Albany-Indiana LLC (see NOTE 6), to pay expenses related to the ongoing financing and acquisition efforts, and to pay a $170,000 fee to Casimir Capital, the placement agent. Additionally, The Company issued Casimir Capital a warrant exercisable for up to 340,000 shares of Common Stock at an exercise price of $0.50 per share. On April 12, 2007, the Debenture was fully paid from proceeds received under the Credit Agreement. Loans From Founders On January 26, 2007, Barrie Damson our former Chairman and CEO and Alan Gaines our Vice Chairman and a director each made a loan of $50,000 to the Company to be used for short term working capital needs. The loans, in the form of promissory notes, bear interest at an annual rate of 6% and mature on the earlier to occur of the date on which Baseline closes a financing transaction in which it obtains proceeds in excess of $5,000,000 or July 26, 2007. On April 10, 2007, Messrs. Gaines and Damson agreed to extend the maturity of their promissory notes to the earlier of October 10, 2010 or the date on which Baseline closes an equity offering in which it obtains gross proceeds in excess of $3,000,000. NOTE 5 - STOCKHOLDERS' EQUITY Common Stock On March 31, 2007, Baseline issued an aggregate of 93,750 shares of common stock, with a value of $46,875, in payment of accrued interest through February 15, 2007, to holders of 10% convertible promissory notes issued by Baseline in privately negotiated transactions involving the offer and sale of $2.375 million in units consisting of such notes and Common Stock. On May 15, 2007, Baseline issued an aggregate of 93,750 shares of common stock, with a value of $46,875, in payment of accrued interest through May 15, 2007, to holders of 10% convertible promissory notes issued by Baseline in privately negotiated transactions involving the offer and sale of $2.375 million in units consisting of such notes and Common Stock. On May 30, 2007, Baseline issued 380,000 shares to holders of 10% convertible promissory notes in consideration of the holders' agreement to extend the maturity of the notes by six months. Baseline's 10% convertible notes will now mature on November 15, 2007. Such shares were valued at $190,000 which has been charged to interest expense. On June 22, 2007, Baseline issued 300,000 shares to an outside consultant as compensation for services valued at $150,000. Stock Options and Warrants On January 4, 2007, Baseline granted a five year stock option to Richard Cohen, CFO, exercisable for up to 100,000 shares of Common Stock at an exercise price of $0.56 per share. Such option had a fair value of $55,371. F-25 On March 15, 2007, concurrently with the closing of the bridge loan financing (see NOTE 4), Alan Gaines, Baseline's Vice-Chairman, and Barrie Damson, a former officer and director of Baseline, each cancelled stock options to purchase 1,670,000 shares of Baseline's common stock at an exercise price of $0.05 per share. In connection with our entry into the Credit Agreement, on April 12, 2007 we issued warrants to Drawbridge and D.B. Zwirn Special Opportunities Fund, L.P., another lender participating therein, which warrants are each exercisable for up to 1.6 million shares of our Common Stock, at an exercise price of $0.50 per share. Pursuant to certain warrant agreements executed with these two lenders, any unexercised warrants expire on April 11, 2014. The warrants also afford the holders certain anti-dilution protection. In connection with the issuance of the warrants we also entered into a registration rights agreement dated April 12, 2007 with each of the holders of the warrants, under which we granted piggy-back registration rights, demand registration rights and shelf registration rights to these holders. Such warrants had a fair value of $1,209,085 which has been capitalized as a deferred loan cost and is being amortized over the term of the Credit Agreement. On April 12, 2007, concurrently with the execution of the Credit Agreement (see Note 4), Alan Gaines, our Vice Chairman, and Barrie Damson, a former officer and director of our Company, each surrendered additional stock options to purchase 1,670,000 shares of Common Stock at an exercise price of $0.05 per share, resulting in the cancellation of options for an aggregate of 3,340,000 million shares of Common Stock. NOTE 6 - INVESTMENT IN JOINT VENTURE AND REDEMPTION OF MEMBERSHIP INTEREST On March 16, 2007, Baseline paid $300,000 to New Albany-Indiana LLC ("New Albany") to pay a portion of the outstanding capital calls that it, as a member of New Albany, was required to make. Pursuant to a Membership Interest Redemption Agreement between the Company and New Albany, Baseline then redeemed its membership interest in New Albany for the direct assignment to the Company of an undivided 40.423% working interest in and to all oil and gas properties, rights, and assets of New Albany. Such assets were then pledged to Lakewood under a mortgage to secure Lakewood's Debenture. The reduction in our membership interest of 50% to a 40.423% direct working interest reflected an adjustment of our membership interest in New Albany at the time of our redemption, as a result of outstanding capital calls owed by us but assumed by the affiliates and/or assigns of Rex Energy, the other joint venture partner. After redeeming its membership interest in New Albany on March 16, 2007, Baseline now owns the following assets: o 19.7% working interest in the Aurora/Wabash Area of Mutual Interest (AMI), consisting of approximately 122,000 gross acres (approximately 24,400 acres net to us), seven New Albany natural gas pilot wells (four horizontal and three vertical wells), one natural gas compression/treating facility, two salt water disposal wells, three Devonian Reef gas wells (5% working interest to us) and three horizontal wells currently scheduled to be drilled in 2007; o 18.2% working interest in the Rex Knox County AMI, consisting of approximately 41,000 total acres (approximately 7,380 acres net to us) acquired from Source Rock, and five horizontal wells currently scheduled to be drilled in 2007; and F-26 o 6.9% working interest in the El Paso AMI, consisting of approximately 8,000 acres (560 acres net to us) and one horizontal well drilled in 2007. NOTE 7 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES On April 12, 2007, in accordance with a requirement of the Credit Agreement, Baseline also entered into a Swap Agreement ("Swap Agreement") with Macquarie Bank Limited, which provides that Baseline puts in place, for each month through the third anniversary of April 12, 2007, separate swap hedges with respect to approximately 75% of the projected production from Proved Developed Producing Reserves. The swap hedges provide for a fixed price of $68.20 per barrel for a three year period, commencing June 1, 2007. The hedging arrangement is based upon a minimum of 11,000 barrels in the first year and provides for monthly settlements. During July 2007, Baseline modified its hedge from a fixed price swap to a collar with a floor of $68.20 and a ceiling of $74.20 for the period from August 2007 through December 2008. Subsequent to December 2008 it reverts to a swap agreement at $68.20. In exchange for the near term switch from a fixed price swap to a collar, Baseline provided a right to the hedge provider to purchase 7,000 barrels per month at $73.20 per barrel from June 2010 through December 2011. SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of each derivative is recorded each period in current earnings or other comprehensive income, depending on whether the derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. To make this determination, management formally documents the hedging relationship and its risk-management objective and strategy for undertaking the hedge, the hedging instrument, the item, the nature of the risk being hedged, how the hedging instrument's effectiveness in offsetting the hedged risk will be assessed, and a description of the method of measuring effectiveness. This process includes linking all derivatives that are designated as cash-flow hedges to specific cash flows associated with assets and liabilities on the balance sheet or to specific forecasted transactions. Baseline also formally assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting cash flows of hedged items. A derivative that is highly effective and that is designated and qualifies as a cash-flow hedge has its changes in fair value recorded in other comprehensive income to the extent that the derivative is effective as a hedge. Any other changes determined to be ineffective do not qualify for cash-flow hedge accounting and are reported currently in earnings. Baseline discontinues cash-flow hedge accounting when it is determined that the derivative is no longer effective in offsetting cash flows of the hedged item, the derivative expires or is sold, terminated, or exercised, the derivative is redesignated as a non-hedging instrument because it is unlikely that a forecasted transaction will occur, or management determines that designation of the derivative as a cash-flow hedge instrument is no longer appropriate. In situations in which cash-flow hedge accounting is discontinued, Baseline continues to carry the derivative at its fair value on the balance sheet and recognizes any subsequent changes in its fair value in earnings. When the criteria for cash-flow hedge accounting are not met, realized gains and losses (i.e., cash settlements) are recorded in other income and expense in the Statements of Operations. Similarly, changes in the fair value of the derivative instruments are recorded as unrealized gains or losses in the Statements of Operations. In contrast cash settlements for derivative instruments that qualify for hedge accounting are recorded as additions to or reductions of oil and gas revenues while changes in fair value of cash flow hedges are recognized, to the extent the hedge is effective, in other comprehensive income until the hedged item is recognized in earnings. F-27 Based on the above, management has determined the swaps qualify for cash-flow hedge accounting treatment. For the period ended June 30, 2007, Baseline recognized a derivative liability of $1,691,686 with the change in fair value reflected in other comprehensive income/loss. NOTE 8 - SUBSEQUENT EVENTS On July 3, 2007, Baseline issued 300,000 shares to a consultant for services rendered valued at $150,000. On July, 5, 2007 non-employee option holders exercised options to purchase 200,000 shares of Common Stock at $ .05 per share on a "cashless" basis. As a result Baseline issued 185,714 shares. On July 13, 2007, a consultant exercised an option to purchase 100,000 shares of Common Stock at $0.30 per share on a "cashless" basis. As a result, Baseline issued 56,522 shares. During July 2007 holders of $150,000 of Baseline's 10% Convertible Promissory Notes converted such notes into 301,676 shares. On August 3, 2007, the Board of Directors (i) granted five-year options exercisable for up to an aggregate of 370,000 shares of common stock to several employees, which options vest in equal one-third installments on each of the first, second and third anniversary dates from the date of grant, (ii) granted a five-year stock option to Richard d'Abo, an outside director, exercisable for up to 150,000 shares of common stock and (iii) authorized the payment of a transaction bonus to Alan Gaines, our vice-chairman, in an amount equal to 0.25% of the gross proceeds raised by Baseline in its next debt and/or equity offering, if any. All such options are exercisable at $0.55 per share. On August 3, 2007 the Company entered into a two year employment agreement with Mr Patrick McGarey to become Chief Financial Officer effective August 16, 2007. Mr McGarey succeeds Richard Cohen who will continue to serve through August 15, 2007. Concurrently with the entry into the employment agreement with Mr. McGarey, Baseline granted to Mr. McGarey five-year options, exercisable for (i) up to 500,000 shares of common stock, at an exercise price equal to $0.55, (ii) up to 500,000 shares, at an exercise price of $0.825 per share, and (iii) up to 500,000 shares, at an exercise price of $1.10 per share. Each option grant provides for the following vesting schedule: (i) 166,666 shares on August 3, 2007, (ii) 166,667 shares on August 3, 2008 and (iii) 166,667 shares on August 3, 2009, provided that Mr. McGarey remains in the employ of the Company through such dates. F-28 (c) Financial Statements of Businesses Acquired. Report of Independent Registered Public Accounting Firm To the Shareholders of Baseline Oil & Gas Corp. Houston, TX We have audited the accompanying Statements of Combined Revenues and Direct Operating Expenses of the Oil and Gas Properties ("Statex Properties") Purchased from Statex Petroleum I, L.P. and Charles W. Gleason, L.P. (the "Financial Statements") for the years ended December 31, 2006 and 2005. These Financial Statements are the responsibility of Baseline Oil & Gas Corp.'s management. Our responsibility is to express an opinion on the Financial Statements based on our audits. We conducted our audit in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). 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 Statement. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall Financial Statement presentation. We believe our audits provide a reasonable basis for our opinion. The accompanying Financial Statements were prepared for the purpose of complying with the rules and regulations of the Securities and Exchange Commission as described in Note 2. The presentation is not intended to be a complete presentation of the properties described above. In our opinion, the Financial Statements referred to above present fairly, in all material respects, the Combined Revenues and Direct Operating Expenses of the Oil and Gas Properties Purchased from Statex Petroleum I, L.P. and Charles W. Gleason, L.P. as described in Note 1 for the years ended December 31, 2006 and 2005, in conformity with U.S. generally accepted accounting principles. /s/ Malone & Bailey, PC - ----------------------- Malone & Bailey, PC www.malone-bailey.com Houston, Texas April 9, 2007 F-29 Baseline Oil & Gas Corp. Statements of Combined Revenues and Direct Operating Expenses of Oil and Gas Properties Purchased From Statex Petroleum I, L.P. and Charles W. Gleason, L.P. For the Years Ended December 31, 2006 2005 -------------------------- Revenues $12,522,236 $10,732,108 Direct operating expenses 6,446,934 5,016,266 ----------- ----------- Excess of revenues over direct operating expenses $ 6,075,302 $ 5,715,842 =========== =========== The accompanying notes are an integral part of the financial statements. F-30 Baseline Oil & Gas Corp. Statement of Combined Revenues and Direct Operating Expenses of Oil and Gas Properties Purchased From Statex Petroleum I, L.P. and Charles W. Gleason, L.P. Notes to Financial Statements (1) The Properties On December 20, 2006, Baseline Oil & Gas, Corp. ("Baseline" or the "Company") entered into a Purchase and Sale Agreement to purchase certain oil and has properties (the "Properties") owned by Statex Petroleum I, L.P. and Charles W. Gleeson L.P. (collectively, the "Seller") for $28,600,000. On April 12, 2007, Baseline finalized the acquisition of the Properties. (2) Basis For Presentation The statement of combined revenues and direct operating expenses has been derived from the Seller's historical financial records and is prepared on the accrual basis of accounting. Revenues and direct operating expenses as set forth in the accompanying statement includes revenues from oil and gas production, net of royalties, and associated direct operating expenses related to the net revenue interest and net working interest, respectively. These revenues and expenses in the Properties represent Baseline's acquired interest. During the periods presented, the Properties were not accounted for or operated as a separate division of the Seller. Accordingly, full separate financial statements prepared in accordance with generally accepted accounting principles do not exist and are not practicable to obtain in these circumstances. This statement varies from an income statement in that it does not show certain expenses, which were incurred in connection with the ownership of the Properties, such as general and administrative expenses, and income taxes. These costs were not separately allocated to the Properties in the Seller's historical financial records and any pro forma allocation would be both timing consuming and expensive and would not be a reliable estimate of what these costs would actually have been had the Properties been operated historically as a stand alone entity. In addition, these allocations, if made using the historical Seller general and administrative structures and tax burdens, would not produce allocations that would be indicative of the historical performance of the Properties had they been assets of Baseline, due to the greatly varying size, structure, and operations between Baseline and the Seller. This statement does not include provisions for depreciation, depletion and amortization as such amounts would not be indicative of future costs and those costs which would be incurred by Baseline upon allocation of purchase price. Accordingly, the financial statement and other information presented are not indicative of the financial condition or results of operations of the Properties going forward due to the changes in the business and the omission of various operating expenses. For the same reason, primarily the lack of segregated or easily obtainable reliable data on asset values and related liabilities, a balance sheet is not presented for the Properties. At the end of the economic life of the Properties, F-31 certain restoration and abandonment costs will be incurred by the respective owners of the Properties. No accrual for these costs is included in the direct operating expenses. (3) Commitments and Contingencies Baseline is not aware of any legal, environmental or other commitments or contingencies relating to the Properties that would have a material effect on the statement of combined revenues and direct operating expenses. (4) Revenue Recognition It is Baseline's policy to recognize revenue when production is sold to a purchaser at a fixed or determinable price. (5) Supplemental Oil and Gas Information (Unaudited) A. General. The estimated net proved oil and gas reserves and the present value of estimated cash flows from those reserves from the Properties acquired by Baseline are summarized below. The reserves were estimated by Pressler Petroleum Consultants, Inc. ("Pressler") in a report dated February 27, 2007 as of December 31, 2006. The reserve study was paid for by Baseline and was based on information provided by the Seller to Pressler. The December 31, 2006 reserve study was the only determination of proved reserves that is available therefore there will be no revisions of reserve estimates because no previous determination of estimates exists. Likewise there was no detail of extensions, discoveries and improved recovery for the periods below because there was no basis in which to determine when a discovery or extension was actually made. B. Estimated Oil and Gas Reserve Quantities. There was no determination of proven reserves at December 31, 2005. The only reserve study was done as of December 31, 2006. For the table below, the December 31, 2006 proved reserve total was adjusted for the actual production activity to determine what the proved reserves would have been at December 31, 2005 based on the reserve study as of December 31, 2006. There are numerous uncertainties inherent in estimating quantities of proved reserves and projecting future rates of production. The following reserve data related to the Properties represent estimates only and should not be construed as being exact. The reliability of the estimates at any point in time depends on both quality and quantity of the technical and economic data, the performance of the reservoirs, as well as extensive engineering judgment. Consequently, reserve estimates are subject to revision as additional data becomes available during the producing life of a reservoir. The evolution of technology may also result in the application of improved recovery techniques, such as supplemental or enhanced recovery projects, which have the potential to increase reserves beyond those currently envisioned. F-32 Estimates of proved reserves are derived from quantities of crude oil and natural gas that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing operating and economic conditions and rely upon a production plan and strategy. Statement of Financial Accounting Standards No. 69, Disclosures About Oil and Gas Producing Activities ("FAS 69"), requires calculation of future net cash flows using a 10% annual discount factor and year-end prices, costs and statutory tax rates, except for known future changes such as contracted price and legislated tax rates. All of the reserves relating to the Properties are located in the United States. Estimated Oil and Gas Information:
Oil Equivalent Oil (Bbls) Gas (Mcf) (BOE) ------------------------- ---------- Total Proved Reserves Balance - December 31, 2005 3,781,640 373,648 3,843,915 Production (193,250) (29,588) (198,181) Purchases of reserve in-place -- -- -- Extensions, discoveries and improved recovery -- -- -- Transfers/sales of reserve in place -- -- -- Revisions of previous estimates -- -- -- ---------- ---------- ---------- Ending reserves - December 31, 2006 3,588,390 344,060 3,645,734 ========== ========== ========== Proved developed reserves: 2,881,390 303,470 2,931,968 ========== ========== ========== Oil Equivalent Oil (Bbls) Gas (Mcf) (BOE) ------------------------- ---------- Total Proved Reserves Balance - December 31, 2004 3,972,921 405,090 4,040,436 Production (191,281) (31,442) (196,521) Purchases of reserve in-place -- -- -- Extensions, discoveries and improved recovery -- -- -- Transfers/sales of reserve in place -- -- -- Revisions of previous estimates -- -- -- ---------- ---------- ---------- Balance - December 31, 2005 3,781,640 373,648 3,843,915 ========== ========== ========== Proved developed reserves: 3,025,312 328,810 3,080,114 ========== ========== ==========
F-33 C. Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves. The following disclosures concerning the standardized measure of future cash flows from proved oil and gas reserves are presented in accordance with FAS 69. As prescribed by FAS 69, the amounts shown are based on prices and costs at the end of each period and a 10% annual discount factor. Future cash flows are computed by applying fiscal year-end prices of natural gas and oil to year-end quantities of proved natural gas and oil reserves. Future operating expenses and development costs are computed primarily by the Company by estimating the expenditures to be incurred in developing and producing the Properties' proved natural gas and oil reserves at the end of the year based on year end costs and assuming continuation of existing economic conditions. Future income taxes are based on currently enacted statutory rates. The standardized measure of discounted future net cash flows is not intended to represent the replacement costs or fair value of the Properties' natural gas and oil reserves. An estimate of fair value would take into account, among other things, anticipated future changes in prices and costs, and a discount factor more representative of the time value of money and the risks inherent in reserve estimates of natural gas and oil producing operations. The standardized measure of discounted future net cash flows from the Company's estimated proved gas reserves is provided for the financial statement user as a common base for comparing oil and gas reserves of enterprises in the industry and may not represent the fair market value of the Company's oil and gas reserves or the present value of future cash flows of equivalent reserves due to various uncertainties inherent in making these estimates. Those factors include changes in oil and gas prices from year end prices used in the estimates, unanticipated changes in future production and development costs and other uncertainties in estimating quantities and present values of oil and gas reserves. The Standardized Measure of Discounted Future Net Cash Flows relating to the Properties' proved oil and gas reserves is as follows:
Years Ended December 31, ------------------------------------- 2006 2005 ------------- ------------- Future cash inflows $ 212,297,137 $ 220,860,507 Future production costs (116,402,890) (122,846,877) Future development costs (5,142,900) (5,142,900) ------------- ------------- Future net cash flows before income taxes 90,751,347 92,870,730 Future income tax (30,428,739) (31,311,622) ------------- ------------- Future net cash flows 60,322,608 61,559,108 Discount at 10% annual rate (27,145,174) (27,701,599) ------------- ------------- Standardized measure of discounted future net cash flows $ 33,177,434 $ 33,857,509 ============= =============
F-34 The principal changes in the standardized measure of discounted future net cash flows relating to proved oil and gas reserve are summarized below:
Years Ended December 31, ------------------------------------ 2006 2005 ------------ ------------ Standardized measure, beginning of year $ 33,857,509 $ 14,578,422 Sales, net of production costs (6,884,367) (5,715,842) Net change in prices, net of production costs 2,620,732 32,530,132 Extensions and discoveries -- -- Development costs incurred -- -- Accretion of discount, changes in production rates and other 3,034,480 2,426,554 Change in income tax 549,080 (9,961,757) Revision of quantity estimates -- -- ------------ ------------ End of year $ 33,177,434 $ 33,857,509 ============ ============
F-35 (d) Pro Forma Financial Information, giving effect to our acquisition of Statex Petroleum I, L.P. Baseline Oil & Gas Corp. Unaudited Pro Forma Condensed Financial Statements The following unaudited pro forma condensed financial statements and related notes are presented to show the pro forma effects of the acquisition of the Properties from the Seller. The pro forma condensed statements of operations are presented to show income from continuing operations as if the acquisition of the Properties occurred effective January 1, 2005. The pro forma condensed balance sheet is based on the assumption that the acquisition of the Properties occurred effective December 31, 2006. Pro forma data are based on assumptions and include adjustments as explained in the notes to the unaudited pro forma condensed financial statements. The pro forma data are not necessarily indicative of the financial results that would have been attained had the acquisition of the Properties occurred on the dates referenced above and should not be viewed as indicative of operations in future periods. The unaudited pro forma condensed financial statements should be read in conjunction with notes thereto, Baseline's Annual Report on Form 10-KSB for the year ended December 31, 2006 and the Statement of Combined Revenues and Direct Operating Expenses Purchased of Oil and Gas Properties Purchased From Statex Petroleum I, L.P. and Charles W. Gleason, L.P. included herein. F-36 Baseline Oil & Gas Corp. Unaudited Pro Forma Condensed Statement of Operations For the Year Ended December 31, 2006
Baseline Properties Pro Forma Historical Historical Adjustments Pro Forma ---------------------------------------------- ------------ Revenues $ -- $ 12,522,236 $ -- $ 12,522,236 ---------------------------------------------- ------------ Direct operating costs -- 6,446,934 -- 6,446,934 Depreciation, depletion and amortization -- -- 1,434,299 (a) 1,434,299 General & administrative 2,386,364 -- -- 2,386,364 Gain on derivitive liability (400,775) -- -- (400,775) Financing costs, net 1,787,295 -- 3,600,010 (b)(c) 5,387,305 ---------------------------------------------- ------------ 3,772,884 6,446,934 5,034,309 15,254,127 ---------------------------------------------- ------------ Income (loss) before income taxes (3,772,884) 6,075,302 (5,034,309) (2,731,891) Provision for income tax -- -- -- -- ---------------------------------------------- ------------ Net income (loss) to common $ (3,772,884) $ 6,075,302 $ (5,034,309) $ (2,731,891) ============================================== ============ Basic and diluted earnings per share $ (0.11) $ (0.08) Weighted shares outstanding 33,989,119 33,989,119
The accompanying notes to the unaudited pro forma condensed financial statements are an integral part of these statements. F-37 Baseline Oil & Gas Corp. Unaudited Pro Forma Condensed Statement of Operations For the Year Ended December 31, 2005
Baseline Properties Pro Forma Historical Historical Adjustments Pro Forma ---------------------------------------------- ------------ Revenues $ -- $ 10,732,108 $ -- $ 10,732,108 ---------------------------------------------- ------------ Direct operating costs -- 5,016,266 -- 5,016,266 Depreciation, depletion and amortization -- -- 1,422,285 (a) 1,422,285 General & administrative 17,305,279 -- 1,292,000 (d) 18,547,279 Financing costs, net 394,170 -- 3,600,010 (b)(c) 3,994,180 ---------------------------------------------- ------------ 17,699,449 5,016,266 6,314,295 29,030,010 ---------------------------------------------- ------------ Income (loss) before income taxes (17,699,449) 5,715,842 (6,314,295) (18,297,902) Provision for income tax -- -- -- -- ---------------------------------------------- ------------ Net income (loss) to common $(17,699,449) $ 5,715,842 $ (6,314,295) $(18,297,902) ============================================== ============ Basic and diluted earnings per share $ (1.20) $ (1.24) Weighted shares outstanding 14,777,299 14,777,299
The accompanying notes to the unaudited pro forma condensed financial statements are an integral part of these statements. F-38 Baseline Oil & Gas Corp. Unaudited Pro Forma Condensed Balance Sheet as of December 31, 2006
Baseline Pro Forma Historical Adjustments Pro Forma ----------------------------- ------------ Assets Current assets $ 248,678 $ -- $ 248,678 Net property, plant and equipment 7,810,135 30,015,320 (1)(2)(3) 37,825,455 Other assets 1,188,578 (1,000,000) (4) 188,578 ----------------------------- ------------ Total Assets $ 9,247,391 $ 29,015,320 $ 38,262,711 ============================= ============ Liabilities and shareholders' equity Current liabilities 2,357,270 -- $ 2,357,270 Long-term debt 28,656,704 (5)(6) 28,656,704 Other non-current liabilities -- -- -- Shareholders equity 6,890,121 358,616 (6)(7) 7,248,737 ----------------------------- ------------ Total liabilities and shareholders equity $ 9,247,391 $ 29,015,320 $ 38,262,711 ============================= ============
The accompanying notes to the unaudited pro forma condensed financial statements are an integral part of these statements. F-39 Baseline Oil & Gas Corp. Notes to Unaudited Pro Forma Condensed Financial Statements Basis of Presentation The unaudited pro forma statement of operations for the year ended December 31, 2005, is based on the audited financial statements of Baseline for the year ended December 31, 2005, the audited the Statements of Combined Revenues and Direct Operating Expenses of Oil and Gas Properties Purchased From Statex Petroleum I, L.P. and Charles W. Gleason, L.P. for the year ended December 31, 2005 and the adjustments and assumptions described below. The unaudited pro forma statement of operations for the year ended December 31, 2006, and the unaudited pro forma balance sheet as of December 31, 2006, are based on the audited financial statements of Baseline as of and for the year ended December 31, 2006, the audited Statements of Combined Revenues and Direct Operating Expenses of Oil and Gas Properties Purchased From Statex Petroleum I, L.P. and Charles W. Gleason, L.P. for the year ended December 31, 2006, and the adjustments and assumptions described below. Pro forma adjustments: The unaudited pro forma statements of operations reflect the following adjustments: a. Record incremental depreciation, depletion and amortization expense, using units of production method, resulting from the purchase of the Properties. b. Record interest expense associated with Revolving Loan A and Term Loan B from Petrobridge Investment Management, LLC ("Petrobridge") c. Record amortization of the $473,320 commitment fee paid and the $1,177,296 fair market value of Warrants issued to Petrobridge. The amounts are being amortized over the life of the notes. d. Record $1,292,000 in non-deal related expenses. The unaudited pro forma balance sheet reflects the following adjustments associated with the acquisition of the Properties as of December 31, 2006. 1. Record the purchase price of the Statex Properties, $28,600,000. 2. Record the $473,320 commitment fee paid to Petrobridge and the $642,000 in other deal related closing costs. 3. Record $300,000 incremental investment in New Albany Indiana properties. 4. Application of deposit to purchase Statex Properties. 5. Record the $30,307,320 borrowed from Petrobridge in the form of the $10,307,320 Revolving Loan A and $20,300,000 Term Loan B. 6. Record amortization of the $473,320 commitment fee and the debt discount of $1,177,296 associated with the issuance of warrants to purchase 3,200,000 shares of stock issued to Petrobridge. 7. Record $1,292,000 in non-deal related expenses. F-40 Baseline Oil & Gas Corp. Pro Forma Supplemental Oil and Gas Disclosures (Unaudited) A. General. The following table sets forth certain unaudited pro forma information concerning Baseline's proved oil and gas reserves as of December 31, 2006 and 2005, giving effect to the purchase of the Properties from the Seller as if it had occurred on January 1, 2005. There are numerous uncertainties inherent in estimating quantities of proved reserves and projecting future rates of production. The following reserve data related to the Properties represent estimates only and should not be construed as being exact. The reliability of these estimates at any point in time depends on both the quality and quantity of the technical and economic data, the performance of the reservoirs, as well as extensive engineering judgment. Consequently, reserve estimates are subject to revision as additional data becomes available during the producing life of a reservoir. The evolution of technology may also result in the application of improved recovery techniques, such as supplemental or enhanced recovery projects, which have the potential to increase reserves beyond those currently envisioned. B. Estimated Oil and Gas Reserve Quantities. There was no determination of proven reserves at December 31, 2005. The only reserve study was done as of December 31, 2006. For the table below, the December 31, 2006 proved reserve total was adjusted for the actual production activity to determine what the proved reserves would have been at December 31, 2005 based on the reserve study as of December 31, 2006. There are numerous uncertainties inherent in estimating quantities of proved reserves and projecting future rates of production and timing of development expenditures. Estimates of proved reserves are derived from quantities of crude oil and gas that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing operating and economic conditions and rely upon a production plan and strategy. The following reserve data represents estimates only and should not be construed as being exact. All of the reserves are located in the United States. F-41 Estimated oil and gas information:
Barrel Oil Equivalent Reserves (BOE) -------------------------------------- Total proved reserves: Baseline Properties Pro Forma -------------------------------------- Balance, December 31, 2005 -- 3,843,915 3,843,915 Production -- (198,181) (198,181) Purchases of reserve in-place -- -- -- Extensions, discoveries and improved recovery -- -- -- Transfers/sales of reserve in place -- -- -- Revisions of previous estimates -- -- -- -------------------------------------- Balance, December 31, 2006 -- 3,645,734 3,645,734 ====================================== Proved developed reserves at December 31, 2006 -- 2,931,968 2,931,968 ====================================== Barrel Oil Equivalent Reserves (BOE) -------------------------------------- Total proved reserves: Baseline Properties Pro Forma -------------------------------------- Balance, December 31, 2004 -- 4,040,436 4,040,436 Production -- (196,521) (196,521) Purchases of reserve in-place -- -- -- Extensions, discoveries and improved recovery -- -- -- Transfers/sales of reserve in place -- -- -- Revisions of previous estimates -- -- -- -------------------------------------- Balance, December 31, 2005 -- 3,843,915 3,843,915 ====================================== Proved developed reserves at December 31, 2005 -- 3,080,114 3,080,114 ======================================
F-42 Pro Forma Standardized Measure of Discounted Future Net Cash Flows: The following is a summary of pro forma standardized measure of discounted future net cash flows from proved oil and gas reserves of Baseline and the Properties as of December 31, 2006 and 2005, net of income tax expense and includes the effects of the acquisition of the Properties. Future cash flows are computed by applying fiscal year-end prices of natural gas and oil to year-end quantities of proved natural gas and oil reserves. Future operating expenses and development costs are computed Baseline by estimating the expenditures to be incurred in developing and producing the Properties' proved natural as and oil reserves at the end of the year, based on year end costs and assuming continuation of existing economic conditions. Future income taxes are based on currently enacted statutory rates. This information should be viewed only as a form of standardized disclosure concerning possible future cash flows that would result under the assumptions used but should not be viewed as indicative of fair market value nor be considered indicative of any trends. Reference should be made to Baseline's financial statements for the year-ended December 31, 2006 and the Statements of Combined Revenues and Direct Operating Expenses Purchased of Oil and Gas Properties Purchased from Statex Petroleum I, L.P. and Charles W. Gleason, L.P. included herein, for a discussion of the assumptions used in preparing the information presented.
Year Ended December 31, 2006 ------------------------------------------------ Baseline Properties Pro Forma ------------------------------------------------ Future cash inflows $ -- $ 212,297,137 $ 212,297,137 Future production costs -- (116,402,890) (116,402,890) Future development costs -- (5,142,900) (5,142,900) ------------------------------------------------ Future net cash flows before income taxes -- 90,751,347 90,751,347 Future income tax -- (30,428,739) (30,428,739) ------------------------------------------------ Future net cash flows -- 60,322,608 60,322,608 Discount at 10% annual rate -- (27,145,174) (27,145,174) ------------------------------------------------ Discounted future net cash flow $ -- $ 33,177,434 $ 33,177,434 ================================================ Year Ended December 31, 2005 ------------------------------------------------ Baseline Properties Pro Forma ------------------------------------------------ Future cash inflows $ -- $ 220,860,507 $ 220,860,507 Future production costs -- (122,846,877) (122,846,877) Future development costs -- (5,142,900) (5,142,900) Future income tax -- (31,311,622) (31,311,622) ------------------------------------------------ Future net cash flows -- 61,559,108 61,559,108 Discount at 10% annual rate -- (27,701,599) (27,701,599) ------------------------------------------------ Discounted future net cash flow $ -- $ 33,857,509 $ 33,857,509 ================================================
F-43 The principal changes in the pro forma standardized measure of discounted future net cash flows relating to proven oil and gas reserve is as follows:
Year Ended December 31, 2006 ------------------------------------------------ Baseline Properties Pro Forma ------------------------------------------------ Beginning of year $ -- $ 33,857,509 $ 33,857,509 Sales, net of production costs -- (6,884,367) (6,884,367) Net change in prices, net of production costs -- 2,620,732 2,620,732 Extensions and discoveries -- -- -- Development costs incurred -- -- -- Accretion of discount, changes in production rates and other -- 3,034,480 3,034,480 Change in income tax -- 549,080 549,080 Revision of quantity estimates -- -- -- ------------------------------------------------ End of year $ -- $ 33,177,434 $ 33,177,434 ================================================ Year Ended December 31, 2005 ------------------------------------------------ Baseline Properties Pro Forma ------------------------------------------------ Beginning of year $ -- $ 14,578,422 $ 14,578,422 Sales, net of production costs -- (5,715,842) (5,715,842) Net change in prices, net of production costs -- 32,530,132 32,530,132 Extensions and discoveries -- -- -- Development costs incurred -- -- -- Accretion of discount, changes in production rates and other -- 2,426,554 2,426,554 Change in income tax -- (9,961,756) (9,961,756) Revision of quantity estimates -- -- -- ------------------------------------------------ End of year $ -- $ 33,857,509 $ 33,857,509 ================================================
F-44 (e) Financial Statements of Business to be Acquired. THE DSX PROPERTIES REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors of Baseline Oil & Gas Corp. Houston, Texas We have audited the accompanying Statements of Combined Revenues and Direct Operating Expenses of the Oil and Gas Properties ("DSX Properties") Purchased from DSX Energy Limited L.L.P. (the "Financial Statements") for the years ended December 31, 2006 and 2005. These Financial Statements are the responsibility of Baseline Oil & Gas Corp.'s management. Our responsibility is to express an opinion on the Financial Statements based on our audits. We conducted our audits in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). 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 our audits provide a reasonable basis for our opinion. The accompanying Financial Statements were prepared for the purpose of complying with the rules and regulations of the Securities and Exchange Commission as described in Note 2. The presentation is not intended to be a complete presentation of the properties described above. In our opinion, the Financial Statements referred to above present fairly, in all material respects, the Combined Revenues and Direct Operating Expenses of the Oil and Gas Properties Purchased from DSX Energy Limited L.L.P. as described in Note 1 for the years ended December 31, 2006 and 2005, in conformity with U.S. generally accepted accounting principles. /s/ Malone & Bailey, PC - ----------------------- Malone & Bailey, PC www.malone-bailey.com Houston, Texas August 31, 2007 F-45 BASELINE OIL & GAS CORP. STATEMENTS OF COMBINED REVENUES AND DIRECT OPERATING EXPENSES of Oil and Gas Properties Purchased From DSX Energy Limited L.L.P.
For the Years Ended For the Six Months Ended December 31, June 30, -------------------------- -------------------------- 2005 2006 2006 2007 ----------- ----------- ----------- ----------- (unaudited) (unaudited) Revenues ................................... $ 7,611,532 $17,086,179 $ 9,814,940 $13,559,373 Direct operating expenses .................. 3,051,276 2,162,328 1,032,183 1,796,132 ----------- ----------- ----------- ----------- Excess of revenues over direct operating expenses ....................... $ 4,560,256 $14,923,851 $ 8,782,757 $11,763,241 =========== =========== =========== ===========
The accompanying notes are an integral part of the financial statements. F-46 Baseline Oil & Gas Corp. Statements of Combined Revenues and Direct Operating Expenses of Oil and Gas Properties purchased from DSX Energy Limited, L.L.P. Notes to Financial Statements (1) The Properties On August 7, 2007, Baseline Oil & Gas, Corp. ("Baseline" or the "Company") entered into a Purchase and Sale Agreement to purchase certain oil and gas properties (the "Properties") owned by DSX Energy Limited L.L.P., Kebo Oil & Gas, Inc., Sanchez Oil & Gas Corp., Sue Ann Operating, L.L.C., and 23 other individuals, trusts and companies (collectively, the "Seller") for $100,000,000. (2) Basis For Presentation The statements of combined revenues and direct operating expenses has been derived from the Seller's historical financial records and is prepared on the accrual basis of accounting. Revenues and direct operating expenses as set forth in the accompanying statements include revenues from oil and gas production, net of royalties, and associated direct operating expenses related to the net revenue interests and net working interests, respectively. These revenues and expenses in the Properties represent Baseline's acquired interest. During the periods presented, the Properties were not accounted for or operated as a separate division of the Seller. Accordingly, full separate financial statements prepared in accordance with generally accepted accounting principles do not exist and are not practicable to obtain in these circumstances. This statement varies from an income statement in that it does not show certain expenses, which were incurred in connection with the ownership of the Properties, such as general and administrative expenses and income taxes. These costs were not separately allocated to the Properties in the Seller's historical financial records and any pro forma allocation would be both timing consuming and expensive and would not be a reliable estimate of what these costs would actually have been had the Properties been operated historically as a stand alone entity. In addition, these allocations, if made using the historical Seller general and administrative structures and tax burdens, would not produce allocations that would be indicative of the historical performance of the Properties had they been assets of Baseline, due to the greatly varying size, structure, and operations between Baseline and the Seller. This statement does not include provisions for depreciation, depletion and amortization as such amounts would not be indicative of future costs and those costs which would be incurred by Baseline upon allocation of purchase price. Accordingly, the financial statement and other information presented are not indicative of the financial condition or results of operations of the Properties going forward due to the changes in the business and the omission of various operating expenses. For the same reason, primarily the lack of segregated or easily obtainable reliable data on asset values and related liabilities, a balance sheet is not presented for the Properties. At the end of the economic life of the Properties, certain restoration and abandonment costs will be incurred by the respective owners of the Properties. No accrual for these costs is included in the direct operating expenses. (3) Commitments and Contingencies Baseline is not aware of any legal, environmental or other commitments or contingencies relating to the Properties that would have a material effect on the statement of combined revenues and direct operating expenses. (4) Revenue Recognition It is Baseline's policy to recognize revenue when production is sold to a purchaser at a fixed or determinable price. (5) Supplemental Oil and Gas Information (Unaudited) General. The estimated net proved oil and gas reserves and the present value of estimated cash flows from those reserves from the Properties acquired by Baseline are summarized below. The reserves were estimated by Cawley Gillespie & F-47 Associates ("Cawley") in a report dated September 4, 2007 as of December 31, 2006. The reserve study was paid for by Baseline and was based on information provided by the Seller to Cawley. The December 31, 2006, reserve study was the only determination of proved reserves that is available, therefore, there will be no revisions of reserve estimates because no previous determination of estimates exists. Likewise there was no detail of extensions, discoveries and improved recovery for the periods below because there was no basis in which to determine when a discovery or extension was actually made. Estimated Oil and Gas Reserve Quantities. There was no determination of proven reserves at December 31, 2005. The only reserve study was done as of December 31, 2006. For the table below, the December 31, 2006 proved reserve total was adjusted for the actual production activity to determine what the proved reserves would have been at December 31, 2005 based on the reserve study as of December 31, 2006. There are numerous uncertainties inherent in estimating quantities of proved reserves and projecting future rates of production. The following reserve data related to the Properties represent estimates only and should not be construed as being exact. The reliability of the estimates at any point in time depends on both quality and quantity of the technical and economic data, the performance of the reservoirs, as well as extensive engineering judgment. Consequently, reserve estimates are subject to revision as additional data becomes available during the producing life of a reservoir. The evolution of technology may also result in the application of improved recovery techniques, such as supplemental or enhanced recovery projects, which have the potential to increase reserves beyond those currently envisioned. Estimates of proved reserves are derived from quantities of crude oil and natural gas that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing operating and economic conditions and rely upon a production plan and strategy. Statement of Financial Accounting Standards No. 69, Disclosures About Oil and Gas Producing Activities ("FAS 69"), requires calculation of future net cash flows using a 10% annual discount factor and year-end prices, costs and statutory tax rates, except for known future changes such as contracted price and legislated tax rates. All of the reserves relating to the Properties are located in the United States. Estimated Oil and Gas Information: Oil Oil Gas Equivalent (MBbl) (MMcf) (MBoe) ----- ------ ---------- Total Proved Reserves Balance--December 31, 2005 .................. 492 11,523 2,413 Production .................................. (92) (1,458) (335) Purchases of reserve in-place ............... -- -- -- Extensions, discoveries and improved recovery 1,227 23,102 5,077 Transfers/sales of reserve in place ......... -- -- -- Revisions of previous estimates ............. -- -- -- ----- ------ ----- Ending reserves--December 31, 2006 .......... 1,627 33,167 7,155 ===== ====== ===== Proved developed reserves: .................. 734 17,433 3,640 ===== ====== ===== Total Proved Reserves Balance--December 31, 2004 .................. 39 1,123 226 F-48 Oil Oil Gas Equivalent (MBbl) (MMcf) (MBoe) ----- ------ ---------- Production .................................. (38) (516) (124) Purchases of reserve in-place ............... -- -- -- Extensions, discoveries and improved recovery 491 10,916 2,310 Transfers/sales of reserve in place ......... -- -- -- Revisions of previous estimates ............. -- -- -- ----- ------ ----- Balance--December 31, 2005 .................. 492 11,523 2,412 ===== ====== ===== Proved developed reserves: .................. 492 11,523 2,412 ===== ====== ===== Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves. The following disclosures concerning the standardized measure of future cash flows from proved oil and gas reserves are presented in accordance with FAS 69. As prescribed by FAS 69, the amounts shown are based on prices and costs at the end of each period and a 10% annual discount factor. Future cash flows are computed by applying fiscal year-end prices of natural gas and oil to year-end quantities of proved natural gas and oil reserves. Future operating expenses and development costs are computed primarily by the Company by estimating the expenditures to be incurred in developing and producing the Properties' proved natural gas and oil reserves at the end of the year based on year end costs and assuming continuation of existing economic conditions. Future income taxes are based on currently enacted statutory rates. The standardized measure of discounted future net cash flows is not intended to represent the replacement costs or fair value of the Properties' natural gas and oil reserves. An estimate of fair value would take into account, among other things, anticipated future changes in prices and costs, and a discount factor more representative of the time value of money and the risks inherent in reserve estimates of natural gas and oil producing operations. The standardized measure of discounted future net cash flows from the Company's estimated proved gas reserves is provided for the financial statement user as a common base for comparing oil and gas reserves of enterprises in the industry and may not represent the fair market value of the Company's oil and gas reserves or the present value of future cash flows of equivalent reserves due to various uncertainties inherent in making these estimates. Those factors include changes in oil and gas prices from year end prices used in the estimates, unanticipated changes in future production and development costs and other uncertainties in estimating quantities and present values of oil and gas reserves. The Standardized Measure of Discounted Future Net Cash Flows relating to the Properties' proved oil and gas reserves is as follows: December 2006 -------------- (in thousands) Future cash inflows ........................................... $ 256,201 Future production costs ....................................... (36,046) Future development costs ...................................... (34,076) -------------- Future net cash flows before income taxes ..................... 186,079 Future income tax ............................................. (18,894) -------------- Future net cash flows ......................................... 167,185 Discount at 10% annual rate ................................... (79,694) -------------- Standardized measure of discounted future net cash flows ...... $ 87,491 ============== F-49 The principal changes in the standardized measure of discounted future net cash flows relating to proved oil and gas reserve are summarized below: Year Ended December 31, 2006 -------------- (in thousands) Standardized measure, beginning of year ....................... $ 90,336 Sales, net of production costs ................................ (14,924) Net change in prices, net of production costs ................. (32,761) Extensions and discoveries .................................... 36,623 Development costs incurred .................................... -- Accretion of discount, changes in production rates and other .. 7,954 Change in income tax .......................................... 263 Revision of quantity estimates ................................ -- -------------- End of year ................................................... $ 87,491 ============= F-50 (f) Pro Forma Financial Information of Baseline Oil & Gas Corp., giving effect to proposed acquisition of DSX Properties UNAUDITED PRO FORMA COMBINED FINANCIAL DATA The following unaudited pro forma combined financial data for the six months ended June 30, 2006 and 2007 and the year ended December 31, 2006 and as of June 30, 2007 have been derived from our historical financial statements as of such dates and for such periods, which are included elsewhere in this prospectus. The pro forma adjustments give effect to our acquisition of the DSX Properties and the Stephens County Acquisition as if they had occurred on June 30, 2007 in the case of balance sheet data, and as of January 1, 2007 and 2006 in the case of statements of operations data. You should read the following data in conjunction with each of our and the DSX Properties' financial statements, including the related notes, included elsewhere in this prospectus. The unaudited pro forma adjustments are based upon currently available information and certain assumptions that we believe to be reasonable under the circumstances. The unaudited pro forma combined financial information has been prepared for informational purposes only and is not intended to represent the results of operations or financial position that we would have reported had the acquisition of the DSX Properties and the Stephens County Acquisition been completed as of the date presented, and should not be taken as representative of our future results of operations or financial position. F-51 UNAUDITED PRO FORMA COMBINED BALANCE SHEET
As of June 30, 2007 ---------------------------------------------------- Baseline Pro Forma Pro Forma Historical Adjustments Combined ---------- ---------------------- --------- (dollars in thousands) Assets: Cash and marketable securities ............................................. $ 156 $ 11,363(1) $ 11,520 Cash--restricted ........................................................... 1,131 -- 1,131 Accounts receivable, trade ................................................. 1,175 -- 1,175 Prepaid and other current assets ........................................... 124 -- 124 --------- --------- --------- Total current assets ............................... 2,586 11,363 13,950 Oil and natural gas properties--using successful efforts method of accounting Proved properties .......................................................... 27,416 102,938(2) 130,354 Unproved properties ........................................................ 8,093 -- 8,093 Less accumulated depletion, depreciation and amortization .................. (515) -- (515) --------- --------- --------- Oil and natural gas properties, net ................ 34,994 102,938 137,932 Deferred loan costs, net of accumulated amortization of $2,142 ............. 3,768 13,538(3) 13,538 (3,768)(4) Other property and equipment, net of accumulated depreciation of $3 at June 30, 2007 .................................................... 38 -- 38 --------- --------- --------- Total other assets ................................. 3,806 9,770 13,575 --------- --------- --------- Total assets ............................................................... $ 41,386 $ 124,071 $ 165,457 ========= ========= ========= Liabilities and stockholders' equity: Accounts payable--trade .................................................... $ 599 $ -- $ 599 Accrued expenses ........................................................... 418 -- 418 Royalties payable .......................................................... 508 -- 508 Short term notes to related parties ........................................ 100 (100)(5) -- Short term debt and current portion of long-term debt ...................... 2,257 (2,257)(5) -- Derivative liability--short term ........................................... 957 -- 957 --------- --------- --------- Total current liabilities .......................... 4,839 (2,357) 2,482 Long-term debt ............................................................. 30,218 160,414 160,414 (30,218)(5) Asset retirement obligations ............................................... 451 -- 451 Derivative liability--long term ............................................ 834 -- 834 --------- --------- --------- Total noncurrent liabilities ....................... 31,504 130,196 161,699 --------- --------- --------- Total liabilities .......................................................... 36,343 127,839 164,181 Stockholders' equity: Common stock, $0.001 par value per share; 140,000,000 shares authorized; 32,210,238 shares issued and outstanding ................... 32 -- 32 Additional paid-in capital ................................................. 31,629 -- 31,629 Accumulated other comprehensive income ..................................... (1,692) -- (1,692) Accumulated deficit ........................................................ (24,926) (3,768)(4) (28,694) --------- --------- --------- Total stockholders' equity ......................... 5,043 (3,768) 1,276 --------- --------- --------- Total liabilities and stockholders' equity ................................. $ 41,386 $ 124,071 $ 165,457 ========= ========= =========
- ---------- (1) Adjustment to record the use of the proceeds from the DSX Financing for general corporate purposes. (2) Adjustment to record the acquisition of the DSX Properties for $100,000,000 and deal related costs of $2,875,000. (3) Adjustment to record amortized debt issue costs related to the DSX Financing. (4) Adjustment to record the elimination of unamortized debt issue costs for prior financing. (5) Adjustment to record the use of the proceeds from the DSX Financing to repay existing debt. (6) Adjustment to record the $165,000,000 aggregate principal amount of the notes issued in connection with the DSX Financing. F-52 UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
Six Months Ended June 30, 2007 ------------------------------------------------------------------------- Pro Forma Pro Stephens Adjustments Forma for County Stephens Stephens Acquisition County County Baseline Properties Acquisition Acquisition Historical Historical Properties Properties ------------- ------------- ------------- ------------- (dollars in thousands) Oil and gas sales ................................. $ 2,820 $ 2,539 $ -- $ 5,359 Operating expenses: Production expenses ............................... 1,309 1,173 -- 2,483 General and administrative expenses ............... 852 -- -- 852 Depreciation, depletion and amortization .......... 518 -- 279 (1) 797 Accretion expense ................................. 12 -- -- 12 ------------- ------------- ------------- ------------- Total operating expenses .......................... 2,691 1,173 279 4,144 ------------- ------------- ------------- ------------- Net income (loss) from operations ................. 128 1,366 (279) 1,215 Other income (expense): Other income (expense) ............................ 23 -- -- 23 Interest income ................................... 1 -- -- 1 Interest expense .................................. (3,520) -- (857)(2) (4,481) (104)(3) Unrealized gain (loss) on derivatives ............. 6 -- -- 6 ------------- ------------- ------------- ------------- Total other expense, net .......................... (3,490) -- (961) (4,451) ------------- ------------- ------------- ------------- Net loss .......................................... $ (3,362) $ 1,366 $ (1,240) $ (3,236) ============= ============= ============= ============= Six Months Ended June 30, 2007 ------------------------------------------------------- Pro Forma DSX Adjustments Pro Properties DSX Forma Historical Properties Combined ------------- ------------- ------------- (dollars in thousands) Oil and gas sales ................................. $ 13,559 $ -- $ 18,918 Operating expenses: Production expenses ............................... 1,796 -- 4,279 General and administrative expenses ............... -- 951 (4) 1,803 Depreciation, depletion and amortization .......... -- 7,219 (5) 8,016 Accretion expense ................................. -- -- 12 ------------- ------------- ------------- Total operating expenses .......................... 1,796 8,170 14,110 ------------- ------------- ------------- Net income (loss) from operations ................. 11,763 (8,170) 4,808 Other income (expense): Other income (expense) ............................ -- -- 23 Interest income ................................... -- -- 1 Interest expense .................................. -- (11,131)(6) (19,772) 857 (7) (1,354)(8) (3,663)(9) Unrealized gain (loss) on derivatives ............. -- -- 6 ------------- ------------- ------------- Total other expense, net .......................... -- (15,291) (19,742) ------------- ------------- ------------- Net loss .......................................... $ 11,763 $ (23,461) $ (14,934) ============= ============= =============
- ---------- (1) To reflect the Stephens County Acquisition properties depreciation, depletion and amortization for production from January 1, 2007 to March 1, 2007. The depreciation, depletion and amortization was computed by allocating the Stephens County Acquisition properties adjusted purchase price of $27,055,079 to leasehold cost and amortizing the costs based on the historical production divided by total proved reserves. There were no amounts allocated to unproved properties at the acquisition date. The allocation of the adjusted purchase price to the individual fields was based on their estimated fair value at the time of acquisition based on amounts contained in the reserve report. (2) To record additional interest expense related to the Stephens County Acquisition properties. Pro forma interest expense assumes the $30,013,224 of borrowing was incurred as if the acquisition of the Stephens County Acquisition properties had occurred on January 1, 2007. (3) To record additional interest expense related to the Stephens County Acquisition properties. Pro forma interest expense includes $104,000 of amortization of debt issue costs related to the borrowing incurred to acquire the Stephens County Acquisition properties. (4) To record additional general and administrative expense. Pro forma general and administrative expense includes an additional $951,000 to reflect the level of expense incurred subsequent to the acquisition of the Stephens County Acquisition properties and adjustments to reflect additional staffing requirements. (5) To reflect the DSX Properties depreciation, depletion and amortization for production from January 1, 2007 to June 30, 2007. The depreciation, depletion and amortization was computed by allocating the DSX Properties adjusted purchase price of $102,937,000 to leasehold cost and amortizing the costs based on the historical production divided by total proved reserves. There were no amounts allocated to unproved properties at the acquisition date. The allocation of the adjusted purchase price to the individual properties was based on their estimated fair value at the time of acquisition based on amounts contained in the reserve report. (6) To record additional interest expense related to the DSX Financing. Pro forma interest expense assumes the $165,000,000 aggregate principal amount of borrowing was incurred on January 1, 2007. (7) To reverse interest expense related to the Stephens County Acquisition properties. Pro forma interest expense assumes repayment of the $30,013,224 of borrowing incurred to acquire the Stephens County Acquisition properties with proceeds from the DSX Financing on January 1, 2007. (8) To record additional interest expense related to the DSX Financing. Pro forma interest expense includes $1,354,000 of amortization of debt issue costs related to the notes issued in connection with the DSX Financing. (9) To record additional interest expense related to the Stephens County Acquisition properties. Pro forma interest expense includes $3,663,000 to fully amortize debt issue costs related to the borrowing incurred to acquire the Stephens County Acquisition properties concurrently with the assumed repayment of such debt on January 1, 2007. F-53 UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
Six Months Ended June 30, 2006 ------------------------------------------------------------------------- Pro Forma Pro Stephens Adjustments Forma for County Stephens Stephens Acquisition County County Baseline Properties Acquisition Acquisition Historical Historical Properties Properties ------------- ------------- ------------- ------------- (dollars in thousands) Oil and gas sales ................................. $ -- $ 6,379 $ -- $ 6,379 Operating expenses: Production expenses ............................... -- 2,982 -- 2,982 General and administrative expenses ............... 1,265 -- -- 1,265 Depreciation, depletion and amortization .......... -- -- 723 (1) 723 ------------- ------------- ------------- ------------- Total operating expenses .......................... 1,265 2,982 723 4,969 ------------- ------------- ------------- ------------- Net income (loss) from operations ................. (1,265) 3,398 (723) 1,410 Other income (expense): Other income (expense) ............................ -- -- -- -- Interest income ................................... 59 -- -- 59 Interest expense .................................. (764) -- (1,543)(2) (2,547) (240)(3) Unrealized gain (loss) on derivatives ............. 334 -- -- 334 ------------- ------------- ------------- ------------- Total other expense, net .......................... (371) -- (1,783) (2,154) ------------- ------------- ------------- ------------- Net loss .......................................... $ (1,636) $ 3,398 $ (2,506) $ (744) ============= ============= ============= ============= Six Months Ended June 30, 2006 ------------------------------------------------------- Pro Forma DSX Adjustments Pro Properties DSX Forma Historical Properties Combined ------------- ------------- ------------- (dollars in thousands) Oil and gas sales ................................. $ 9,815 $ -- $ 16,194 Operating expenses: Production expenses ............................... 1,032 -- 4,014 General and administrative expenses ............... -- 1,515 (4) 2,780 Depreciation, depletion and amortization .......... -- 3,573 (5) 4,296 ------------- ------------- ------------- Total operating expenses .......................... 1,032 5,088 11,090 ------------- ------------- ------------- Net income (loss) from operations ................. 8,783 (5,088) 5,105 Other income (expense): Other income (expense) ............................ -- -- -- Interest income ................................... -- -- 59 Interest expense .................................. -- (11,131)(6) (17,136) 1,543 (7) (1,354)(8) (3,647)(9) Unrealized gain (loss) on derivatives ............. -- -- 334 ------------- ------------- ------------- Total other expense, net .......................... -- (14,589) (16,743) ------------- ------------- ------------- Net loss .......................................... $ 8,783 $ (19,677) $ (11,638) ============= ============= =============
- ---------- (1) To reflect the Stephens County Acquisition properties depreciation, depletion and amortization for production from January 1, 2006 to June 30, 2006. The depreciation, depletion and amortization was computed by allocating the Stephens County Acquisition properties adjusted purchase price of $27,055,079 to leasehold cost and amortizing the costs based on the historical production divided by total proved reserves. There were no amounts allocated to unproved properties at the acquisition date. The allocation of the adjusted purchase price to the individual fields was based on their estimated fair value at the time of acquisition based on amounts contained in the reserve report. (2) To record additional interest expense related to the Stephens County Acquisition properties. Pro forma interest expense assumes the $30,013,224 of borrowing was incurred as if the acquisition of the Stephens County Acquisition properties had occurred on January 1, 2006. (3) To record additional interest expense related to the Stephens County Acquisition properties. Pro forma interest expense includes $240,000 of amortization of debt issue costs related to the borrowing incurred to acquire the Stephens County Acquisition properties. (4) To record additional general and administrative expense. Pro forma general and administrative expense includes an additional $1,515,000 to reflect the level of expense incurred subsequent to the acquisition of the Stephens County Acquisition properties and adjustments to reflect additional staffing requirements. (5) To reflect the DSX Properties depreciation, depletion and amortization for production from January 1, 2006 to June 30, 2006. The depreciation, depletion and amortization was computed by allocating the DSX Properties adjusted purchase price of $102,937,000 to leasehold cost and amortizing the costs based on the historical production divided by total proved reserves. There were no amounts allocated to unproved properties at the acquisition date. The allocation of the adjusted purchase price to the individual properties was based on their estimated fair value at the time of acquisition based on amounts contained in the reserve report. (6) To record additional interest expense related to the DSX Financing. Pro forma interest expense assumes the $165,000 aggregate principal amount of borrowing was incurred on January 1, 2006. (7) To reverse interest expense related to the Stephens County Acquisition properties. Pro forma interest expense assumes repayment of the $30,013,224 of borrowing incurred to acquire the Stephens County Acquisition properties with proceeds from the DSX Financing on January 1, 2006. (8) To record additional interest expense related to the DSX Financing. Pro forma interest expense includes $1,354,000 of amortization of debt issue costs related to the notes issued in connection with the DSX Financing. (9) To record additional interest expense related to the Stephens County Acquisition properties. Pro forma interest expense includes $3,647,000 to fully amortize debt issue costs related to the borrowing incurred to acquire the Stephens County Acquisition properties concurrently with the assumed repayment of such debt on January 1, 2006. F-54 UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
Fiscal Year Ended December 31, 2006 ---------------------------------------------------------------------- Pro Forma Pro Stephens Adjustments Forma for County Stephens Stephens Acquisition County County Baseline Properties Acquisition Acquisition Historical Historical Properties Properties ------------- ------------- ------------- ------------- (dollars in thousands) Oil and gas sales ................................. $ -- $ 12,522 $ -- $ 12,522 Operating expenses: Production expenses ............................... -- 6,447 -- 6,447 General and administrative expenses ............... 2,386 -- -- 2,386 Depreciation, depletion and amortization .......... -- -- 1,436 (1) 1,436 ------------- ------------- ------------- ------------- Total operating expenses .......................... 2,386 6,447 1,436 10,269 ------------- ------------- ------------- ------------- Net income (loss) from operations ................. (2,386) 6,075 (1,436) 2,253 Other income (expense): Other income (expense) ............................ (213) (213) Interest income ................................... 117 -- -- 117 Interest expense .................................. (1,692) -- (3,085)(2) (5,258) (481)(3) Unrealized gain (loss) on derivatives ............. 401 -- -- 401 ------------- ------------- ------------- ------------- Total other expense, net .......................... (1,387) -- (3,566) (4,952) ------------- ------------- ------------- ------------- Net loss .......................................... $ (3,773) $ 6,075 $ (5,000) $ (2,699) ============= ============= ============= ============= Fiscal Year Ended December 31, 2006 --------------------------------------------------- Pro Forma DSX Adjustments Pro Properties DSX Forma Historical Properties Combined ------------- ------------- ------------- (dollars in thousands) Oil and gas sales ................................. $ 17,086 $ -- $ 29,608 Operating expenses: Production expenses ............................... 2,162 -- 8,609 General and administrative expenses ............... -- 3,030 (4) 5,416 Depreciation, depletion and amortization .......... -- 6,920 (5) 8,356 ------------- ------------- ------------- Total operating expenses .......................... 2,162 9,950 22,381 ------------- ------------- ------------- Net income (loss) from operations ................. 14,924 (9,950) 7,227 Other income (expense): Other income (expense) ............................ (213) Interest income ................................... -- -- 117 Interest expense .................................. -- (22,263)(6) (30,549) 3,085 (7) (2,708)(8) (3,406)(9) Unrealized gain (loss) on derivatives ............. -- -- 401 ------------- ------------- ------------- Total other expense, net .......................... -- (25,292) (30,244) ------------- ------------- ------------- Net loss .......................................... $ 14,924 $ (35,242) $ (23,017) ============= ============= =============
- ---------- (1) To reflect the Stephens County Acquisition properties depreciation, depletion and amortization for production from January 1, 2006 to December 31, 2006. The depreciation, depletion and amortization was computed by allocating the Stephens County Acquisition properties adjusted purchase price of $27,055,079 to leasehold cost and amortizing the costs based on the historical production divided by total proved reserves. There were no amounts allocated to unproved properties at the acquisition date. The allocation of the adjusted purchase price to the individual fields was based on their estimated fair value at the time of acquisition based on amounts contained in the reserve report. (2) To record additional interest expense related to the Stephens County Acquisition properties. Pro forma interest expense assumes the $30,013,224 of borrowing was incurred as if the acquisition of the Stephens County Acquisition properties had occurred on January 1, 2006. (3) To record additional interest expense related to the Stephens County Acquisition properties. Pro forma interest expense includes $481,000 of amortization of debt issue costs related to the borrowing incurred to acquire the Stephens County Acquisition properties. (4) To record additional general and administrative expense. Pro forma general and administrative expense includes an additional $3,030,000 to reflect the level of expense incurred subsequent to the acquisition of the Stephens County Acquisition properties and adjustments to reflect additional staffing requirements. (5) To reflect the DSX Properties depreciation, depletion and amortization for production from January 1, 2006 to December 31, 2006. The depreciation, depletion and amortization was computed by allocating the DSX Properties adjusted purchase price of $102,937,000 to leasehold cost and amortizing the costs based on the historical production divided by total proved reserves. There were no amounts allocated to unproved properties at the acquisition date. The allocation of the adjusted purchase price to the individual properties was based on their estimated fair value at the time of acquisition based on amounts contained in the reserve report. (6) To record additional interest expense related to the DSX Financing. Pro forma interest expense assumes the $165,000,000 aggregate principal amount of borrowing was incurred on January 1, 2006. (7) To reverse interest expense related to the Stephens County Acquisition properties. Pro forma interest expense assumes repayment of the $30,013,224 of borrowing incurred to acquire the Stephens County Acquisition properties with proceeds from the DSX Financing on January 1, 2006. (8) To record additional interest expense related to the DSX Financing. Pro forma interest expense includes $2,708,000 of amortization of debt issue costs related to the notes issued in connection with the DSX Financing. (9) To record additional interest expense related to the Stephens County Acquisition properties. Pro forma interest expense includes $3,406,000 to fully amortize debt issue costs related to the borrowing incurred to acquire the Stephens County Acquisition properties concurrently with the assumed repayment of such debt on January 1, 2006 F-55 -----END PRIVACY-ENHANCED MESSAGE-----