-----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, KL1Rc7u8tyGiF+nxAzjGriuG9zV4Skzes9SjeGRGuBxugLdoFxZspv5vWqjOJcxI xZnHavGzh4jZxZLw5uY5xw== 0001090002-04-000296.txt : 20041115 0001090002-04-000296.hdr.sgml : 20041115 20041115143807 ACCESSION NUMBER: 0001090002-04-000296 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20040930 FILED AS OF DATE: 20041115 DATE AS OF CHANGE: 20041115 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAPCO ENERGY INC CENTRAL INDEX KEY: 0000354767 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 840846529 STATE OF INCORPORATION: CO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-10157 FILM NUMBER: 041144167 BUSINESS ADDRESS: STREET 1: 5555 SAN FELIPE STREET 2: SUITE 725 CITY: HOUSTON STATE: TX ZIP: 77056 BUSINESS PHONE: 713-622-5550 MAIL ADDRESS: STREET 1: 5555 SAN FELIPE STREET 2: SUITE 725 CITY: HOUSTON STATE: TX ZIP: 77056 FORMER COMPANY: FORMER CONFORMED NAME: ALFA RESOURCES INC DATE OF NAME CHANGE: 19920703 10QSB 1 cp10q304.txt REPORT ON FORM 10-QSB FOR QUARTER ENDED SEPTEMBER 30, 2004 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended September 30, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from _______, 20___ to _______, 20___. Commission File Number: 0-10157 CAPCO ENERGY, INC. --------------------------------------------------------------- (Exact Name of Small Business Issuer as Specified in its Charter) COLORADO 84-0846529 -------------------------------- ----------------------- (State or Other Jurisdiction of (IRS Employer Incorporation or Organization) Identification Number) 5555 SAN FELIPE, SUITE 725 HOUSTON, TEXAS 77056 -------------------------------------- Address of Principal Executive Offices (713) 622-5550 -------------------------------------------------- (Registrant's Telephone Number, Including Area Code) 4800 SUGAR GROVE BLVD., SUITE 601, STAFFORD, TX 77477 --------------------------------------------------- (Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report) Check whether the Issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Issuer was required to file such reports), and 2) has been subject to such filing requirements for the past 90 days. [ X ] Yes [ ] No There were 99,735,768 shares of the Registrant's $.001 par value common stock outstanding as of November 3, 2004. PART I. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS CAPCO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 2004 (Unaudited) ASSETS (Dollars in Thousands) Current Assets: Cash $ 198 Accounts receivable-trade, net of allowance of $46 374 Accounts receivable-related party 26 Note receivable 208 Deferred tax asset 27 Other current assets 22 ------ Total Current Assets 855 Oil and gas properties, using full cost accounting, less accumulated depreciation and depletion of $2,259 12,061 Other Assets: Assets attributable to businesses under contract for sale (note 3) 4,013 Land 214 Other property, less accumulated depreciation of $64 113 Other assets 812 ------ Total Assets $ 18,068 ====== Accompanying notes are an integral part of the consolidated financial statements. 2 CAPCO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (continued) SEPTEMBER 30, 2004 (Unaudited) LIABILITIES AND STOCKHOLDERS' EQUITY (Dollars in Thousands) Current Liabilities: Accounts payable, trade $ 952 Current maturities, long-term debt, including a related party 2,010 Accrued expenses 851 ------- Total Current Liabilities 3,813 ------- Non-current Liabilities: Long term debt, less current maturities 3,595 Long term liabilities 1,766 Accounts payable, related parties 402 Deferred tax liability 27 ------- Total Non-current Liabilities 5,790 ------- Liabilities attributable to businesses under contract for sale, (note 3) 4,346 ------- Total Liabilities 13,949 ------- Commitments and Contingencies -- Stockholders' Equity: Common stock, $0.001 par value; authorized 150,000,000 shares; 97,298,716 shares issued 98 Additional paid in capital 2,635 Treasury stock, 1,267,708 shares, at cost (138) Retained earnings 1,524 ------- Total Stockholders' Equity 4,119 ------- Total Liabilities and Stockholders' Equity $ 18,068 ======= Accompanying notes are an integral part of the consolidated financial statements. 3 CAPCO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) For the Three Months Ended September 30, 2004 and 2003 (Unaudited) (Dollars in Thousands except per share) 2004 2003 ------ ------ Sales $ 1,145 $ 819 Cost of sales 633 335 ------ ------ Gross profit 512 484 ------ ------ General and administrative expenses 404 186 Depreciation, depletion and amortization 141 152 ------ ------ Total operating expenses 545 338 ------ ------ (Loss) income from operations (33) 146 Other Income (Expenses): Interest income 4 43 Interest expense (108) (22) Gain on sales of investments- marketable securities -- 1 Holding losses-marketable securities (1) (14) Other (57) -- ------ ------ (Loss) income from continuing operations before taxes and minority interest (195) 154 Provision for income taxes -- -- Minority interest in income of consolidated subsidiary -- (1) ------ ------ (Loss) income from continuing operations (195) 153 Discontinued operations: (note 2) Loss from operations of business transferred under contractual obligation to a related party during the year 2003 (net of applicable income tax benefit of $-0-) -- (305) Loss on disposal of discontinued operations to a related party -- (730) (Continued on Next Page) Accompanying notes are an integral part of the consolidated financial statements. 4 CAPCO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS For the Three Months Ended September 30, 2004 and 2003 (Unaudited) (Dollars in Thousands except per share) (continued) 2004 2003 ------ ------ Net loss and comprehensive loss $ (195) $ (882) ====== ====== Earnings per share-basic: Income from continuing operations $ -- $ -- Loss from discontinued operations, including business transferred under contractual obligation -- (0.01) ------ ------ Net loss $ -- $ (0.01) ====== ====== Earnings per share-diluted: Income from continuing operations $ -- $ -- Loss from discontinued operations, including business transferred under contractual obligation -- (0.01) ------ ------ Net loss $ -- $ (0.01) ====== ====== Weighted average common share and common share equivalents: Basic 95,363,332 77,091,108 ========== ========== Diluted 101,306,267 79,819,312 =========== ========== Accompanying notes are an integral part of the consolidated financial statements. 5 CAPCO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) For the Nine Months Ended September 30, 2004 and 2003 (Unaudited) (Dollars in Thousands except per share) 2004 2003 ------ ------ Sales $ 3,702 $ 2,354 Cost of sales 1,914 1,100 ------ ------ Gross profit 1,788 1,254 ------ ------ General and administrative expenses 912 721 Depreciation, depletion and amortization 454 474 ------ ------ Total operating expenses 1,366 1,195 ------ ------ Income from operations 422 59 Other Income (Expenses): Interest income 10 43 Interest expense (263) (98) Losses on sales of investments- marketable securities (63) (11) Holding (losses) gains-marketable securities (2) 64 Other (57) 100 ------ ------ Income from continuing operations before taxes and minority interest 47 157 Provision for income taxes -- -- Minority interest in loss of consolidated subsidiary -- 1 ------ ------ Income from continuing operations 47 158 Discontinued operations: (note 2) Loss from operations of business transferred under contractual obligation to a related party during the year 2003 (net of applicable income tax benefit of $-0-) -- (1,264) Loss on disposal of discontinued operations to a related party -- (730) (Continued on Next Page) Accompanying notes are an integral part of the consolidated financial statements. 6 CAPCO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) For the Nine Months Ended September 30, 2004 and 2003 (Unaudited) (Dollars in Thousands except per share) (continued) 2004 2003 ------ ------ Net income (loss) 47 (1,836) Other comprehensive loss-net of tax Foreign currency translation adjustment -- (18) Less: minority interest in comprehensive loss of consolidated subsidiary -- 2 ------ ------ Comprehensive income (loss) $ 47 $(1,852) ====== ====== Earnings per share-basic: Income from continuing operations $ -- $ -- Loss from discontinued operations, including business transferred under contractual obligation -- (0.02) ------ ------ Net income (loss) $ -- $ (0.02) ====== ====== Earnings per share-diluted: Income from continuing operations $ -- $ -- Loss from discontinued operations, including business transferred under contractual obligation -- (0.02) ------ ------ Net income (loss) $ -- $ (0.02) ====== ====== Weighted average common share and common share equivalents: Basic 95,101,333 77,098,876 ========== ========== Diluted 103,495,977 79,500,980 =========== ========== Accompanying notes are an integral part of the consolidated financial statements. 7 CAPCO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Nine Months Ended September 30, 2004 and 2003 (Unaudited) (Dollars in Thousands) 2004 2003 ------ ------ Cash Flows From Continuing Operating Activities: Net income (loss) $ 47 $(1,836) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Net loss from discontinued operations -- 1,264 Loss on disposal of discontinued operations -- 730 Depreciation, depletion and amortization 454 474 Losses on sales of investments-marketable securities 63 11 Holding losses (gains)-marketable securities 2 (64) Foreign currency translation adjustment 57 -- Minority interest in loss of consolidated subsidiary -- 1 Compensation cost resulting from grant of options to acquire Common Stock -- 38 Decrease in deferred tax asset 77 29 Decrease in deferred tax liability (77) (29) Changes in assets and liabilities: (Increase) decrease in assets: Accounts receivable-trade (141) (425) Note receivable 2 -- Other current assets 3 29 Other assets (16) 87 Increase (decrease) in liabilities: Accounts payable 562 (41) Accrued expenses 255 99 ------ ------ Net cash provided by continuing operating activities 1,288 367 ------ ------ Cash Flows From Discontinued Operating Activities: Net loss -- (1,264) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation, depletion and amortization -- 595 Loss on sale of assets -- 126 Decrease (increase) in deferred tax asset -- 219 (Decrease) increase in deferred tax liability -- (219) (Continued on Next Page) Accompanying notes are an integral part of the consolidated financial statements. 8 CAPCO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Nine Months Ended September 30, 2004 and 2003 (Unaudited) (Dollars in Thousands) (continued) 2004 2003 ------ ------ Changes in assets and liabilities: (Increase) decrease in assets: Accounts receivable-trade -- 2,741 Inventory -- 1,653 Other current assets -- (194) Other assets -- 5 Increase (decrease) in liabilities: Accounts payable -- (455) Accrued expenses -- (262) Taxes payable -- (448) ------ ------ Net cash provided by discontinued operating activities -- 2,497 ------ ------ Net cash provided by all operating activities 1,288 2,864 ------ ------ Cash Flows From Continuing Investing Activities (Decrease) increase in related party accounts (125) 966 Equity contribution to subsidiary -- (400) Capital expenditures for oil and gas property (1,674) (185) Expenditures for other property and assets (110) -- Proceeds from sale of marketable securities 129 63 Increase in other assets (8) -- Purchase of marketable securities -- (2) ------ ------ Net cash (used in) provided by continuing investing activities (1,788) 442 ------ ------ Cash Flows From Discontinued Investing Activities: Cash applicable to assets held for sale -- 1 Net (advances) repayments with related parties -- (482) Cash proceeds from sale of equity investment -- 766 Cash proceeds from sale of property -- 87 Cash proceeds from equity contribution -- 400 Purchase of property and equipment -- -- Notes receivable payments, net -- 35 ------ ------ Net cash provided by discontinued investing activities -- 807 ------ ------ Net cash (used in) provided by all investing activities (1,788) 1,249 ------ ------ (Continued on Next Page) Accompanying notes are an integral part of the consolidated financial statements. 9 CAPCO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Nine Months Ended September 30, 2004 and 2003 (Unaudited) (Dollars in Thousands) (continued) 2004 2003 ------ ------ Cash Flows From Continuing Financing Activities: Proceeds from long-term debt 1,710 -- Payments on long term debt (1,025) (796) Increase in other assets (75) -- Purchase of Common Stock (12) (3) Sale of Common Stock 65 -- ------ ------ Net cash provided by (used in) continuing financing activities 663 (799) ------ ------ Cash Flows from Discontinued Financing Activities: Net (payments) advances on revolver -- (3,022) Decrease in book overdraft -- (83) Payments on long term debt -- (639) Decrease in restricted cash -- 441 ------ ------ Net cash used in discontinued financing activities -- (3,303) ------ ------ Net cash provided by (used in) all financing activities 663 (4,102) ------ ------ Net increase in cash 163 11 Cash, beginning of period 35 2 ------ ------ Cash, end of period $ 198 $ 13 ====== ====== Supplemental disclosure of cash flow information for continuing operations: Interest paid $ 235 $ 76 ====== ====== Taxes paid $ -- $ -- ====== ====== Supplemental disclosure of cash flow information for discontinued operations: Interest paid $ -- $ 383 ====== ====== Taxes paid $ -- $ -- ====== ====== (Continued on Next Page) Accompanying notes are an integral part of the consolidated financial statements. 10 CAPCO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Nine Months Ended September 30, 2004 and 2003 (Unaudited) (Dollars in Thousands) (continued) 2004 2003 ------ ------ Supplemental disclosure of non-cash financing and investing activities for continuing operations: Common Stock issued in settlement of liability $ 30 $ -- ====== ====== Paid in capital provided as equity component of debt financing $ 112 $ -- ====== ====== Debt issued for oil and gas property acquisition $ 160 $ -- ====== ====== Accrual for acquisition cost of oil and gas property to be settled with issuance of Common Stock $ 443 $ -- ====== ====== Long-term debt issued for asset acquisition $ -- $ 500 ====== ====== Supplemental disclosure of non-cash financing and investing activities for discontinued operations: Note receivable and account receivable provided as proceeds in connection with sale of preferred membership interests $ -- $ 349 ====== ====== Long-term debt and accrued expenses reduced for property sold/exchanged $ -- $ 975 ====== ====== Accompanying notes are an integral part of the consolidated financial statements. 11 CAPCO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2004 NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS Capco Energy, Inc. ("Capco" or the "Company") is an independent energy company engaged primarily in the acquisition, exploration, development, production and sale of oil, gas and natural gas liquids. The Company's production activities are located in the United States of America. Effective December 31, 2003, the Company divested of its oil and gas interests in Canada which were not significant to either consolidated financial position or consolidated results of operations. Capco's operations consist of one segment of business, oil and gas production. The principal executive offices of the Company are located at 5555 San Felipe, Suite 725, Houston, Texas 77056. The Company was incorporated as Alfa Resources, Inc. a Colorado corporation on January 6, 1981. In November 1999, the Company amended its articles of incorporation to change its name from Alfa Resources, Inc. to Capco Energy, Inc. The Company's future financial condition and results of operations will depend upon prices received for its oil and natural gas and the costs of finding, acquiring, developing and producing reserves. Prices for oil and natural gas are subject to fluctuations in response to changes in supply, market uncertainty and a variety of other factors beyond the Company's control. These factors include worldwide political instability (especially in the Middle East), the foreign supply of oil and natural gas, the price of foreign imports, the level of consumer product demand and the price and availability of alternative fuels. BASIS OF PRESENTATION These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, such interim statements reflect all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position and the results of operations and cash flows for the interim periods presented. The results of operations for these interim periods are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes for the year ended December 31, 2003, filed with the Company's Form 10-KSB. 12 NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. The Company has had recurring losses and marginal or negative cash flows from continuing operations in each of the last two fiscal years, and has negative working capital as of September 30, 2004. The Company is the guarantor to certain lending agreements for which the obligor, a former subsidiary, is in default. These factors raise substantial doubt about the Company's ability to continue as a going concern. Without realization of additional capital, it would be unlikely for the Company to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or amounts and classification of liabilities that might be necessary should the Company be unable to continue its existence. The Company has taken steps to improve its operating income and satisfy its working capital requirements. 1. Effective November 1, 2003, the Company's interest in producing property located in Michigan was pledged as additional collateral in connection with an acquisition of producing property in Montana. The net cash flow from both the Michigan and Montana properties is being used to retire the debt that was incurred with the acquisition. 2. Effective November 30, 2003, the Company acquired a 65% working interest in producing properties located in the Texas Gulf Coast that are providing positive cash flow to the Company. 3. In October 2002, the Company's board of directors authorized management to pursue a plan that would result in the divestiture of its petroleum products marketing and convenience store operation segments, operations that have been reported as discontinued operations in the accompanying financial statements. 4. In December 2002, an agreement was reached for the sale of principally all of the Company's assets in the state of New Mexico. Consideration for this transaction consisted primarily of the assumption by the buyer of approximately $4.5 million of indebtedness related to the assets. 5. In March 2003, a company owned by the Company's Chief Executive Officer submitted a proposal to acquire the remaining business interests designated for divestiture for total cash consideration of $2.5 million, plus other consideration. The Company's Board of Directors accepted the proposal, subject to the receipt of a fairness opinion that was received in August 2003 and subsequently amended in October 2003. Following adjustments to the agreement that reduced the sales price to $1.75 million, the Company recorded the sale of the business interests, effective September 30, 2003, recording a loss of $730,000 for the disposal of the discontinued business interests. 13 NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued 6. In February 2004, the Company's Board of Directors authorized management to seek additional financing. A private placement of convertible notes payable closed in June 2004, providing the Company with net proceeds of $1.0 million. A second private placement of a convertible note payable closed in September 2004, providing the Company with net proceeds of $0.7 million. A portion of the proceeds from the additional financing is being used to fund property development activities in an effort to increase cash flow to the Company. 7. Effective September 30, 2004, the Company sold its interests in non-operated properties located in Alabama and Louisiana to a company owned by the Company's Chief Executive Officer. Sales proceeds in the amount of $0.4 million were received by the Company in October 2004 and were used for working capital. In connection with some of the transactions described above, the Company is considering the availability of equity and/or debt financing opportunities, although no decisions have been reached in this regard at this time. Management believes that an increase in cash flow from (1) existing properties, and (2) properties to be acquired during the year 2004, coupled with proceeds from additional financing and the disposition of non-operated producing properties will enable the Company to meet its working capital requirements. BASIS OF CONSOLIDATION The consolidated financial statements include the accounts of Capco and its wholly and majority owned subsidiaries. All references herein to Capco or the Company include the consolidated results. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company's significant subsidiaries in the year 2004 include Capco Offshore, Inc. and Capco Asset Management, Inc. Effective December 31, 2003, the Company agreed to sell its equity ownerships in Capco Resource Corporation ("Resource"), except for interests in certain non-operated oil and gas producing properties, and Capco Resources Ltd. ("Limited") to a related party. The historical operations of Resource and Limited are included in the results of operations from continuing operations for the three and nine month periods ended September 30, 2003. Effective January 1, 2003, the Company agreed to sell Meteor Enterprises, Inc. ("Enterprises"), including all of that company's subsidiaries, the most significant of which at that date was Meteor Marketing, Inc. ("Marketing"). The results of operations of Enterprises for the three and nine month periods ended September 30, 2003, are reported as discontinued operations. MAJOR CUSTOMERS Two customers accounted for 60% and 18%, respectively, of the Company's net sales for the three months ended September 30, 2004, and one customer accounted for 81% of the Company's net sales for the three months ended September 30, 2003. Two customers accounted for 58% and 26%, respectively, of the Company's net sales for the nine months ended September 30, 2004, and two customers accounted for 80% and 11%, respectively, of the Company's net sales for the nine months ended September 30, 2003. Four customers accounted for 34%, 18%, 10% and 10%, respectively, of the Company's accounts receivable at September 30, 2004. 14 NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued OIL AND GAS PROPERTY In April 2004, the Company announced that it has elected to divest of its ownership of producing properties located in the state of Michigan. Sales proceeds, after settlement of secured indebtedness of approximately $1.0 million, were to be used principally to place shut-in wells on the Company's Texas Gulf Coast property into production. Following a period of marketing and analysis of offered bids, the Company decided to discontinue the sales effort and retain the property interest. Net revenue from this property will continue to be applied to the indebtedness issued by the Company in November 2003 in connection with the acquisition of producing property in Montana. During the quarter ended September 30, 2004, the Company incurred expenditures of approximately $1.6 million in its oil and gas acquisition and development activities. Of this amount, $0.6 million was expended on the Company's Brazos Field in the Texas Gulf Coast, principally on well workovers in an effort to increase gas production from the property. Capital expenditures on the Green Ranch property in Stephens County, Texas totaled $0.6 million, consisting of $0.4 million for prospect acquisition costs and $0.2 million for the drilling and completion of a gas well. Approximately 70% of the acquired working interest in the property was acquired either from individuals, or entities controlled by individuals, who have either a direct, or beneficial, relationship to the Company; however, the negotiated acquisition price was determined in a manner uniform to all members of the selling group. Sales from the completed gas well began in the month of October. The Company also participated in a Black Warrior Basin drilling prospect located in Fayette County, Alabama. Capital expenditures during the quarter ended September 30, 2004, totaled $0.2 million, consisting principally of prospect acquisition costs. One well was drilled on the prospect and is currently being tested for commercial production as a gas well. The Company charged a total of $0.1 million of in-house and third party general and administrative charges to the full cost pool as a result of time and expenses incurred during the quarter ended September 30, 2004, in its efforts to acquire and develop additional oil and gas reserves. LONG-TERM DEBT During the quarter ended September 30, 2004, the Company retired $0.3 million of indebtedness that was issued in November 2003 in connection with the acquisition of producing properties in the state of Montana. The debt service payments were funded by net cash flow from the acquired oil and gas properties and from the Company's producing properties located in the state of Michigan. For the period of time from November 2003 to September 30, 2004, the acquisition debt has been reduced from $4.5 million to $3.3 million. 15 NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued During the quarter ended September 30, 2004, the Company closed on a $0.7 million private placement of a convertible three-year note with an annual interest rate of 9%. The note is convertible into 4,125,000 shares of Common Stock. If the note is not converted during the three-year period from date of sale it will be redeemed for its face amount on the third anniversary from the subscription date. Net proceeds from the offering of the note are to be used for development activities on properties in the Texas Gulf Coast region and for working capital. The indebtedness is convertible at the option of the holder at issuance and, pursuant to EITF 98-5, "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios", a discount attributable to the beneficial conversion feature of approximately $83,000 was recorded as additional paid in capital. The discount will be amortized using the effective interest rate method over the term of the indebtedness. COMMON STOCK During the quarter ended September 30, 2004, the Company issued 1.0 million shares of Common Stock for the exercise of options, receiving proceeds in the amount of $63,000. The Company acquired 42,600 shares of Common Stock to be held as Treasury Stock at a cost of $8,100. STOCK BASED COMPENSATION During the quarter ended September 30, 2004, the Company granted to employees and directors options to acquire 6.2 million shares of Common Stock at exercise prices ranging from $0.175 to $0.35, which prices were in excess of the market price on the dates of grant. A portion of the options were fully vested on the grant date; the balance vest over a period of five years from the date of grant. The options are exercisable over a period of time ranging from five to six years from date of grant. Any unexercised options remaining at the end of the respective exercise periods will expire. Had compensation cost been determined based on the fair value at grant dates for stock option awards consistent with SFAS 123 and SFAS 148, the Company's net (loss) income for the three and nine month periods ended September 30, 2004 and 2003, would have been adjusted to the pro forma amounts indicated below (in thousands): Three Months Nine Months Ended September 30, Ended September 30, 2004 2003 2004 2003 ------ ------ ------ ------ Net (loss) income: As reported $ (195) $ (882) $ 47 $(1,836) Compensation recognized under SFAS 123 $ (220) $ -- $ (250) $ (390) Proforma $ (415) $ (882) $ (203) $(2,226) 16 NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued During the quarter ended September 30, 2003, the Company did not grant any stock option awards. There were, however, outstanding stock option awards that had been granted in prior periods. A portion of the compensation expense recognized under SFAS 123 for the three and nine month periods ended September 30, 2004 and 2003, is attributable to options granted in prior periods that vested during the respective periods in 2004 and 2003. The pro forma compensation expense based on the fair value of the options is estimated on the grant date using the Black-Scholes options-pricing model with the following assumptions used for the grants in 2004 and 2003: no dividends; expected lives ranging from 3.0 years to 5.0 years; expected volatility ranging from 0.85% to 11.9%; and risk free rates of return ranging from 2.27% to 3.81%. The weighted average fair value of the purchase rights granted in 2004 and 2003 ranged from $0.05 to $0.18. NEW ACCOUNTING PRONOUNCEMENTS In December 2003, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition." SAB 104 supersedes SAB 101, "Revenue Recognition in Financial Statements." SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superseded as a result of the issuance of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." Additionally, SAB 104 rescinds the SEC's Revenue Recognition in Financial Statements Frequently Asked Questions and Answers ("the FAQ") issued with SAB 101 that had been codified in SEC Topic 13, Revenue Recognition. Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104, which was effective upon issuance. The adoption of SAB 104 did not impact the consolidated financial statements. In March 2004, the Financial Accounting Standards Board (FASB) approved the consensus reached on the Emerging Issues Task Force (EITF) Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." The objective of this Issue is to provide guidance for identifying impaired investments. EITF 03-1 also provides new disclosure requirements for investments that are deemed to be temporarily impaired. The accounting provisions of EITF 03-1 are effective for all reporting periods beginning after June 15, 2004, while the disclosure requirements are effective only for annual periods ending after June 15, 2004. The Company has evaluated the impact of the adoption of EITF 03-1 and does not believe the impact will be significant to the Company's overall results of operations or financial position. FOUR-FOR-ONE FORWARD STOCK SPLIT Effective December 26, 2003, the Company's Board of Directors approved a four-for-one forward stock split on all outstanding shares of Common Stock. The Company's outstanding stock option awards and convertible notes were also adjusted accordingly. All share and per share amounts have been adjusted to give retroactive effect to this split for all periods presented. 17 NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued RECLASSIFICATION Certain reclassifications for the prior year have been made to conform to the current year's presentation. NOTE 2 - DISCONTINUED OPERATIONS In October 2002, the Company's Board of Directors directed management to sell all assets and liabilities of the petroleum marketing operations, including the convenience stores operations. In December 2002, the Company closed on the sale of assets located in the state of New Mexico (see Note 3). In March 2003, the Company received a proposal from Sedco, Inc. ("Sedco"), a private company owned by Ilyas Chaudhary, the Company's Chief Executive Officer, to acquire Enterprises, except for 4.0 million shares of Enterprises' equity ownership in Network Fueling Corp. ("NFC"), at a cash price of $2.5 million, effective January 1, 2003. The Company's Board of Directors accepted the proposal, subject to the receipt of a fairness opinion that was received in August 2003. At that time the Company had received a nonrefundable deposit in the amount of $300,000, a 7% promissory note in the amount of $1.0 million due October 31, 2003, and a second 7% promissory note in the amount of $1.2 million due April 30, 2004. In addition, Sedco provided 12,000,000 shares of the Company's Common Stock as security for payment of the two promissory notes. In September 2003, the transaction was amended for the following: the cash purchase price was reduced to $1.75 million and the 4,000,000 shares of NFC common stock were returned to Enterprises. In addition, Sedco assumed an obligation in the amount of $1.45 million that the Company owed to Enterprises. This amount, combined with the nonrefundable deposit in the amount of $300,000, constituted full payment of the amended purchase price of $1.75 million. In October 2003, the Company received a revised fairness opinion that reflected the changes to the transaction as originally proposed. The Company recorded the sale of the business interests, effective September 30, 2003, recording a loss of $730,000 for the disposal of the discontinued business interests. The historical operations of the business interests subject to the disposition have been presented in the 2003 interim period statements of operations and statements of cash flows as discontinued operations. The Company is guarantor of certain obligations of Enterprises and its subsidiaries in the aggregate amount of $1.5 million at September 30, 2004. The obligations consist of vendor trade accounts, and real estate and equipment purchases. Management believes that there is sufficient underlying collateral value in the related assets to significantly reduce the potential loss, if any, to the Company. The Company is a guarantor of a portion of indebtedness that was included in the sale of its propane distribution operation in April 2002, and the lender has yet to release the Company from the guarantee. As a result, the Company has included in its balance sheet at September 30, 2004, under the captions "Other Assets" and "Long term liabilities" the amount of $432,000 to reflect management's estimate of the underlying asset value and outstanding debt balance at September 30, 2004, applicable to this indebtedness. 18 NOTE 2 - DISCONTINUED OPERATIONS, Continued Summarized below are the results of discontinued operations for the three and nine month periods ended September 30, 2003 (in thousands): Three Months Nine Months Ended September 30, Ended September 30, 2003 2003 -------- -------- Sales $ 11,042 $ 49,082 Gross profit $ 2,308 $ 8,860 Loss from operations $ (292) $ (841) Net loss from operations $ (305) $ (1,264) NOTE 3 - BUSINESSES UNDER CONTRACT FOR SALE Effective December 31, 2002, the Company entered into an agreement to sell Graves and Capco Monument LLC, subsidiaries whose assets, consisting principally of land, buildings and equipment, were primarily located in the state of New Mexico, at a sales price of $10,000 cash. The assets of Graves were utilized in the distribution of refined petroleum products. The convenience store business consisted of two store locations that were in operation in Albuquerque and Farmington, New Mexico. The Company agreed to continue to operate the businesses for a period of time subsequent to the date of sale to allow the buyer time to make separate credit arrangements with lenders and suppliers, and to negotiate for the removal of the Company as the guarantor of a significant portion of the indebtedness assumed by the buyer. The sales transaction resulted in a gain to the Company in the amount of $182,000; however, due to the significant risk still assumed by the Company in the form of the loan guarantees, the gain was deferred until such time that the risk had either been significantly reduced or eliminated. At September 30, 2004, approximately $3.7 million of indebtedness, including accrued interest, was owed to one lender, and the borrower, a former subsidiary, was in default on the indebtedness. Remedies available to the lender include declaring the entire note balances, including accrued and unpaid interest, immediately due and payable, foreclosing on the pledged security, which includes land, buildings, and equipment, and collecting on any guarantees. Discussions have been held with the lender, but no settlement has been reached at this time. Beginning in the year 2003, the buyer marketed the real estate for sale, and certain properties are currently under contract for sale. The sale of one property closed in September 2003, resulting in a reduction in the amount of $623,000 to the total debt assumed by the buyer. Effective September 30, 2003, the Company re-evaluated the exposure relating to the debt guarantees. While management believed that there was sufficient value in the underlying assets such that the Company would not incur a loss from this disposal, the Company believed that the disposal no longer met the criteria to be recorded as a divestiture of a subsidiary for accounting purposes. Accordingly, the decision was made at September 30, 2003, to restore the assets and liabilities attributable to the businesses that were sold to the Balance Sheet to be reported as "Assets attributable to businesses under contract for sale" and "Liabilities attributable to businesses under contract for sale". 19 NOTE 3 - BUSINESSES UNDER CONTRACT FOR SALE, Continued The Company further evaluated the exposure relating to the debt guarantees as of December 31, 2003, and determined that there was not sufficient value in the underlying assets such that the Company will, in all likelihood, incur a loss from this disposal. It was estimated that the liabilities which are guaranteed by the Company exceed the underlying net assets by approximately $333,000. The Company accounted for this deficit by eliminating the deferred gain of $182,000 that was recorded at December 31, 2002, and by recording a charge to year 2003 operations in the amount of $151,000. In August 2004, the debt was reduced $100,000 by proceeds from the sale of a property. Net assets and liabilities attributable to the Company's guarantees consisted of the following at September 30, 2004 (in thousands): Net assets to be realized $ 4,013 ===== Liabilities, including accrued interest of $378 $ 4,346 ===== No additional loss contingency has been recorded for the three and nine month periods ended September 30, 2004. NOTE 4 - EARNINGS PER SHARE The Company uses SFAS No. 128, "Earnings Per Share" for calculating the basic and diluted earnings (loss) per share. Basic earnings (loss) per share are computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding. Diluted earnings (loss) per share is computed similar to basic earnings (loss) per share except that the numerator is increased by the amount of interest expense attributable to the convertible promissory notes payable and the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. On a diluted basis, under the treasury method of calculating the additional shares outstanding, the Company's weighted average shares outstanding for the nine months ended September 30, 2004, have been increased for 5,556,688 shares of Common Stock as associated stock options have a dilutive effect on net income. The Company's weighted average number of shares outstanding for the three months ended September 30, 2004, would have increased for 5,243,294 shares of Common Stock if associated stock options would have had a dilutive effect; however, due to the net loss for the period the effect of the options is antidilutive. Additionally, the number of shares outstanding for the three and nine month periods ended September 30, 2004, have been increased for 5,942,935 and 2,837,956 shares of Common Stock, respectively, determined under the "if converted" method, due to the issuance of convertible notes payable during the nine months ended September 30, 2004. On a diluted basis, the 20 NOTE 4 - EARNINGS PER SHARE, Continued Company's weighted average shares outstanding for the three and nine month periods ended September 30, 2003, have been increased for 2,728,204 and 2,402,104 shares of Common Stock, respectively, as associated stock options have a dilutive effect on income from continuing operations, which is the benchmark number for determining whether potential common stock is included in determining earnings (loss) per share. In accordance with SFAS No. 128, the stock options are also considered to be potential common stock in determining loss per share on loss from discontinued operations and net loss, even though the stock options are antidilutive. NOTE 5 - BUSINESS SEGMENTS During the three and nine month periods ended September 30, 2004 and 2003, the Company operated in one business segment: acquisition, exploration, development, and production of oil and gas reserves, including investments in the equity securities of other public companies involved in similar activities. The Company's headquarters and all of its operations are located in the United States of America. Effective December 31, 2003, the Company divested of its oil and gas interests located in Canada. A summary of the Company's revenues and long-lived assets by geographic area is as follows (in thousands): United Canada States Total -------- -------- ------- Sales: Three months ended September 30, 2004 $ -- $ 1,145 $ 1,145 ====== ====== ====== Three months ended September 30, 2003 $ 8 $ 811 $ 819 ====== ====== ====== Nine months ended September 30, 2004 $ -- $ 3,702 $ 3,702 ====== ====== ====== Nine months ended September 30, 2003 $ 8 $ 2,346 $ 2,354 ====== ====== ====== At September 30, 2004: Oil and gas properties (net) $ -- $ 12,061 $ 12,061 ====== ====== ====== Land $ 214 $ -- $ 214 ====== ====== ====== Other property and equipment (net) $ -- $ 113 $ 113 ====== ====== ====== 21 NOTE 6 - SUBSEQUENT EVENTS Effective September 30, 2004, the Company sold its interest in non-operated properties located in Alabama and Louisiana to a company owned by the Company's Chief Executive Officer. Sales proceeds in the amount of $0.4 million were received by the Company in October 2004 and were used for working capital. The sales proceeds were credited against the Company's basis in oil and gas properties. No gain or loss was recognized from the sale as the disposition did not represent a significant portion of the Company's proved reserves. The Company has the option to repurchase the properties for an amount equal to the sales price within the next twelve month period. If it is determined through due diligence by the Company that the properties could have been sold for an amount greater than $0.4 million, then the related party has the obligation to pay such excess to the Company. In October 2004, the Company issued 3.6 million shares of Common Stock in settlement of the acquisition cost of the Green Ranch property in Stephens County, Texas, that had been accrued as of September 30, 2004. 22 Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that include, among others, statements concerning: the benefits expected to result from Capco's divestiture of its petroleum marketing operations, including decreased expenses and expenditures that are expected to be realized by Capco as a result of the divestiture, and other statements of: expectations, anticipations, beliefs, estimations, projections, and other similar matters that are not historical facts, including such matters as: future capital, development and exploration expenditures (including the amount and nature thereof), drilling of wells, reserve estimates (including estimates of future net revenues associated with such reserves and the present value of such future net revenues), future production of oil and gas, repayment of debt, business strategies, and expansion and growth of business operations. These statements are based on certain assumptions and analyses made by the management of Capco in light of past experience and perception of: historical trends, current conditions, expected future developments, and other factors that the management of Capco believes are appropriate under the circumstances. Capco cautions the reader that these forward-looking statements are subject to risks and uncertainties, including those associated with: the financial environment, the regulatory environment, and trend projections, that could cause actual events or results to differ materially from those expressed or implied by the statements. Such risks and uncertainties include those risks and uncertainties identified below. Significant factors that could prevent Capco from achieving its stated goals include: declines in the market prices for oil and gas and adverse changes in the regulatory environment affecting Capco. Capco or persons acting on its or their behalf should consider cautionary statements contained or referred to in this report in connection with any subsequent written or oral forward-looking statements that may be issued. Capco undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. RESULTS OF OPERATIONS - --------------------- THREE MONTHS ENDED SEPTEMBER 30, 2004, COMPARED TO SEPTEMBER 30, 2003 Capco's revenues from oil and gas activities were $1.1 million in 2004 compared to $0.8 million in 2003. This increase is due principally to increases in quantities of oil and gas sold from properties that were acquired by the Company during the fourth calendar quarter of 2003. Revenues from the sale of oil and gas provided by the property acquisitions in Montana and the Texas Gulf Coast totaled $0.5 million in 2004. On a barrel of oil equivalent ("BOE") basis, the price paid at the wellhead for the Company's production decreased from $34.78 in 2003 to $33.98 in 2004, resulting in a decrease in total revenue of $19,000. Revenues from operator fees and pipeline transmission tariffs increased from $-0- in 2003 to $0.1 million in 2004. 23 Capco's cost of sales increased to $0.6 million in 2004 from $0.3 million in 2003, due principally to an increase in production volumes from 23,600 BOE in 2003 to 30,400 BOE in 2004. A total of 15,900 BOE was produced from the acquisitions in Montana and the Texas Gulf Coast. On a BOE basis, cost of sales attributable to the production of oil and gas increased from $14.23 in 2003 to $18.87 in 2004. The cost of price hedging programs on the Michigan and Montana properties, and remedial expenses incurred on the Texas Gulf Coast property were principally responsible for this increase. Net operating revenues from Capco's oil and gas production are very sensitive to changes in the price of oil; thus it is difficult for management to predict whether or not the Company will be profitable in the future. General and administrative expenses were $0.4 million in 2004 and $0.2 million in 2003. Non-recurring compensation costs of approximately $0.1 million associated with the employment of full-time and part-time personnel was the principal component of this increase. Depreciation, depletion and amortization was $0.1 million in 2004 and $0.2 million in 2003. This change is attributable to the increase in the depletable basis of the Company's United States full cost pool resulting principally from acquisitions during the fourth quarter of year 2003, the increase in production volumes resulting from the acquisitions and an increase in proved reserves from 1.0 million BOE at January 1, 2003, to 3.5 million BOE at January 1, 2004. The cost depletion rate per BOE decreased from $6.52 in 2003 to $4.50 in 2004 as a result of the changes in the depletable basis and proved reserves. Interest expense increased to $0.1 million in 2004 from $22,000 in 2003, due to the debt assumed in November 2003 with the acquisition of producing properties in the state of Montana and the private placements of convertible notes payable that closed in June and September 2004. Losses from sales of marketable securities, including unrealized holding gains, resulted in a losses of $13,000 in 2003 and $1,000 in 2004 as the Company had liquidated its marketable securities portfolio in prior periods. NINE MONTHS ENDED SEPTEMBER 30, 2004, COMPARED TO SEPTEMBER 30, 2003 Capco's revenues from oil and gas activities were $3.7 million in 2004 compared to $2.4 million in 2003. This increase is due principally to increases in quantities of oil and gas sold from properties that were acquired by the Company during the fourth calendar quarter of 2003. Revenues from the sale of oil and gas provided by the property acquisitions in Montana and the Texas Gulf Coast totaled $1.7 million in 2004. On a barrel of oil equivalent ("BOE") basis, the price paid at the wellhead for the Company's production decreased from $32.54 in 2003 to $32.44 in 2004, resulting in a decrease in total revenue of $8,000. Revenues from operator fees and pipeline transmission tariffs increased from $1,000 in 2003 to $0.3 million in 2004. 24 Capco's cost of sales increased to $1.9 million in 2004 from $1.1 million in 2003, due principally to an increase in production volumes from 73,300 BOE in 2003 to 104,500 BOE in 2004. A total of 55,500 BOE was produced from the acquisitions in Montana and the Texas Gulf Coast. On a BOE basis, cost of sales attributable to the production of oil and gas increased from $15.21 in 2003 to $16.80 in 2004. The cost of price hedging programs on the Michigan and Montana properties, and remedial expenses incurred on the Texas Gulf Coast property were principally responsible for this increase. Net operating revenues from Capco's oil and gas production are very sensitive to changes in the price of oil; thus it is difficult for management to predict whether or not the Company will be profitable in the future. General and administrative expenses were $0.9 million in 2004 and $0.7 million in 2003. Non-recurring compensation costs of approximately $0.1 million associated with the employment of full-time and part-time personnel during the three month period ended September 30, 2004, was the principal component of this increase. Depreciation, depletion and amortization was $0.5 million in both 2004 and in 2003. The cost depletion rate per BOE decreased from $6.51 in 2003 to $4.27 in 2004 as a result of changes in the depletable basis and proved reserves during the respective periods. Interest expense increased to $0.3 million in 2004 from $0.1 million in 2003, due to the debt assumed in November 2003 with the acquisition of producing properties in the state of Montana and the private placements of convertible notes payable that closed in June and September 2004. Losses from sales of marketable securities, including unrealized holding (losses) gains, decreased to a loss of $65,000 in 2004 from a gain of $53,000 in 2003, as the Company liquidated its marketable securities portfolio. LIQUIDITY AND CAPITAL RESOURCES At September 30, 2004, the Company had a working capital deficit of $3.0 million. This negative working capital is due, in large part, to the current portion of long-term debt, $2.0 million, which includes an obligation in the amount of $1.3 million that was incurred in connection with the acquisition of a producing oil and gas property during the year 2003. This debt, plus an additional $1.9 million that is classified as non-current, is to be repaid from future cash flow from the acquired property and other property owned by the Company that is located in the state of Michigan. Assuming current cash flow, it is estimated that the debt will be paid in full during the year 2007, after which the net cash flow will be paid to the Company. In addition, current liabilities at September 30, 2004, include accrued expenses in the amount of $0.4 million for the acquisition cost of an oil and gas property. This amount was paid in October 2004 by the issuance of Common Stock to the sellers of the acquired property. 25 Management of the Company has implemented plans and initiated actions in an effort to reduce the working capital deficit. These actions include the following: 1. Effective November 1, 2003, the Company's interest in producing property located in Michigan was pledged as additional collateral in connection with an acquisition of producing property in Montana. The net cash flow from both the Michigan and Montana properties is being used to retire the debt that was incurred with the acquisition. 2. Effective November 30, 2003, the Company acquired a 65% working interest in producing properties located in the Texas Gulf Coast that are providing positive cash flow to the Company. 3. Gross profit from property operations increased from $1.3 million in 2003 to $1.8 million in 2004, due principally to property acquisitions closed by the Company during the calendar years 2002 and 2003. 4. The Company's Board of Directors approved a plan in October 2002, which authorized management to pursue the divestiture of its petroleum products marketing and convenience store operations. 5. In December 2002, an agreement was reached for the sale of principally all of its assets in the state of New Mexico. Consideration for this transaction consisted primarily of the assumption by the buyer of approximately $4.5 million of indebtedness related to the assets. 6. In March 2003, a company owned by the Company's Chief Executive Officer submitted a proposal to acquire the remaining business interests designated for divestiture for total cash consideration of $2.5 million. The Company's Board of Directors accepted the proposal, subject to the receipt of a fairness opinion that was received in August 2003 and subsequently amended in October 2003. Following adjustments to the agreement that reduced the sales price to $1.75 million, the Company recorded the sale of the business interests, effective September 30, 2003. 7. In February 2004, the Company's Board of Directors authorized management to seek additional financing. A private placement of convertible notes payable closed in June 2004, providing the Company with net proceeds of $1.0 million. A second private placement of a convertible note payable closed in September 2004, providing the Company with net proceeds of $0.7 million. A portion of the proceeds from the additional financing is being used to fund property development activities in an effort to increase cash flow to the Company. 8. Effective September 30, 2004, the Company sold its interest in non-operated properties located in Alabama and Louisiana to a company owned by the Company's Chief Executive Officer. Sales proceeds in the amount of $0.4 million were received by the Company in October 2004 and were used for working capital. In connection with some of the transactions described above, the Company is considering the availability of equity and/or debt financing opportunities, although no decisions have been reached in this regard at this time. 26 CONTINUING OPERATIONS Net cash provided by operating activities totaled $1.3 million for the nine months ended September 30, 2004, compared to cash provided by operating activities of $0.4 million for the nine months ended September 30, 2003. In 2004, net income, adjusted for reconciling items, provided a cash inflow of $0.6 million. Changes in assets and liabilities in 2004 resulted in a cash inflow of $0.7 million. In 2003, net loss, adjusted for reconciling items, resulted in a cash inflow of $0.6 million. Changes in assets and liabilities resulted in a cash outflow of $0.2 million. Net cash used in investing activities totaled $1.8 million for the nine months ended September 30, 2004, compared to cash provided by investing activities of $0.4 million for the nine months ended September 30, 2003. Proceeds from the sale of marketable securities in the amount of $0.1 million were the principal source of cash inflow in 2004. Expenditures for oil and gas property and other assets totaled $1.8 million, due principally to the Company's capital program to enhance and improve the infrastructure and gas delivery capability of its offshore platforms in the Texas Gulf Coast and conduct workover operations on wells in that area. Payments to reduce amounts owed to related parties, net of related advances, totaled $0.1 million in 2004. Net advances from related parties in the amount of $1.0 million, was the principal source of cash inflow in 2003. An equity contribution to a subsidiary in the amount of $0.4 million was the principal outflow of cash in 2003. Net cash provided by financing activities totaled $0.7 million for the nine months ended September 30, 2004, and net cash used in financing activities totaled $0.8 million for the nine months ended September 30,2003. Proceeds from the private placement of convertible notes payable provided cash inflow in the amount of $1.7 million in 2004. Payments on long term debt in the amount of $1.0 million and $0.8 million in 2004 and 2003, respectively, resulted in cash outflows in both periods. The Company has various loans which require principal payments of $2.0 million during the twelve month period ending September 30, 2005. Of this amount, approximately $1.3 million will be repaid from future cash flow from specific producing oil and gas properties. The remainder of the payments are anticipated to be made from cash flow available from the operations of other producing property, and from proceeds from the sale of assets and equity and/or debt fundings. To the extent such cash flow is insufficient to make the debt payments and provide adequate working capital for the business of the Company, the Company may be required to reduce or curtail certain operations or seek other sources of capital. The Company does not currently have any agreements or arrangements providing for such financing and it may not be available on terms acceptable to the Company. The Company is the guarantor of approximately $5.6 million of indebtedness for which the obligors are former subsidiaries of the Company. Approximately $1.9 million of the indebtedness is being serviced by the respective debtor companies. The obligor for the remaining $3.7 million is in default to the lender. Discussions have been held with the lender, but no settlement has been reached at this time. The Company is currently not making payments with regard to any of these obligations. While management believes that there is sufficient underlying asset value in the respective companies to significantly mitigate any potential loss exposure to the Company over the amounts already recorded by the Company, there is no assurance that the Company may not be called upon to settle some portion of the indebtedness in the future. 27 The Company is obligated to pay operating lease costs of approximately $0.1 million during the twelve month period ending September 30, 2005, for land and facilities. The Company is responsible for any contamination of land it owns or leases. However, there may be limitations on any potential contamination liabilities as well as claims for reimbursement from third parties. DISCONTINUED OPERATIONS The following discussion relates to only the nine month period ended September 30, 2003. The Company divested of the discontinued business interests effective September 30, 2003, and as a result, there is no reporting of discontinued operations during the year 2004. Net cash provided by operating activities totaled $2.5 million. Net loss, adjusted for reconciling items, resulted in a cash outflow of $0.5 million. Changes in assets and liabilities resulted in a cash inflow of $3.0 million. Net cash provided by investing activities totaled $0.8 million. Proceeds from the sale of an equity investment of $0.8 million and an equity contribution of $0.4 million were the principal sources of cash inflow. Advances to related parties in the amount of $0.5 million were the principal cash outflow. Net cash used in financing activities totaled $3.3 million. Net payments on the revolving line of credit and long term debt resulted in cash outflows of $3.0 million and $0.6 million, respectively. A decrease in restricted cash provided a cash inflow of $0.4 million. EFFECT OF CHANGES IN PRICES Changes in prices during the past few years have been a significant factor in the oil and gas industry. The price received for the oil and gas produced by Capco has fluctuated significantly during the last year. Changes in the price that Capco receives for its oil and gas is set by market forces beyond Capco's control as well as government intervention. The volatility and uncertainty in oil and gas prices have made it more difficult for a company like Capco to increase its oil and gas asset base and become a significant participant in the oil and gas industry. Most of Capco's oil and gas production is sold to certain major oil companies and gas transmission companies. However, in the event these purchasers discontinued oil and gas purchases, Capco has made contact with other purchasers who would purchase the oil and gas at terms standard in the industry. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's Discussion and Analysis of Financial Condition and Results of Operations discusses the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to revenue recognition, intangible assets, recovery of oil and gas reserves, financing operations, and contingencies and litigation. 28 Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The most significant accounting estimates inherent in the preparation of the Company's financial statements include estimates as to the appropriate carrying value of certain assets and liabilities which are not readily apparent from other sources, primarily allowance for doubtful accounts, the discounted value of recoverable oil and gas reserves, the proceeds to be realized from the sale of real property, and the recognition and classification of net operating loss carryforwards between current and long-term assets. These accounting policies are described at relevant sections in this discussion and analysis and in the notes to the consolidated financial statements included in our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2003. Item 3: CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 (the "1934 Act") is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (the "SEC"). Those disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the 1934 Act is accumulated and communicated to the Company's management, including its principal executive and principal accounting officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based upon the evaluation of those controls and procedures performed as of September 30, 2004, the Company's management, with the participation of its chief executive officer and chief accounting officer, concluded that the Company's disclosure controls and procedures were adequate. The Company has implemented a process designed by, or under the supervision of, its principal executive and principal accounting officers, or persons performing similar functions, and effected by the Company's board of directors, management or other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the Company's assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that the Company's receipts and expenditures are being made only in accordance with authorizations of the Company's management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. The Company's management, with the participation of its chief executive officer and chief accounting officer, has determined that there has been no change in the Company's internal control over financial reporting that occurred during the Company's last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 29 PART II - OTHER INFORMATION Item 1. Legal Proceedings. None. Item 2. Changes in Securities. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None. Item 5. Other Information. The Registrant does not have procedures in place by which security holders may recommend nominees to the Registrant's Board of Directors. Item 6. Exhibits and Reports on Form 8-K. (a) The following exhibits are filed as part of this report: 31.1 Certification of Chief Executive Officer 31.2 Certification of Chief Accounting Officer 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. section 1350 32.2 Certification of Chief Accounting Officer pursuant to 18 U.S.C. section 1350 (b) Reports on Form 8-K None 30 SIGNATURES In accordance with the requirements of the Exchange Act, the Issuer caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. CAPCO ENERGY, INC. Dated: November 15, 2004 By: /s/ Ilyas Chaudhary ------------------------ Ilyas Chaudhary, Chief Executive Officer 31 EX-31.1 2 cpex311.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER EXHIBIT 31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Ilyas Chaudhary, the Chief Executive Officer of Capco Energy, Inc., certify that: 1. I have reviewed this form 10-QSB for the quarterly period ended September 30, 2004, of Capco Energy, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report; 4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under my supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this report is being prepared; b) Omitted; c) Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this report my conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter (the small business issuer's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting; and 5. I have disclosed, based on my most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal control over financial reporting. Date: November 15, 2004 /s/ Ilyas Chaudhary - ----------------------------- Ilyas Chaudhary Chief Executive Officer EX-31.2 3 cpex312.txt CERTIFICATION OF CHIEF ACCOUNTING OFFICER EXHIBIT 31.2 CERTIFICATION OF CHIEF ACCOUNTING OFFICER I, Walton C. Vance, the Chief Accounting Officer of Capco Energy, Inc., certify that: 1. I have reviewed this form 10-QSB for the quarterly period ended September 30, 2004, of Capco Energy, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report; 4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under my supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this report is being prepared; b) Omitted; c) Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this report my conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter (the small business issuer's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting; and 5. I have disclosed, based on my most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal control over financial reporting. Date: November 15, 2004 /s/ Walton C. Vance - ----------------------------- Walton C. Vance Chief Accounting Officer EX-32.1 4 cpex321.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 EXHIBIT 32.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C.SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT In connection with the Quarterly Report of Capco Energy, Inc. the "Company") on Form 10-QSB for the quarterly period ended September 30, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Ilyas Chaudhary, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company at the dates and for the periods indicated. /s/ Ilyas Chaudhary - ------------------- Ilyas Chaudhary Chief Executive Officer November 15, 2004 EX-32.2 5 cpex322.txt CERTIFICATION OF CHIEF ACCOUNTING OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 EXHIBIT 32.2 CERTIFICATION OF CHIEF ACCOUNTING OFFICER PURSUANT TO 18 U.S.C.SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT In connection with the Quarterly Report of Capco Energy, Inc. (the "Company") on Form 10-QSB for the quarterly period ended September 30, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Walton C. Vance, Chief Accounting Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company at the dates and for the periods indicated. /s/ Walton C. Vance - ------------------- Walton C. Vance Chief Accounting Officer November 15, 2004 -----END PRIVACY-ENHANCED MESSAGE-----