-----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, RRy6xm2uZ057NFW8MXHJc/0cyFYWl0OUJf57OmgpB62ANGuRTp4DhOm3p97QiRJR ET3QgJWbz7+djkcc/gUmgg== 0001021890-97-000079.txt : 19970329 0001021890-97-000079.hdr.sgml : 19970329 ACCESSION NUMBER: 0001021890-97-000079 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970328 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PEASE OIL & GAS CO /CO/ CENTRAL INDEX KEY: 0000076878 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 870285520 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-06580 FILM NUMBER: 97567470 BUSINESS ADDRESS: STREET 1: 751 HORIZON COURT STE 203 STREET 2: P O BOX 60219 CITY: GRAND JUNCTION STATE: CO ZIP: 81506-8758 BUSINESS PHONE: 970-243-8840 MAIL ADDRESS: STREET 2: P O BOX 60219 CITY: GRAND JUNCTION STATE: CO ZIP: 81506-8758 FORMER COMPANY: FORMER CONFORMED NAME: WILLARD PEASE OIL & GAS CO DATE OF NAME CHANGE: 19920703 10KSB 1 ANNUAL REPORT ON FORM 10-KSB--DECEMBER 31, 1996 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 or [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-6580 PEASE OIL AND GAS COMPANY --------------------------------------------------------- (Name of small business issuer as specified in its charter) Nevada 87-0285520 ------------------------------ --------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 751 Horizon Court, Suite 203, Grand Junction, Colorado 81506 -------------------------------------- -------- (Address of principal executive offices) (Zip code) (970) 245-5917 ---------------------------------------------- (Issuer's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: (None) Securities registered pursuant to Section 12(g) of the Act: Common Stock (Par Value $.10 Per Share) Series A Cumulative Convertible Preferred Stock (Par Value $0.01 Per Share) Common Stock Purchase Warrants (Expire August 13, 1998) Title of Class Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ] Check if disclosure of delinquent filers in response to Item 405 of Regulation S-B, is not contained in this form and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to the Form 10-KSB. [ ] The issuer's revenues for its most recent fiscal year were $6,165,664. As of February 21, 1997, Registrant had 8,357,427 shares of its $0.10 par value Common Stock and 141,822 shares of its $0.01 par value Series A Cumulative Convertible Preferred Stock outstanding. As of February 21, 1997 the aggregate market value of the common stock, the Registrant's only class of voting stock, held by non-affiliates was $23,584,935. This calculation is based upon the closing sales price of $3.25 per share on February 21, 1997. TABLE OF CONTENTS AND CROSS REFERENCE SHEET PART I Item 1 Description of Business Item 2 Description of Property Item 3 Legal Proceedings Item 4 Submission of Matters to a Vote of Security Holders PART II Item 5 Market for Common Equity and Related Stockholder Matters Item 6 Management's Discussion and Analysis Item 7 Financial Statements Item 8 Changes In and Disagreements with Accountants on Accounting and Financial Disclosure PART III Item 9 Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act. Item 10 Executive Compensation. Item 11 Security Ownership of Certain Beneficial Owners and Management. Item 12 Certain Relationships and Related Transactions. Item 13 Exhibits and Reports on Form 8-K PART I ITEM 1 - BUSINESS GENERAL Pease Oil and Gas Company ("Company"), was incorporated under the laws of the state of Nevada on September 11, 1968. The Company's address is 751 Horizon Court, Suite 203, Grand Junction, Colorado 81506 and its telephone number is (970) 245-5917. The Company is engaged in the oil and gas acquisition, exploration, development and production business. Historically, the Company's operations were in the western United States, primarily in Colorado, Nebraska, Utah, and Wyoming. During 1996 and early in 1997, the Company has taken initiatives to expand its operations in to the Gulf Coast region of Alabama, Southern Louisiana and Texas. On August 23, 1993, the Company acquired Skaer Enterprises, Inc. a Colorado corporation, its related businesses and related oil and gas properties (collectively "Skaer"). Skaer was privately owned and operated, and was considered one of the largest private independent oil and gas companies in Colorado, operating exclusively in the Denver-Julesburg Basin ("DJ Basin") of northeastern Colorado. This acquisition substantially expanded the Company's operations into providing oil field services, oil field supplies, natural gas processing and natural gas marketing. Skaer was acquired for $12,200,000, including $300,000 of various costs associated with the acquisition. This acquisition was financed through: i) the issuance of 900,000 shares of preferred stock in a public offering which generated net proceeds of $7,965,000; ii) the issuance of restricted common and preferred stock with an agreed value of $1,900,000 to the sellers; and iii) a $2,400,000 loan from a bank. RECENT ACQUISITIONS AND DEVELOPMENTS As discussed in the following paragraphs, the Company, through a series of acquisitions and the development of strategic alliances with several private and public exploration companies, has positioned itself to expand its asset base into the Gulf Coast Region of Alabama, Southern Louisiana and Texas. On January 10, 1997, the Company acquired a 7.8125% After Prospect Payout Working Interest in the East Bayou Sorrel Prospect from third parties for a total purchase price of $1.75 million. The purchase price consisted of the issuance of 315,000 shares of the Company's common stock and $875,000 cash. On March 3, 1997 the Company acquired an additional 10% working interest in this prospect from unrelated third parties for $2.5 million cash. The prospect contains a discovery well, the C.E. Schwing #1, which in February 1997 was producing in excess of 1,400 barrels of oil per day and 1,300 MCF of natural gas per day with a flowing tubing pressure of 6,300 PSI on a 12/64" choke from a perforated interval of 13,208 feet to 13,226 feet. The C.E. Schwing #1 went on production in December 1996. These acquisitions were funded with the Company's existing working capital and the proceeds generated from a private placement of common stock during February and March 1997. In that placement, the Company sold 1,500,000 shares of the Company's restricted common stock to accredited investors for $2.50 per share. The private placement was completed on March 10, 1997 generating net proceeds of approximately $3.3 million. On February 4, 1997 the Company entered into a definitive agreement with National Energy Group, Inc. ("NEGX"), a publicly held company headquartered in Dallas, Texas. NEGX is the operator of the East Bayou Sorrel Prospect. The Agreement provides the Company the right and obligation to participate with NEGX in various oil and gas exploration projects over the course of the next two years. Essentially, the agreement consists of three main elements. First, Pease has the right and obligation to participate as a 12.5% working interest owner in NEGX's outlined exploration program. Specifically, there are 10 identified projects including: Mustang Island located in Nueces County, Texas; Bayou Sorrel located in Iberville Parish, Louisiana; and Robertsdale located in Baldwin County, Alabama. Second, subject to certain conditions defined in the agreement, Pease has the right and obligation to participate in any future prospects generated under NEGX's exclusive arrangement with Sandefer Oil and Gas, Inc. ("Sandefer"). Sandefer is a private corporation owned and operated by a group of geologists and geophysicists who generate Gulf Coast, Southern Louisiana and other wildcat prospects. The East Bayou Sorrel prospect discussed in the previous paragraph was generated by Sandefer. Third, Pease is entitled to participate in any third party generated prospects that NEGX participates in subject to certain conditions as defined in the Agreement. 1 BUSINESS STRATEGY The recent acquisitions and developments are the first steps in transforming the Company. Its future business strategy is to expand its reserve base and cash flow by utilizing its existing asset base in the Rocky Mountain Region and cultivating the recent acquisitions, strategic alliances and opportunities in the Gulf Coast Region of Alabama, Southern Louisiana and Texas. The Company will attempt to execute this strategy through: o Raising significant capital to take advantage of leading edge technologies such as horizontal drilling and 3-D seismic exploration projects; o Positioning itself with strategic sources of capital and partners that can react to opportunities in the oil and gas business when they present themselves; o Developing alliances with major oil and gas finders that have been trained by major oil companies; o Participating in exploration projects that have opportunities involving relatively small amounts of capital that could potentially generate significant rates of return. These projects include areas with large field potentials in Alabama, Southern Louisiana, Texas and the Gulf of Mexico. Generally, the exploration projects will target fields with potential reserves of 10 million barrels of oil or 100 Bcf of gas; o Implementing the Company's investment strategy to carefully consider, analyze, and exploit the potential value of the Company's existing assets to increase the rate of return to its shareholders; o Reinvesting operating cash flows into development drilling and recompletion activities; o Continuing the expansion of the Company's operations outside the D-J Basin; o Continuing the implementation of asset rationalization and operating efficiencies designed to improve operating margins and lower per unit operating cost; o Acquiring properties that build upon and enhance the Company's existing asset base; o Developing a long term track record regarding stock price performance and a reasonable rate of return to shareholders. The Company recognizes that the ability to implement its business strategies is largely dependent on the ability to raise additional debt or equity capital to fund future acquisition, exploration, drilling and development activities. The Company's Capital resources are discussed more thoroughly in Part II, Item 6, in Management's Discussion and Analysis. OPERATIONS As of December 31, 1996, the Company had varying ownership interests in 189 gross productive wells (174 net) located in five states. The Company operates 179 of the 189 wells, the other wells are operated by independent operators under contracts that are standard in the industry. The following table presents information on the Company's major operating areas as of December 31, 1996: Net Proved Reserves ------------------- STATE REGION Bbls Mcf ----- ------ ---- --- CO, WY, NE .......................... DJ Basin 996,000 3,950,000 Utah ................................ Greater Cisco and Four Corners 143,000 750,000 Wyoming ............................. Big Horn Basin 35,000 -- CO & AR ............................. Various 1,000 133,000 --------- --------- Total .......................... 1,175,000 4,833,000 ========= ========= It is a primary objective of the Company to operate most of the oil and gas properties located in the Rocky Mountain Region in which it has an economic interest. The Company believes, with the responsibility and authority as operator, it is in a better position to control costs, safety, and timeliness of work as well as other critical factors affecting the economics of a well. At the present time, oil and natural gas prospects pursued in the Gulf Coast region will be pursued by the Company as a non-operator. 2 COMPETITION The oil and gas industry is highly competitive in all phases. The Company encounters strong competition from other independent oil and gas companies in acquiring economically desirable prospects as well as in marketing production therefrom and obtaining external financing. Many of the Company's competitors may have financial resources, personnel resources, and facilities substantially greater than those of the Company. Because there has been a decrease in exploration for and development of oil and gas properties in the United States, there is increased competition for lower risk development opportunities and for available sources of financing. In addition, the marketing and sale of natural gas and processed gas are extremely competitive. Accordingly, the competitive environment in which the Company operates is unsettled. MARKETS Overview - The three principal products currently produced and marketed by the Company are crude oil, natural gas and natural gas liquids ("NGL's"). The Company does not currently use commodity futures contracts and price swaps in the sales or marketing of its natural gas and crude oil. Crude Oil - Oil produced from the Company's properties is generally transported by truck to unaffiliated third-party purchasers at the prevailing field price ("the posted price"). Currently, the three primary purchasers of the Company's crude oil are Total Petroleum, Inc., Texaco Trading and Transportation, Inc. and Scurlock-Permian Corporation. Together these three purchasers buy more than 80% of the Company's annual crude oil production. The contracts are month-to-month and subject to change. The market for the Company's crude oil is competitive and therefore the Company does not believe that the loss of one of its primary purchasers would have a material adverse effect on the Company's business because other arrangements could be made to market the Company's crude oil products. The Company does not anticipate problems in selling future oil production since purchases are made based on current market conditions and pricing. Oil prices are subject to volatility due to several factors beyond the Company's control including: political turmoil; domestic and foreign production levels; OPEC's ability to adhere to production quotas; and possible governmental control or regulation. Natural Gas - The Company sells its natural gas production in two principal ways: a.) at the wellhead to various pipeline purchasers or natural gas marketing companies; and b.) at the tailgate of its Gas Plant to either Public Service Company of Colorado ("PSCo") or Hewlett-Packard Company ("HP"). The wellhead contracts have various terms and conditions, including contract duration. Under each wellhead contract the purchaser is generally responsible for gathering, transporting, processing and selling the natural gas and natural gas liquids and the Company receives a net price at the wellhead. The residue gas sold at the tailgate of the Company's Gas Plant to PSCo is subject to a month-to-month contract and the Gas sold to HP is subject to a 17-year contract. The gas to both parties is priced on an MMBtu basis at an index spot price. Natural Gas Liquids - The Company produces two natural gas liquid products at its Gas Plant, butane-gasoline mix and propane. The butane gasoline mix is sold to an unaffiliated party at prevailing market prices on a month-to-month basis. The propane is sold under a month-to-month arrangement with one or more local propane wholesalers for resale to the local propane market. The Company does not believe that the loss of the current purchasers of these products would have a material adverse effect on the Company's business because it believes other, similar arrangements could be made to market the Company's natural gas liquids. REGULATIONS General - All aspects of the oil and gas industry are extensively regulated by federal, state, and local governments in all areas in which the Company has operations. The following discussion of regulation of the oil and gas industry is necessarily brief and is not intended to constitute a complete discussion of the various statutes, rules, regulations or governmental orders to which the Company's operations may be subject. 3 Price Controls on Liquid Hydrocarbons - There are currently no federal price controls on liquid hydrocarbons (including oil, natural gas and natural gas liquids). As a result, the Company sells oil produced from its properties at unregulated market prices which historically have been volatile. Federal Regulation of Sales and Transportation of Natural Gas - Historically, the transportation and sale of natural gas in interstate commerce have been regulated pursuant to the Natural Gas Act ("NGA"), the Natural Gas Policy Act of 1978 ("NGPA") and regulations promulgated thereunder. The Natural Gas Wellhead Decontrol Act of 1989 eliminated all regulation of wellhead gas sales effective January 1, 1993. As a result, the Company's gas sales are no longer regulated. The transportation and resale in interstate commerce of natural gas produced and sold by the Company continues to be subject to regulation by the Federal Energy Regulatory Commission ("FERC") under the NGA. The transportation and resale of natural gas transported and resold within the state of its production is usually regulated by the state involved. In Colorado such regulation is by the Colorado Public Utility Commission. Although federal and state regulation of the transportation and resale of natural gas produced by the Company currently does not have any material direct impact on the Company, such regulation does have a material impact on the market for the Company's natural gas production and the price the Company receives for its natural gas production. Adverse changes in the regulation affecting the Company's gas markets could have a material impact on the Company. Commencing in the mid-1980's and continuing until the present, the FERC promulgated several orders designed to correct market distortions and to make gas markets more flexible and competitive. These orders have had a profound influence on natural gas markets in the United States and have, among other things, increased the importance of interstate gas transportation and encouraged development of a large spot market for gas. On April 8, 1992, the FERC issued Order No. 636 requiring material restructuring of the sales and transportation service provided by interstate pipeline companies. The primary element of Order No. 636 was the mandatory unbundling of interstate gas transportation services and storage separately from their gas sales. The unbundled transportation and storage was required to be offered without favoring gas bought from the pipeline. Order No. 636 did not require pipelines to stop buying and reselling gas; to the contrary, it contained specific provisions to allow pipelines to continue unbundled sales of natural gas. However, after Order No. 636 there was little reason for a pipeline to continue selling natural gas and most pipelines moved all or almost all of their gas purchases and sales to affiliated marketing companies. Order No. 636 does not regulate gas producers such as the Company. However, Order No. 636 does appear to have achieved FERC's stated goal of fostering increased competition within all phases of the natural gas industry. Generally speaking, this increased competition has driven the price down for natural gas produced by the Company and other producers in the DJ Basin. It is unclear what further impact the increased competition will have on the Company as a gas producer and seller in the future. Increased flexibility and competition provides greater assurance of access to markets, but has consequently reduced or restrained prices. In addition to FERC regulation of interstate pipelines under the NGA, various state commissions also regulate the rates and services of pipelines whose operations are purely intrastate in nature. To the extent intrastate pipelines elect to transport gas in interstate commerce under certain provisions of the NGPA, those transactions are subject to limited FERC regulation under the NGPA and may ultimately effect the price of natural gas sold by the Company. There are many legislative proposals pending in Congress and in the legislatures of various states that, if enacted, might significantly affect the oil and gas industry. The Company is not able to predict what will be enacted and thus what effect, if any, such proposals would ultimately have on the Company. State and Local Regulation of Drilling and Production - State regulatory authorities have established rules and regulations requiring permits for drilling, bonds for drilling, reclamation and plugging operations, limitations on spacing and pooling of wells, and reports concerning operations, among other matters. The states in which the Company operates also have statutes and regulations governing a number of environmental and conservation matters, including the unitization and pooling of oil and gas properties and establishment of maximum rates of production from oil and gas wells. A few states also prorate production to the market demand for oil and gas. These statutes and 4 regulations limit the rate at which oil and gas could otherwise be produced or the prices obtained from the Company's properties. During the 1993 session of the Colorado legislature, a coalition of surface owner organizations attempted to persuade the legislators to enact a bill requiring the payment of damages to surface owners. Such legislation could increase the cost of the Company's operations and erode the traditional rights of the oil and gas industry in Colorado to make reasonable use of the surface to conduct drilling and development activities. Although the bill was withdrawn by the surface owners after it was significantly amended, and no such legislation has been presented since 1993 (to the Company's knowledge), surface owner groups have indicated they may seek a statewide constitutional ballot initiative to mandate compensation to surface owners and will attempt to increase regulation of the oil and gas industry at the local government level. The involvement of such local governments could not prohibit the conduct of drilling activities within their boundaries which were the subject of permits issued by the Colorado Oil and Gas Conservation Commission ("COGCC") but that they could regulate such activities under their land use authority. Accordingly, under these decisions, local municipalities and counties may take the position that they have the authority to impose restrictions or conditions on the conduct of such operations which could materially increase the cost of such operations or even render them entirely uneconomic. In 1993 and 1991 the Cities of Thornton, Broomfield, and Greeley, the Town of Frederick and Boulder County, enacted such ordinances. The Company does not have any properties within these boundaries. The Company is not able to predict which jurisdictions may adopt such regulations, what form they will take or the ultimate effects of such enactments on its operations. However, in general these ordinances are aimed at increasing the involvement of local governments in the permitting of oil and gas operations, requiring additional restrictions or conditions on the conduct of operations to reduce the impact on the surrounding community and increasing financial assurance requirements. Accordingly, the ordinances have the potential to delay and increase the cost, or even in some cases to prohibit entirely, the conduct of the Company's drilling activities. In response to the concerns of surface owner groups, the COGCC has adopted regulations for the D-J Basin governing notices to and consultation with surface owners prior to the conduct of drilling operations, imposing specific reclamation requirements on operators upon the conclusion of operations, and containing bonding provisions to enforce these new requirements. The COGCC in 1994 modified its rules to require the mandatory installation of surface casing to depths below known fresh water aquifers in the D-J Basin and is continuing to consider additional measures for protection of surface owners, enhanced financial assurance requirements, and modifications to its rules concerning safety and plugging and abandonment. The rules adopted or modified by the COGCC to date have not had a material impact on the Company but it is not possible to predict what additional changes will be made or what their financial or operational impact will be on the Company. Under the sponsorship of the Colorado Department of Natural Resources, legislation was approved in the 1994 session of the Colorado legislature to enhance the authority of the COGCC to regulate oil and gas operations. Representatives of the oil and gas industry were involved in the drafting of this legislation, along with representatives of the agricultural industry, local governments and environmental groups, and are working closely with the COGCC on the consideration and drafting of new rules to address the concerns that have been raised about the effects of oil and gas operations. Although the Company believes that it generally conducts its operation in accordance with the procedures contemplated in the pending regulatory initiatives, management is not able to predict the final form of the initiatives or their impact on the Company. Recently, Wyoming increased its bonding and financial requirements for operators acquiring existing properties. These new requirements are not expected to have a significant impact on the Company or its operations. Environmental Regulations - The production, handling, transportation and disposal of oil and gas and by-products are subject to regulation under federal, state and local environmental laws. In most instances, the applicable regulatory requirements relate to water and air pollution control and solid waste management measures or to restrictions of operations in environmentally sensitive areas. In connection with its acquisitions, the Company attempts to perform environmental assessments. However, environmental assessments have not been performed on all of the Company's properties. To date, expenditures for environmental control facilities and for remediation have not been significant in relation to the Company's results of operations. However, it is reasonably likely that the trend in environmental legislation and regulations will continue towards stricter standards and may result in significant 5 future costs to the Company. For instance, efforts have been made in Congress to amend the Resource Conservation and Recovery Act to reclassify oil and gas production wastes as "Hazardous Waste," the effect of which would be to further regulate the handling, transportation and disposal of such waste. If such legislation were to pass, it could have a significant adverse impact on the operating costs of the Company, as well as the oil and gas industry in general. New initiatives regulating the disposal of oil and gas waste are also pending in certain states, including states in which the Company conducts operations, and these various initiatives could have a similar impact on the Company. The COGCC has enacted rules regarding the regulation of disposal of oil field waste, including waste currently exempt from federal regulation. These rules may require the termination of production from some of the Company's marginal wells for which the cost of compliance would exceed the value of remaining production. In addition, as indicated above, the COGCC has enacted regulations imposing specific reclamation requirements on operators upon the conclusion of the operations, and is currently chairing a group including representatives of the oil and gas industry, environmental groups, surface owners, and local governments to consider adopting statewide reclamation requirements. The COGCC is also in the process of preparing new rules governing production pits which are intended to require closure of unlined pits and certain steel, fiberglass, cement and other vessels in designated sensitive areas (which will probably include most of the areas in Colorado that the Company operates) or adequate proof that such pits or vessels are not leaking. As currently drafted, such rules would permit operators to comply over a period of at least two years. The COGCC proposals will be subject to review and comment of water quality agencies and other interested parties and thus may change from the approach described above. Management believes that compliance with current applicable laws and regulations or with proposals in their present form could possibly have a material adverse impact on the Company, but management is unable to predict the final form of the pending regulations or their potential impact on the Company. Wyoming has recently established more stringent environmental regulations to ensure compliance with federal regulations. These new regulations are not expected to have a significant impact on the Company or its operations. The Company believes that its operations comply with all applicable legislation and regulations in all material respects, and that the existence of such regulations has had no more restrictive effect on the Company's method of operations than other similar companies in the industry. Although the Company does not believe its business operations presently impair environmental quality, compliance with federal, state and local regulations which have been enacted or adopted regulating the discharge of materials into the environment could have an adverse effect upon the capital expenditures, earnings and competitive position of the Company, the extent of which the Company now is unable to assess. OPERATIONAL HAZARDS AND INSURANCE The Company's operations are subject to the usual hazards incident to the drilling and production of oil and gas, such as blowouts, cratering, explosions, uncontrollable flows of oil, gas or well fluids, fires, pollution, releases of toxic gas and other environmental hazards and risks. These hazards can cause personal injury and loss of life, severe damage to and destruction of property and equipment, pollution or environmental damage and suspension of operations. The Company maintains insurance of various types to cover its operations. The Company's insurance does not cover every potential risk associated with the drilling and production of oil and gas. In particular, coverage is not obtainable for certain types of environmental hazards. The occurrence of a significant adverse event, the risks of which are not fully covered by insurance, could have a material adverse effect on the Company's financial condition and results of operations. Moreover, no assurance can be given that the Company will be able to maintain adequate insurance in the future at rates it considers reasonable. ADMINISTRATION Office Facilities - The Company currently rents approximately 4,000 square feet in an office facility in Grand Junction, Colorado owned by an unrelated party. The rental rate is $31,440 per year through June 30, 2000. 6 Employees - As of February 21, 1997, the Company had 35 full time employees, none of whom is covered by a collective bargaining agreement. The Company considers its relations with its employees satisfactory. ITEM 2 - PROPERTIES PRINCIPAL OIL AND GAS INTERESTS Developed Acreage - The Company's producing properties as of December 31, 1996 are located in the following areas shown in the table below:
OIL GAS Developed Acreage --------------- --------------- ----------------- Gross Net(2) Gross Net(2) Gross Net(2) Fields State Wells(1) Wells Wells(1) Wells Acreage Acreage - ------------------------ ------------ ----- ----- ----- ----- ------- ------- Loveland Field Colorado 88 87 5,083 5,047 Lower Horse Draw Field Colorado 2 1 400 204 North Minto Field Colorado 3 3 440 432 Pod Field Colorado 6 6 600 600 Yenter Field Colorado 6 6 1,655 1,655 Johnson's Corner Colorado 5 4 1,122 1,122 West Peetz Field Colorado 5 4 785 785 Cisco Dome Utah 1 1 38 31 8,877 8,267 Cowboy Utah 4 4 1,200 1,199 Enos Creek Wyoming 2 1 280 215 Other Fields CO/NB/UT 25 23 4 3 6,443 4,543 ------ ------ ----- ----- ------ ------ Totals 147 140 42 34 26,885 24,069 ====== ====== ===== ===== ====== ======
- ------------------ Footnotes (1) Wells which produce both gas and oil in commercial quantities are classified as "oil" wells for disclosure purposes. (2) "Net" wells and "net" acres refer to the Company's fractional working interests multiplied by the number of wells or number of acres. The majority of the Company's producing oil and gas properties are located on leases held by the Company for as long as production is maintained. Undeveloped Acreage - The Company's gross and net working interests in leased undeveloped acreage in the Rocky Mountain Region as of December 31, 1996 is 406 and 366 acres, respectively. All these properties are located in Colorado and will expire at various times in 1997 unless production has been obtained. The Company's gross and net working interests in leased and developed acreage in Louisiana as of December 31, 1996 is 1600 and 100 acres respectively. This consists of one property and will expire in 1998 unless production has been obtained. 7 GULF COAST PROSPECTS Overview - In 1997 and 1998, the Company will be directing a significant portion of its resources to the Gulf Coast region, which is currently one of the most actively explored areas in the United States. The Company's strategy for entering the Gulf Coast area is to team up with the best oil and gas finders in any specific area. The Company is focusing in South Louisiana, shallow Texas State waters and specific areas where the Company believes it has strategic advantage including Alabama and certain Texas areas., The parameters in general are that the target reserves are 100 BCFG and/or 10 million bbls. oil. With this strategy in mind, the Company is typically drilling to deeper horizons which significant reserves have been found at shallower depths. Currently, three prospects are in the process of drilling or are expected to commence drilling in the first quarter of 1997. These include East Bayou Sorrel, South Lake Arthur and Brazos Block 480. A brief description of these prospects follows. East Bayou Sorrel and Bayou Sorrel Area: This exploration prospect was generated by Sandefer Oil and Gas. The initial exploratory location was selected with the use of reprocessed 2D seismic data. The well, Schwing #1, was drilled in the East Bayou Sorrel field, Iberville Parish, LA, to a total depth of 13,200 ft. Upon test it flowed at a sustained rate of 1,026 barrels of oil and 980 Mcf of gas per day with a flowing tubing pressure of 6,670 psi on an 8/64" choke. In February 1997, the well was producing at or near the maximum allowable rate of 1,400 barrels of oil per day on a restricted choke. In January 1997, the Company purchased a 7.8125% after prospect payout working interest in the area of mutual interest (AMI) which includes the East Bayou Sorrel Prospect. The Company acquired an additional 10% working interest in this prospect in February 1997. The operator has identified seven productive zones in the Schwing #1 well of which only one was tested and is on production. Additional pay sands may be discovered in the second well, which is expected to commence drilling operations in March 1997. National Energy has planned a 33-square mile 3D seismic exploration program over the Bayou Sorrel AMI area. The seismic program will commence in 1997. The 3D data will compliment an already extensive database of reprocessed 2D seismic data and a number of existing well logs. The Company's participation in the Bayou Sorrel drilling and 3D seismic exploration program are expected to provide significant exposure to potential productive drilling opportunities. The 3D interpretation should help define the potential of the upper Marg vag pay zone sandstone. It is believed that a productive section of a proven producing formation will be found in Bayou Sorrel based on the existing 2D and well log data. Because the formation is a profile producer in the region, Bayou Sorrel is a potential large reserve prospect. Sandefer Oil and Gas and NEGX have also identified two other fault blocks suitable for drilling from existing data and will focus on this area with the 3D seismic exploration program which will give the Company additional opportunities to participate in high potential reserve projects. South Lake Arthur - South Lake Arthur is located in Jefferson Davis Parish, Louisiana. It is a four-way dip closure. Sandefer Oil and Gas has previously drilled this prospect to 17,375 feet but the well was subsequently abandoned. In reviewing the well data of this and other nearby wells, it was determined that the well was most likely not tested sufficiently and inadequately completed. Sandefer geologists believe this well would have been found to be a producer if it had been properly tested. NEGX acquired this lease from Sandefer and planned a well near the original Sandefer well. The well is currently being drilled. The Company is participating at 1/16 of the working interest under its agreement with NEGX. A very large gas field is in close proximity. A productive sandstone formation underlies the prospect at a depth of between 18,000 feet and 20,000 feet. A large multi-national natural resources firm has announced plans to drill to the same formation in the area, which may reveal the potential of this deep play and influence future participation in this prospect. Brazos Block 480 Prospect - Brazos Block 480 is the only offshore prospect in which the Company is presently participating. This prospect, located within a prolific gas producing geologic trend of offshore Texas, is believed to be analogous to Amoco's Matagorda Block 519 Field which produced over 120 BCFG from November 1985 through September 1995. A well is scheduled to commence drilling operations in April 1997, at a site located adjacent to Cove Field about eight miles offshore in approximately 60 feet of water. The prospect is tightly controlled by numerous 2D seismic lines. A nine-square mile 3D seismic survey has also been shot and interpreted. 8 COLORADO PROPERTIES Overview - The Denver-Julesburg ("DJ") Basin encompasses most of northeast Colorado and parts of southeast Wyoming, southwest Nebraska and western Kansas. Oil and gas are produced mainly from Cretaceous sandstones and limestones, with the "D" and the "J" sandstones being the most prolific producers in the Basin at depths ranging in general from approximately 5,000 feet to approximately 7,500 feet. The Company's activities have focused on the historically better producing zones, the "D" and the "J" sandstones and the Niobrara formation. At December 31, 1996, 84% of the Company's reserves were in the DJ Basin. A summary of the notable fields in the DJ Basin are as follows: Loveland Field, Larimer and Weld Counties - Loveland Field is located near the City of Loveland, Colorado, 40 miles north of Denver. The area is producing both oil and gas at an average rate in 1996 of approximately 248 barrels of oil equivalent ("BOE") per day (205 BOE net to the Company). Loveland Gas Plant and associated Pease facilities are located near the center of the field. Johnson's Corner Field is located just 4 miles east of Loveland Field. Together, the Loveland Field, Johnson's Corner Field and Loveland Gas Plant constitute more than half of Pease's total Rocky Mountain assets. All of the Company's gas production from the Loveland and Johnson's Corner fields is processed in the Company's Loveland Gas Plant, which has a rated capacity of approximately 6,000 Mcf per day. Pipeline systems are in place to gather gas from the Loveland and Johnson's Corner fields. There is also an interconnect into the Wattenberg pipeline system of K N Energy, which gives the gas plant access to third-party gas from the extensive Wattenberg field complex. Approximately 1,000 Mcf of gas per day from the Loveland and Johnson's Corner fields is currently processed through the Loveland gas plant. The natural gas produced from the Loveland area is extremely rich in liquid composition with an average heat content of 1,430 BTU per cubic foot. The ability of the gas plant to recover natural gas liquids, such as propane and natural gasolines (B-G Mix), from the gas enhances the value of gas production and significantly increases the economic viability of additional development in the Loveland and Johnson's Corner fields. Among the existing wells, numerous opportunities exist to recomplete in certain behind-pipe zones using newer stimulation technologies. In many wells, Codell sandstone and Timpas limestone reserves remain behind-pipe which is available for production upon recompletion of existing well bores. Among the wells that have been completed in these zones, the Company believes that original completions were often inadequate because of limited stimulation. Of the three benches (separate sedimentary levels) of the Niobrara Formation, the upper bench has been completed in most wells whereas the middle and lower benches are available for production upon recompletion in many wells. Currently, a program is being implemented to recomplete several selected wells. Johnson's Corner Field, Larimer County, Colorado - Johnson's Corner Field is an extension of the Wattenberg Field with Muddy "J" Sandstone gas production. The wells produce approximately 40 BOE per day from the "J" sand. One well has also been completed in the Codell and Niobrara formations and oil production from all three zones is commingled. Recently two wells were recompleted in Codell sandstone and the initial results are promising. In addition, the Company believes there are several additional in-fill development locations. West Peetz Field, Logan County, Colorado - The Company operates 5 wells in two leases in the West Peetz field. The wells currently produce about 20 BOPD from the J sand. A detailed geological and engineering evaluation of the field in early 1995 suggested that West Peetz field can be produced profitably for many years to come and the field has an excellent potential for secondary recovery. A low-cost simple water injection plan has been recommended and is currently under consideration. Pod Field, Washington County, Colorado - In Pod Field, the Company has a 100% working interest and operates five wells which produce from the "J" sand. A geological and engineering evaluation of the field conducted in 1995 indicates the potential presence of undeveloped gas reserves in the Niobrara Formation. However, further study will be necessary before any action will be taken. 9 Yenter Field, Logan County, Colorado - Yenter Field is a structural trap which has produced more than 10 MMBO and 24 BCFG since the 1950s from the "J" sand. Approximately 80% of wells in the field have been plugged and abandoned. The Company owns and operates five wells with production of about 35 barrels of oil per day ("BOPD"). Water produced with oil from these five wells is injected back into the reservoir to help maintain reservoir pressures for continued production. The Company has conducted a complete geological and engineering study of Yenter Field, which has identified undeveloped potential in additional sandstone reservoirs and recommended reworking "J" sandstone wells which have been shut in since the mid 1970s, and upgrading the pressure maintenance program. The Company desires to acquire additional acreage in the field to implement a secondary recovery program possibly with horizontal wells. North Minto Field, Logan County, Colorado - North Minto is a "J" Sandstone field and was unitized for secondary recovery in 1989. One well was producing approximately 8 BOPD during 1993. The injection well had been shut-in during October 1992. The Company completed geologic and engineering reviews of the field after the acquisition and consequently re-established the injection program which increased production to 32 BOPD. In 1996, the Company restored one well back into production to benefit from the waterflood. Additional leases have been acquired as a result of this study and two additional drill sites have reserve potential in the North Minto Unit. Lower Horse Draw Field, Rio Blanco County, Colorado - The Company has interests in two wells that produce gas from the Mancos B fractured silty shale in the Lower Horse Draw Field. Proved developed reserves include 162,000 Mcf of gas net to the Company. UTAH PROPERTIES Cisco Dome Area, Grand County, Utah - In April 1995, the Company purchased an 80% working interest in approximately 8,877 acres in the Cisco Dome Field. The Cisco Dome Field is located adjacent to the Calf Canyon Field. The property in the Cisco Dome Field contains 39 wells of which 21 are currently producing gas from intervals ranging from 2,000 to 3,200 feet. The average aggregate production from these properties is approximately 400 Mcf and 7 bbls of oil per day. The Company is presently working to recomplete several wells in behind-pipe zones to take advantage of current gas prices in the market. Among the recompleted wells, one is producing 250 Mcf per day. The company expects that after finishing the recompletion program, daily gas production can be significantly increased. Management of the Company has extensive knowledge and experience with operations in and near this field. Cisco Dome field is large and geologically complex. There are numerous locations on the Company's acreage available for additional drilling. A geological and engineering study is currently being conducted to seek further development opportunities in the existing wells as well as to delineate optimal drilling locations. Cowboy Field, San Juan County, Utah - The Company has a 100% interest in four oil wells in Cowboy Field in southeast Utah. The field is within the Paradox Basin and production is from the Pennsylvanian Ismay Formation. The Company has behind pipe potential and at least one development drillsite. WYOMING PROPERTIES Enos Creek Field, Hot Springs County, Wyoming - Enos Creek Field is located in the southwestern Big Horn Basin of central Wyoming. In early 1992, the Company entered into a farmout agreement with an industry partner to co-develop Enos Creek Prospect. During the summer of 1992, the Company and its partners drilled a side track well from an existing wellbore targeted at a separate fault block in the geologic structure. The well penetrated three oil zones while drilling, one in the Curtis Formation and two in the Phosphoria Formation. The well is currently producing from the Phosphoria Formation. The Company intends to recomplete a well adjacent to existing well in the Tensleep Formation sometime in the future. 10 TITLE TO PROPERTIES As is customary in the oil and gas industry, only a perfunctory title examination is conducted at the time oil and gas leases are acquired by the Company. Prior to the commencement of drilling operations, a thorough title examination is conducted. The Company believes that title to its properties is good and defensible in accordance with standards generally accepted in the oil and gas industry, subject to such exceptions, which in the opinion of counsel, are not so material as to detract substantially from the property economics. In addition, some prospects may be burdened by customary royalty interests, liens incident to oil and gas operations and liens for taxes and other governmental charges as well as encumbrances, easements and restrictions. The Company does not believe that any of these burdens will materially interfere with the use of the property. ESTIMATED PROVED RESERVES The oil and gas reserve and reserve value information is included in Part II, Item 7 at footnote 12 of the consolidated financial statements, titled Supplemental Oil and Gas Disclosures. This information is prepared pursuant to Statement of Financial Accounting Standards No. 69, which includes the estimated net quantities of the Company's "proved" oil and gas reserves and the standardized measure of discounted future net cash flows. The reserve information is based upon an engineering evaluation by McCartney Engineering, Inc. The estimated proved reserves represent forward-looking statements and should be read in connection with the disclosure on forward-looking statements included herein under Item 6 in Managements' Discussion and Analysis. The Company has not filed any reports containing oil and gas reserve estimates with any federal authority or agency other than the Securities and Exchange Commission and the Department of Energy. There were no differences in the reserve estimates reported to these two agencies. All of the Company's oil and gas reserves are located in the Continental United States. The Table below sets forth the Company's estimated quantities of proved reserves, and the present value of estimated future net revenues discounted by 10 percent per year using prices being received by the Company at the end of each of the last three fiscal years on a non-escalated basis. The prices used at December 31, 1996 were $24.43 per barrel of oil and $3.73 per MCF of natural gas:
December 31, -------------------------------------- 1996 1995 1994 ---- ---- ---- Estimated Proved Oil Reserves (Bbls) ...... 1,175,000 1,294,000 1,352,000 Estimated Proved Gas Reserves (Mcf) ....... 4,833,000 5,851,000 5,724,000 Estimated Future Net Revenues (before the estimated future income taxes) ....... $26,506,000 $15,480,000 $14,016,000 Present Value of Estimated Future Net Revenues (before the estimated future income tax expenses) ........... $15,641,000 $ 9,616,000 $ 8,519,000
The table above does not include the reserve values associated with the Gas Plant. The Gas Plant reserves are disclosed in Part II, Item 7 of footnote 12. No reserves have been estimated for the Company's interest in the East Bayou Sorrel Prospect which was acquired subsequent to the Company's last fiscal year end and will not be estimated until at least a developmental well is drilled on the property in 1997. Other than that, there has been no major discovery or other favorable or adverse event that is believed to have caused a significant change in the estimated quantities of proved reserves subsequent to December 31, 1996. However, the prices for oil and gas have decreased as of the date of this report below those used for the reserve estimates. The Company's reserves for its oil and gas properties at December 31, 1996, discounted at 10%, using the average sales prices in 1996 ($20.35 per bbl. of oil and $1.26 per Mcf of gas) are approximately 47% lower, or $7.3 million dollars. 11 NET QUANTITIES OF OIL AND GAS PRODUCED The Company's net oil and gas production for each of the last three years (all of which was from properties located in the United States) was as follows: Year Ended December 31, ----------------------------------------- 1996 1995 1994 ------- ------- ------- Oil (Bbls) .................. 100,000 121,000 155,000 Gas (Mcf) ................... 412,000 497,000 543,000 The average sales price per barrel of oil and Mcf of gas, and average production costs per barrel of oil equivalent ("BOE") excluding depreciation, depletion and amortization were as follows: Average Sales Prices Average Year Ended --------------------------------------- Production December 31 Oil (Bbls) Gas (Mcf) Per BOE Cost Per BOE ----------- ----------- ----------- -------- ------------ 1996 $ 20.35 $ 1.26 $ 15.10 $ 8.46 1995 $ 16.77 $ 1.18 12.85 $ 7.92 1994 $ 15.94 $ 1.36 13.09 $ 8.90 The above table represents activities related only to oil and gas production. It does not include any value from the natural gas liquids extracted by the Gas Plant. DRILLING ACTIVITY The following table summarizes the Company's oil and gas drilling activities, all of which were located in the continental United States, during the last three fiscal years:
Year Ended December 31, --------------------------------------------------------------------------- 1996 1995 1994 ------------------ ----------------- ------------------ Wells Drilled Gross Net Gross Net Gross Net ----- --- ----- --- ----- --- Exploratory Oil .................................... -- -- -- -- -- -- Gas .................................... -- -- -- -- -- -- Non-productive ......................... 1 .19 -- -- 1 .25 -- ---- --- --- ---- ---- Total .............................. 1 .19 -- -- 1 .25 ==== === === ==== ==== Development Oil .................................... 1 1 -- -- 4 3.92 Gas .................................... -- -- -- -- -- -- Non-productive ......................... -- -- -- -- -- -- -- ---- --- --- ---- ---- Total .............................. 1 1 -- -- 4 3.92 == ==== === === ==== ====
The Company was not participating in any drilling activity at December 31, 1996. However, the Company is participating to the extent of a 6.25% working interest in the E. Winn #1 well, a 17,375 foot Miogyp Sand test, in the South Lake Arthur Prospect, located in Jefferson Davis Parish, Louisiana, that commenced drilling operations on January 9, 1997. Total depth is expected to be reached sometime in April 1997. This prospect consists of approximately 1,600 gross acres. ITEM 3 - LEGAL PROCEEDINGS The Company may from time to time be involved in various claims, lawsuits, disputes with third parties, actions involving allegations of discrimination, or breach of contract incidental to the operation of its business. At December 31, 1996 and as of the date of this report, the Company was not involved in any litigation which it believes could have a materially adverse effect on its financial condition or results of operations. 12 ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of the Company's Security holders during the fourth quarter ending December 31, 1996. Part II ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (a) Market Information - The Company's Common Stock has been quoted on the NASDAQ Small-cap Market, under the symbol WPOG, since July 1980. The Company's Preferred Stock, has traded on the NASDAQ Small-cap Market under the symbol WPOGP since August 1993. Bid Quotations - The following table shows the range of high and low bid quotations for each quarterly period since January 1, 1995, as reported by the National Association of Securities Dealers, Inc. (such quotations represent prices between dealers and do not include retail markups, markdowns, or commissions and do not necessarily represent actual transactions.): Bid Prices ----------------------------------------- Common Stock Preferred Stock ----------------- ---------------- Quarter Ended High Low High Low - ------------- ---- --- ---- --- December 31, 1996 ........... 3 5/16 2 1/16 10 3/4 6 September 30, 1996 .......... 2 1/8 1 7/32 6 3/4 5 1/4 June 30, 1996 ............... 1 11/16 1 5/64 7 4 1/4 March 31, 1996 .............. 1 3/8 19/32 5 3 1/2 December 31, 1995 ........... 9/16 13/32 4 5/8 3 7/8 September 30, 1995 .......... 7/8 1/2 4 5/8 4 5/8 June 30, 1995 ............... 31/32 5/8 5 7/8 4 3/4 March 31, 1995 .............. 2 3/32 1 3/4 5 7/8 3 5/8 (b) Stockholders - As of February 21, 1997 the Company had 978 holders of record of the Company's Common Stock and 17 holders of record of the Company's Preferred Stock. This does not include the holders whose shares are held in a depository trust in "street" name. As of February 21, 1997 at least 5,306,000 shares (or 62%) of the issued and outstanding common stock and at least 134,000 shares (or 95%) of the issued and outstanding preferred stock was held in a depository trust in "street" name. (C) Dividends - The Company has not paid cash dividends on its Common Stock in the past and does not anticipate doing so in the foreseeable future. The Company is precluded from paying dividends on its Common Stock so long as any dividends on the Preferred Stock are in arrears. Holders of shares of Preferred Stock are entitled to receive, when, as and if declared by the Board of Directors out of funds at the time legally available therefor, cash dividends at an annual rate of 10% (equal to $1.00 per share annually), payable quarterly in arrears. Cumulative dividends accrue and are payable to holders of record as they appear on the stock books of the Company on such record dates as are fixed by the Board of Directors. The Preferred Stock was issued in August 1993 and the Company declared and paid five consecutive dividends for the quarters ended September 30, 1993 through September 30, 1994. In December 1994, the Board of Directors voted not to declare the quarterly cash dividend to holders of the Company's Preferred Stock for the fourth quarter of 1994. The decision to not pay the quarterly dividend was a result of the Company's continuing operating losses, the cash and working capital position, and the Company's belief that its primary lender would not approve the payment thereof. In March 1995, the Board of Directors voted to suspend payment on any future Preferred Stock dividends indefinitely. However, pursuant to the terms of the Preferred Stock, dividends will continue to accrue 13 on a quarterly basis. Dividends paid in the future, if any, on the Preferred Stock will be contingent on many factors including, but not limited to, whether or not a dividend can be justified through the cash flow and earnings generated from future operations. The Preferred Stock will have priority as to dividends over the Common Stock and any series or class of the Company's stock hereafter issued, and no dividend (other than dividends payable solely in Common Stock or any other series or class of the Company's stock hereafter issued that ranks junior as to dividends to the Preferred Stock) may be declared, paid or set apart for payment on, and no purchase, redemption or other acquisition may be made by the Company of, any Common Stock or other stock unless all accrued and unpaid dividends on the Preferred Stock have been paid or declared and set apart for payment. (d) Recent Sales of Unregistered Securities - During the fiscal year ended December 31, 1996, the Company issued and sold the following securities without registration under the Securities Act of 1933, as amended. 1. Between June 1996 and November 15, 1996, the Company issued $5,000,000 in collateralized convertible 10% debentures and warrants to purchase up to 2,500,000 shares of the Company's common stock at $1.25 per share. The securities were offered and sold as units, with each unit consisting of $50,000 in debentures and warrants to purchase 25,000 shares. The securities were sold by the Company and by 12 broker\dealers registered as such with the Securities and Exchange Commission and who are members of the National Association of Securities Dealers, Inc. The securities were sold to 105 private investors each of whom qualified as an accredited investors as such term is defined in Regulation D adopted by the Securities and Exchange Commission under the Securities Act. The Company received $5.0 million for the securities and paid total underwriting discounts and commissions of $547,000. The debentures sold by the Company are convertible into common stock of the Company at the election of the holder at the rate of one share of common stock for each $3.00 in principal amount of debenture, or a total of 1,666,666 shares upon conversion of all debentures issued. The warrants included in the units are exercisable at any time by the holder and may be called for redemption by the Company at $0.10 per share upon 45 days notice if the reported market price for common stock of the Company is at least $3.00 per share for a period of 10 consecutive trading days or more. The Company relied upon Section 4(2) of the Securities Act and Rule 506 of Regulation D in claiming exemption from the registration requirements of the Securities Act for the securities issued. 2. On March 9, 1996, the Company issued 38,050 shares of its common stock to 22 persons who were employees or directors of the Company in lieu of cash for services to the Company valued at $35,050 for financial reporting purposes. 3. Effective February 12, 1996, the Company issued warrants entitling the holders to purchase up to 1,000,000 shares of the Company's common stock at $0.75 per share to 14 persons in connection with a consulting agreement between the Company and Beta Capital Corp., with whom the Company has a consulting agreement. Issuance of the warrants was required by the consulting agreement and the exercise price of the warrants was equal to the reported market price for the Company's common stock at the time the Company became obligated to issue the warrants. For financial reporting purposes, these warrants were valued at $192,300. The warrants are exercisable for five years from the date of issuance. 4. On May 13, 1996, the Company issued 82,353 shares of its common stock to three holders who elected to convert $70,000 in principal amount of outstanding convertible debentures originally issued in a private placement in 1991. 5. On August 13, 1996, the Company issued 15,000 shares of its common stock to a consultant of the Company in lieu of cash for consulting services to the Company valued at $22,977 for financial reporting purposes. 6. On December 16, 1996, the Company issued 60,000 shares of its common stock to Willard H. Pease, Jr., the President of the Company, upon conversion of a promissory note of the Company in the principal amount of $60,000 issued to Mr. Pease in 1994 in payment of certain obligations. 14 7. Between November 22, 1996 and December 13, 1996, the Company issued 50,000 shares of its common stock upon exercise of three warrants held by two persons. The warrants were exercised at $0.85 per share for total proceeds to the Company of $42,500. The warrants had been issued in a private transaction in 1995 as compensation to a consultant. 8. On December 16 and 17, 1996, the Company issued 17,500 shares of its common stock upon exercise of two warrants held by two persons. The warrants had been issued in the private placement of securities described in subparagraph 1 above. The Company received proceeds of $21,875 upon exercise of the warrant. 9. On December 16, 1996, 13,440 shares of common stock were issued to eight nonemployee-directors of the Company in lieu of cash for services to the Company valued at $24,261 by the Company for financial reporting purposes. 10. Effective November 15, 1996, the Company issued warrants to purchase up to 223,500 shares of common stock at $2.00 per share to 12 broker\dealers as partial compensation to such persons for sale of the securities in the private offering described in subparagraph 1 above. The warrants are exercisable upon issuance and expire if not exercised three years after issuance. 11. On March 9, 1996, the Company issued warrants to purchase 40,000 shares of common stock at $0.75 per share to one person in lieu of cash for consulting services provided to the Company valued at $7,700 for financial reporting purposes. The warrants may be exercised at any time before March 9, 2001. As to each issuance of securities identified above, the Company relied upon Section 4(2) of the Securities Act in claiming exemption from the registration requirements of the Securities Act. All the persons to whom the securities were issued had full information concerning the business and affairs of the Company and acquired the shares for investment purposes. Certificates representing the securities issued bear a restrictive legend and stop transfer instructions have been entered prohibiting transfer of the securities except in compliance with applicable securities laws. ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS SELECTED FINANCIAL DATA
Statement of Operations Data: Year Ended December 31, 1996 1995 ---- ---- Oil and gas sales ...................................... $ 2,546,676 $ 2,623,782 Natural gas marketing and trading ...................... 2,067,379 3,872,565 Gas plant processing revenue ........................... 818,356 1,135,050 Total revenue .......................................... 6,165,664 9,031,816 Net loss ............................................ (1,411,582) (765,436) Preferred Stock Dividends: Declared ............................................ -- -- Converted ........................................... (22,750) (117,000) In arrears .......................................... (179,938) (202,688) Non-cash inducement .................................... -- (1,523,906) ----------- ----------- Net loss applicable to common stockholders .............................. $(1,614,270) $(2,609,030) =========== =========== Per Share Data: ........................................ 1996 1995 ---- ---- Before non-cash inducement charge ...................... $ (0.22) $ (0.18) Effect of non-cash inducement charge ................... -- (0.24) ----------- ----------- Net loss per common share ....................................... $ (0.22) $ (0.42) =========== =========== Cash dividends declared per common share ............... $ -- $ -- =========== =========== 15 Balance Sheet Data: As of December 31, -------------------------------- 1996 1995 ---- ---- Working capital (deficit) .............................. $ 1,907,694 $ (500,180) Total assets ........................................... $ 14,901,149 $ 13,439,726 Long-term liabilities .................................. $ 5,276,033 $ 1,602,811 Stockholder's equity ................................... $ 8,472,188 $ 9,017,262
Disclosure Regarding Forward-Looking Statements This report on Form 10-KSB includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements other than statements of historical facts included in this report, including, without limitation, statements under "Business and Properties" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" regarding the Company's financial position, reserve quantities and net present values, business strategy, plans and objectives of management of the Company for future operations and capital expenditures, are forward-looking statements and the assumptions upon which such forward-looking statements are based are believed to be reasonable. The Company can give no assurance that such expectations and assumptions will prove to have been correct. Reserve estimates of oil and gas properties are generally different from the quantities of oil and natural gas that are ultimately recovered or found. This is particularly true for estimates applied to exploratory prospects. Additionally, any statements contained in this report regarding forward-looking statements are subject to various known and unknown risks, uncertainties and contingencies, many of which are beyond the control of the Company. Such things may cause actual results, performance, achievements or expectations to differ materially from the anticipated results, performance, achievements or expectations. Factors that may affect such forward-looking statements include, but are not limited to, the Company's ability to generate additional capital, risks inherent in oil and gas acquisitions, exploration, drilling, development and production, price volatility of oil and gas, competition, shortages of equipment, services and supplies, government regulation, environmental matters, financial condition of the other companies participating in the exploration, development and production of oil and gas programs and other matters. All written and oral forward-looking statements attributable to the Company or persons acting on its behalf subsequent to the date of this report are expressly qualified in their entirety by this disclosure. Liquidity and Capital Resources At December 31, 1996, the Company's cash balance was $1,995,860 with a positive working capital position of $1,907,694, compared to a cash balance of $677,275 and a working capital deficit of $500,180 at December 31, 1995. The change in the Company's cash balance is summarized as follows: Cash balance at December 31, 1995 ............................ $ 677,275 Cash used in operating activities ............................ (143,615) Capital expenditures ......................................... (1,403,413) Proceeds from the sale of property and equipment .............................................. 163,821 Redemption of certificate of deposit ......................... 53,500 Payments on long-term debt ................................... (1,795,670) Net proceeds from issuance of convertible debt ........................................... 4,323,992 Proceeds from common stock subscription receivable and warrant exercises, net ......... 119,970 ----------- Cash balance at December 31, 1996 ............................ $ 1,995,860 =========== The significant improvement in the Company's cash balance and working capital position is directly related to: a) the proceeds received from the private placement of convertible debentures; and b) the repayment of the entire balance of outstanding debt with Colorado National Bank ("CNB"). In November 1996, the Company completed a private placement of $5,000,000 of collateralized convertible debentures and warrants to purchase up to 2,500,000 shares of stock, sold in "Units", which generated net cash proceeds of $4,300,000. Each Unit sold for $50,000 and consisted of one $50,000 five-year 10% collateralized convertible debenture and warrants to purchase 25,000 shares of the Company's common stock at $1.25 per share. The debentures are collateralized by a first priority interest in certain 16 oil and gas properties owned and operated by the Company. The debentures are convertible, at the holders option, into the Company's common stock for $3.00 per share and may be redeemed by the Company, in whole or in part, beginning at a premium of 110% of the original principal amount and are subject to adjustment beginning on April 25, 1999. Interest on the debentures is payable quarterly and the entire principal balance will be due on April 15, 2001. The warrants are currently exercisable and will expire on July 31, 2001. The Company is entitled to call the warrants at any time after February 15, 1997 at a price of $0.10 per warrant. (As discussed later in this section, the Company initiated a call on these warrants on February 28, 1997.) In a registration statement effective February 10, 1997, the Company registered for resale: (1) the shares of common stock into which the debentures may be converted; and (2) the shares of common stock issuable upon exercise of the warrants. The completion of that private placement and repayment of the entire balance of outstanding debt with CNB with a portion of the proceeds thereof, significantly improved the Company's working capital position and provided the funds necessary to pursue additional acquisition, drilling and development activities on a limited basis. Recently, the Company has charted a course of action to maintain its existing asset base in the Rocky Mountain region and expand into the Gulf Coast region of Alabama, Southern Louisiana and Texas through a series of acquisitions and strategic alliances which is discussed more thoroughly in the following paragraphs. However, this new course of action will require the Company to seek a significant amount of additional capital to fully fund and implement that plan. On February 4, 1997, the Company signed a definitive agreement with National Energy Group, Inc. ("NEGX"), a publicly held Company, headquartered in Dallas, Texas. The agreement provides the Company the right and obligation to participate with NEGX in various oil and gas exploration projects over the course of next two years. Essentially, the agreement consists of three main elements. First, the Company has the right and obligation to participate as a 12.5% working interest owner in NEGX's outlined program which consists of 10 identified projects in Alabama, Southern Louisiana, and Texas. Second, subject to certain conditions defined in the agreement, the Company has the right and obligation to participate in any future projects generated under NEGX's exclusive arrangement with Sandefer Oil and Gas Company, Inc. ("Sandefer"). Sandefer is a private corporation owned and operated by a group of geologists and geophysicists who generate Gulf Coast, Southern Louisiana and other wildcat prospects. Third, the Company is entitled to participate in any other third party generated prospects that NEGX participates in subject to certain conditions as defined in the agreement. Pursuant to the terms of the agreement with NEGX, the Company's minimum obligation is at least $5.0 million per year in dry hole, or drilling, costs. Additional costs will be incurred for completion and development of successful projects. Accordingly, the Company anticipates the actual obligation will be higher assuming that a reasonable amount of success is achieved with the underlying prospects. If all the prospects prove to be productive (which the Company believes is unlikely as the drilling program is a wildcat exploration program), the total obligation to the Company for 1997 could be in excess of $20.0 million. If all the contemplated exploratory prospects are successful and the properties are eventually fully developed, the net reserves attributable to the Company's interest would be several times the Company's present reserves. The Company's current reserves are approximately 2 million barrels of oil (or equivalent). Accordingly, the agreement with NEGX provides the Company with an exploration program that has the potential to significantly increase its existing reserves and future cash flow. In order to fund the obligation with NEGX the Company intends to seek additional financing. The Company intends to pursue additional equity through exercise of outstanding warrants, private equity placements, and/or other potential financing vehicles. Specifically, in December 1996, the Company initiated a warrant call underlying warrants to purchase 250,000 shares of the Company's common stock held by 11 persons that were exercisable at $1.25 per share. These warrants were issued as part of a "Unit" of common stock and warrants issued in a private placement during 1995. All the holders of the warrants elected to exercise their warrants prior to redemption by the Company. Exercise of the warrants generated net cash proceeds of $290,000 in January 1997. Also, during February and early March, 1997, the Company completed a private placement of 1,500,000 shares of common stock for proceeds of $3.75 million as described below. On February 28, 1997, the Company initiated a call of the warrants that were attached to the convertible debentures issued in the private placement which was 17 completed in 1996. The warrants were held by approximately 105 persons and are exercisable for $1.25 per share. Pursuant to the terms of the warrant, the holders have forty-five days after the call notice (or until April 15, 1997) to exercise their warrants or they will be redeemed by the Company for $.10 per warrant. If all the warrants are exercised (which the Company believes is likely based on the market price of the Company's common stock as of the date of this report), it will generate net proceeds to the Company of approximately $2.9 million. The proceeds generated from these warrant calls should cover the Company's working capital needs, including the anticipated exploration costs associated with the letter agreement with NEGX, at least through the second quarter of 1997. After that, the Company will need to seek additional financing. Anticipating the need for additional financing, in February 1997 the Company signed a non-binding letter of intent with a brokerage firm setting forth the terms and conditions under which the broker will attempt to assist the Company with a future private placement. The letter agreement with the brokerage firm contemplates a future placement of at least $6.0 million dollars in common stock in the second or third quarter of 1997. The agreement is subject to several contingencies including, but not limited to, due diligence and the execution of formal agreement. If the Company is unsuccessful in completing the private placement, or if additional funds are necessary either before or after such a transaction, it is uncertain at this time what actions the Company will take. Possibilities include other debt or equity financings or the sale of existing assets. In March 1996 the Company retained Beta Capital Group, Inc. ("Beta") as a consultant to the Company. Beta is located in Newport Beach, California and specializes in emerging oil and gas companies that have capital resources needs and market support requirements. Beta has worked closely with the Company to structure its financings and meet the Company's expected cash and capital resources requirements. Beta's President, Steve Antry, was an officer of Benton Oil and Gas Company between 1989 and 1992. During that time, Mr. Antry was instrumental in obtaining various sources of capital that Benton Oil and Gas required during a very significant growth period. Based on Mr. Antry's background, the Company believes that Beta adds a tremendous value to the Company because of their network of financial resources. Therefore, the Company will attempt to utilize Beta's syndication of financial resources to fund future capital requirements. In addition to the identified exploration program with NEGX, the Company has pursued the acquisition of an oil and gas property in Southern Louisiana. On January 10, 1996, the Company acquired a 7.8125% After Prospect Payout Working Interest ("APPO WI") in the East Bayou Sorrel Prospect from third parties for a total purchase price of $1.75 million. The purchase price consisted of the issuance of 315,000 shares of the Company's common stock and $875,000 in cash. On March 3, 1997 the Company acquired an additional 10% working interest in the same prospect for $2.5 million cash from third parties. The prospect includes a discovery well, the C.E. Schwing #1, which in February 1997 produced at a rate in excess of 1,400 barrels of oil per day and 1,300 Mcf of natural gas per day with a flowing tubing pressure of 6,300 PSI on a 12/64" choke from a perforated interval of 13,208 feet to 13,226 feet. If that production rate is sustained, this acquisition will increase the Company's net production (per BOE) by 25% (based on 1996's average net daily production. An offset developmental well to the C.E. Schwing #1 is expected to commence drilling operations in the second quarter of 1997. These acquisitions were funded with the Company's existing working capital and the proceeds generated from a private placement of common stock during February and March 1997. In that placement, the Company sold 1,500,000 shares of the Company's restricted common stock to accredited investors for $2.50 per share. The private placement was completed on March 10, 1997 generating net proceeds of approximately $3.3 million. The Company has agreed to use its best efforts to register the shares sold in this private placement for resale on or before July 10, 1997. 18 Capital Expenditures During 1996, the Company capitalized or invested $1,403,413 in property and equipment as follows: Oil and Gas Properties: Drilling Costs - Exploratory Dry Holes ..................................... $ 525,000 Developmental well ........................................ 435,647 ---------- Total Drilling Costs .................................. 960,647 Workovers or Recompletions of existing properties ......... 206,627 Deposit on future exploratory well ........................ 181,312 ---------- Total Oil and Gas properties .......................... 1,348,586 Service Equipment and Rolling Stock ............................ 27,777 Office Equipment ............................................... 19,930 Gas Plant facility ............................................. 7,120 ---------- $1,403,413 ========== During 1996 the Company drilled two new wells. The first well was a "double-stacked" horizontal - the first of its kind in Colorado. The well was drilled in Loveland Field, located in Larimer County, Colorado. A "double-stacked" horizontal well consists of drilling two separate horizontal wells, or legs, in two different geologic formations from a single well bore. This technology has been used extensively in the Austin Chalk Formation in Texas and Pease Oil and Gas was the first company to attempt this technology in Colorado. The geologic formations targeted during this well were the Niobrara, a proved zone, and the Timpas, an unproved zone. Unfortunately, the Timpas zone was found to be unproductive and the Company wrote-off $450,000 to dry hole costs (this represents the estimated costs attributable to drilling the Timpas leg). The remaining costs associated with this well for the Niobrara leg were capitalized as developmental costs. The second well was a deep wildcat prospect in Southern Louisiana that was generated by NEGX. The well was drilled in excess of 14,000 feet and although the logs indicated some excellent shows, it appears the targeted formation either did not receive a hydrocarbon charge or it had passed through the formation and the well was plugged and abandoned. The Company's cost for this dry hole was $75,000. In 1996, the Company spent $206,627 for workovers, recompletions and equipment acquisitions related to maintaining or enhancing the current production of its producing oil and gas properties. In November 1996, the Company also paid $181,312 for a deposit on an exploratory well which commenced drilling operations on January 9, 1997. This well, the E. Winn #1, is a 17,375 foot Miogyp Sand test, in the South Lake Arthur prospect, located in Jefferson Davis Parish, Louisiana. Total depth is expected to be reached sometime in April 1997. The deposit has been capitalized as of December 31, 1996 and will remain that way, along with the future drilling costs incurred, until the outcome of the exploratory well is known. RESULTS OF OPERATIONS Overview The Company's largest source of operating revenue is from the sale of produced oil, natural gas, and natural gas liquids. Therefore, the level of the Company's revenues and earnings are affected by prices at which natural gas, oil and natural gas liquids are sold. As a result, the Company's operating results for any prior period are not necessarily indicative of future operating results because of the fluctuations in natural gas, oil and natural gas liquid prices and the lack of predictability of those fluctuations as well as changes in production levels. Early in 1995, the Company initiated a corporate restructuring that focused on: eliminating areas of its business that were losing money, reducing operating costs, increasing efficiencies, and generating funds for working capital. These initiatives included but were not limited to downsizing of the Company's oil field service and supply operations and closing the administrative office in Denver, Colorado. As is more fully discussed later in this section under their 19 respective captions, the Company's oil field service supply operating margins have been historically low and even unprofitable. The burden of these low margins or operating losses have been compounded with the risks inherent in these operations and the capital investment required to maintain and operate. Accordingly, the decision was made to downsize these operations in May 1995. The administrative office was closed because the Company could not afford the luxury and expense of two administrative offices. In December 1994 the Company's Board of Directors did not declare the quarterly cash dividend to holders of the Company's Series A Cumulative Convertible Preferred Stock ("Preferred Stock") for the fourth quarter of 1994. In March 1995, the Board of Directors voted to suspend payment on any future Preferred Stock dividends indefinitely. These decisions were based on the Company's working capital position at that time, and the belief that the Company's primary lender would not approve a dividend payment. However, pursuant to the terms underlying the Preferred Stock, dividends continue to accrue on a quarterly basis and will increase the number of common shares that will be issued upon conversion of the preferred stock pursuant to the terms of the Company's Articles of Incorporation. Whether dividends are paid in the future on the Preferred stock will be contingent on many factors, including but not limited to, whether or not a dividend can be justified through the cash flow and earnings generated from future operations. In January 1995, the Company extended a tender offer to the Preferred stockholders. On February 28, 1995, the Company completed the tender offer to its Preferred Stockholders whereby the holders of the Company's Preferred Stock were given the opportunity to convert each share of Preferred Stock and all then accrued and undeclared dividends (including the full dividend for the quarters ended December 31, 1995 and March 31, 1995) into 4.5 shares of the Company's Common Stock and warrants to purchase 2.625 shares of Common Stock at $5.00 per share through December 31, 1996 and $6.00 per share through August 13, 1998 (the date the warrants expire). As a result of the tender offer 933,492 shares of the Preferred stock converted into 4,200,716 shares of the Company's Common Stock and warrants to purchase 2,450,417 shares of Common stock. In addition, 21,600 shares of Preferred Stock converted into 56,739 shares of Common Stock prior to the tender offer. In 1996, an additional 22,750 shares of the Preferred Stock converted into 69,670 shares of common pursuant to terms of such conversion set forth in the Company's Articles of Incorporation. Accordingly, as of December 31, 1996 there remained 179,938 shares of Preferred Stock outstanding. These conversions substantially changed the capital structure of the Company. Consideration of the restructuring initiatives is an important component when comparing the results of operations between the two periods presented. Total Revenue Total Revenue from all operations was as follows:
Year Ended December 31, -------------------------------------------------------- 1996 1995 ----------------------- ---------------------- Amount % Amount % ------ -- ------ -- Oil and gas sales ................ $2,546,676 41% $2,623,782 29% Natural gas marketing and trading .................... 2,067,379 34% 3,872,565 43% Gas plant processing ............. 818,356 13% 1,135,050 13% Oil field services and supply ..................... 618,225 10% 1,302,741 14% Well administration and other income ............... 115,028 2% 97,678 1% ---------- ----- ---------- ---- Total revenue .............. $6,165,664 100% $9,031,816 100% ========== ===== ========== ====
The decrease in total revenue is a result of: a) the expiration of the Company's natural gas marketing and trading contract with Public Service Company of Colorado effective July 1, 1996; b) no third party gas was processed by the Company's gas plant facility in 1996; c) a decrease in oil and gas production; and d) downsizing of the Company's service and supply operations. These circumstances, along with any known trends or changes that effect revenue on a line-by-line basis, are discussed in the following paragraphs under their respective captions. 20 Oil and Gas Operating statistics for oil and gas production for the periods presented are as follows: For the Year Ended December 31, ------------------------------ 1996 1995 ----------- ----------- Production: Oil (bbls) ........................... 100,000 121,500 Gas (Mcf) ............................ 412,000 496,500 BOE (6:1) ............................ 168,700 204,000 Average Collected Price: Oil (per bbl) ........................ $ 20.35 $ 16.77 Gas (per Mcf) ........................ $ 1.26 $ 1.18 Per BOE (6:1) ........................ $ 15.10 $ 12.85 Gross Margin: Revenue .............................. $ 2,546,676 $ 2,623,782 Operating costs ...................... (1,426,549) (1,617,318) ----------- ----------- Gross Margin ....................... $ 1,120,127 $ 1,006,464 =========== =========== Gross Margin Percent ............... 44% 38% =========== =========== Average Production Costs per BOE before DD&A ........................ $ 8.46 $ 7.92 DD&A per BOE ............................. 3.50 3.63 ----------- ----------- Total Costs of Production per BOE ............................ $ 11.96 $ 11.55 =========== =========== Change in oil and gas revenue attributed to: Production ........................... $ (465,388) Price ................................ 388,282 ----------- Net change between 1995 and 1996 .... $ (77,106) =========== Most of the decrease in oil and gas production can be attributed to the following: 1) the sale of several marginal, uneconomic, or nonstrategic oil and gas properties in 1996 (see divested production table below); and 2) to a much lesser extent the natural decline in production that is inherent in oil and gas wells. Both these circumstances were largely offset by an increase in price. The production included in the above tables and associated with the wells sold during 1996 is as follows: For the Year Ended December 31, ------------------------------- Divested Production 1996 1995 - ------------------- ---- ---- Oil (bbls) ............................. 3,900 16,700 Gas (Mcf) .............................. 4,500 23,000 BOE (6:1) .............................. 4,650 20,500 Natural Gas Marketing and Trading The Company had a "take-or-pay" contract with Public Service Company of Colorado ("PSCo") which called for PSCo to purchase from the Company a minimum of 2.92 billion cubic feet ("BCF") of natural gas annually. The price paid the Company by PSCo was based on the Colorado Interstate Gas Commission's "spot" price, plus a fixed price bonus. The natural gas marketing and trading activities represent natural gas that was purchased from third parties and sold to PSCo under the terms of the contract. 21 Operating statistics for the Company's Marketing and Trading Activities for the periods presented are as follows: For the Year Ended December 31, --------------------------------- 1996 1995 ---- ---- Total Volume Sold (Mcf) .............. 1,223,855 2,586,205 Average Price ........................ $ 1.69 $ 1.50 ----------- ----------- Total Revenue ............... $ 2,067,379 $ 3,872,565 Costs ................................ (1,745,446) (3,404,169) ----------- ----------- Gross Margin ................ $ 321,933 $ 468,396 =========== =========== The contract with PSCo expired on June 30, 1996. Historically, the price paid by PSCo under that contract was at a premium above the market and therefore allowed for the marketing and trading activities. Although the Company has been negotiating with PSCo to renew the contract, no formal agreement has been reached as of the date of this report. Consequently, no marketing and trading revenues have been generated subsequent to June 30, 1996. With the increasing competition fostering within all phases of the natural gas industry, it is unlikely that the contract will be renewed at an above market premium, if at all, and the Company is unlikely to resume marketing and trading activities. Since the gross margin represents the net cash flow and income generated from this activity, the loss of this premium contract price has and will have a material and negative impact on the Company's current and future operations. Gas Plant Processing Revenues This category accounts for the natural gas processed and the natural gas liquids extracted and sold by the Gas Plant facility. Operating statistics for the periods presented are as follows: For the Year Ended December 31, ------------------------------- 1996 1995 ---- ---- Production: Natural Gas Processed (Mcf) - From Company owned wells ......... 363,000 424,600 Third party gas .................. -- 228,000 ----------- ----------- Total gas processed ....... 363,000 653,400 Liquids Produced - B-G Mix (gallons) ................ 907,600 1,314,900 Propane (gallons) ................ 694,000 1,053,900 Average Sales Price of Liquids (per gallon) $ 0.45 $ 0.34 =========== =========== Gross Margin: ............................... Amount Amount ----------- ----------- Revenue .......................... $ 818,356 $ 1,135,050 Costs ............................ (464,512) (942,867) ----------- ----------- Gross Margin .............. $ 353,844 $ 192,183 =========== =========== Gross Margin Percent ...... 43% 17% The decrease in processing volumes and revenue during 1996 as compared to the same periods in 1995, can be substantially attributed to the Company purchased and processed third party gas between February 1995 and September 1995. In October 1995 the Company stopped processing third party gas to correct some operational problems. The operational problems have been corrected and the plant is now running more efficiently and effectively than it has in the past. However, with the increased competition to process natural gas and the historically low gas prices prevalent in the Rocky Mountain Region, the Company has not been able to purchase third party gas at an economical rate. These factors along with the increasing competitive environment in the natural gas market, it is uncertain at this time if the Company will be able to compete with other gas plants and purchasers of natural gas in its market area. Accordingly, it cannot be determined at this time when, or if, the Company will process any additional third party gas. 22 Costs associated with the Gas Plant operations consist of both semi-fixed and variable costs. The semi-fixed costs consist of direct payroll, utilities, operating supplies, general and administrative costs, and other items necessary in the day-to-day operations. The semi-fixed costs average approximately $435,000 annually and are not expected to change significantly regardless of the volume processed by the Gas Plant. The variable costs consist primarily of purchased gas, plant fuel and shrink, lubricants, repair and maintenance, and costs of gas marketing and buying. These costs are generally a direct function of the volume processed by the Gas Plant and are expected to either increase or decrease proportionately with the corresponding plant production. When compared to 1996, the costs in 1995 were higher in amount and as a percentage of revenue as a result of the Company purchasing and processing third party gas between February 1995 and September 1995. Currently, the gas processed by the Gas Plant facility is from wells the Company owned. Accordingly, the costs, as a percentage of revenue, have decreased in 1996. As stated above, the Company currently processes natural gas exclusively from wells owned or operated by the Company. Given the extremely competitive environment in the DJ Basin where the gas plant facility is located, management is exploring the possibility of increasing the Company's net cash flow by entering into a gas processing agreement with a third party. Under this scenario, the current operations at the gas plant facility would be shut down and the gas currently processed by the plant would be sold to a third party. Although no formal decision has been made, this possibility is being disclosed since such a decision may ultimately impact the carrying value of the gas plant facility under Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets." As of December 31, 1996 the net carrying value of the gas plant facility was approximately $3.34 million. It is not certain at this time if a decision of this nature will ultimately be made, and if so, if that decision would ultimate impact the carrying value of the gas plant facility. However, should a determination be made in the future that the carrying value of the gas plant facility will not be realized, a non-cash impairment charge may need to be recognized as prescribed under SFAS No. 121, which could have a material negative impact on the Company's future results of operations and balance sheet. Oil Field Services and Oil Field Supply Operating statistics for the Company's oil field service and supply operations for the periods presented are as follows: Service and Supply Operations For the Year Ended December 31, ------------------------------- 1996 1995 ---- ---- Revenue .................................. $ 618,225 $ 1,302,741 Costs .................................... 553,343 (1,391,588) ----------- ----------- Net Operating Income (Loss) .............. $ 64,882 $ (88,847) =========== =========== The decrease in revenue from the service and supply operations is directly related to the restructuring initiatives conducted in 1995. A summary of the restructuring for both operations is discussed in the following paragraphs. Service Operations Historically, the Company's service business operated out of two locations - Loveland and Sterling Colorado. The services provided included: servicing rigs, vacuum trucks, roustabout services, and hot oiling services. The operations serviced both the Company's needs and those of third parties. The restructuring was focused on reducing the service rig, vacuum truck, and roustabout operations to a point where the Company can service its own oil and natural gas operations efficiently and at the lowest possible cost, while performing only limited services for third parties. Any services of this type to third parties will be limited to those circumstances when the equipment and man power is not needed in the Company's operations. The Company did retain its hot oiler fleet (consisting of three trucks) and intends to continue providing this service to third parties on a full time basis. Supply Operations Historically, the Company's supply business has operated out of two locations - Loveland and Sterling, Colorado. The restructuring was focused on consolidating the operations to one location (Loveland, Colorado), eliminating duplicate costs and ultimately reducing the amount of inventory. 23 Although total revenues from the service and supply operations decreased approximately 53% from 1995 to 1996 as a result of the restructuring, the margins improved since the operations ran more efficiently on the smaller scale. Well Administration and Other Income This revenue primarily represents the revenue generated by the Company for operating oil and gas properties. There has been no significant change in the average monthly revenue between 1996 and 1995 and Management does not expect any significant change in the future. Consulting Arrangement - Related Party The Company entered into a consulting agreement with Beta in March 1996. Fees and reimbursed expenses incurred by the Company in connection with Beta's contract were $257,199 for the year ended December 31, 1996 with no similar expenditures in 1995. Depreciation, Depletion and Amortization Depreciation, Depletion and Amortization ("DD&A") for the periods presented by cost center consisted of the following: For the Year Ended December 31 ------------------------------ 1996 1995 ---- ---- Oil and Gas Properties ............ $ 589,853 $ 741,924 Gas Plant Operations .............. 234,534 245,953 Service and Supply Operations ..... 140,132 166,173 Furniture and Fixtures ............ 45,126 46,437 Non-Compete Agreements ............ 45,994 91,827 ---------- ---------- Total ........................... $1,055,639 $1,292,314 ========== ========== As discussed above under the caption Oil and Gas, DD&A per BOE for oil and gas properties has remained relatively constant for the periods presented. The decrease in DD&A for the Service and Supply Operations can be attributed to the disposition of the corresponding assets during the restructuring initiatives conducted in 1995. The decrease in the amortization of the Non-compete Agreements can be attributed to one agreement which became fully amortized in 1995. That particular agreement had an original cost basis of $100,000 and was amortized over a 24 month period. Dry Hole, Plugging and Abandonment As previously discussed under the caption Capital Expenditures, the Company charged $450,000 to dry hole costs for the estimated costs attributable to drilling the Timpas leg attempted on the horizontal well in Loveland Field, Colorado and another $75,000 for a dry hole on a wildcat prospect in Southern Louisiana that was generated by NEGX. The remaining costs in 1996 as well as all the costs in 1995 relate to plugging and abandonment of a few depleted wells in the Rocky Mountain Region. Restructuring Charges The restructuring charges incurred in 1995 were directly related to the initiatives discussed above under the caption Overview and consisted primarily of severance pay, relocation costs and a loss on the abandonment of the administrative office lease in Denver, Colorado. The Company did not incur any such costs in 1996. Interest Expense The higher interest expense incurred in 1996 is reflective of the increase in the average long-term debt outstanding and amortization of the corresponding debt issuance costs. Both of these circumstances are directly related to the convertible debentures sold by the Company pursuant to the private placement completed in November 1996 and previously discussed under the caption Liquidity and Capital Resources. (Loss) Gain on Sale of Assets The gain on sale of assets in 1995 is primarily related to the sale of oil field service equipment in connection with the Company's restructuring initiatives and the sale of various oil and gas properties. The loss on sale of assets in 1996 is primarily related to the sale of certain oil and gas properties and the abandonment of obsolete or unusable office equipment, furniture and fixtures. 24 Net Loss Per Common Share Net loss per common share is computed by dividing the net loss applicable to common stockholders (which includes accrued but unpaid preferred dividends) by the weighted average number of common shares outstanding during the year. All common stock equivalents have been excluded from the computations because their effect would be anti-dilutive. The Company completed a tender offer to the Company's preferred stockholders in February 1995. In connection therewith, the Company offered the preferred holders 4.5 common shares for each preferred share owned. The 4.5 shares represented an increase from the original terms of the preferred stock which provided for 2.625 common shares for each preferred share. In order to comply with an accounting pronouncement, the Company was required to reduce earnings available to common stockholders to convert their shares. Since the Company issued an additional 1,750,000 common shares in the tender offer compared to the shares that would have been issued under the original terms of the preferred stock, the Company was required to deduct the fair value of these additional shares of $1,523,906 from earnings available to common stockholders. This non-cash charge resulted in the reduction of earnings per share by $.24 for the year ended December 31, 1995. While this charge is intended to show the cost of the inducement to the owners of the Company's common shares immediately before the tender offer, management does not believe that it accurately reflects the impact of the tender offer on the Company's common stockholders. As disclosed to the preferred stockholders in connection with the tender offer, the book value per share of common stock increased from a negative amount to approximately $1.00 per share as a result of the tender offer. Therefore, management believes that, even though the current accounting rules require the $.24 charge per common share, there are other significant offsetting factors by which the common shareholders benefited from this conversion which are not reflected in the 1995 earnings per share presentation. 25 PART II - OTHER INFORMATION ITEM 7. FINANCIAL STATEMENTS The Consolidated Financial Statements that constitute Item 7 are included at the end of this report beginning on Page F-1. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE This item is not applicable to the Registrant. ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT Directors and Executive Officers The following table sets forth the names and ages of the current directors and executive officers of the Company, the principal offices and positions with the Company held by each person and the date such person became a director or executive officer of the Company. The executive officers of the Company are elected annually by the Board of Directors. The Board of Directors is divided into three approximately equal classes. The directors serve three year terms and until their successors are elected. Each year the stockholders elect one class of directors. The executive officers serve terms of one year or until their death, resignation or removal by the Board of Directors. There are no family relationships between any of the directors and executive officers. In addition, there was no arrangement or understanding between any executive officer and any other person pursuant to which any person was selected as an executive officer. The directors and executive officers of the Company are as follows:
Served as Name Age Position With the Company Director Since - -------------------- --- ------------------------- --------------- Willard H. Pease, Jr. (1) 37 President, Chief Executive Officer 1983 and Director (Term Expires 1999) James N. Burkhalter 61 Vice President of Engineering and 1993 Production and Director (Term Expires 1997) Patrick J. Duncan (1) 34 Chief Financial Officer, Treasurer, 1995 Corporate Secretary and Director (Term Expires 1997) Steve A. Antry 41 Director (Term Expires 1997) 1996 Richard A. Houlihan (1) 57 Director (Term Expires 1998) 1996 Homer C. Osborne (2) 68 Director (Term Expires 1998) 1994 James C. Ruane (2) 63 Director (Term Expires 1998) 1980 Leroy W. Smith 68 Director (Term Expires 1997) 1996 Robert V. Timlin 66 Director (Term Expires 1997) 1981 Clemons F. Walker (2) 58 Director (Term Expires 1999) 1996 William F. Warnick (2) 50 Director (Term Expires 1999) 1988
26 (1) Member of the Audit Committee of the Board of Directors. (2) Member of the Compensation Committee. Willard H. Pease, Jr. has been President and Chief Executive Officer of the Company since 1990. Mr. Pease was Executive Vice President and Chief Operating Officer of the Company from 1983 to 1990. Mr. Pease is responsible for the Company's corporate finance, managing the day-to-day operations of the Company and is principally responsible for the Company's oil and gas exploration and production activities. Mr. Pease has worked in the oil field business for over 17 years. Mr. Pease received a B.A. degree in management with additional educational focuses in geology in 1983. James N. Burkhalter has been Vice President of Engineering and Production of the Company since 1993, and is responsible for the Company's engineering, production, regulatory compliance, and gas plant operations. Prior to joining the Company Mr. Burkhalter was owner and president of Burkhalter Engineering, an engineering firm which he formed in 1975. Mr. Burkhalter has been Chairman of the Colorado Board of Registration for Professional Engineers and Surveyors, serving eight years. From 1959 to 1975 Mr. Burkhalter worked for Amoco and Rocky Mountain Natural Gas as a petroleum engineer. Mr. Burkhalter received a B.S. degree in petroleum engineering in 1959 from the Colorado School of Mines. Patrick J. Duncan has been the Chief Financial Officer of the Company since September, 1994, the Company's Corporate Secretary since April 1995 and the Company's Treasurer since March 1996. Mr. Duncan is responsible for all the financial, accounting and administrative reporting and compliance required by his individual job titles. Mr. Duncan was an Audit Manager with HEIN + ASSOCIATES LLP, Certified Public Accountants, from 1991 until joining the Company as the Company's Controller in April 1994. From 1988 until 1991, Mr. Duncan was an Audit Supervisor with Coopers & Lybrand, Certified Public Accountants. Mr. Duncan received a B.S. degree from the University of Wyoming in 1985. Steve A. Antry is founder and president of Beta Capital Group, Inc., a financial consulting firm located in Newport Beach, California. Beta specializes in advising emerging oil and gas exploration companies that have both capital needs and market support requirements. Prior to forming Beta in 1992, Mr. Antry was an executive officer of Benton Oil & Gas Company from 1989 to 1992 and a Marketing Director for Swift Energy's income funds from 1987 to 1989. Mr. Antry is also a registered representative with Signal Securities, Inc., a registered broker/dealer, and has B.B.A. and M.B.A. degrees from Texas Christian University. Richard A. Houlihan is a Certified Public Accountant, Senior Member of the American Society of Appraisers and a Certified General Appraiser in Nevada and Utah. He has been a principal of Houlihan Valuation Advisors since 1986, Mr. Houlihan also was founder and president of Solitude Ski Resort, founder and president of Houlihan, Lokey, Howard & Zukin, Inc., one of the largest business valuation firms in the United States, was financial vice president of Carr-Sigoloff Industries Corporation specializing in mergers and acquisitions, and MAS Manager at Price Waterhouse & Company Management Advisory Services. Mr. Houlihan has a B.S. degree from Brigham Young University and a M.V.S. degree from Lindenwood College. Homer C. Osborne was an officer and director of Garrett Computing System, Inc., a petroleum engineering and computing firm, from 1967 until 1976, at which time he organized Osborne Oil Company as a wholly-owned subsidiary of Garrett Computing Systems, Inc. Mr. Osborne has operated Osborne Oil Company as a separate entity since 1976. James C. Ruane has owned and operated Goodall's Charter Bus Service, Inc., a bus chartering business representing Grey Line in the San Diego area, since 1958. Mr. Ruane has been an oil and gas investor for over 20 years. Leroy W. Smith was president and owner of Doctors' Financial Management Co., Inc. from 1956 through 1994 with offices in Burbank and Santa Ana, California, which provided accounting and business management services for professionals. Since retiring in 1994 Mr. Smith has served as trustee and managed three retirement trusts with total market value of approximately $5.5 million. Mr. Smith is also an Enrolled Agent before the Internal Revenue Service. 27 Robert V. Timlin has been self-employed as a consulting petroleum engineer since 1989. Mr. Timlin has been involved in the oil and gas industry for over 30 years and has served in a managerial capacity with several companies, including HMT Management Inc., an oil and gas management firm, from 1983 to 1988; T&M Casing Service, Inc., from 1975 to 1983; Dowell Studer, Inc., and Husky Oil Company. Mr. Timlin received an Associates Degree in petroleum engineering in 1957. Clemons F. Walker has been an independent financial consultant since August of 1996. Prior to that he was employed as an investment banker and stockbroker. Between 1978 and August 1995 Mr. Walker worked for Wilson Davis in Las Vegas, Nevada when Presidential Brokerage purchased the Wilson Davis office in Las Vegas and he continued to work for the surviving entity until August of 1996. Since 1978 Mr. Walker has focused his efforts in investment banking by supporting small-cap companies through assistance in private placements, public offerings and other capital raising efforts. During his career, Mr. Walker has organized, advised, facilitated, sold and participated in numerous debt and equity transactions (both public and private) in a variety of industries, including the oil and gas industry. Mr. Walker has a bachelor of arts degree in Business Administration from Brigham Young University with a concentration in Finance. William F. Warnick has been a practicing attorney in Lubbock, Texas since 1971. Mr. Warnick serves as the Texas Attorney General's appointee to the Texas School Board Land Commission and is a member of the American, Texas, and Lubbock Bar Associations. He is an oil and gas investor and has served in various management positions of private independent oil and gas companies. Mr. Warnick received a B.A. degree in finance and a J.D. degree in 1971. COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934 Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of the Company's Common Stock, to file reports of ownership and changes in ownership with the Securities and Exchange Commission ("SEC"). Officers, directors and greater than ten percent stockholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file. The following disclosure is based solely upon a review of the Forms 3 and 4 and any amendments thereto furnished to the Company during the Company's fiscal year ended December 31, 1996, and Forms 5 and amendments thereto furnished to the Company with respect to such fiscal year, or written representations that no Forms 5 were required to be filed by such persons. Based on this review the following persons who were directors, officers and beneficial owners of more than 10% of the Company's outstanding Common Stock during such fiscal year filed late reports on Forms 3 and 4. James C. Ruane filed one late report on Form 4 reporting one transaction. LeRoy W. Smith filed one late report on Form 4 reporting two transactions. ITEM 10-EXECUTIVE COMPENSATION Summary Compensation Table The Summary Compensation Table shows certain compensation information for services rendered in all capacities during each of the last three fiscal years by the Chief Executive Officer. No executive officer received salary and bonus in excess of $100,000 in 1996. The following information for the Chief Executive Officer includes the dollar value of base salaries, bonus awards, the number of stock options granted and certain other compensation, if any, whether paid or deferred. 28
SUMMARY COMPENSATION TABLE Annual Compensation Long-Term Compensation Awards --------------------------------------------- ----------------------------- Restricted Securities Name and Principal Other Annual Stock Underlying Position Year Salary Bonus Compensation Awards Options/SARs(#) - -------- ---- -------- ----- ------------ ------- -------------- Willard H. Pease, Jr .... 1996 $78,530(1) $5,000(3) $101,250 (2) None 110,400 President and Chief 1995 $75,240(1) None None None 139,600 Executive Officer 1994 $75,240(1) None None None None
(1) Includes $240 contributed by the Company to a qualified 401(k) retirement plan. (2) At December 31, 1995 the Company owed $60,000 to Willard H. Pease, Jr., the Company's President and CEO. This loan was unsecured, bore interest at 8% per annum and was originally cue on January 31, 1996. On March 9, 1996 the Board of Directors agreed to change the terms of the note to allow the note to be convertible into the Company's common stock at $1.00 per share, the then current market rate, in exchange for a one-year extension on the note. On December 16, 1996 Mr. Pease elected to convert the note in its entirety, the note was canceled and Mr. Pease was issued 60,000 shares of the Company's restricted common stock. The $101,250 shown as other annual compensation represents the difference between the closing sales price as reported by NASDAQ on December 16, 1996 and the conversion price of $1.00 per share. No additional amounts have been shown as Other Annual Compensation because the aggregate incremental cost to the Company of personal benefits provided to Mr. Pease did not exceed the lesser of $50,000 or 10% of his annual salary in any given year. (3) On March 9, 1996 the Board of Directors granted Mr. Pease 5,000 shares of the Company's common stock for prior services. The shares were valued at $5,000 or $1.00 per share which represented the market price of the Company's common stock on the date of grant. The shares are fully vested. Option Grants in the Last Fiscal Year Set forth below is information relating to grants of stock options to the Chief Executive Officer pursuant to the Company's Stock Option Plans during the fiscal year ended December 31, 1996.
Option/SAR Grants in Last Fiscal Year Individual Grants - ------------------------------------------------------------------------------------------------------- Number of Securities % of Total Underlying Options/SARs Options/ Granted to Exercise or SARs Employees in Base Price Expiration Name Granted (#) Fiscal Year ($/Sh) Date ---- ---------- ------------ ----------- ---------- Willard H. Pease, Jr................. 110,400 (1) 33.9% $1.00(3) 03/08/01 President and Chief 60,000 (2) 18.4% $1.00(3) 01/31/97 Executive Officer
(1) Consists of 8,900 shares underlying options issued under one of the Company's qualified stock option plans and 101,500 shares underlying warrants to purchase common stock. All these Options and Warrants became exercisable on September 8, 1996. (2) At December 31, 1995 the Company owed $60,000 to Willard H. Pease, Jr., the Company's President and CEO. This loan was unsecured, bore interest at 8% per annum and was originally cue on January 31, 1996. On March 9, 1996 the Board of Directors agreed to change the terms of the note to allow the note to be convertible into the Company's common stock at $1.00 per share, the then current market price, in exchange for a one-year extension on the note. (3) The exercise price listed above was 100% of the market price of the Common Stock on the date the options, warrants or convertible notes were granted or approved by the Company's Board of Directors. 29 Aggregated Option Exercises in the Last Fiscal Year and the Fiscal Year-End Option Values Set forth below is information with respect to the unexercised options to purchase the Company's Common Stock held by Willard H. Pease, Jr. at December 31, 1996. No options were exercised during fiscal 1996.
Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End Option/SAR Values Number of Securities Value of Underlying Unexercised Unexercised In-the-Money Options/SARs Options/SARs at FY-End (#) at FY-End ($) Shares Acquired Value Realized Exercisable/ Exercisable/ Name on Exercise (#) ($) Unexercisable Unexercisable - -------- -------------- -------------- ------------- ------------- Willard H. Pease, Jr. 60,000 (1) $101,250 (1) 250,000/-0- $544,557/-0- (2) President and Chief Executive Officer
(1) On December 16, 1996, Mr. Pease converted a $60,000 promissory note into 60,000 shares of the Company's common stock pursuant to the terms of the underlying promissory note. The $101,250 shown as other annual compensation represents the difference between the closing sales price as reported by NASDAQ on December 16, 1996 and the conversion price of $1.00 per share. (2) The value of the unexercised In-the-Money Options 1996 was determined by multiplying the number of unexercised options by the closing sales of the Company's common stock on December 31,1996 as reported by NASDAQ and from that total, subtracting the total exercise price. Employment Contract The Company has entered into an employment agreement with a Director, Willard Pease, Jr., who is also the Company's President and Chief Executive Officer. The employment agreement was entered into in 1993 and may be terminated by the Company without cause on 30 days notice provided the Company continues to pay the salary of Mr. Pease for 36 months. The salary must be paid in a lump sum if the termination occurs after a change in control of the Company as defined in the employment agreement. Mr. Pease may terminate the employment agreement on 90 days written notice. The base salary of Mr. Pease under the employment agreement was increased to a base salary of $95,000 per year effective October 1, 1996. Compensation of Directors Directors who are employees do not receive additional compensation for service as directors. Other directors each receive a $1,000 annual retainer fee, $750 per meeting attended and $100 per meeting conducted via telephone conference. Directors may elect to receive the compensation either in cash or stock. All the compensation paid to the outside directors in 1995 and 1996 was in the form of stock. ITEM 11- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding the beneficial ownership of the Company's Common Stock, its only class of outstanding voting securities as of February 21, 1997, by (i) each person who is known to the Company to own beneficially more than 5% of the outstanding Common Stock with the address of each such person, (ii) each of the Company's directors and officers, and (iii) all officers and directors as a group: 30
Name and Address of Beneficial Owner or Amount and Nature of Name of Officer or Director Beneficial Ownership(1) Percent of Class - --------------------------- ---------------------- ---------------- Steve Allen Antry 901 Dove Street, Suite 230 Newport Beach, CA 92660 .............. 671,832 Shares (2) 7.4% James N. Burkhalter P.O. Box 60219 Grand Junction, CO 81506 ............. 165,710 Shares (3) 2.0% Patrick J. Duncan P.O. Box 60219 Grand Junction, CO 81506 ............. 170,625 Shares (4) 2.0% Richard A. Houlihan 650 Town Center Drive, Suite 550 Costa Mesa, CA 92625 ................. 288,983 Shares (5) 3.4% Homer C. Osborne 1200 Preston Road #900 Dallas, TX 75230 ..................... 49,407 Shares (6) 0.6% Willard H. Pease, Jr .................... P.O. Box 60219 Grand Junction, CO 81506 ............. 786,139 Shares (7) 9.2% James C. Ruane 5010 Market St. San Diego, CA 92102 .................. 281,838 Shares (8) 3.3% Leroy W. Smith P.O. Box 10040 Santa Ana, CA 92711-0040 ............. 181,280 Shares (9) 1.8% Robert V. Timlin 1989 South Balsam Lakewood, CO 80277 ................... 63,490 Shares (10) 0.8% Clemons F. Walker 748 Rising Star Drive Henderson, NV 89104 .................. 362,763 Shares (11) 4.2% William F. Warnick 2022 Broadway Lubbock, TX 79401 .................... 84,193 Shares (12) 1.0% All Officers and Directors as a group (eleven persons) ................ 3,106,260 Shares (13) 29.8%
(1) Beneficial owners listed have sole voting and investment power with respect to the shares unless otherwise indicated. On December 18, 1996, Mr. Pease converted a $60,000 promissory note into 60,000 shares of the Company's common stock pursuant to the terms of the underlying promissory note. The $101,250 shown as other annual compensation represents the difference between the closing sales price as reported by NASDAQ on December 16, 1996 and the conversion price of $1.00 per share. (2) Includes 2,680 shares that are owned directly by Mr. Antry, 7,500 shares underlying options that become exercisable on July 27, 1997, 61,137 shares underlying presently exercisable warrants, 515 shares underlying convertible preferred stock and 600,000 shares underlying presently exercisable warrants that are held by Mr. Antry's wife. (3) Includes 15,710 shares owned directly by Mr. Burkhalter, 115,000 shares underlying presently exercisable options, and 35,000 shares underlying options that become exercisable on July 27, 1997. 31 (4) Includes 20,625 shares owned directly by Mr. Duncan, 105,000 shares underlying presently exercisable options, and 45,000 shares underlying options that become exercisable on July 27, 1997. (5) Includes 151,150 shares owned directly by Mr. Houlihan, 7,500 shares underlying options that become exercisable on July 27, 1997, 97,500 shares underlying presently exercisable options, 8,333 shares underlying a convertible debenture, and 24,500 shares owned by a trust that Mr. Houlihan has sole voting and investment power. (6) Includes 6,607 shares owned directly by Mr. Osborne, 35,300 shares underlying presently exercisable options, and 7,500 shares underlying options that become exercisable on July 27, 1997. (7) Includes 121,173 shares that are owned directly by Mr. Pease, 364,966 shares are owned by entities affiliated with Mr. Pease over which shares Mr. Pease has sole voting and investment power, 148,500 shares underlying presently exercisable options, 50,000 shares underlying options that become exercisable on July 24, 1997, and 101,500 shares underlying presently exercisable warrants. (8) Includes 107,528 shares owned directly by Mr. Ruane, 4,560 shares held by Mr. Ruane as trustee for two trusts, over which shares Mr. Ruane may be deemed to have shared voting and investment power, 12,500 shares underlying presently exercisable warrants, 70,000 shares underlying presently exercisable options, and 7,500 shares underlying options that become exercisable on July 27, 1997. (9) Includes 1,280 shares owned directly by Mr. Smith, 10,000 shares owned by a trust that Mr. Smith acts as the Trustee and is therefore deemed to have beneficial ownership, 5,000 shares owned by his wife, 10,000 shares underlying presently exercisable options, 7,500 shares underlying options that become exercisable on July 27, 1997, 100,000 shares underlying presently exercisable warrants that are owned by two separate trusts that Mr. Smith acts as the Trustee and is therefore deemed to have beneficial ownership, 12,500 shares underlying convertible preferred stock owned directly by Mr. Smith; 12,500 shares underlying convertible preferred stock held by his wife, and 22,500 shares underlying convertible preferred stock that are owned by two separate trusts that Mr. Smith acts as the Trustee and is therefore deemed to have beneficial ownership. (10) Includes 5,990 shares owned directly by Mr. Timlin, 26,693 shares underlying presently exercisable options, and 7,500 shares underlying options that become exercisable on July 27, 1997. (11) Includes 142,062 shares owned directly by Mr. Walker, 212,686 shares underlying presently exercisable warrants, 7,500 shares underlying options that become exercisable on July 27, 1997, and 515 shares underlying convertible preferred stock. (12) Includes 26,693 shares owned directly by Mr. Warnick, 50,000 shares underlying presently exercisable options, and 7,500 shares underlying options that become exercisable on July 27, 1997. (13) Includes 583.800 shares underlying presently exercisable options, 190,000 shares underlying options that become exercisable on July 27, 1997, 1,185,073 shares underlying presently exercisable warrants, 48,530 shares underlying convertible preferred stock, and 8,333 shares underlying a convertible note. ITEM 12-CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. From time to time, various officers and directors of the Company and their affiliates have participated in the drilling of oil and gas wells which were drilled and operated by the Company. All such persons and entities have taken working interests in the wells and have paid the drilling, completion and related costs of the wells on the same basis as the Company and all other working interest owners. On occasions of such participation the Company retained the maximum interest in the well that it could justify, given its cash availability and the risk involved. 32 In August 1996, Richard A. Houlihan, a director of the Company purchased a $25,000 10% collateralized debenture that included warrants to purchase 25,000 shares of Common Stock at $1.25 per share on the same terms as other nonaffiliated purchasers. At December 31, 1996 the Company owed certain affiliates of Willard H. Pease, Jr. $116,719 principal, plus $31,398 in accrued interest, for oil and gas revenue attributable to interests in wells operated by the Company that are owned by the individuals and related entities. Of the principal amount, $2,877 was incurred in 1994, $4,603 was incurred in 1993, $20,992 was incurred in 1992, $85,518 was incurred in 1991 and $2,729 was incurred in 1990. At December 31, 1995 the Company owed $60,000 to Willard H. Pease, Jr., the Company's President and CEO. This loan was unsecured, bears interest at 8% per annum and was originally due in January 1996. In March 1996 the Board of Directors agreed to change the terms of the note to allow the note to be convertible into the Company's common stock at $1.00 per share, the then current market price, in exchange for a one-year extension of the note. In December 1996 Mr. Pease elected to convert the note in its entirety, the note was canceled and Mr. Pease was issued 60,000 shares of the Company's restricted common stock. Until June 1993, Willard H. Pease, Jr. owned an oil well servicing business, Grand Junction Well Services, Inc. ("GJWS"), which operated a workover and completion rig. In June 1993, the Company acquired GJWS from Mr. Pease by merging GJWS into a newly-formed subsidiary of the Company. In the merger, the Company issued Mr. Pease 46,667 shares of Common Stock and the Company's 6% secured convertible promissory note in the principal amount of $175,000, for a total value of $350,000, which was the estimated fair market value of the GJWS assets and business. The note was originally payable in three annual principal installments of $45,000 on October 1, 1994, $65,000 on April 1, 1995 and $65,000 on April 1, 1996. The October 1, 1994 principal payment of $45,000 was paid and the remaining installments were extended to October 1, 1997 and October 1, 1998, respectively. The unpaid principal portion of $130,000 is convertible at the election of Mr. Pease into Common Stock at $5.00 per share. The transaction was approved unanimously by the disinterested directors of the Company. In March 1996 the Company entered into a three-year consulting agreement with Beta Capital Group, Inc. ("Beta"). Beta's president, Steve Antry, has been a director of the Company since August 1996. The consulting agreement with Beta provides for minimum monthly cash payments of $17,500 plus reimbursement for out-of-pocket expenses. The Company also agreed to pay Beta additional fees, as defined in the agreement, that are based on a percentage of the gross proceeds generated from any public financing, private financing or from any warrants that are exercised during the term of the agreement. During 1996 the Company paid Beta, or its agents, a total of $424,706 under the terms of the agreement. The total amount paid consisted of: a.) $162,500 for monthly consulting fees; b.) $94,700 for the reimbursement of out-of-pocket expenses; c.) $163,000 for fees related to funds generated from private placements; and d.) $4,506 for fees related to funds generated from the exercise of warrants. In addition to the cash compensation, the Company granted Beta warrants to purchase 1.0 million shares of the Company's common stock for $.75 per share. As allowed under the terms of the agreement, Beta assigned 400,000 of those warrants to other parties, including 100,000 to a Mr. Richard Houlihan, a director of the Company. All these warrants expire in April 2001. All existing loans or similar advances to, and transactions with, officers and their affiliates were approved or ratified by the independent and disinterested directors. Any future material transactions with officers, directors and owners of 5% or more of the Company's outstanding Common Stock or any affiliate of any such person shall be on terms no less favorable to the Company than could be obtained from independent unaffiliated third parties and must be approved by a majority of the independent disinterested directors. 33 PART IV ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K Exhibit No. Description and Method of Filing - ---------- -------------------------------- (3.1) Articles of Incorporation, as amended. (1) (3.2) Plan of Recapitalization. (1) (3.3) Certificate of Amendment to the Articles of Incorporation filed on July 6, 1994. (2) (3.4) Certificate of Amendment to the Articles of Incorporation filed on December 19, 1994. (2) (3.5) Bylaws, as amended and restated May 11, 1993. (1) (4.1) Representative's Preferred Stock Purchase Warrant. (1) (4.2) Warrant Agency Agreement between Willard Pease Oil and Gas Company and American Securities Transfer, Inc. dated August 23, 1993. (1) (4.3) Amendment to Warrant Agency Agreement dated January 5, 1995. (2) (4.4) Certificate of Designation of Series A Cumulative Convertible Preferred Stock. (1) (4.5) Certificate of Amendment of Certificate of Designation of Series A Cumulative Convertible Preferred Stock filed on August 16, 1993. (2) (4.6) Second Certificate of Amendment of Certificate of Designation of Series A Cumulative Convertible Preferred Stock filed on November 1, 1994. (2) (10.1) Residue Gas Sales and Purchase Agreement dated June 22, 1986, between Western Gas Supply Company and Loveland Gas Processing, Ltd., and Amendments dated July 30, 1986, August 12, 1986, September 11, 1986, April 16, 1987, April 1, 1988, January 2, 1992, March 26, 1992 and May 1, 1992. (1) (10.2) Amendment dated December 1, 1993, between Public Service Company of Colorado and Loveland Gas Processing Co., Ltd., to Residue Gas Sales and Purchase Agreement dated June 22, 1986, between Western Gas Supply Company and Loveland Gas Processing, Ltd. (2) (10.3) Gas Purchase and Sale Contract dated November 1, 1988, between Fuel Resources Development Co. as seller and Loveland Gas Processing Co., Ltd., as buyer, pertaining to the purchase of gas, and Amendments dated November 1, 1990, January 24, 1991, May 1, 1991, July 5, 1991, August 1, 1991, April 1, 1992 and August 1, 1992. (1) (10.4) Purchase Order No. 5 dated January 1, 1994 from Loveland Gas Processing Co., Ltd. to Fuel Resources Development Co. that amends the Gas Purchase and Sale Contract dated November 1, 1988, between Fuel Resources Development Co. and Loveland Gas Processing, Ltd. (2) (10.5) Form of Warrants issued to Ronin Group Ltd., and Clemons F. Walker for the purchase of an aggregate of 240,000 shares of Common Stock. (3) (10.6) 1990 Stock Option Plan. (1) (10.7) 1993 Stock Option Plan (1) (10.8) 1994 Employee Stock Option Plan. (2) (10.9) Form of 12% Convertible Unsecured Promissory Notes issued by Pease Oil and Gas Company in 1994 Private Placement. (2) (10.10) Form of Warrants issued to brokers Sales Agents in 1994 Private Placements. (2) (10.11) Employment Agreement effective September 16, 1994 between Pease Oil and Gas Company and Willard H. Pease, Jr. (2) (10.12) Employment Agreement effective December 27, 1994 between Pease Oil and Gas Company and Patrick J. Duncan. (2) (10.13) Employment Agreement effective December 27, 1994 between Pease Oil and Gas Company and James N. Burkhalter. (2) (10.18) Interconnect Agreement dated January 1, 1995, between KN Front Range Gathering Company and Loveland Gas Processing Co., Ltd.(2) (10.19) Gas Gathering Agreement dated February 1, 1995, between KN Front Range Gathering Company and Loveland Gas Processing Co., Ltd. (2) 34 (10.20) Agreement dated August 15, 1994, between Hewlett-Packard Company, Loveland Gas Processing Co., Ltd., Pease Oil and Gas Company and Pease Operating Company. (2) (10.21) Purchase and Sale Agreement dated April 24, 1995 among Pease Oil and Gas Company, Thermo Cogeneration Partnership, L.P and Seahawk Energy, Inc. (3) (10.22) Agreement between Beta Capital Group, Inc., and Pease Oil and Gas Company dated March 9, 1996. (4) (10.24) Form of Warrant issued to Beta Capital Group, Inc. (10.25) 1996 Stock Option Plan. (10.26) Mortgage, Assignment of Proceeds, Security Agreement and Financing Statement from Pease Oil and Gas Company to Holders of 1996 Collateralized Subordinated Convertible Debentures dated as of November 15, 1996. (10.27) Purchase and Sale Agreement dated December 31, 1996 by and between Atocha Exploration, Inc., Browning Oil Company, Inc., Potosky Oil and Gas, Inc. and Pease Oil and Gas Company. (5) (10.28) Letter Agreement dated February 4, 1997 by and between National Energy Group, Inc. and Pease Oil and Gas Company. (6) (10.29) Purchase and Sale Agreement dated February 26, 1997 by and between Transworld Exploration & Production, Inc. (7) (21) List of Subsidiaries. (3) (23) Consents of Experts (23.1) Consent of McCartney Engineering, LLC Consulting Petroleum Engineers (23.2) Consent of Hein + Associates LLP, Certified Public Accountants (27) Financial Data Schedule. Footnotes: (1) Incorporated by reference to Registration Statement No. 33-64448 on Form SB-2. (2) Incorporated by reference to the Registrant's 1994 Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994. (3) Incorporated by reference to Registration Statement No. 33-94536 on Form SB-2. (4) Incorporated by reference to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1995. (5) Incorporated by reference to Form 8-K filed January 10, 1997. (6) Incorporated by reference to Form 8-K filed February 19, 1997. (7) Incorporated by reference to Form 8-K filed March 17, 1997. 35 SIGNATURES In accordance with Section 13 or 15 (d) of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PEASE OIL AND GAS COMPANY Date: March 27, 1997 By:/s/ Willard H. Pease, Jr. ---------------------------- Willard H. Pease, Jr. President and Chief Executive Officer Date: March 27, 1997 By: /s/ Patrick J. Duncan ------------------------- Patrick J. Duncan Chief Financial Officer, Treasurer, and Principal Accounting Officer In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Date: March 27, 1997 By:/s/ Willard H. Pease, Jr. ---------------------------- Willard H. Pease, Jr., President and Chairman of the Board Date: March 27, 1997 By: /s/ Patrick J. Duncan ------------------------- Patrick J. Duncan Chief Financial Officer, Treasurer, and Director Date: March 27, 1997 By:/s/ James N. Burkhalter -------------------------- James N. Burkhalter, Vice-President Engineering and Production, and Director Date: March 27, 1997 By:/s/ Steve A. Antry --------------------------- Steve A. Antry, Director Date: March 27, 1997 By:/s/ Richard A. Houlihan ---------------------------- Richard A. Houlihan, Director Date: March 27, 1997 By:/s/ Homer C. Osborne ---------------------------- Homer C. Osborne, Director Date: March 27, 1997 By:/s/ James C. Ruane ---------------------------- James C. Ruane, Director Date: March 27, 1997 By:/s/ Leroy W. Smith ----------------------------- Leroy W. Smith, Director Date: March 27, 1997 By:/s/ Robert V. Timlin ------------------------------ Robert V. Timlin, Director Date: March 27, 1997 By:/s/ Clemons F. Walker ------------------------------ Clemons F. Walker, Director Date: March 27, 1997 By:/s/ William F. Warnick ------------------------------ William F. Warnick, Director 36 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Independent Auditor's Report.................................................F-2 Consolidated Balance Sheets - December 31, 1996 and 1995 ....................F-3 Consolidated Statements of Operations - For the Years Ended December 31, 1996 and 1995................................................................F-5 Consolidated Statements of Stockholders' Equity - For the Years Ended December 31, 1996 and 1995..............................................F-6 Consolidated Statements of Cash Flows - For the Years Ended December 31, 1996 and 1995...........................................................F-7 Notes to Consolidated Financial Statements...................................F-8 F-1 INDEPENDENT AUDITOR'S REPORT Board of Directors Pease Oil and Gas Company Grand Junction, Colorado We have audited the accompanying consolidated balance sheets of Pease Oil and Gas Company and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pease Oil and Gas Company and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. /s/ HEIN + ASSOCIATES LLP HEIN + ASSOCIATES LLP Denver, Colorado February 21, 1997 F-2 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET
DECEMBER 31, --------------------------- 1996 1995 ---- ---- ASSETS CURRENT ASSETS: Cash and equivalents ........................................... $ 1,995,860 $ 677,275 Trade receivables, net of allowance for bad debts of $25,000 and $51,000, respectively ..................................... 599,648 963,315 Inventory ...................................................... 408,787 532,289 Prepaid expenses and other ..................................... 56,327 77,844 Common stock subscription receivable, 91,667 shares ............ -- 68,750 ------------ ------------ Total current assets ................................. 3,060,622 2,319,473 ------------ ------------ OIL AND GAS PROPERTIES, at cost (successful efforts method): Undeveloped properties ......................................... 351,727 377,606 Wells in progress .............................................. 181,312 -- Developed properties ........................................... 9,505,408 9,149,516 ------------ ------------ Total oil and gas properties ......................... 10,038,447 9,527,122 Less accumulated depreciation and depletion .................... (3,946,974) (3,608,917) ------------ ------------ Net oil and gas properties ........................... 6,091,473 5,918,205 ------------ ------------ PROPERTY, PLANT AND EQUIPMENT, at cost: Gas plant ...................................................... 4,099,285 4,095,227 Service equipment and vehicles ................................. 879,313 855,025 Buildings and office equipment ................................. 459,228 529,703 ------------ ------------ Total property, plant and equipment .................. 5,437,826 5,479,955 Less accumulated depreciation .................................. (1,376,154) (1,034,731) ------------ ------------ Net property, plant and equipment .................... 4,061,672 4,445,224 ------------ ------------ OTHER ASSETS: Debt issuance costs, net of accumulated amortization of $170,134 and $29,167, respectively ................................. 1,105,874 20,833 Non-compete agreements, net of accumulated amortization of $253,322 ............................................... 306,678 352,674 Other .......................................................... 274,830 383,317 ------------ ------------ Total other assets ................................... 1,687,382 756,824 ------------ ------------ TOTAL ASSETS ........................................................ $ 14,901,149 $ 13,439,726 ============ ============ The accompanying notes are an integral part of these consolidated financial statements. F-3 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (continued) DECEMBER 31, ---------------------------- 1996 1995 ---- ---- LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current maturities of long-term debt: Related parties ....................................... $ 285,895 $ -- Other ................................................. 45,944 1,100,474 Accounts payable, trade .................................... 267,540 1,172,567 Accrued production taxes ................................... 288,122 303,287 Other accrued expenses ..................................... 265,427 243,325 ------------ ------------ Total current liabilities ........................ 1,152,928 2,819,653 ------------ ------------ LONG-TERM LIABILITIES: Long-term debt, less current maturities: Convertible debentures ................................ 5,000,000 -- Other ................................................. 19,945 1,223,159 Accrued production taxes ................................... 256,088 379,652 ------------ ------------ Total long-term liabilities ...................... 5,276,033 1,602,811 ------------ ------------ COMMITMENTS AND CONTINGENCIES (Notes 3, 5, 6, and 11) STOCKHOLDERS' EQUITY: Preferred Stock, par value $.01 per share, 2,000,000 shares authorized, 179,938 and 202,688 shares of Series A Cumulative Convertible Preferred Stock issued and outstanding (liquidation preference of $2,204,000 and $2,280,000, respectively) ............................. 1,799 2,027 Common Stock, par value $.10 per share, 25,000,000 shares authorized, issued and outstanding 7,526,817 shares and 7,180,804 shares, respectively ........................ 752,682 718,081 Additional paid-in capital ................................. 17,392,329 16,560,194 Accumulated deficit ........................................ (9,674,622) (8,263,040) ------------ ------------ Total stockholders' equity ....................... 8,472,188 9,017,262 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ...................... $ 14,901,149 $ 13,439,726 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-4 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, -------------------------- 1996 1995 ---- ---- REVENUE: Oil and gas sales ............................. $ 2,546,676 $ 2,623,782 Natural gas marketing and trading ............. 2,067,379 3,872,565 Gas plant processing .......................... 818,356 1,135,050 Oil field services and supply ................. 618,225 1,302,741 Well administration and other income .......... 115,028 97,678 ----------- ----------- Total revenue .......................... 6,165,664 9,031,816 ----------- ----------- OPERATING COSTS AND EXPENSES: Oil and gas production ........................ 1,426,549 1,617,318 Natural gas marketing and trading ............. 1,745,446 3,404,169 Gas plant processing .......................... 464,512 942,867 Oil field services and supply ................. 553,343 1,391,588 General and administrative .................... 1,092,342 1,059,306 Consulting arrangement - related party ........ 257,199 -- Depreciation, depletion and amortization ...... 1,055,639 1,292,314 Dry holes, plugging, and abandonments ......... 555,685 18,786 Restructuring costs ........................... -- 226,986 ----------- ----------- Total operating costs and expenses ..... 7,150,715 9,953,334 ----------- ----------- LOSS FROM OPERATIONS ................................ (985,051) (921,518) ----------- ----------- OTHER INCOME (EXPENSES): Interest income ............................... 41,148 8,444 Interest expense: Amortization of debt issuance costs .... (190,967) (17,554) Other .................................. (311,461) (288,881) Gain (loss) on sale of assets ................. (6,660) 75,073 ----------- ----------- Net .................................... (467,940) (222,918) ----------- ----------- LOSS BEFORE INCOME TAXES ............................ (1,452,991) (1,144,436) Income tax benefit ............................ 41,409 379,000 ----------- ----------- NET LOSS ............................................ (1,411,582) (765,436) Preferred stock dividends: Converted .............................. (22,750) (117,000) In arrears ............................. (179,938) (202,688) ----------- ----------- Total preferred stock dividends... (202,688) (319,688) ----------- ----------- Loss before non-cash inducement... (1,614,270) (1,085,124) Non-cash inducement in tender offer (Note 1)... -- (1,523,906) ----------- ----------- NET LOSS APPLICABLE TO COMMON STOCKHOLDERS .......... $(1,614,270) $(2,609,030) =========== =========== NET LOSS PER COMMON SHARE: Before non-cash inducement .................... $ (.22) $ (.18) Non-cash inducement (Note 1) .................. -- (.24) ----------- ----------- $ (.22) $ (.42) =========== =========== WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING................................. 7,278,000 6,190,000 =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. F-5 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
Preferred Stock Common Stock Additional ------------------------- ------------------------ Paid-in Shares Amount Shares Amount Capital ------ ------ ------ ------ ---------- BALANCES January 1, 1995 ....................... 1,157,780 $ 11,578 2,286,028 $ 228,603 $ 16,744,348 Conversion of preferred stock to common stock: In tender offer ...................... (933,492) (9,335) 4,200,716 420,072 (410,737) Other ................................ (21,600) (216) 56,739 5,673 (5,457) Acquisition of oil and gas properties for common stock ......................... -- -- 65,000 6,500 53,422 Sale of common stock in private placement . -- -- 500,000 50,000 325,000 Offering costs ............................ -- -- -- -- (77,953) Issuance of common stock to directors and employees for services and other ..... -- -- 21,036 2,104 11,327 Settlement of trade payable for common stock ................................ -- -- 63,206 6,321 (30,948) Cancellation of trestury shares ........... -- -- (11,921) (1,192) (48,808) Net loss .................................. -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ BALANCES December 31, 1995 ..................... 202,688 2,027 7,180,804 718,081 16,560,194 Issuance of common stock to officers, directors, and employees for compensation ......................... -- -- 51,490 5,149 57,162 Fair value of warrants granted for debt issuance costs ....................... -- -- -- -- 600,000 Conversion of debentures into common stock ................................ -- -- 82,353 8,235 61,765 Issuance of common stock for engineering services ............................. -- -- 15,000 1,500 21,477 Exercise of options and warrants to purchase common stock ................ -- -- 67,500 6,750 57,625 Conversion of note payable to director into common stock ......................... -- -- 60,000 6,000 54,000 Conversion of preferred stock to common stock ................................ (22,750) (228) 69,670 6,967 (6,739) Offering costs ............................ -- -- -- -- (13,155) Net loss .................................. -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ BALANCES, December 31, 1996 .................... 179,938 $ 1,799 7,526,817 $ 752,682 $ 17,392,329 ============ ============ ============ ============ ============ Tresury Stock Total Accumulated --------------------------- Stockholders' Deficit Shares Amount Equity ----------- ------ ------ ------------- BALANCES January 1, 1995 ....................... $ (7,497,604) 28,715 $ (132,588) $ 9,354,337 Conversion of preferred stock to common stock: In tender offer ...................... -- -- -- -- Other ................................ -- -- -- -- Acquisition of oil and gas properties for common stock ......................... -- -- -- 59,922 Sale of common stock in private placement . -- -- -- 375,000 Offering costs ............................ -- -- -- (77,935) Issuance of common stock to directors and employees for services and other ..... -- -- -- 13,431 Settlement of trade payable for common stock ................................ -- (16,794) 82,588 57,961 Cancellation of trestury shares ........... -- (11,921) 50,000 -- Net loss .................................. (765,436) -- -- (765,436) ---------- ----------- ---------- ---------- BALANCES December 31, 1995 ..................... (8,263,040) -- -- 9,017,262 Issuance of common stock to officers, directors, and employees for compensation ......................... -- -- -- 62,311 Fair value of warrants granted for debt issuance costs ....................... -- -- -- 600,000 Conversion of debentures into common stock ................................ -- -- -- 70,000 Issuance of common stock for engineering services ............................. -- -- -- 22,977 Exercise of options and warrants to purchase common stock ................ -- -- -- 64,375 Conversion of note payable to director into common stock ......................... -- -- -- 60,000 Conversion of preferred stock to common stock ................................ -- -- -- -- Offering costs ............................ -- -- -- (13,155) Net loss .................................. (1,411,582) -- -- (1,411,582) ---------- ----------- ---------- ---------- BALANCES, December 31, 1996 .................... $ (9,674,622) -- $ -- $ 8,472,188 ========== =========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. F-6 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, ------------------------------ 1996 1995 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss .................................................... $(1,411,582) $ (765,436) Adjustments to reconcile net loss to net cash provided by operating activities: Provision for depreciation and depletion .................... 1,009,645 1,200,487 Amortization of intangible assets ........................... 236,963 109,381 Deferred income taxes ....................................... -- (400,000) Loss (gain) on sale of property and equipment ............... 6,660 (75,073) Provision for bad debts ..................................... 21,497 35,176 Dry holes and abandonments .................................. 525,000 -- Issuance of common stock for services ....................... 85,288 71,392 Other ....................................................... (54,942) (41,770) Changes in operating assets and liabilities: (Increase) decrease in: Trade receivables ........................................ 342,170 625,286 Inventory ................................................ 124,502 296,824 Prepaid expenses and other ............................... (14,316) 14,001 Increase (decrease) in: Accounts payable ......................................... (905,027) (529,581) Accrued expenses ......................................... (109,473) (160,512) ----------- ----------- Net cash provided by (used in) operating activities ......... (143,615) 380,175 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures for property, plant and equipment ...... (1,403,413) (387,403) Proceeds from redemption of certificate of deposit .......... 53,500 43,000 Proceeds from sale of property and equipment ................ 163,821 823,631 ----------- ----------- Net cash provided by (used in) investing activities ...... (1,186,092) 479,228 ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of convertible debentures ............ 5,000,000 -- Repayment of long-term debt ................................. (1,795,670) (943,341) Proceeds from sale of common stock .......................... 133,125 281,250 Offering costs .............................................. (13,155) (52,953) Debt issuance costs ......................................... (676,008) -- ----------- ----------- Net cash provided by (used in) financing activities ...... 2,648,292 (715,044) ----------- ----------- INCREASE (DECREASE) IN CASH AND EQUIVALENTS ................... 1,318,585 144,359 CASH AND EQUIVALENTS, beginning of year ....................... 677,275 532,916 ----------- ----------- CASH AND EQUIVALENTS, end of year ............................. $ 1,995,860 $ 677,275 =========== =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest ...................................... $ 192,502 $ 273,735 =========== =========== Cash received (paid) for income taxes ....................... $ 41,409 $ (21,000) =========== =========== SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Fair value of warrants granted for debt issuance costs ...... $ 600,000 $ -- Conversion of long-term debt to common stock ................ 130,000 -- Long-term debt incurred for purchase of vehicles ............ -- 24,992 Acquisition of oil and gas properties for common stock ...... -- 59,922 Common stock subscription receivable ........................ -- 68,750
The accompanying notes are an integral part of these consolidated financial statements. F-7 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Nature of Operations - Pease Oil and Gas Company (the "Company") explores for, develops, produces and sells oil and natural gas; transports, processes, sells, markets and trades natural gas and natural gas liquids at a gas processing plant; performs oil and gas well completion and operational services; and sells new, used and reconditioned oil and gas production equipment and oil field supplies. The Company conducts its business through the following wholly-owned subsidiaries: Loveland Gas Processing Company, Ltd. ("LGPCo"); Pease Oil Field Services, Inc.; Pease Oil Field Supply, Inc.; and Pease Operating Company, Inc. Principles of Consolidation - The accompanying financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany transactions and accounts have been eliminated in consolidation. Cash and Equivalents - For purposes of the statements of cash flows, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Oil and Gas Producing Activities - The Company follows the "successful efforts" method of accounting for its oil and gas properties. Under this method of accounting, all property acquisition costs and costs of exploratory and development wells are capitalized when incurred, pending determination of whether the well has found proved reserves. If an exploratory well has not found proved reserves, the costs of drilling the well are charged to expense. The costs of development wells are capitalized whether productive or nonproductive. Geological and geophysical costs and the costs of carrying and retaining undeveloped properties are expensed as incurred. Management estimates that the salvage value of lease and well equipment will approximately offset the future liability for plugging and abandonment of the related wells. Accordingly, no accrual for such costs has been recorded. Depletion and depreciation of capitalized costs for producing oil and gas properties is provided using the units-of-production method based upon proved reserves. Depletion and depreciation expense for the Company's oil and gas properties amounted to $589,853 and $741,924 for the years ended December 31, 1996 and 1995, respectively. Impairment of Long-Lived Assets - The Company performs an assessment for impairment whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. When an assessment for impairment of oil and gas properties is performed, the Company compares the net carrying value of proved oil and gas properties on a lease-by-lease basis (the lowest level at which cash flows can be determined on a consistent basis) to the related estimates of undiscounted future net cash flows for such properties. If the net carrying value exceeds the net cash flows, then impairment is recognized to reduce the carrying value to the estimated fair value. The allowance for impairment is included in accumulated depreciation and depletion in the accompanying balance sheets. F-8 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Property, Plant and Equipment - Property, plant, and equipment is stated at cost. Depreciation of property, plant and equipment is calculated using the straight-line method over the estimated useful lives of the assets, as follows: YEARS ----- Gas plant 17 Service equipment and vehicles 4-7 Buildings and office equipment 7-15 Depreciation expense related to property, plant and equipment amounted to $419,792 and $458,563 for the years ended December 31, 1996 and 1995, respectively. The cost of normal maintenance and repairs is charged to operating expenses as incurred. Material expenditures which increase the life of an asset are capitalized and depreciated over the estimated remaining useful life of the asset. The cost of properties sold, or otherwise disposed of, and the related accumulated depreciation or amortization are removed from the accounts, and any gains or losses are reflected in current operations. Non-compete Agreements - The costs of non-compete agreements were incurred in connection with the 1993 acquisition of substantially all of the Company's assets. These costs are being amortized over the terms of the two to ten-year agreements on a straight-line basis. Amortization expense related to the non-compete agreements was $45,994 and $91,827 for the years ended December 31, 1996 and 1995, respectively. Debt Issuance Costs - Debt issuance costs relate to the $5 million private placement of convertible debentures discussed in Note 3. These costs are being amortized using the straight-line method (which approximates the interest method) over the 5-year term of the debentures. Inventory - Inventory consists primarily of oil and gas production equipment and oil field supplies. These items are generally held for resale. At December 31, 1996 and 1995, inventory also includes approximately $72,000 and $100,000, respectively, of crude oil, fuel, and propane. Inventory is carried at the lower of cost or market, cost being determined generally under the first-in, first-out (FIFO) method of accounting, or where possible, by specific identification. At December 31, 1996 and 1995, the Company has classified $200,000 of used oil field equipment inventory as long-term (included in other assets) because, based on current inventory usage, it is not expected to be sold within the next year. Accounting Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. The actual results could differ from those estimates. F-9 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company's financial statements are based on a number of significant estimates including the allowance for doubtful accounts, accrued production taxes, realizability of intangible assets, assumptions affecting the fair value of stock options and warrants, selection of the useful lives for property, plant and equipment, and oil and gas reserve quantities which are the basis for the calculation of depreciation, depletion, and impairment of oil and gas properties. Management emphasizes that reserve estimates are inherently imprecise and that estimates of more recent discoveries are more imprecise than those for properties with long production histories. At December 31, 1996, approximately 35% of the Company's oil and gas reserves are attributable to non-producing properties. Accordingly, the Company's estimates are expected to change as future information becomes available. The Company is required under certain circumstances to evaluate the possible impairment of the carrying value of its long-lived assets. For proved oil and gas properties, this involves a comparison to the estimated future undiscounted cash flows, which is the primary basis for determining the related fair values for such properties. In addition to the uncertainties inherent in the reserve estimation process, these amounts are affected by historical and projected prices for oil and natural gas which have typically been volatile. It is reasonably possible that the Company's oil and gas reserve estimates will materially change in the forthcoming year. At December 31, 1996, the Company's gas plant had a net carrying value of approximately $3,340,000. The determination of impairment of the gas plant may change in the future based on the Company's ability to continue to develop its properties whereby sufficient quantities of natural gas and liquids are available to operate the plant profitably. Income Taxes - Income taxes are provided for in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." SFAS No. 109 requires an asset and liability approach in the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of the Company's assets and liabilities. Revenue Recognition - The Company recognizes gas plant revenues and oil and gas sales upon delivery to the purchaser. Revenues from oil field services are recognized as the services are performed. Oil field supply and equipment sales are recognized when the goods are shipped to the customer. Net Loss Per Common Share - Net loss per common share is computed by dividing the net loss applicable to common stockholders (which includes accrued but unpaid preferred dividends) by the weighted average number of common shares outstanding during the year. All common stock equivalents have been excluded from the computations because their effect would be anti-dilutive. In connection with the 1995 conversion of preferred stock to common stock discussed in Note 6, the Company experienced a significant change in its capital structure. The pro forma effect of these changes, as if the conversions occurred on January 1, 1995, would have resulted in a reduction in the 1995 loss applicable to common stockholders before non-cash inducement from $.18 per share to $.14 per share. The pro forma loss per F-10 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS share calculations give effect to 4,257,455 common shares which were issued in the conversion and the elimination of dividends related to the converted preferred shares of approximately $117,000 for 1995. However, the pro forma information does not give effect to the inducement discussed in the following paragraph. The Company completed a tender offer to the Company's preferred stockholders in February 1995. In connection therewith, the Company offered the preferred holders 4.5 common shares for each preferred share owned. The 4.5 shares represented an increase from the original terms of the preferred stock which provided for 2.625 common shares for each preferred share. Under a recently issued accounting pronouncement, the Company was required to reduce earnings available to common stockholders by the fair value of the additional shares which were issued to induce the preferred stockholders to convert their shares. Since the Company issued an additional 1,750,000 common shares in the tender offer compared to the shares that would have been issued under the original terms of the preferred stock, the Company was required to deduct the fair value of these additional shares of $1,523,906 from earnings available to common stockholders. This non-cash charge resulted in the reduction of earnings per share by $.24 for the year ended December 31, 1995. While this charge is intended to show the cost of the inducement to the owners of the Company's common shares immediately before the tender offer, management does not believe that it accurately reflects the impact of the tender offer on the Company's common stockholders. As disclosed to the preferred stockholders in connection with the tender offer, the book value per share of common stock increased from a negative amount to approximately $1.00 per share as a result of the tender offer. Therefore, management believes that, even though the current accounting rules require the $.24 charge per common share, there are other significant offsetting factors by which the common shareholders benefited from this conversion which are not reflected in the 1995 earnings per share presentation. Stock-Based Compensation - The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, compensation cost for stock options granted to employees is measured as the excess, if any, of the quoted market price of the Company's common stock at the measurement date (generally, the date of grant) over the amount an employee must pay to acquire the stock. In October 1995, the Financial Accounting Standards Board issued a new statement titled "Accounting for Stock-Based Compensation" (FAS 123). FAS 123 requires that options, warrants, and similar instruments which are granted to non-employees for goods and services be recorded at fair value on the grant date. Fair value is generally determined under an option pricing model using the criteria set forth in FAS 123. Reclassifications - Certain reclassifications have been made to the 1995 financial statements to conform to the presentation in 1996. The reclassifications had no effect on the 1995 net loss. 2. RESTRUCTURING: During 1995, in light of declining natural gas prices, declining rig counts, lackluster margins and the competitive environment inherent in the F-11 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS oil and gas industry, the Company undertook steps to reduce operating costs, increase efficiencies, reduce operating risks and generate additional working capital. During the second quarter of 1995, the Company announced a restructuring program that included substantially downsizing its service and supply businesses and closing its administrative office in Denver, Colorado. As a result of this restructuring, 35 of the Company's 70 employees were terminated, and service equipment, land and buildings were sold. As of December 31, 1995, the Company recognized $226,986 of costs incurred in connection with both the tender offer discussed in Note 6, and the restructuring discussed above. The costs recognized in the restructuring consist primarily of severance pay, a loss on the abandonment of the office lease, and a $90,000 loss from the liquidation of inventory at an auction. For the year ended December 31, 1995, the operating revenues and net operating loss of the service and supply businesses, exclusive of restructuring charges and gains on sales of assets, were as follows: Revenues $1,302,741 Operating costs (1,391,588) Depreciation (157,380) ---------- Net operating loss $(246,227) ========== Substantially, all of the 1995 net operating loss from these operations was incurred prior to completion of the restructuring discussed above. 3. DEBT FINANCING ARRANGEMENTS: Long-Term Debt - Long-term debt at December 31, 1996 and 1995, consists of the following:
1996 1995 ----- ---- Unaffiliated Parties: Collateralized convertible 10% debentures due April 2001 ............. $5,000,000 $ -- Other installment notes. Interest at 6.9% to 9.75%, monthly principal and interest payments of approximately $3,440 through 1998. All of the notes are collateralized by vehicles ............................. 52,555 85,423 Contract payable, $4,444 credited monthly against gas purchases, due July 1997, collateralized by certificate of deposit ................... 13,334 66,667 Note payabel to a bank, interest at prime plus 3% ..................... -- 1,762,802 F-12 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1996 1995 ----- ---- Convertible 12% debentures, due May 1996, convertible into 82,353 share of common stock .......................................... -- 70,000 ---------- --------- Total unaffiliated parties ...................................... 5,065,889 1,984,892 ---------- --------- Related Parties: Note payable to the Company's president and CEO. Interest at 6% annual principal payments of $65,000 due January 1997 and 1998. note is convertible into common stock at $5.00 per share and is collateralized by equipment ........................................... 130,000 130,000 Unsecured notes payable to the Company's president and CEO and various entities controlled by him. Interest at 8% to 10% with principal and interest due January 1, 1997 ............................ 116,719 176,717 Accrued interest ...................................................... 39,177 32,024 --------- --------- Total related parties ............................................. 285,896 338,741 --------- --------- Total long-term debt .................................................. 5,351,785 2,323,633 Less current maturities: Related parties .................................................... (285,896) -- Other .............................................................. (45,944) (1,100,474) --------- --------- Total long-term debt, less current maturities ..................... $5,019,945 $1,223,159 ========= ==========
In March 1996, the Company's president agreed to extend the due date of a delinquent $60,000 note payable to him. As consideration for the extension, the Company's Board of Directors approved amending the note to provide for conversion to common stock at $1.00 per share. In December 1996, the president exercised the conversion feature. The Company's Board of Directors has resolved to repay all outstanding loans from related parties during 1997. Accordingly, all such amounts are included in current liabilities in the 1996 balance sheet. F-13 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Aggregate Debt Maturities - The aggregate maturities of long-term debt are as follows: Year Ending Related December 31, Parties Others Total ------------ ------- ------ ----- 1997 $285,896 $ 45,944 $ 331,840 1998 -- 19,945 19,945 2001 -- 5,000,000 5,000,000 -------- --------- --------- $285,896 $5,065,889 $5,351,785 ======== ========== ========== Convertible Debt and Consulting Agreement - In March 1996, the Company entered into a consulting agreement with a company (the "Consultant") that specializes in developing and implementing capitalization plans, including the utilization of debt capital in business operations. The initial term of the agreement is for two years and provides for minimum monthly cash payments of $17,500. The Consultant can elect to extend the agreement for an additional period of one year. In addition to cash compensation, the Company agreed to grant warrants to purchase 1,000,000 shares of the Company's common stock. The exercise price of the warrants is $.75 per share and they expire in March 2001. In April 1996, the Company, with the assistance of the Consultant, initiated a private placement to sell up to $5,000,000 of collateralized convertible debentures in the form of "Units." Each Unit consists of one $50,000 five-year 10% collateralized convertible debenture and warrants to purchase 25,000 shares of the Company's common stock at $1.25 per share (see Note 7 for additional information with respect to the warrants). In November 1996, the offering was completed and the Company was successful in selling the entire $5,000,000 generating net cash proceeds of $4,300,000. The debentures are collateralized by a first priority interest in certain oil and gas properties owned and operated by the Company. The debentures are convertible, at the holders option, into the Company's common stock for $3.00 per share and may be redeemed by the Company, in whole or in part, beginning at a premium of 110% of the original principal amount and are subject to adjustment beginning on April 25, 1999. Interest on the debentures is payable quarterly commencing on September 30, 1996 and the entire principal balance is due on April 15, 2001. The Company also agreed to pay the Consultant a fee equal to 2% of the net proceeds from the private placement and up to 7% from the net proceeds from any warrants which are exercised during the term of the agreement or up to six months after termination in certain circumstances. All of the compensation paid to the Consultant is limited to 15% of the gross proceeds generated from the private placement, exercise of warrants, or other debt or equity financings that may be consummated during the term of the agreement. In August 1996, a major shareholder of the Consultant was elected to the Company's Board of Directors. F-14 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. INCOME TAXES: The Company's income tax benefit for the years ended December 31, 1996 and 1995 consists of the following:
1996 1995 ---- ---- Current benefit (provision) $ 41,409 $ (21,000) Deferred benefit -- 400,000 --------- ---------- Total $ 41,409 $ 379,000 ========= ==========
A reconciliation of the income tax benefit at the statutory rate to the income tax benefit reported in the accompanying financial statements is as follows:
1996 1995 ---- ---- Computed tax benefit at the expected statutory rate $ 494,000 $ 389,100 State income taxes and other 39,000 10,900 Federal income taxes assessed in audit -- (21,000) Increase in valuation allowance (533,000) -- Federal income tax refund 41,409 -- --------- ---------- Total $ 41,409 $ 379,000 ========= ==========
Deferred tax assets (liabilities) as of December 31, 1996 and 1995 are comprised of the following:
1996 1995 ---- ---- Long-term Assets: Net operating loss carryforwards $ 3,616,000 $ 3,050,000 Tax credit carryforwards 294,000 294,000 Percentage depletion carryforwards 58,000 58,000 Other 25,000 45,000 --------- ---------- Total 3,993,000 3,447,000 Less valuation allowance (1,770,000) (1,237,000) --------- ---------- 2,223,000 2,210,000 Long-term liability for property and equipment (2,223,000) (2,210,000) --------- ---------- Net long-term liability $ -- $ -- ========= ==========
F-15 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company has provided a valuation allowance for the net operating loss and credit carryforwards based upon the various expiration dates and the limitations which exist under IRS Sections 382 and 384. During the year ended December 31, 1996, the Company increased the valuation allowance by $533,000 primarily due to an increase in the net operating loss carryforwards which are not considered to be realizable. At December 31, 1996, the Company has net operating loss carryforwards for income tax purposes of approximately $9,600,000, which expire primarily in 2008 through 2011. Approximately $2,880,000 of these net operating losses are subject to limitations under IRS Sections 382 and 384. These losses may only offset future taxable income to the extent of approximately $335,000 per year and generally may not offset any gain on the sale of assets acquired in the acquisition of Skaer Enterprises, Inc. Additionally, the Company has tax credit carryforwards at December 31, 1996, of approximately $294,000 and percentage depletion carryforwards of approximately $150,000. 5. COMMITMENTS AND CONTINGENCIES: Gas Contracts - The Company operates a natural gas processing plant (the "Gas Plant"). The Company had a contract with a major utility which called for the major utility to purchase a minimum of 2.92 billion cubic feet ("BCF") and a maximum of 3.65 BCF of natural gas annually. The price paid by the major utility was on an MMBTU basis above the Colorado Interstate Gas Company's Northern Pipeline "spot" price. The contract expired on June 30, 1996. Historically, the price paid under this contract was at a premium above the market which allowed the Company to conduct its marketing and trading activities. The expiration of this contract and the corresponding loss of the market premium resulted in the elimination of the Company's marketing and trading activities beginning in July 1996. Management is continuing to explore alternatives with the major utility and other purchasers of natural gas in order to maximize the Company's natural gas revenue. The Company also had a contract with an independent producer that required purchases of gas quantities at a fixed margin per MMBTU for any difference between plant sales and the contract volumes with the utility. This contract also expired in June 1996. The revenue and corresponding costs incurred pursuant to these contracts have been reflected as Gas Marketing and Trading in the consolidated statements of operations. Leases - The Company leases its office facilities under noncancellable operating leases. The total minimum commitments under these leases amounted to approximately $100,000 as of December 31, 1996. Total rent expense under all operating leases for the years ended December 31, 1996 and 1995, was $26,807 and $90,569, respectively. F-16 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Employment Agreements - During 1994, the Board of Directors approved employment agreements with the Company's executive officers. The agreements may be terminated by the officers upon 90 days notice or by the Company without cause upon 30 days notice. In the event of a termination by the Company without cause, the Company would be required to pay the officers their respective salaries for one to three years. If the termination occurs following a change in control, the Company would be required to make lump sum payments equivalent to two to three years salary for each of the officers. Profit Sharing Plan - The Company has established a 401(k) profit sharing plan that covers all employees with one month of service who elect to participate in the Plan. The Plan provides that the employees may elect to contribute up to 15% of their salary to the Plan. All of the Company's contributions are discretionary and amounted to $8,926 and $2,996 for the years ended December 31, 1996 and 1995, respectively. Contingencies - The Company may from time to time be involved in various claims, lawsuits, disputes with third parties, actions involving allegations of discrimination, or breach of contract incidental to the operations of its business. The Company is not currently involved in any such incidental litigation which it believes could have a materially adverse effect on its financial condition or results of operations. 6. PREFERRED STOCK: The Company has the authority to issue up to 2,000,000 shares of Preferred Stock, which may be issued in such series and with such preferences as determined by the Board of Directors. During 1993, the Company issued 1,170,000 shares of Series A Cumulative Convertible Preferred Stock (the "Preferred Stock"). At December 31, 1996, the Preferred Stock had a liquidation preference of $12.25 per share ($10 liquidation value plus $2.25 of dividends in arrears), and each share of Preferred Stock was convertible into 3.0625 shares of common stock and warrants to purchase 3.0625 common shares. Each warrant entitles the holder to purchase one share of common stock at $6.00 per share through August 13, 1998, when the warrants expire. The Preferred Stock will automatically convert into common stock if the reported sale of Preferred Stock equals or exceeds $13.00 per share for ten consecutive days. The Company may redeem the Preferred Stock at $10.00 per share plus any dividends in arrears. Each share of Preferred Stock is entitled to receive dividends at 10% per annum when, as and if declared by the Company's Board of Directors. Unpaid dividends accrue and are cumulative. In February 1995, the Company completed a tender offer to the preferred stockholders whereby the holders of the Preferred Stock were given the opportunity to convert each share of Preferred Stock and all accrued and undeclared dividends (including the full dividend for the quarters ended December 31, 1994 and March 31, 1995) into 4.5 shares of the Company's common stock. As a result of this tender offer, 933,492 shares of the preferred stock converted into 4,200,716 shares of the Company's common stock. In connection with the tender offer and other conversions of preferred stock through December 31, 1996, warrants for an aggregate of 2,605,900 shares are outstanding. F-17 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Through December 31, 1996, the Board of Directors has elected to forego the declaration of the regular quarterly dividend for five consecutive quarters resulting in dividends in arrears of approximately $405,000 ($2.25 per share) related to 179,938 outstanding shares of Preferred Stock. The Company is precluded from paying dividends on its common stock so long as any dividends on the Preferred Stock are in arrears. The terms of the Preferred Stock prohibited the Company from entering into certain transactions without an affirmative vote of the preferred stockholders. Otherwise, the preferred stockholders have no voting rights. In connection with the Company's 1993 preferred stock offering, the Company issued warrants to the underwriter to purchase 90,000 shares of preferred stock at $12.00 per share. If not previously exercised, these warrants will expire in August 1998. In 1993, the Company also granted warrants to a consultant for the purchase of 60,000 shares of common stock. The warrants are exercisable for $6.00 per share and expired in November 1996. 7. STOCK BASED COMPENSATION: Stock Option Plans - The Company's shareholders have approved four stock option plans that authorize an aggregate of 900,000 shares for stock options that may be granted to officers, directors, employees, and consultants. The plans permit the issuance of incentive and non-statutory options and provide for a minimum exercise price equal to 100% of the fair market value of the Company's common stock on the date of grant. The maximum term of options granted under the plans is 10 years and options granted to employees expire three months after the termination of employment. None of the options may be exercised during the first six months of the option term. No options may be granted after 10 years from the adoption date of each plan. The following is a summary of activity under these stock option plans for the years ended December 31, 1996 and 1995:
1996 1995 -------------------------- --------------------------- Weighted Weighted Average Average Number Exercise Number Exercise of Shares Price of Shares Price --------- --------- --------- --------- Outstanding, beginning of year 459,600 $.94 347,000 $3.53 Canceled - - (224,000) 3.43 Expired (4,000) 7.19 (99,000) 3.70 Granted 165,700 1.39 435,600 .79 ------- ------- Outstanding, end of year 621,300 1.02 459,600 .94 ======= =======
F-18 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For all options granted during 1996 and 1995, the weighted average market price of the Company's common stock on the grant date was approximately equal to the weighted average exercise price. At December 31, 1996, options for 542,000 shares were exercisable and options for the remaining 79,300 shares became exercisable in February 1997. If not previously exercised, options outstanding at December 31, 1996, will expire as follows: Weighted Average Number Exercise Year Ending December 31, of Shares Price ----------------------- --------- -------- 1997 5,000 $3.44 1998 15,000 2.94 2000 295,600 .83 2000 140,000 .70 2001 86,400 1.00 2001 79,300 1.81 ------- 621,300 ======= Warrants and Non-Qualified Stock Options - The Company has also granted warrants and non-qualified options which are summarized as follows for the years ended December 31, 1996 and 1995:
1996 1995 ----------------------- --------------------------- Weighted Weighted Average Average Number Exercise Number Exercise of Shares Price of Shares Price --------- -------- --------- -------- Outstanding, beginning of year 3,359,418 $5.00 232,302 $4.05 Granted to: Officer and director 101,500 1.00 -- -- Consultants 1,090,000 .75 358,000 .97 Former officer and director -- -- 77,000 3.61 Investors in private placements of: Common stock -- -- 250,000 1.25 Convertible debentures 2,500,000 1.25 -- -- Brokers in private placement of convertible debentures 223,500 2.00 -- -- Issued to former holders of preferred stock upon conversion 69,670 6.00 2,507,116 6.00 Repriced -- -- (15,000) 6.00 Expired (60,000) 6.00 (50,000) .85 Exercised (67,500) .95 -- -- --------- --------- Outstanding, end of year 7,216,588 2.94 3,359,418 5.00 ========= =========
F-19 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS All outstanding warrants and non-qualified options were exercisable at December 31, 1996. If not previously exercised, warrants and non-qualified options outstanding at December 31, 1996, will expire as follows: Weighted Average Number Exercise Year Ending December 31, of Shares Price ------------------------ --------- -------- 1997 400,000 $1.25 1998 2,605,900 6.00 1998 118,188 1.51 1999 223,500 2.00 1999 50,000 3.34 2000 118,000 .76 2000 77,000 3.61 2001 1,040,000 .75 2001 101,500 1.00 2001 2,482,500 1.25 --------- Total 7,216,588 ========= Presented below is a comparison of the weighted average exercise price and market price of the Company's common stock on the measurement date for all warrants and stock options granted to non-employees during 1996 and 1995:
1996 1995 -------------------------------- ------------------------------- Number of Exercise Market Number of Exercise Market Shares Price Price Shares Price Price --------- -------- ------ --------- -------- ------ Market price equal to exercise price 101,500 $1.00 $1.00 118,000 $ .76 $ .76 Market price greater than exercise price 50,000 .85 1.00 -- -- -- Exercise price greater than market price 3,763,500 1.16 .69 567,000 1.50 .79
Fair value of all warrants and stock options granted to non-employees during the year ended December 31, 1996, was determined using the Black-Scholes option pricing model. Significant assumptions included a risk-free interest rate of 6.5%, expected volatility of 63%, and that no dividends would be declared during the expected term of the options. The F-20 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS weighted average contractual term of the options was approximately 4.8 years compared to a weighted average expected term of 1.9 years. The estimated fair value of warrants granted to non-employees in 1996 amounted to $600,000, which is recorded as a debt issuance cost in the 1996 balance sheet. In connection with private placements of debt and equity securities, the Company granted common stock purchase warrants that are redeemable at the option of the Company. Presented below is a summary of these warrants: Redemption Year Expiration Exercise Number of Price Per Granted Date Price Shares Share ------- ---------- -------- --------- ---------- 1994 August 1998 $1.92 83,188 $.25 1995 April 1997 1.25 250,000 .25 1996 July 2001 1.25 2,500,000 .10 In December 1996, the Company provided notice of redemption to the holders of the warrants granted in 1995. Accordingly, the holders must exercise their warrants by January 31, 1997 or accept the redemption price (see Note 11). Pro Forma Stock-Based Compensation Disclosures - The Company applies APB Opinion 25 and related interpretations in accounting for stock options and warrants which are granted to employees. Accordingly, no compensation cost has been recognized for grants of options and warrants to employees since the exercise prices were not less than the fair value of the Company's common stock on the grant dates. Had compensation cost been determined based on the fair value at the grant dates for awards under those plans consistent with the method of FAS 123, the Company's net loss and loss per share would have been changed to the pro forma amounts indicated below. Year Ended December 31, ------------------------ 1996 1995 ---- ---- Net loss applicable to common stockholders: As reported $(1,614,270) $(2,609,030) Pro forma (1,764,270) (2,772,030) Net loss per common share: As reported $ (.22) $ (.42) Pro forma (.24) (.45) F-21 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The fair value of each employee option and warrant granted in 1996 and 1995 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: Year Ended December 31, ----------------------- 1996 1995 ---- ---- Expected volatility 64% 61% Risk-free interest rate 6.5% 6.5% Expected dividends -- -- Expected terms (in years) 3.4 3.3 8. FINANCIAL INSTRUMENTS: Statement of Financial Accounting Standards No. 107 requires all entities to disclose the fair value of certain financial instruments in their financial statements. Accordingly, at December 31, 1996, management's best estimate is that the carrying amount of cash, receivables, notes payable to unaffiliated parties, accounts payable, and accrued expenses approximates fair value due to the short maturity of these instruments. Management estimates that fair value is approximately equal to carrying value of the convertible debentures since market interest rates have not changed significantly since the offering commenced. Management estimates that fair value differs from carrying value for the following instruments as of December 31, 1996 and 1995:
1996 1995 --------------------- ------------------------ Carrying Fair Carrying Fair Value Value Value Value Long-term portion of accrued $256,088 $225,000 $379,652 $335,000 production taxes Notes payable to related parties 285,896 271,000 338,741 300,000
Fair value of the above debt instruments was estimated using market interest rates at December 31, 1996 for debt with comparable terms. 9. SIGNIFICANT CONCENTRATIONS: Substantially all of the Company's accounts receivable at December 31, 1996 and 1995, result from crude oil, natural gas sales, and joint interest billings to companies in the oil and gas industry. This concentration of customers and joint interest owners may impact the Company's overall credit risk, either positively or negatively, since these entities may be similarly affected by changes in economic or other conditions. In determining whether or not to require collateral from a customer or joint F-22 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS interest owner, the Company analyzes the entity's net worth, cash flows, earnings, and/or credit ratings. Receivables are generally not collateralized; however, receivables from joint interest owners are subject to collection under operating agreements which generally provide lien rights. Historical credit losses incurred on trade receivables by the Company have been insignificant. The Company's oil and gas properties are predominantly located in a single basin in which the gas marketing arrangements are influenced by local supply and demand. Accordingly, in comparison to the net price received by gas producers in many other areas of the United States, the Company often realizes a lower net sales price. Additionally, since the Company's gas plant is located in this basin and its oil field service and supply operations are conducted in this basin, the Company is vulnerable to a curtailment in drilling activity in order to realize the value of oil field inventories and related operating assets. At December 31, 1996, the Company had a receivable from a single customer for $67,718, which was collected in January 1997. For the years ended December 31, 1996 and 1995, the Company had natural gas sales to the major utility discussed in Note 5 which accounted for 34% and 46% of total revenues, respectively. For the year ended December 31, 1996, the Company also had oil sales to a single customer which accounted for 11% of total revenues. At December 31, 1996, the Company has temporary cash investments of $1,941,550 with a single financial institution. 10. FOURTH QUARTER ADJUSTMENTS: During the fourth quarter of 1996, the Company recognized a charge of $450,000 for drilling costs related to an unsuccessful well. This charge is included in dry holes, plugging and abandonments in the 1996 statement of operations. 11. SUBSEQUENT EVENTS (UNAUDITED): Property Acquisitions - In January 1997, the Company completed the acquisition of a 7.8125% after prospect payout working interest in a producing oil and gas prospect in Louisiana. The prospect is operated by Natural Energy Group, Inc. (NEGX), an independent oil and gas producer. The purchase price was $1,750,000 which consisted of $875,000 in cash and the issuance of 315,000 shares of the Company's common stock with a fair value of $875,000. In February 1997, the Company entered into agreements with unaffiliated parties for the purchase of a 10% working interest in this prospect. The purchase price totals $2.5 million and the agreements provide for an effective date of October 16, 1996. NEGX is the operator of these properties. F-23 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In February 1997, the Company entered into an agreement with NEGX that provides the Company with the right and the obligation to participate as a 12.5% working interest owner in NEGX's defined drilling program. The agreement provides that the Company will be required to pay 16.7% of the costs to earn its 12.5% interest, under certain circumstances. The Company is also committed to participate in other prospects operated by NEGX through February 1999 when the initial term of the agreement expires. Management estimates that the Company's capital requirements under this agreement will be between $5 million and $20 million for the year ending December 31, 1997. Financing Arrangements - In January 1997, the Company commenced a private placement of up to 1,500,000 shares of common stock for $2.50 per share. In connection with the private placement, the Company agreed to use its best efforts to register the shares for sale by including such securities in a registration statement. As of March 10, 1997, the Company had received subscriptions for the entire 1,500,000 shares resulting in total proceeds of $3,750,000. Commissions and other costs of the offering are estimated to be approximately 10% of the gross proceeds. Through March 25, 1997, options and warrants were exercised for an aggregate of 1.65 million shares, resulting in net proceeds of $1.9 million. In February 1997, the Company entered into a letter of intent with an underwriter for a proposed private placement of the Company's common stock. The aggregate gross proceeds of the offering will be at least $6 million unless otherwise agreed by the parties. The underwriter would receive commissions equal to 10% of the gross proceeds and warrants to purchase the Company's common stock. In January 1997, options for 190,000 shares of the Company's common stock were granted to officers and directors. The options are exercisable at $2.97 per share and expire in January 2002. 12. SUPPLEMENTAL OIL AND GAS DISCLOSURES: Costs Incurred in Oil and Gas Producing Activities - The following is a summary of costs incurred in oil and gas producing activities for the years ended December 31, 1996 and 1995: 1996 1995 ---- ---- Property acquisition costs $ 16,022 $ 60,000 Development costs 806,564 161,000 Exploration costs 555,685 -- --------- -------- Total $1,378,271 $ 221,000 ========= ======== F-24 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Results of Operations from Oil and Gas Producing Activities - Results of operations from oil and gas producing activities (excluding natural gas marketing and trading, well administration fees, general and administrative expenses, and interest expense) for the years ended December 31, 1996 and 1995 are presented below. 1996 1995 ---- ---- Oil and gas sales: LGPCo $ 340,000 $ 373,000 Unaffiliated entities 2,207,000 2,251,000 --------- --------- Total oil and gas sales 2,547,000 2,624,000 Exploration and abandonment expenses (556,000) (19,000) Production costs (1,427,000) (1,617,000) Depletion, depreciation and impairment (590,000) (742,000) Imputed income tax benefit (provision) 10,000 (91,000) --------- --------- Results of operations from oil and gas producing activities $ (16,000) $ 155,000 ========= ========= Oil and Gas Reserve Quantities (Unaudited) - Proved oil and gas reserves are the estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed oil and gas reserves are those reserves expected to be recovered through existing wells with existing equipment and operating methods. The reserve data is based on studies prepared by the Company's consulting petroleum engineers. Reserve estimates require substantial judgment on the part of petroleum engineers resulting in imprecise determinations, particularly with respect to new discoveries. Accordingly, it is expected that the estimates of reserves will change as future production and development information becomes available. Approximately 25% of the Company's proved developed reserves are currently non-producing as certain wells require workovers, recompletions, or construction of a gathering system to an existing gas pipeline at an estimated total cost of $1.4 million. All proved oil and gas reserves are located in the United States. The following table presents estimates of the Company's net proved oil and gas reserves, and changes therein for the years ended December 31, 1996 and 1995. F-25 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Changes in Net Quantities of Proved Reserves (Unaudited)
1996 1995 ------------------------- --------------------------- Oil Gas Oil Gas (Bbls) (Mcf) (Bbls) (Mcf) Proved reserves, beginning of year 1,294,000 5,851,000 1,352,000 5,724,000 Purchase of minerals in place 7,000 - 38,000 447,000 Sale of minerals in place (27,000) (26,000) (14,000) (107,000) Extensions, discoveries other additions 72,000 455,000 82,000 382,000 Revisions of previous estimates (71,000) (1,035,000) (43,000) (98,000) Production (100,000) (412,000) (121,000) (497,000) --------- ---------- --------- --------- Proved reserves, end of year 1,175,000 4,833,000 1,294,000 5,851,000 ========= ========== ========= ========= Proved developed reserves, end of year 1,034,000 4,078,000 1,014,000 4,302,000 ========= ========== ========= ---------
Standardized Measure of Discounted Future Net Cash Flows (Unaudited) - Statement of Financial Accounting Standards No. 69 prescribes guidelines for computing a standardized measure of future net cash flows and changes therein relating to estimated proved reserves. The Company has followed these guidelines which are briefly discussed below. Future cash inflows and future production and development costs are determined by applying year-end prices and costs to the estimated quantities of oil and gas to be produced. Estimated future income taxes are computed using current statutory income tax rates including consideration for estimated future statutory depletion and tax credits. The resulting future net cash flows are reduced to present value amounts by applying a 10% annual discount factor. The assumptions used to compute the standardized measure are those prescribed by the Financial Accounting Standards Board and, as such, do not necessarily reflect the Company's expectations for actual revenues to be derived from those reserves nor their present worth. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the standardized measure computations since these estimates are the basis for the valuation process. F-26 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following summary sets forth the Company's future net cash flows relating to proved oil and gas reserves as of December 31, 1996 and 1995 based on the standardized measure prescribed in Statement of Financial Accounting Standards No. 69. 1996 1995 ---- ---- Future cash inflows $ 46,727,000 $ 32,620,000 Future production costs (17,220,000) (13,871,000) Future development costs (3,001,000) (3,269,000) Future income tax expense (6,200,000) (1,800,000) ----------- ----------- Future net cash flows 20,306,000 13,680,000 10% annual discount for estimated timing of cash flow (8,326,000) (5,200,000) ----------- ---------- Standardized Measure of Discounted Future Net Cash Flows $ 11,980,000 $ 8,480,000 ========== ========== Changes in Standardized Measure (Unaudited) - The following are the principal sources of change in the standardized measure of discounted future net cash flows for the years ended December 31, 1996 and 1995:
1996 1995 ---- ---- Standardized measure, beginning of year $ 8,480,000 $ 6,500,000 Sale of oil and gas produced, net of production costs (1,120,000) (1,006,000) Purchase of minerals in place 45,000 228,000 Sale of minerals in place (45,000) (80,000) Net changes in prices and production costs 8,815,000 617,000 Net changes in estimated development costs 233,000 785,000 Revisions of previous quantity estimates (3,769,000) (803,000) Discoveries, extensions, and other additions 1,089,000 620,000 Accretion of discount 848,000 650,000 Changes in income taxes, net (2,596,000) 969,000 ----------- ---------- Standardized Measure, end of year $ 11,980,000 $ 8,480,000 ========== ==========
F-27 PEASE OIL AND GAS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Gas Plant (Unaudited) - The Company processes most of the natural gas from its properties in a gas plant owned by the Company. Since the revenues from the Company's properties are subject to agreements with royalty owners and, in some cases, other working interest owners, gas processing agreements have been entered into to set forth the contractual arrangements for processing charges. Generally, the Company's processing fee consists of ownership of the natural gas liquids and a portion of the residue gas that results from processing. The Standardized Measure of Discounted Future Net Cash Flows shown above excludes the Company's share of the natural gas liquids and residue gas related to the Company's gas processing activities, as well as marketing and trading activities. The Company's reserve engineer has prepared the following estimates for the reserves related to these activities as of December 31, 1996. Future net revenues, discounted at 10% $ 537,000 ========= Net quantities: Natural gas (mcf) 1,514,000 ========= Liquids (bbls) 237,000 ========= F-28 EXHIBIT INDEX Exhibit Description Page No. - ------- ----------- -------- (3.1) Articles of Incorporation, as amended. (1) (3.2) Plan of Recapitalization. (1) (3.3) Certificate of Amendment to the Articles of Incorporation filed on July 6, 1994. (2) (3.4) Certificate of Amendment to the Articles of Incorporation filed on December 19, 1994. (2) (3.5) Bylaws, as amended and restated May 11, 1993. (1) (4.1) Representative's Preferred Stock Purchase Warrant. (1) (4.2) Warrant Agency Agreement between Willard Pease Oil and Gas Company and American Securities Transfer, Inc. dated August 23, 1993. (1) (4.3) Amendment to Warrant Agency Agreement dated January 5, 1995. (2) (4.4) Certificate of Designation of Series A Cumulative Convertible Preferred Stock. (1) (4.5) Certificate of Amendment of Certificate of Designation of Series A Cumulative Convertible Preferred Stock filed on August 16, 1993. (2) (4.6) Second Certificate of Amendment of Certificate of Designation of Series A Cumulative Convertible Preferred Stock filed on November 1, 1994. (2) (10.1) Residue Gas Sales and Purchase Agreement dated June 22, 1986, between Western Gas Supply Company and Loveland Gas Processing, Ltd., and Amendments dated July 30, 1986, August 12, 1986, September 11, 1986, April 16, 1987, April 1, 1988, January 2, 1992, March 26, 1992 and May 1, 1992. (1) (10.2) Amendment dated December 1, 1993, between Public Service Company of Colorado and Loveland Gas Processing Co., Ltd., to Residue Gas Sales and Purchase Agreement dated June 22, 1986, between Western Gas Supply Company and Loveland Gas Processing, Ltd. (2) (10.3) Gas Purchase and Sale Contract dated November 1, 1988, between Fuel Resources Development Co. as seller and Loveland Gas Processing Co., Ltd., as buyer, pertaining to the purchase of gas, and Amendments dated November 1, 1990, January 24, 1991, May 1, 1991, July 5, 1991, August 1, 1991, April 1, 1992 and August 1, 1992. (1) (10.4) Purchase Order No. 5 dated January 1, 1994 from Loveland Gas Processing Co., Ltd. to Fuel Resources Development Co. that amends the Gas Purchase and Sale Contract dated November 1, 1988, between Fuel Resources Development Co. and Loveland Gas Processing, Ltd. (2) (10.5) Form of Warrants issued to Ronin Group Ltd., and Clemons F. Walker for the purchase of an aggregate of 240,000 shares of Common Stock. (3) (10.6) 1990 Stock Option Plan. (1) (10.7) 1993 Stock Option Plan (1) (10.8) 1994 Employee Stock Option Plan. (2) (10.9) Form of 12% Convertible Unsecured Promissory Notes issued by Pease Oil and Gas Company in 1994 Private Placement. (2) (10.10) Form of Warrants issued to brokers Sales Agents in 1994 Private Placements. (2) (10.11) Employment Agreement effective September 16, 1994 between Pease Oil and Gas Company and Willard H. Pease, Jr. (2) (10.12) Employment Agreement effective December 27, 1994 between Pease Oil and Gas Company and Patrick J. Duncan. (2) (10.13) Employment Agreement effective December 27, 1994 between Pease Oil and Gas Company and James N. Burkhalter. (2) Exhibit Description Page No. - ------- ----------- -------- (10.18) Interconnect Agreement dated January 1, 1995, between KN Front Range Gathering Company and Loveland Gas Processing Co., Ltd.(2) (10.19) Gas Gathering Agreement dated February 1, 1995, between KN Front Range Gathering Company and Loveland Gas Processing Co., Ltd. (2) (10.20) Agreement dated August 15, 1994, between Hewlett-Packard Company, Loveland Gas Processing Co., Ltd., Pease Oil and Gas Company and Pease Operating Company. (2) (10.21) Purchase and Sale Agreement dated April 24, 1995 among Pease Oil and Gas Company, Thermo Cogeneration Partnership, L.P and Seahawk Energy, Inc. (3) (10.22) Agreement between Beta Capital Group, Inc., and Pease Oil and Gas Company dated March 9, 1996. (4) (10.24) Form of Warrant issued to Beta Capital Group, Inc. (10.25) 1996 Stock Option Plan. (10.26) Mortgage, Assignment of Proceeds, Security Agreement and Financing Statement from Pease Oil and Gas Company to Holders of 1996 Collateralized Subordinated Convertible Debentures dated as of November 15, 1996. (10.27) Purchase and Sale Agreement dated December 31, 1996 by and between Atocha Exploration, Inc., Browning Oil Company, Inc., Potosky Oil and Gas, Inc. and Pease Oil and Gas Company. (5) (10.28) Letter Agreement dated February 4, 1997 by and between National Energy Group, Inc. and Pease Oil and Gas Company. (6) (10.29) Purchase and Sale Agreement dated February 26, 1997 by and between Transworld Exploration & Production, Inc. (7) (21) List of Subsidiaries. (3) (23) Consents of Experts (23.1) Consent of McCartney Engineering, LLC Consulting Petroleum Engineers (23.2) Consent of Hein + Associates LLP, Certified Public Accountants (27) Financial Data Schedule. (1) Incorporated by reference to Registration Statement No. 33-64448 on Form SB-2. (2) Incorporated by reference to the Registrant's 1994 Annual Report on Form 10-KSB for the fiscal year ended December 31, 1994. (3) Incorporated by reference to Registration Statement No. 33-94536 on Form SB-2. (4) Incorporated by reference to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1995. (5) Incorporated by reference to Form 8-K filed January 10, 1997. (6) Incorporated by reference to Form 8-K filed February 19, 1997. (7) Incorporated by reference to Form 8-K filed March 17, 1997. EX-1 2 EXHIBIT 10.24-FORM OF WARRANT 1996-- - WARRANT A - ---------------- ----------------- WARRANT NO. Number of Shares THIS WARRANT HAS NOT BEEN REGISTERED UNDER THE UNITED STATES SECURITIES ACT OF 1933, AS AMENDED, AND MAY NOT BE SOLD, HYPOTHECATED OR OTHERWISE TRANSFERRED OR DISPOSED OF IN THE ABSENCE OF SUCH REGISTRATION, UNLESS AN EXEMPTION FROM THE REQUIREMENT OF SUCH REGISTRA TION IS AVAILABLE UNDER THE CIRCUMSTANCES AT THE TIME OBTAINING. Void After 5:00 P.M. Denver, Colorado Time on February 12, 2001 PEASE OIL AND GAS COMPANY Common Stock Purchase Warrant PEASE OIL AND GAS COMPANY, a NEVADA corporation ("Pease" or the "Company"), hereby certifies that, ----------------, with an address of - ------------------------------------------------------, or ------ permitted assigns, for valuable consideration received, is entitled, subject to the terms and conditions herein set forth, to purchase from the Company up to ------- fully paid and nonassessable shares of Common Stock, $0.10 par value per share, of the Company, at the per share purchase price of $0.75 per share (the "Purchase Price"), at any time or from time to time on or after the date hereof and up to 5:00 P.M. Denver, Colorado time on February 12, 2001 (the "Expiration Date"). The number and character of such shares of Common Stock are subject to adjustment as provided herein. 1. Definitions. As used herein, unless the context otherwise requires, the following terms have the following respective meanings: (a) "Act" shall mean the Securities Act of 1933, as amended. (b) "Additional Shares of Common Stock" shall mean all shares (including treasury shares) of Common Stock issued or sold (or, pursuant to Section 3.7 hereof, deemed to be issued) by the Company after the date hereof, whether or not subsequently reacquired or retired by the Company, other than shares of Common Stock issuable pursuant to this Warrant. (c) "Adjusted Exercise Price" shall have the meaning specified in Section 3.2 hereof. (d) "Company" means Pease Oil and Gas Company or any corporation which shall succeed to or assume the obligations of Pease Oil and Gas Company hereunder. - 1 - (e) "Common Stock" shall mean the Common Stock, par value $0.10 per share, of the Company and any stock into which such common stock shall have been changed or any stock resulting from any reclassification of such common stock, and shall include all other stock of any class (however designated) of the Company the holders of which have the right, without limitation as to amount, either to all or to a share of the balance of current dividends and liquidating dividends after the payment of dividends and distributions of any shares entitled to preference. (f) "Convertible Securities" shall mean any evidences of indebtedness, shares of stock (other than Common Stock) or other securities directly or indirectly convertible into or exchangeable for Common Stock, other than any securities issuable pursuant to this Warrant. (g) "Market Price", as used with reference to any share of stock on any specified date, shall mean: (i) if such stock is listed and registered on any national securities exchange or traded on The Nasdaq Stock Market ("Nasdaq"), (A) the last reported sale price on such exchange or Nasdaq of such stock on the business day immediately preceding the specified date, or (B) if there shall have been no such reported sale price of such stock on the business day immediately preceding the specified date, the average of the last reported sale price on such exchange or on Nasdaq on (x) the day next preceding the specified date for which there was a reported sale price and (y) the day next succeeding the specified date for which there was a reported sale price; or (ii) if such stock is not at the time listed on any such exchange or traded on Nasdaq but is traded on the over-the-counter market as reported by the National Quotation Bureau or other comparable service, (A) the average of the closing bid and asked prices for such stock on the business day immediately preceding the specified date, or (B) if there shall have been no such reported bid and asked prices for such stock on the business day immediately preceding the specified date, the average of the last bid and asked prices on (x) the day next preceding the specified date for which such information is available and (y) the day next succeeding the specified date for which such information is available; or (iii) if clauses (i) and (ii) above are not applicable, the fair value per share of such stock as determined in good faith and on a reasonable basis by the Board of Directors of the Company and, if requested, set forth in a certificate delivered to the holder of this Warrant upon the exercise hereof. - 2 - (h) "Options" shall mean rights, options or warrants to subscribe for, purchase or otherwise acquire either Common Stock or Convertible Securities. (i) "Other Securities" shall mean any stock and other securities of the Company or any other person (corporate or otherwise) which the holders of this Warrant at any time shall be entitled to receive, or shall have received, upon the exercise of this Warrant, in lieu of or in addition to the Common Stock, or which at any time shall be issuable or shall have been issued to holders of the Common Stock in exchange for, in addition to or in replace ment of the Common Stock or Other Securities pursuant to Section 3.5 or otherwise. (j) "Purchase Price" shall mean $0.75 per share, subject to adjustment as provided herein. 2. Exercise of Warrant. 2.1. Manner of Exercise. This Warrant may be exercised by the holder hereof, in whole or in part (but not as to fewer than 10,000 shares of the Common Stock unless, at the time of exercise, this Warrant entitles the holder to purchase fewer than 10,000 shares of the Common Stock), on any business day on or after the date hereof and before the Expiration Date, by surrender of this Warrant, with the form of subscription at the end hereof (or a reasonable facsimile thereof) duly executed by such holder, to the Company at its office in Grand Junction, Colorado, and, except as otherwise provided in Section 2.1(b), accompanied by payment, by certified or official bank check payable to the order of the Company, in the amount obtained by multiplying (x) the number of shares of the Common Stock (without giving effect to any adjustment therein) designated in such form of subscription (or such reasonable facsimile) by (y) the Purchase Price, and such holder shall thereupon be entitled to receive the number of shares of the Common Stock determined as provided hereunder. 2.2. When Exercise Effective. Each exercise of this Warrant shall be deemed to have been effected immediately prior to the close of business on the business day on which this Warrant shall have been surrendered to the Company as provided in Section 2.1, and the person(s) in whose name(s) the certificate(s) for shares of the Common Stock (or Other Securities) that are to be issued upon such exercise in accordance with Section 2.3 shall be deemed the holder(s) of record thereof at such time. 2.3. Delivery of Stock Certificates, etc. As soon as practicable after the exercise of this Warrant in full or in part in accordance herewith the Company, at its expense (including the payment by it of any applicable issue taxes), will cause to be issued in the name of and delivered to the holder hereof, or as such holder (upon payment by such holder of any applicable transfer taxes) may direct, (a) a certificate or certificates, marked with an appropriate legend referring to the terms of this Warrant and any applicable restrictions on such shares imposed by the Federal or any state securities laws, for the - 3 - number of full shares of the Common Stock (or Other Securities) to which such holder shall be entitled upon such exercise plus, in lieu of any fractional share to which such holder would otherwise be entitled, cash in an amount equal to the same fraction of the Market Price of one full share of the Common Preferred Stock on the business day next preceding the date of such exercise, and (b) in case such exercise is in part only, a new Warrant or Warrants of like tenor, calling in the aggregate on the face or faces thereof for the number of shares of the Common Stock equal (without giving effect to any adjustment therein) to the number of such shares called for on the face of this Warrant minus the number of shares designated by the holder upon such exercise as provided in Section 2.1. 3. Common Stock Issuable Upon Exercise. 3.1. General. The number of shares of the Common Stock which the holder of this Warrant shall be entitled to receive upon the exercise hereof or, if securities or other property in addition to or in lieu of the Common Stock shall by reason of the operation of the provisions of this Section be issuable upon such exercise, the amount and kind of such securities or other property, shall be adjusted or determined as provided in this Section 3. 3.2. Adjusted Exercise Price. The number of shares of the Common Stock which the holder of this Warrant shall be entitled to receive upon the exercise hereof shall be determined by multiplying the number of shares of the Common Stock which, but for the provisions of this Section 3, would otherwise be issuable upon such exercise, as designated by the holder hereof pursuant to Section 2.1, by the fraction of which the numerator is the per share Purchase Price and the denominator is the per share Adjusted Exercise Price (as herein defined) in effect on the date of such exercise. The per share Adjusted Exercise Price of the Common Stock shall initially be the Purchase Price (as defined in Section 1) and shall be adjusted and readjusted from time to time as provided in this Section 3 (and, as so adjusted or readjusted, shall remain in effect until a further adjustment or readjustment thereof is required by this Section 3). 3.3. Stock Dividends, Stock Splits, etc. In case the Company at any time or from time to time after the date hereof shall declare or pay any dividend on the Common Stock payable in Common Stock, or effect a subdivision of the outstanding shares of the Common Stock into a greater number of shares of the Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock), then, in any such event, the per share Adjusted Exercise Price per share shall be adjusted effective as of the close of business on (i) the record date for the determination of shareholders entitled to receive such dividend if such dividend is in fact paid, or (ii) the day immediately preceding the day upon which such subdivision shall become effective (any such day, as the case may be, shall be referred to herein as the "Subdivision Effective Date"), by multiplying the per share Adjusted Exercise Price in effect immediately prior to the Subdivision Effective Date by the fraction of which (x) the numerator - 4 - shall be the number of shares of the Common Stock outstanding immediately prior to the Subdivision Effective Date and (y) the denominator shall be the number of shares of the Common Stock outstanding immediately prior to the Subdivision Effective Date plus the number of shares of the Common Stock issuable upon the payment of such dividend or the consummation of such subdivision, as the case may be. 3.4. Adjustments for Combinations, etc. In case the outstanding shares of the Common Stock shall be combined or consolidated, by reclassification or otherwise, into a lesser number of shares of Common Stock, the Adjusted Exercise Price shall be adjusted, effective as of the close of business on the day immediately preceding the day upon which such combination or consolidation is effective (the "Combination Effective Date"), by multiplying the per share Adjusted Exercise Price in effect immediately prior to the Combination Effective Date by the fraction of which (x) the numerator shall be the number of shares of the Common Stock outstanding immediately prior to the Combination Effective Date and (y) the denominator shall be the number of shares of the Common Stock outstanding immediately after the Combination Effective Date. 3.5. Adjustments for Consolidation, Merger, Sale of Assets, Reorganization, etc. In case the Company, after the date hereof, (a) shall consolidate with or merge into any other person and shall not be the continuing or surviving corporation of such consolidation or merger, or (b) shall permit any other person to consolidate with or merge into the Company and the Company shall be the continuing or surviving person but, in connection with such consolidation or merger, the Common Stock shall be changed into or exchanged for stock or other securities or property of any other person, or (c) shall effect a capital reorganization or reclassification of the Common Stock (other than a reclassification subject to Sections 3.3 or 3.4), then, and in each such case, proper provision shall be made so that the holder of this Warrant, upon the exercise hereof at any time after the consummation of such consolidation, merger, reorganization or reclassification, shall be entitled to receive, in lieu of the Common Stock (or Other Securities) issuable upon such exercise prior to such consummation, the stock and other securities and property to which such holder would have been entitled upon such consummation if such holder had so exercised this Warrant immediately prior thereto, subject to adjustments (subsequent to such corporate action) as nearly equivalent as possible to the adjustments provided for in this Section 3. 4. No Dilution or Impairment. The Company will not, by amendment of its articles of organization or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the holder of this Warrant against dilution or other impairment. - 5 - 5. Notices of Record Date, etc. In the event of (a) any taking by the Company of a record of the holders of any class of securities for the purpose of determining the holders thereof who are entitled to receive any dividend or other distribution, or any right to subscribe for, purchase or otherwise acquire any shares of stock of any class or any other securities or property, or to receive any other right, or (b) any capital reorganization of the Company, any reclassification or recapitalization of the capital stock of the Company or any transfer of all or substantially all the assets of the Company to any other person or any consolidation or merger involving the Company and any other person, or (c) any voluntary or involuntary dissolution, liquidation or winding-up of the Company, the Company will give to the holder of this Warrant a notice specifying (i) the date or expected date on which any such record is to be taken for the purpose of such dividend, distribution or right, and stating the amount and character of such dividend, distribution or right, and (ii) the date or expected date on which any such reorganization, reclassification, recapitalization, transfer, consolidation, merger, dissolution, liquidation or winding-up is to take place and the time, if any such time is to be fixed, as of which the holders of record of the Common Stock (or Other Securities) shall be entitled to exchange their shares of the Common Stock (or Other Securities) for securities or other property deliverable upon such reorganization, reclassification, recapitalization, transfer, consolidation, merger, dissolution, liquidation or winding-up. Unless otherwise required by law to be given sooner, such notice shall be mailed within a reasonable time prior to the date therein specified. 6. Reservation of Stock, etc. The Company will at all times reserve and keep available out of its authorized but unissued Common Stock, solely for issuance and delivery upon the exercise of this Warrant, the full number of shares of Common Stock (or Other Securities) then issuable upon the exercise of this Warrant. All shares of the Common Stock issuable upon the exercise of this Warrant shall be duly authorized, and when issued and paid for in full, validly issued, fully paid and non-assessable with no liability on the part of the holders thereof. 7. Registration Rights. (a) Definitions. For purposes of this Section 7, the following terms shall have the following respective meanings: (i) "Commission" shall mean the United States Securities and Exchange Commission or any other Federal agency at the time administering the Act. (ii) The term "holder or holders of Registrable Stock" shall mean the holders of Common Stock or Other Securities issued pursuant to this Warrant. - 6 - (iii) The terms "register," "registered" and "registration" refer to a registration effected by preparing and filing a registration statement or similar document in compliance with the Act, and the declaration or ordering of effectiveness of such registration statement or document by the Commission. (iv) The term "Registration Period" shall mean the period commencing on the date hereof and ending (a) if this Warrant shall expire without having been exercised in whole or in part, the Expiration Date or (b) if this Warrant shall have been exercised in whole or in part, at such time as all shares of Registrable Stock have been sold by the initial holder or can be sold publicly without registration under the Act. (v) The term "Registrable Stock" means (a) the shares of Common Stock issued or issuable upon the exercise of this Warrant, and (b) any Other Securities issued or issuable pursuant to this Warrant; provided, however, that shares of Registrable Stock shall cease to be Registrable Stock if they are sold or transferred pursuant to a registered public offering or other transaction which does not result in restrictions on resale being imposed on the transfer by virtue of Federal or state securities laws; and provided further that Registrable Stock shall cease to be Registrable Stock if the holder could sell or transfer such securities held by him in one or more transactions pursuant to Rule 144 promulgated under the Act. (b) Incidental Registration ("Piggyback"). (i) If, during the Registration Period, the Company at any time or from time to time proposes to file with the Commission a registration statement under the Act with respect to any proposed distribution of any of its securities (other than a registration to be effected on Form S-4, S-8 or other similar limited purpose form), whether for sale for its own account or for the account of any other person holding registration rights with respect to the securities of the Company, then the Company shall give written notice of such proposed filing to the holders of Registrable Stock at least thirty (30) days before the anticipated filing date, and such notice shall describe in detail the proposed registration and distribution (including those jurisdictions where registration or qualification under the securities or blue sky laws is intended) and shall offer the holders of Registrable Stock the opportunity to register such number of shares of Registrable Stock as the holders of Registrable Stock may request. Upon receipt by the Company by the anticipated filing date of written requests from the holders of Registrable Stock ("Participating Holders") for the Company to register their Registrable Stock, the Company shall permit, or in the event of an underwritten offering, shall use its best efforts to cause the managing underwriter or underwriters of such proposed underwritten offering to permit, the Participating Holders to include such securities in such offering on the same terms and conditions as any similar securities of the Company included therein; provided, however, that if in the opinion of the managing underwriter or underwriters of such offering, the inclusion of the total amount or kind of securities which it or the Company, and any other persons or entities, intend to include in such offering would interfere, hinder, delay, reduce or prevent the - 7 - effectiveness or sale of the Company's shares of Common Stock proposed to be so registered or would otherwise adversely affect the success of such offering, then the amount or kind of securities to be offered for the accounts of the Company and each holder of Common Stock (including without limitation Registrable Stock) or securities convertible into or exercisable for Common Stock proposed to be registered (other than any persons exercising demand registration rights) shall be reduced (or eliminated) in proportion to their respective values to the extent necessary to reduce the total amount of securities to be included in such offering on behalf of such holders of securities to the amount recommended by such managing underwriter. For purposes of this Section, "value" shall mean principal amount with respect to debt securities and the proposed offering price per share with respect to equity securities. Notwithstanding the foregoing, if, at any time after giving written notice of its intention to register Common Stock or other securities convertible into or exercisable for Common Stock and prior to the effectiveness of the registration statement filed in connection with such registration, the Company determines for any reason either not to effect such registration or to delay such registration, the Company may, at its election, by delivery of written notice to the Participating Holders, (i) in the case of a determination not to effect registration, relieve itself of its obligations to register any Registrable Stock in connection with such registration, or (ii) in the case of determination to delay the registration, delay the registration of such Registrable Stock for the same period as the delay in the registration of such other shares of Common Stock or other securities convertible into or exercisable for Common Stock. (ii) Exception. The Company shall not be required to include any of the Registrable Stock of a Participating Holder in any registration statement or post-effective amendment prepared at its own instance unless such Participating Holder shall furnish such information and sign such documents as may be required by the Commission or reasonably requested by the Company in accordance with generally accepted practices, in connection with such proposed distribution. (c) Covenants of the Company with Respect to Registration. In connection with any registration under this Section 7, the Company shall, as expeditiously as is reasonably possible: (i) Prepare and file with the Commission a registration statement with respect to the Participating Holders' Registrable Stock and, subject to the last sentence of Section 7(b(i) hereof, use its best efforts to cause such registration statement to become effective. (ii) Prepare and file with the Commission such amendments and supplements to such registration statement and prospectus used in connection with such registration statement as may be necessary to comply with the provisions of the Act with respect to the disposition of all securities covered by such registration statement. (iii) Furnish to the Participating Holders such numbers of copies of a prospectus, including, if applicable, a preliminary prospectus, in conformity with the requirements of the Act, and such other documents as the selling shareholders may reasonably request in order to facilitate the disposition of Registrable Stock owned by the Participating Holders. - 8 - (iv) Use its best efforts to register and qualify the securities covered by such registration statement under such other securities or blue sky laws of such jurisdictions within the United States as shall be reasonably requested by the Participating Holders; provided, however, that the Company shall not be required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process in any such states or jurisdictions. (v) In the event of any underwritten public offering, enter into and perform its obligations under an underwriting agreement, in usual and customary form, with the managing underwriter of such offering. The Participating Holders shall also enter into and perform their obligations under such an agreement. (vi) Notify the Participating Holders, at any time when a prospectus relating to Registrable Stock covered by such registration statement is required to be delivered under the Act, of the happening of any event as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing. (vii) Furnish to the Participating Holders, on the date that shares of Registrable Stock are delivered to the underwriters for sale in connection with a registration pursuant to this Section 7, if such securities are being sold by underwriters, or, on the date that the registration statement with respect to such securities becomes effective, (i) an opinion as to matters of law only, dated such date, of counsel representing the Company for the purposes of such registration, in form and substance as is customarily given to underwriters in an underwritten public offering, addressed to the underwriters, if any, and to the Participating Holders and (ii) a letter dated such date, from the independent certified public accountants of the Company, in form and substance as is customarily given by independent certified public accountants to underwriters in an underwritten public offering, addressed to the underwriters, and to the Participating Holders. (d) The Company shall pay all costs, fees and expenses in connection with all registration statements filed under this Section 7 including, without limitation, the Company's legal and accounting fees, printing expenses and blue sky fees and expenses, but not including the fees and expenses of counsel for the Participating Holders in connection with such registration. However, the Company shall not pay for underwriting discounts and commissions and underwriters' expenses allocable to the Registrable Stock being registered or state transfer taxes. (e) Indemnification. (i) The Company shall indemnify each Participating Holder under this Agreement, its officers and directors and any person controlling it within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act, against any loss, claim, damage, expense or liability (including without limitation all expenses reasonably incurred in investigating, preparing, or defending against any claim whatsoever, such expenses to be reimbursed by the Company as they are - 9 - incurred) to which it may become subject under the Act, the Exchange Act or otherwise, arising out of or based upon (i) any untrue statement or alleged untrue statement of a material fact contained in any registration statement or prospectus or any amendments or supplements thereto in which Registrable Stock is included or in any application, statement or other document filed by the Company with the Commission or any securities exchange or in any jurisdiction in connection with qualifying such shares under the securities laws thereof, or (ii) the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein not misleading, unless such statement or omission is made in reliance upon and in conformity with written information furnished to the Company by or on behalf of such Participating Holder or an underwriter expressly for use in any such registration statement or other document. (ii) Each Participating Holder shall, as a condition to such registration of Registrable Stock, agree to indemnify the Company, its officers and directors and any person controlling the Company within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act, against any loss, claim, damage or expense or liability (including without limitation all expenses reasonably incurred in investigating, preparing or defending against any claim whatsoever, such expenses to be reimbursed by the undersigned as they are incurred) to which they may become subject under the Act, the Exchange Act or otherwise, arising out of or based upon (i) any untrue statement or alleged untrue statement of a material fact contained in any registration statement or prospectus or any amendments or supplements thereto in which Registrable Stock is included or in any application, statement or other document filed by the Company with the Commission or any securities exchange or in any jurisdiction in connection with qualifying such shares under the securities laws thereof, or (ii) the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein not misleading, provided in each case that such statement or omission is made in reliance upon and in conformity with written information furnished to the Company by or on behalf of such Participating Holder expressly for use in any such registration statement or other document, or (iii) any misuse by the Participating Holder of any prospectus included in the registration statement or any violation of the Act by the Participating Holder in connection with the sale or distribution of his or her Registrable Stock under the registration statement. (iii) Promptly upon receipt by a party claiming indemnification hereunder of notice of the commencement of any action involving a claim referred to above, such indemnified party will, if a claim in respect thereof is to be made against a party which may be required to indemnify such party hereunder, give written notice to the latter of the commencement of such action. In case any such action is brought against an indemnified party, the indemnifying party shall be entitled to participate in and to assume the defense of such action, to the extent that it may wish, with counsel reasonably satisfactory to such indemnified party. Except as set forth herein, the indemnified party and any party cooperating in the defense of such claim shall not settle or compromise any such claim or admit liability without the express written consent of the indemnifying party. The indemnified party shall have the right to be represented by an advisory counsel and accountants, at its own expense, and the indemnified - 10 - party shall be kept fully informed of such action, suit or proceeding at all stages thereof whether or not the indemnified party is so represented. After a period of thirty days following the date the written notice of such claim was given to the indemnifying party the indemnified party may settle any such claim (and the amount of any such settlement shall be subject to indemnification hereunder) unless within such thirty-day period the indemnifying party shall have provided the indemnified party with notice and evidence to the indemnified party's satisfaction that the indemnifying party reasonably disputes such claim and has the financial ability to meet its indemnification obligations hereunder. Notwithstanding the foregoing, the indemnified party may immediately cause to be paid or discharged any asserted claim the nonpayment of which would have an immediate substantial adverse impact on the indemnified party and any claim which the indemnifying party has not disputed within thirty days of notice as provided above. (iv) If the indemnification provided for in this Section 7(e) is unavailable or insufficient to hold harmless an indemnified party under such subsection in respect of any losses, claims, damages or liabilities or action in respect thereof or referred to therein, then each indemnifying party shall in lieu of indemnifying such indemnified party contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages, liabilities or actions in such proportion as is appropriate to reflect the relative fault of the Company, on the one hand, and the Participating Holders, on the other, in connection with the statements or omissions which resulted in such losses, claims, damages, liabilities or actions as well as any other relevant equitable considerations, including the failure to give the notice required under such subsections. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact relates to information supplied by the Company on the one hand, or the Participating Holders, on the other hand, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and the Participating Holders agree that it would not be just and equitable if contribution pursuant to this Section 7(e)(iv) were determined by pro rata allocation or by any other method of allocation which did not take account of the equitable considerations referred to above in this subsection. No person guilty of fraudulent misrepresentations (within the meaning of Section 11(f) of the Securities Act), shall be entitled to contribution from any person who is not guilty of such fraudulent misrepresentations. (v) The obligations of the Company and the Participating Holders under this Section 7(e) shall survive the completion of any offering of Registrable Stock in a registration statement under this Section 7. (vi) The rights of indemnification contained in this Section 7 shall not be deemed to be the exclusive remedy of the parties hereto and such rights shall be in addition to any other rights or remedies which any party hereto may have at law or equity. (f) Assignment of Registration Rights. The undersigned's rights set forth in this Section 7 shall automatically be deemed assigned to any transferee or assignee of this Warrant or shares of Common Stock or Other Securities issuable hereunder, provided that immediately following such transfer the further - 11 - disposition of such securities by the transferee or assignee is restricted under the Act; provided however, that, the termination of registration rights in respect of any shares of Registrable Stock shall be binding upon any transferee of such shares. Upon the request of any such holder, the Company will confirm in writing to any transferee of such holder's Registrable Stock the Company's continuing obligation to afford such transferee the benefits of the Company's agreements contained in this Section 7, but no failure of the Company to confirm such obligations shall in any way impair such transferee's rights under this Section 7. 8. Substitution of Warrants. 8.1. Exchange of Warrants. Subject to the provisions appearing at the top of the first page of this Warrant concerning, inter alia, the sale, transfer, encumbrance or other disposition of this Warrant, upon surrender or exchange of this Warrant, properly endorsed, to the Company, the Company at its expense will issue and deliver to or upon the order of the holder thereof a new Warrant or Warrants of like tenor, in the name of such holder or as such holder (upon payment by such holder of any applicable transfer taxes) may direct, calling in the aggregate on the face or faces thereof for the number of shares of Common Stock called for on the face or faces of the Warrant or Warrants so surrendered. 8.2. Replacement of Warrant. Upon receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of this Warrant and, in the case of any such loss, theft or destruction, upon delivery of an indemnity agreement reasonably satisfactory to the Company, or, in the case of any such mutilation, upon surrender and cancellation of such Warrant, the Company at its expense will execute and deliver, in lieu thereof, a new Warrant of like tenor. 9. Ownership of Warrant. Until this Warrant is transferred on the books of the Company, the Company may treat the person in whose name this Warrant is issued as the absolute owner hereof for all purposes, notwithstanding any notice to the contrary, except that, if and when this Warrant is properly assigned in blank, the Company may (but shall not be obligated to) treat the bearer hereof as the absolute owner of this Warrant for all purposes, notwithstanding any notice to the contrary. A Warrant, if properly assigned, may be exercised to the extent provided herein by a new holder without first having a new Warrant issued. 10. Notices, etc. All notices and other communications from the Company to the holder of this Warrant or from the holder of this Warrant shall be delivered personally, by facsimile (if confirmed and followed by delivery by first class mail), reputable overnight courier service, or mailed by first class registered or certified mail, postage prepaid, to the Company at 751 Horizon Court, Suite 203, P. O. Box 60219, Grand Junction, Colorado 81506-8758, Attn: President, or to the holder at such address as may have been furnished to the Company in writing by such holder, or, until an address is so furnished, to and at the address of the last holder of this Warrant who has so furnished an address to the Company. Any such notice shall be deemed to have been given on the date of personal delivery, facsimile, delivery to a reputable overnight courier service or deposit in the mail. - 12 - 11. Warrant Holder Not a Shareholder. Holder shall not, by virtue of anything contained in this Agreement or otherwise, prior to exercise of this Warrant, be entitled to any right whatsoever, either in law or equity, of a shareholder of the Company, including without limitation, the right to receive dividends or to vote or to consent or to receive notice as a shareholder in respect of the meetings of shareholders or the election of directors of the Company or any other matter; provided however that all holders of Warrants will be entitled to notice if: (a) the Company grants holders of its Common Stock rights to purchase any shares of capital stock or any other rights, or (b) the Company authorizes a reclassification, capital reorganization, consolidation, merger or sale of substantially all of its assets. 12. Nontransferable. This Warrant is nontransferable without the prior consent of the Company. Any such transfer shall be made in accordance with Section 8.1 above. 13. Miscellaneous. The Company may from time to time supplement or amend this Warrant without the approval of the holder in order to cure any ambiguity or to be correct or supplement any provision contained herein which may be defective or inconsistent with any other provision, or to make any other provisions in regard to matters or questions herein arising hereunder which the Company may deem necessary or desirable and which shall not materially adversely affect the interest of the holder. This Warrant and any term hereof may be amended, changed, waived, discharged or terminated only by an instrument in writing signed by the Company and consented to in writing by the holder of this Warrant. If for any reason any provision, paragraph or term of this Warrant is held to be invalid or unenforceable, all other valid provisions herein shall remain in full force and effect and all terms, provisions and paragraphs of this Warrant shall be deemed to be severable. This Warrant shall be construed and enforced in accordance with and governed by the laws of the state of Colorado applicable to contracts made and to be performed entirely therein. The headings in this Warrant are for reference purposes only and shall not limit or otherwise affect the meaning hereof. Dated as of: February 12, 1996. PEASE OIL AND GAS COMPANY By: ---------------------------------- Willard H. Pease, Jr., President - 13 - FORM OF SUBSCRIPTION [To be signed only upon exercise of the Warrant] To: PEASE OIL AND GAS COMPANY The undersigned, the holder of the within Warrant, hereby irrevocably elects to exercise the purchase right represented by such Warrant for, and to purchase thereunder, ------------* shares of the Common Stock of PEASE OIL AND GAS COMPANY and herewith makes payment of $----------- therefor, and requests that the certificates for such shares be issued in the name of, and delivered to, ------------------, whose address is -----------------------------------. Dated: ----------------------------------------- ----------------------------------------- (Signature must conform in all respects to the name of the holder as specified on the face of the Warrant) ----------------------------------------- (Address) - -------------- * Insert the number of shares called for on the face of the Warrant (or, in the case of a partial exercise, the portion thereof as to which the Warrant is being exercised), in either case without making any adjustment for additional Common Stock or any other stock or other securities or property or cash which, pursuant to the adjustment provisions of the Warrant, may be deliverable upon exercise. - 14 - FORM OF ASSIGNMENT [To be signed only upon transfer of the Warrant] For value received, the undersigned hereby sells, assigns and transfers unto ------------ the right represented by the within Warrant to purchase - ----------- shares of the Common Stock of PEASE OIL AND GAS COMPANY to which the within Warrant relates, and appoints ------------------------ Attorney to transfer such right on the books of PEASE OIL AND GAS COMPANY, with full power of substitution in the premises. Dated: ----------------------------------------- ----------------------------------------- (Signature must conform in all respects to the name of the holder as specified on the face of the Warrant) ----------------------------------------- (Address) Signed in the presence of: - ---------------------------- - 15 - EX-2 3 EXHIBIT 10.25--1996 STOCK OPTION PLAN PEASE OIL AND GAS COMPANY 1996 STOCK OPTION PLAN 1. Purpose of Plan. The purpose of this 1996 Employee Stock Option Plan ("Plan") is to secure and retain employees responsible for the success of Pease Oil and Gas Company ("Company"), to motivate such persons to exert their best efforts on behalf of the Company, to encourage stock ownership and to provide such persons with proprietary interests in, and a greater concern for, the welfare of, and an incentive to continue service with, the Company. For purposes of this Plan, the term "Company" shall include where appropriate in the context used any "parent corporation" or "subsidiary corporation" of the Company, as those terms are defined in Sections 424(e) and (f) of the Code, whether in existence on the date of adoption of the Plan or formed after the adoption of this Plan. Options issued pursuant to this Plan will constitute incentive stock options within the meaning of ss. 422 of the Internal Revenue Code of 1986, as amended ("Code"), at the time of grant ("Incentive Stock Options"), or other options ("Nonstatutory Stock Options"). Incentive Stock Options and Nonstatutory Stock Options may both be granted hereunder and any option granted which for any reason does not qualify as an Incentive Stock Option shall be a Nonstatutory Stock Option; provided, however, that in no event shall an Incentive Stock Option and a Nonstatutory Stock Option granted to any Optionee under a single stock option agreement be subject to a "tandem" exercise arrangement such that the exercise of one such Option affects the Optionees's right to exercise the other Option granted under such stock option agreement. Unless the context requires otherwise, the term "Option" in this Plan refers to both Incentive Stock Options and Nonstatutory Stock Options. 2. Stock Subject to the Plan. The number of shares of the Company's $.10 par value common stock ("Common Stock") which may be optioned under this Plan is 350,000 shares. Such shares may consist, in whole or in part, of unissued shares or treasury shares. The maximum number of shares issuable pursuant to this Plan, including shares subject to outstanding options, shall be subject to adjustment as provided in Section 6 of this Plan. The aggregate fair market value of the shares subject to Incentive Stock Options granted to any Optionee which become exercisable in a particular calendar year shall not exceed $100,000. For purposes of such limitation, the fair market value of Common Stock shall be determined as of the date of grant and the limitations shall be applied by taking into account Incentive Stock Options in the order granted. For purposes of this Plan, market value of shares subject to an option shall be determined as follows: (i) If the Common Stock is listed on the New York Stock Exchange, the American Stock Exchange or such other securities exchange designated by the Committee, or admitted to unlisted trading privileges on any such exchange, or if the Common Stock is quoted on a National Association of Securities Dealers, Inc. system that reports closing prices, the fair market value shall be the closing price of the Common Stock as reported by the Wall - 1 - Street Journal on the day the fair market value is to be determined, or if no such price is reported for such day, then the determination of such closing price shall be as of the last immediately preceding day on which the closing price is so reported; or (ii) If the Common Stock is not so listed or admitted to unlisted trading privileges or so quoted, the fair market value shall be the average of the last reported highest bid and the lowest asked prices quoted on the National Association of Securities Dealers, Inc. Automated Quotations System or, if not so quoted, then by the National Quotation Bureau, Inc. on the day the fair market value is determined; or (iii) If the Common Stock is not so listed or admitted to unlisted trading privileges or so quoted, and bid and asked prices are not reported, the fair market value shall be determined in such reasonable manner as may be prescribed by the Committee. If any outstanding Option under this Plan for any reason expires or is terminated, the shares of Common Stock allocable to the unexercised portion of such Option may again be optioned under this Plan subject to the limitations, terms and conditions of this Plan. The Board of Directors, and the proper officers of the Company, shall from time to time take appropriate action required for delivery of Common Stock, in accordance with any exercise of Options under this Plan. 3. Administration. Administration of the Plan shall be administered by the Compensation Committee of the Board of Directors of the Company, hereinafter referred to as the "Committee." The Committee shall consist of at least two members of the Board of Directors having full authority to act in the matter, none of whom during the one year prior to such appointment or while serving on the Committee, is granted an Option under this Plan or is granted or awarded equity securities pursuant to any other plan of the Company or any of its affiliates, except as permitted by Rule 16b-3 under the Securities Exchange Act of 1934, as amended (the "1934 Act"). If the Committee thus established shall consist of fewer than two members at the time of any action by the Committee, then the directors shall select enough other shareholders to serve on the Committee to have two members and to meet any requirements of ss. 422 of the Code and regulations adopted thereunder and regulations adopted under the 1934 Act. Once appointed, the Committee shall continue to serve until otherwise directed by the Board. From time to time, the Board may increase the size of the Committee and appoint additional members thereof, remove members (with or without cause) and appoint new members in substitution therefor, fill vacancies however caused, or remove all members of the Committee and thereafter directly administer the Plan. With respect to persons subject to Section 16 of the 1934 Act, transactions under this Plan are intended to comply with all applicable conditions of Rule 16b-3 or its successors under the 1934 Act. To the extent any provision of the Plan or action by the Committee fails to so comply, it shall be deemed null and void, to the extent permitted by law and deemed advisable by the Committee. - 2 - Subject to compliance with Section 16 of the 1934 Act, members of the Board who are either eligible for Options or who have been granted Options may vote on any matters affecting the administration of the Plan or the grant of any Options pursuant to the Plan, except that no such member shall act upon the granting of an Option to himself, but any such member may be counted in determining the existence of a quorum at any meeting of the Board during which action is taken with respect to the granting of Options to such member. The decision of a majority of those present at any meeting of the Committee where a quorum consisting of a majority of the Committee is present shall constitute the decision of the Committee. The Committee is authorized and empowered to administer the Plan insofar as it relates to Options and, consistent with the terms of the Plan, to (a) select the employees to whom Options are to be granted and to fix the number of shares and other terms and conditions of the Options to be granted; (b) determine the date upon which Options shall be granted and the terms and conditions of the granted Options in a manner consistent with the Plan, which terms need not be identical as between Options or Optionees; (c) interpret the Plan and the Options granted under the Plan; (d) adopt, amend and rescind rules and regulations for the administration of the Plan insofar as it relates to Options; and (e) direct the Company to execute Stock Option agreements pursuant to the Plan. All such actions of the Committee shall be binding upon all participants in the Plan. 4. Eligibility. The employees of the Company who shall be eligible to receive grants of Options under this Plan shall be those key employees, including officers or directors of the Company who are also employees, who are from time to time responsible for the management, growth or success of the business of the Company and who shall have been selected by the Committee. The Company may also grant Options to Consultants and Directors who are not employees of the Company; provided, however, that Consultants and Directors who are not employees are eligible to receive only Nonstatutory Options. The persons to receive Options under the Plan shall be selected from time to time by the Committee, in its sole discretion, and the Committee shall determine, in its sole discretion, the number of shares to be covered by the Options granted to each person selected. Subject to the exception under Section 5(b), no person may be granted an Option if such person, at the time the Option is granted, owns shares of Common Stock possessing more than 10% of the total combined voting power of all classes of stock of the Company. For purposes of calculating such stock ownership, the attribution rules of stock ownership set forth in Section 424(d) of the Code shall apply. Accordingly, an Optionee, with respect to whom such 10% limitation is being determined, shall be considered as owning Common Stock owned directly or indirectly by or for the Optionee's brothers and sisters (whether by the whole or half-blood), spouse, ancestors and - 3 - lineal descendants; and any Common Stock owned directly or indirectly by or for a corporation, partnership, estate or trust, shall be considered as being owned proportionately by or for its shareholders, partners or beneficiaries. 5. Terms and Conditions. The Plan shall become effective upon the approval of a majority of the holders of the Company's Common Stock present, or represented, and entitled to vote, at a meeting at which a quorum of stockholders of the Company is present or represented. Such approval must occur within 12 months after the date this Plan is adopted by the Board of Directors. It shall continue in effect for a period of ten years from the date of its effectiveness. All Options granted under this Plan shall be subject to the terms and conditions of this Plan, including all of the following: (a) Option Price. Subject to the provisions of Section 5(b), the Option price per share shall be determined by the Committee but shall not be less than 100% of the fair market value of such shares at the time the Option is granted. (b) More than 10% Shareholder. If an employee owns more than 10% of the total combined voting power of all classes of stock of the Company as determined under Section 4, at the time an Incentive Stock Option is granted under this Plan, the Committee may issue an Incentive Stock Option to such person at 110% of the fair market value of the Common Stock. Any Incentive Stock Option granted to any such employee shall not be exercisable after the expiration of five years from the date such Incentive Stock Option is granted. (c) Limitations on Grant of Options. Subject to the limitations under Section 5(b) of this Plan, no Option shall be granted which may be exercised more than ten years after the date it was granted. (d) Limitations on Exercise of Option. No Optionee granted an Option under this Plan may exercise such Option for six months following the date of grant of the Option and unless at all times during the period beginning on the date of the granting of the Option and ending on the day three months before the date of such exercise such Optionee was employed by the Company or a corporation or subsidiary thereof issuing or assuming the Option in a transaction set forth under Section 6 of this Plan. (e) Payment for Shares. Payment in full, in cash, shall be made for all shares issued pursuant to the exercise of an Incentive Stock Option, provided that the Committee may permit payment to be made with shares of the Company's Common Stock owned by the Optionee to be valued at the fair market value at the date of exercise. All Options shall be exercised for 100 shares, or a multiple thereof, or for the full number of shares for which the Option is then exercisable. No Optionee shall have the right to - 4 - dividends or other rights of a stockholder with respect to shares subject to an Option until the Optionee has given written notice of exercise of the Optionee's Incentive Stock Option and paid in full for such shares. (f) Manner of Exercise. Any Option granted pursuant to this Plan may be exercised at such time or times as set forth in the Option, by the delivery of written notice to any officer of the Company, other than the Optionee, together with payment in full, for the number of shares to be purchased pursuant to such exercise. Such notice (i) shall state the election to exercise the Option, (ii) shall state the number of shares in respect of which the Option is being exercised, (iii) shall state the Optionee's address, (iv) shall state the Optionee's social security number, (v) shall contain such representations and agreements concerning Optionee's investment intent with respect to such shares of Common Stock as shall be satisfactory to the Company's counsel, (vi) shall state that the certificate evidencing the shares may be stamped with a restrictive legend and the shares evidenced by such certificate will constitute "restricted securities" as defined in Rule 144 promulgated under the Securities Act of 1933, as amended (the "Act") (unless the shares to be acquired are registered under the Act) and (vii) shall be signed and dated by Optionee. (g) Conditions of Issuance of Shares. Shares shall not be issued pursuant to the exercise of an Option unless the exercise of such Option and the issuance and delivery of such Shares pursuant thereto shall comply with all relevant provisions of law, including, without limitation, the Act, the 1934 Act, the rules and regulations promulgated thereunder, applicable state securities law, and the requirements of any stock exchange or automated quotation system upon which the Share may be listed or quoted, and shall be subject to the approval of legal counsel for the Company with respect to such compliance. (h) Limitation on Transfer of Shares. Unless shares issued upon exercise are at the time of exercise registered under the Act, all shares of Common Stock acquired by an Optionee upon exercise of an Option granted under this Plan shall be deemed to be "restricted securities" as defined in Rule 144 promulgated under the Act and the certificate evidencing such shares shall contain a legend as follows: "The securities represented by this certificate may not be offered for sale, sold or otherwise transferred except pursuant to an effective registration statement under the Securities Act of 1933 (the `Act') or pursuant to an exemption from registration under the Act, the availability of which is to be established to the satisfaction of the Company." (i) Other Representations or Warranties. As a further condition to the exercise of any Option granted under this Plan, the Company may require each Optionee to make any representation and warranty to the Company as may be required by any applicable law or regulation. - 5 - (j) Holding Period of Shares. No shares of Common Stock acquired upon exercise of an Incentive Stock Option granted under this Plan shall be sold or otherwise disposed of, within the meaning of Section 424(c) of the Code, at any time before the sooner of two years from the date of the grant of an Incentive Stock Option under this Plan or one year after the date of exercise of the Incentive Stock Option. However, an Optionee who has acquired shares of Common Stock upon exercise of a stock option granted under this Plan, who transfers such shares to a trustee, receiver, or other similar fiduciary in any proceeding under Title 11 of the United States Bankruptcy Law or any other similar insolvency proceeding at a time when such Optionee is insolvent shall not have been deemed to have made a transfer or disposition for purposes of this subsection, nor shall one who acquires the shares from the Company with another person in joint tenancy be deemed to have made a transfer or disposition. Shares of Common Stock acquired by exercise of a Nonstatutory Stock Option under the Plan shall not be sold or otherwise disposed of at any time before one year from the date of the grant of the Nonstatutory Stock Option. (k) Death of Optionee. If an Optionee dies, any Option previously granted to the Optionee shall be exercisable by the personal representative or administrator of the deceased Optionee's estate, or by any trustee, heir, legatee or beneficiary (collectively referred to for convenience as the "legal representative") who shall have acquired the Option directly from the Optionee by will or by the laws of descent and distribution at any time within one year after his death, but not more than ten years [five years if Section 5(b) is applicable] after the date of granting of the Option, provided the deceased Optionee was entitled to exercise such Option at the time of his death. Prior to the exercise of any such Option, the legal representative of the deceased Optionee shall furnish to the Company written notice of such exercise, together with a certified copy of letters testamentary or other proof deemed sufficient by the Committee of the right of the legal representative to exercise such Option in accordance with the provisions of this Plan. (l) Retirement. If an Optionee's employment with the Company terminates by reason of retirement, any Option previously granted to him shall be exercisable as determined in the sole discretion of the Committee at any time within three months after the date of such termination, but not more than ten years [five years if Section 5(b) is applicable] after the date of granting of the Option, and then only to the extent to which it was exercisable at the time of such termination by retirement; provided, however, that if the Optionee dies within three months after termination by retirement, any unexercised Option, to the extent to which it was exercisable at the time of his death, shall thereafter be exercisable for one year after the date of his death, but not more than ten years [five years if Section 5(b) is applicable] after the date of granting of the Option. (m) Disability. If an Optionee becomes disabled within the meaning of Section 22(e)(3) of the Code, and at the time of such disability the Optionee is entitled to exercise an Option, the Optionee shall have the right to exercise such Option within one year after such disability - 6 - provided that the Optionee exercises within ten years after the date of grant thereof [or five years if Section 5(b) is applicable], and then only to the extent to which it was exercisable at the time of such disability. (n) Optionee's Termination. If an Optionee ceases to serve an Employee, Consultant or Director, as the case may be, for any reason other than death, retirement or disability, any Option previously granted to the Optionee which was exercisable at the time of termination shall terminate three months after the date of such termination or at such earlier time as provided in the terms of the Option granted to the Optionee. To the extent that an Option is not exercised within the time specified herein, the Option shall terminate. (o) Leave of Absence. For the purposes of this Plan (i) a leave of absence, duly authorized in writing by the Company for military service or sickness, or for any other purpose approved by the Company, if the period of such leave does not exceed 90 days and (ii) a leave of absence in excess of 90 days, duly authorized in writing by the Company provided the Optionee's right to re-employment is guaranteed either by statute or by contract, shall not be deemed a termination of employment. (p) Nontransferability of Options. No Option granted under this Plan will be transferable by the Optionee other than by will or the laws of descent and distribution. During the lifetime of the Optionee, the Option will be exercisable only by Optionee. (q) Exercisability of Options. No Optionee granted an Option under this Plan shall be entitled to exercise such Option at any time after the expiration of such Option as specified in the option certificate evidencing such Option. 6. Adjustments Upon Recapitalization, Merger, Etc. If the outstanding shares of $.10 par value Common Stock of the Company shall at any time be changed or exchanged by declaration of a stock dividend, split-up, subdivision or combination of shares, recapitalization, merger, consolidation or other corporate reorganization in which the Company (including a merger or similar reorganization which effects a reincorporation of the Company in a different county or province) is the surviving corporation, the number and kind of shares subject to this Plan or subject to any Options previously granted, and the Option prices, shall be appropriately and equitably adjusted, so as to maintain the proportionate number of shares without changing the aggregate Option price. In the event of a dissolution or liquidation of the Company, or a merger, consolidation, sale of all or substantially all of its assets, or other corporate reorganization in which the Company is not the surviving corporation and the holder of Common Stock receives securities of another corporation, then any outstanding Options hereunder shall terminate as of the effective date of such event; provided that immediately prior to such event each Optionee shall have the right to exercise any unexpired Option in whole or in part whether or not the Option would otherwise be exercisable. The Company shall afford each person who holds an Incentive Stock Option under this Plan with at least 30 days advance written notice of such event. The existence of this Plan, or of any - 7 - Options hereunder, shall not in any way prevent any transaction described in this section, nor shall anything contained in this Plan prevent the substitution of a new Option by a surviving corporation. 7. Use of Proceeds. Proceeds from the sale of stock pursuant to Options granted under this Plan shall constitute general funds of the Company may be used for such general corporate purposes as the Company's Board of Directors shall determine. 8. Reservation of Issuance of Shares. The Company shall at all times during the duration of this Plan reserve and keep available such number of shares of Common Stock as will be sufficient to satisfy the requirements of all Options granted pursuant to this Plan, and shall pay all original issue and transfer taxes with respect to the issuance of shares pursuant to the exercise of such Options, and shall pay all of the fees and expenses necessarily incurred in connection with the exercise of such Options and the issuance of such shares. 9. Amendments. The Board of Directors may amend, alter, or discontinue this Plan, but no amendment, alteration or discontinuation shall be made which would impair the rights of any Optionee under any Options previously granted, without the Optionee's consent, or which, without the approval of the stockholders, would: (i) except as is provided in Section 6 of this Plan, increase the total number of shares reserved for the purposes of this Plan; (ii) decrease the Option price to less than 100% of the fair market value or 110% if Section 5(b) is applicable on the date of the granting of the Option; (iii) change the persons (or class of persons) eligible to receive Options under this Plan; or (iv) so long as the Company has a class of equity security registered under Section 12 of the 1934 Act, make any material amendment to the Plan. Any such amendment or termination of the Plan shall not affect Options already granted and such Options shall remain in full force and effect as if the Plan had not been amended or terminated, unless mutually agreed otherwise between the Optionee and the Board in a writing signed by both parties. 10. Indemnification. In addition to such other rights of indemnification as they may have as directors, the members of the Committee and the Board of Directors shall be indemnified by the Company against reasonable expenses, including attorneys' fees actually incurred in connection with the defense of any action, suit or proceeding, or in connection with any appeal therefrom, to which they or any of them may be a party by reason of any action taken or failure to act under or in connection with this Plan or any Option granted hereunder, or shares purchased pursuant to the exercise of Options under this Plan, and against all amounts paid by them in settlement thereof (provided such - 8 - settlement is approved by independent legal counsel selected by the Company) or paid by them in satisfaction of judgment in any action, suit or proceeding, except in relation to matters as to which it shall be adjudged in such action, suit or proceeding, that such member of the Board of Directors is liable for gross negligence, fraud or willful misconduct in the performance of the director's duties so long as within 60 days after institution of any such action, suit or proceeding, the director shall in writing offer the Company the opportunity, at its own expense, to handle and defend such action, suit or proceeding. 11. Miscellaneous. Unless the context requires otherwise, words denoting the singular may be construed as denoting the plural, and words denoting the plural may be construed as denoting the singular, and words of one gender may be construed as denoting such other gender as is appropriate. Paragraph headings are not to be considered part of this Plan and are included solely for convenience and are not intended to be full or accurate descriptions of the contents thereof. Adopted by Shareholders: August __, 1996 PEASE OIL AND GAS COMPANY organized under the laws of Nevada ATTEST: By -------------------------------- Willard H. Pease, Jr., Chairman - -------------------------------------- Patrick J. Duncan, Secretary S E A L - 9 - EX-3 4 EXHIBIT 10.26--MORTGAGE/ASSIGNMENT/AGREEMENT MORTGAGE, ASSIGNMENT OF PROCEEDS, SECURITY AGREEMENT AND FINANCING STATEMENT (Oil and Gas) FROM PEASE OIL AND GAS COMPANY TO HOLDERS OF 1996 10% COLLATERALIZED SUBORDINATED CONVERTIBLE DEBENTURES DATED AS OF NOVEMBER 15, 1996 - -------------------------------------------------------------------------------- THIS INSTRUMENT CONTAINS AFTER-ACQUIRED PROPERTY PROVISIONS. THE OIL AND GAS INTERESTS INCLUDED IN THE MORTGAGED PROPERTY WILL BE FINANCED AT THE WELLHEADS OF THE WELLS LOCATED ON THE PROPERTY DESCRIBED IN EXHIBIT A HERETO, AND THIS FINANCING STATEMENT IS TO BE FILED FOR RECORD, AMONG OTHER PLACES, IN THE REAL ESTATE RECORDS OF THE COUNTY RECORDER. THE SECURED PARTY IS NOT A SELLER OR PURCHASE MONEY LENDER OF THE COLLATERAL COVERED BY THIS INSTRUMENT. THIS DOCUMENT WAS PREPARED BY AND WHEN RECORDED AND/OR FILED SHOULD BE RETURNED TO: Alan W. Peryam, Esq. Hopper and Kanouff, P.C. 1610 Wynkoop Street, Suite 200 Denver, Colorado 80202 - 1 - SUBORDINATED MORTGAGE, ASSIGNMENT OF PROCEEDS, SECURITY AGREEMENT AND FINANCING STATEMENT This SUBORDINATED Mortgage, Assignment of Proceeds, Security Agreement and Financing Statement (the "Mortgage") is entered into as of the Effective Date (as defined below) by and between the undersigned Pease Oil and Gas Company, a Nevada corporation (formerly Willard Pease Oil and Gas Company and successor by merger to Skaer Enterprises, Inc., a Colorado corporation, herein called "Mortgagor"), whose address is 751 Horizon Court, Suite 203, Grand Junction, Colorado 81506-8758, and those persons who are the registered holders of the 1996 10% Collateralized Subordinated Convertible Debentures of Pease Oil and Gas Company, the total principal amount of which is Five Million Dollars ($5,000,000) (hereafter the "Debentures") and the names, addresses and principal amount of Debentures held is set forth on Exhibit B, incorporated herein by this reference (hereafter the "Debenture Mortgagees"), is subject and subordinate to the Mortgage, Assignment, Proceeds, Security Agreement and Financing Statement pertaining to the collateral, dated August 23, 1996, recorded in Larimer County, Colorado as Reception No. 93062241 and No. 93062242 and in Weld County, Colorado in Book 1399 at File 1122 as Reception No. 02348218 and Book 0189 at File 1186 as Reception No. U0253060. The parties hereto agree as follows: ARTICLE 1 - DEFINITIONS Section 1.1 Defined Terms. For the purposes of this instrument: "Collateral" includes Fixture Collateral, Personalty Collateral and Realty Collateral as hereinafter defined. "Dollars" and "US$" mean lawful money of the United States of America. "Effective Date" means as of November 15, 1996. "Environmental Laws" shall mean any and all laws,, statutes, ordinances, rules, regulations, orders, or determinations of any Governmental Authority pertaining to health or the environment in effect in any and all jurisdictions in which Mortgagor is conducting or at any time has conducted business, or where any Property of Mortgagor is located, or where any hazardous substances generated by or disposed of by Mortgagor are located, including, without limitation, the Clean Air Act, as amended; the Comprehensive Environmental, Response, Compensation, and Liability Act of 1980 ("CERCLA"), as amended; the Federal Water Pollution Control Act, as amended; the Occupational Safety and Health Act of 1970, as amended; the Resource Conservation and Recovery Act of 1976 ("RCRA"), as amended; the Safe Drinking Water Act, as amended; the Toxic Substances Control Act, as amended; the Superfund Amendments and Reauthorization - 2 - Act of 1986, as amended; and other environmental conservation or protection laws. The terms "hazardous substance," "release" and "threatened release" have the meanings specified in CERCLA, and the terms "solid waste" and "disposal" (or "disposed") have the meanings specified in RCRA; provided, however, in the event either CERCLA or RCRA is amended so as to broaden the meaning of any term defined thereby, such broader meaning shall apply subsequent to the effective date of such amendment with respect to all provisions of this Agreement, and provided further that, to the extent the laws of the state in which any Property of Mortgagor is located establish a meaning for "hazardous substance," "release," "solid waste" or "disposal" which is broader than that specified in either CERCLA or RCRA, such broader meaning shall apply. "Fixture Collateral" means all of Mortgagor's interest in and to all Operating Equipment which is or becomes so related to the Oil and Gas Property or any part thereof that an interest in the Operating Equipment arises under the real property law of the State in which it is situated, including all oil or natural gas delivery pipelines. "Hazardous Materials" means (a) petroleum or petroleum products, natural or synthetic gas other than crude oil, natural gas and natural gas liquids prior to capture and production thereof; (b) asbestos in any form that is or could become friable, urea formaldehyde foam insulation, and radon gas; and (c) any other substances defined as or included in the definition of "hazardous substances," "hazardous wastes," "hazardous materials," "extremely hazardous wastes," "restricted hazardous wastes," "toxic substances," "toxic pollutants," "contaminants" or "pollutants" under any applicable Environmental Law. "Hydrocarbons" means oil, gas and other liquid or gaseous hydrocarbons, whether or not treated or processed. "Obligations" means the aggregate of: (a) all amounts payable pursuant to any of the Debentures at any time outstanding in the aggregate principal amount not to exceed Five Million Dollars ($5,000,000) issued by Mortgagor to the Debenture Mortgagees with a stated maturity date of April 15. 2001, bearing interest at the rates specified in and otherwise subject to the terms of the Debentures dated on or about November 15, 1996 among the Mortgagor and the Debenture Mortgagees, with such Debentures, and all modifications, extensions and renewals thereof referred to as the "Debentures," and with the holders of the Debentures and all subsequent holders of all or any part thereof referred to as the "Secured Parties"; (b) claims, as defined in Section 3.5 which are identified (whether or not the specific amount thereof has been determined) prior to payment of all principal and interest due under the Debentures; - 3 - (c) any and all other or additional indebtedness or liabilities for which Mortgagor is now or may become liable to any Secured Party or Debenture Mortgagees in any manner pursuant to the Debentures; (d) all sums advanced and costs and expenses incurred by or on behalf of the Debenture Mortgagees, including without limitation all legal, accounting, engineering, management, consulting or like fees, made and incurred in connection with the Obligations described in paragraphs (i) and (ii) above or any part thereof, any renewal, extension or modification of, or substitution for, the foregoing Obligations or any part thereof, or the acquisition, perfection or maintenance and preservation of the security therefor, whether such advances, costs or expenses shall have been made and incurred at the request of Mortgagor or the Debenture Mortgagees; and (e) any and all extensions and renewals of, substitutions for, or modifications or amendments of any of the foregoing Obligations or any part thereof. "Oil and Gas Property" means all of the oil and gas leasehold interests and estates and other interests of Mortgagor in the lands, leases and agreements described in Exhibit A attached hereto and made a part hereof, (it being expressly understood and agreed that the undivided interests in such properties set forth in Exhibit A are for information purposes and do not establish a limit on Mortgagor's interests therein which are subject to this Mortgage) whether now owned or hereafter acquired, by operation of law or otherwise, together with all of Mortgagor's interests of any nature whatsoever now or hereafter incident or appurtenant thereto, including, but not limited to, fee mineral and surface interests in said lands, royalty interests therein, all unsevered and unextracted Hydrocarbons in, under or attributable to Mortgagor's interests in said lands, oil and gas (or oil, gas and mineral) leases, subleases, mineral agreements, farmin agreements, farmout agreements, bottom hole agreements, other participation agreements of any kind, royalties, overriding royalties, net profits interests, production payments, licenses, servitudes, orders, acreage contribution agreements, processing agreements, options and similar interests, and all rights-of-way, surface leases, and easements affecting the foregoing interests of Mortgagor or useful or appropriate in exploring and/or drilling for, producing, processing, treating, handling, storing, transporting or marketing Hydrocarbons therefrom or the disposal of water, Hydrocarbons or associated substances from said lands. "Operating Equipment" means all surface or subsurface machinery, equipment, facilities, supplies or other property of whatsoever kind or nature and any replacements thereof, substitutions therefor or accessions thereto (including leases of equipment), now or hereafter located in, on or under, affixed or attributable to or obtained or used in connection with any of the Oil and Gas Property or any portion thereof or interest therein, including, without limiting the generality of the foregoing, goods which are or are to become fixtures on the Oil and Gas Property, oil wells, gas wells, water wells, injection wells, casing, tubing, rods, pumps, pumping units and engines, Christmas trees, derricks, separators, gun barrels, flow lines, tanks, gas systems (for gathering, treatment, compression and transmission), chemicals, solutions, water systems (for treating, disposal and injection), power plants, boilers, poles, - 4 - lines, transformers, starters and controllers, valves, meters, measuring devices, machine shops, tools, storage yards and equipment stored therein, buildings and camps, secondary and other recovery equipment, systems and processes, plans, drawings, specifications, surveys, engineering, geological and geophysical studies and reports, well logs, reports and related data, seismographic studies, reports and information, office and personnel books, files, records and correspondence, computer output and data files, maps, plats, abstracts of title, lease files, unit files, production marketing files, title curative opinions, title files and title records, division orders and division order records, ownership maps, warranties and guarantees of manufacturers and others, telegraph, telephone and other communication systems, roads, loading docks, shipping facilities and building and construction materials. "Personalty Collateral" means all of Mortgagor's interest now owned or hereafter acquired in and to: (i) all Operating Equipment; (ii) all Hydrocarbons, whether or not extracted from or attributable to the Oil and Gas Property; (iii) all Production Sales Contracts; and (iv) all other personal property, movable and immovable, tangible or intangible, of whatsoever nature and kind, wherever located, including, without limitation, all accounts, contract rights, general intangibles, equipment, inventory, goods, chattel paper, permits, authorizations, seismic or other data, title information, title abstracts and maps, now owned or existing or hereafter acquired by Mortgagor or arising in connection with the conduct by Mortgagor of any activity on or relating to the Collateral, except that organizational, tax and other internal records, agreements or documents of the Mortgagor or any partner therein which are not related to or necessary for the ownership and operation of the Collateral and sale of Hydrocarbons are excluded from Personalty Collateral. "Proceeds" includes whatever is received upon the sale, exchange, collection or other disposition of the Collateral and insurance payable or damages or other payments by reason of loss or damage to the Collateral, and all additions thereto, substitutions and replacements thereof or accessions thereto. "Production Sales Contract" means each contract now in effect or hereafter entered into by Mortgagor or Mortgagor's predecessors in title for the sale, purchase, exchange or processing of Hydrocarbons extracted from or attributable to the Oil and Gas Property. "Realty Collateral" means all of Mortgagor's interest in and to the Oil and Gas Property, including, but not limited to, the interests of Mortgagor described or specified in Exhibit A hereto. ARTICLE 2 - CREATION OF SECURITY Section 2.1 Grant. In consideration of the Debenture Mortgagees' acquisition of the Debentures constituting the Obligations, and in consideration of the mutual covenants contained herein, and for the purpose of securing payment of the Obligations, Mortgagor hereby grants, bargains, sells, warrants, mortgages, assigns, transfers and conveys the Realty Collateral and Fixture - 5 - Collateral to the Debenture Mortgagees, pari passu among all the Debenture Mortgagees with power of sale to have and to hold the Realty Collateral and Fixture Collateral, together with all and singular the rights, privileges, contracts, and appurtenances now or hereafter at any time before the foreclosure or release hereof, in any way appertaining or belonging thereto, unto the Debenture Mortgagees and to their substitutes or successors, forever, upon the terms and conditions herein set forth; and Mortgagor hereby binds and obligates Mortgagor and Mortgagor's successors and assigns, to warrant and to defend, all and singular, title to the Collateral unto the Debenture Mortgagees and its substitutes or successors, forever, against the claims of any and all persons whomsoever claiming any part thereof. Section 2.2 Creation of Security Interest. In addition to the grant contained in Section 2.1, and for the same consideration and purpose, Mortgagor hereby grants to the Debenture Mortgagees, pari passu among all the Debenture Mortgagees, security interest in all Personalty Collateral, now owned or hereafter acquired by the Mortgagor, and in all Proceeds. Without limiting the foregoing provisions of this Section 2.2, Mortgagor stipulates that the grant made by this Section 2.2 includes a grant of a security interest in Hydrocarbons extracted from or attributable to the Oil and Gas Property and in the Proceeds resulting from sale of such Hydrocarbons (including, but not limited to, sales at the wellhead), such security interest to attach to such Hydrocarbons as extracted and to the accounts resulting from such sales. Section 2.3 Proceeds. The security interest of Debenture Mortgagees hereunder in the Proceeds shall not be construed to mean that any Debenture Mortgagees consent to the sale or other disposition of any part of the Collateral other than Hydrocarbons extracted from or attributable to the Oil and Gas Property and sold in the ordinary course of business. ARTICLE 3 - ASSIGNMENT OF PRODUCTION PROCEEDS Section 3.1 Assignment. As further security for the payment of the Obligations, upon default by the Company under the terms of the Debentures, the Mortgagor shall transfer, assign, warrant and convey to Debenture Mortgagees, pari passu among all the Debenture Mortgagees, all Hydrocarbons (and the Proceeds therefrom) which are extracted from or attributable to the Oil and Gas Property. All parties producing, purchasing and receiving such Hydrocarbons or the Proceeds therefrom are authorized and directed to treat Debenture Mortgagees, pari passu among all the Debenture Mortgagees, as the person entitled in Mortgagor's place and stead to receive the same; and further, those parties will be fully protected in so treating Debenture Mortgagees and will be under no obligation to see to the application by Debenture Mortgagees of any Proceeds received by it. - 6 - Section 3.2 Application of Proceeds. (a) All payments received by Debenture Mortgagees pursuant to Section 3.1 above shall be placed in a collateral collection account at the financial institution designated by the Debenture Mortgagees and on the last day of each month shall be applied as follows: (i) first, toward satisfaction of all costs and expenses incurred in connection with the collection of Proceeds and the payment of any part of the Obligations not represented by a written instrument; (ii) second, to the payment of all accrued interest on the Debentures and of all other fees or payments required in the Debentures; (iii) third, to the payment of any then due and owing principal on the Debentures; and (iv) the balance, if any, shall be released to Mortgagor. (b) If any date of application specified above (herein called a "regular application date") shall be a Saturday, Sunday or legal banking holiday under the laws of the jurisdiction in which such proceeds shall be applied, the proceeds to be applied by Debenture Mortgagees pursuant to this Section 3.2 shall be applied on the last business day next preceding such regular application date that is not a Saturday, Sunday or legal banking holiday, but the amount to be applied pursuant to paragraph (a)(ii) of this Section 3.2 shall nevertheless be the amount accrued up to, but not including, such regular application date. Section 3.3 Mortgagor's Payment Duties. Nothing contained herein will limit Mortgagor's duty to make payment on the Obligations when the Proceeds received by Debenture Mortgagees pursuant to this Article 3 are insufficient to pay the costs, interest, principal and any other portion of the Obligations then owing, and the receipt of Proceeds by Debenture Mortgagees will be in addition to all other security now or hereafter existing to secure payment of the Obliga tions. Section 3.4 Debenture Mortgagees Collection Duties. Debenture Mortgagees have no obligation to enforce collection of any Proceeds and are hereby released from all responsibility in connection therewith, except the responsibility to account to Mortgagor for Proceeds actually received. Section 3.5 Indemnification. Mortgagor agrees to indemnify Debenture Mortgagees and each other Secured Party against and hold Debenture Mortgagees and each other Secured Party harmless from all claims, actions, liabilities, losses, judgments, attorneys' fees, costs and expenses and other charges of any description whatsoever (all of which are hereafter referred to in this Section 3.5 as "Claims") made against or sustained or incurred by Debenture Mortgagees or any other Secured Party as a consequence of the assertion, either before or after the payment in full of the Obligations, that Debenture Mortgagees or any - 7 - other Secured Party received Hydrocarbons or Proceeds pursuant to this instrument. Debenture Mortgagees and each other Secured Party will have the right to employ attorneys and to defend against any Claims and unless furnished with satisfactory indemnity, after notice to Mortgagor, Debenture Mortgagees or any other Secured Party will have the right to pay or compromise and adjust all Claims in its sole reasonable discretion. Mortgagor shall indemnify and pay to Debenture Mortgagees or any other Secured Party all amounts paid by Debenture Mortgagees or any other Secured Party in compromise or adjustment of any of the Claims or amounts adjudged against Debenture Mortgagees or any other Secured Party in respect of any of the Claims. The liabilities of Mortgagor as set forth in this Section 3.5 will constitute Obligations and will survive the termination of this instrument for a period of six months. Section 3.6 Limitation of Liability. The Mortgagor is liable for the full amount of the Obligations, including, without limitation, the Obligations evidenced by the Debentures. If, in connection with this Mortgage and the transactions contemplated hereby, there is a foreclosure of Liens by private power of sale or otherwise, and attachment, execution or other writ against the assets of the Mortgagor, no judgment for any deficiency upon the Obligations shall be sought or obtained by the Debenture Mortgagees or any other Secured Party against any general partner (other than as may be required to enforce rights and remedies against the Mortgagor). ARTICLE 4 - MORTGAGOR'S WARRANTIES AND COVENANTS Section 4.1 Warranties and Covenants. (a) Mortgagor warrants and covenants that: (i) Mortgagor, to the extent of the interests of Mortgagor in Exhibit A, has good and defensible title (as defined in the Credit Agreement) to each property right or interest constituting the Collateral free of any adverse claim, burden, mortgage, lien, security interest, pledge, charge, encumbrance or interest of or in favor of any third party other than as stated in Exhibit A, except as previously disclosed to Debenture Mortgagees in writing, or as previously disclosed to Debenture Mortgagees, no financing statement covering any of the Collateral in favor of any third party is on file in any public office; Mortgagor holds the working interests in the Oil and Gas Property described in Exhibit A; and Mortgagor has a good and legal right and full authority to grant and convey same to Debenture Mortgagees pursuant to this instrument; (ii) the oil and gas (or oil, gas and mineral) leases and mineral agreements included in the Oil and Gas Property are valid and subsisting and all payments, rentals and royalties due under each of them have been properly and timely paid, and all conditions and obligations necessary to keep them in force have been fully satisfied and performed; and all producing wells located on the Oil and Gas Property or properties unitized - 8 - therewith have been drilled, operated and produced in conformity with all applicable laws and rules, regulations and orders of all governmental authorities having jurisdiction and are subject to no penalties on account of past production; (iii) no approval or consent of any regulatory or administrative commission or authority or of any other governmental body or any other party is necessary to authorize the execution and delivery of this instrument or of any other written instrument constituting or evidencing the Obligations, or to authorize the observance or performance by Mortgagor of the covenants contained in this instrument or in the other written instruments constitut ing or evidencing the Obligations or to enable the Debenture Mortgagees to exercise its rights hereunder; and (iv) Mortgagor has taken all proper corporate action to authorize the execution and delivery of the Debentures secured hereby and of this instrument and to make the Debentures and this instrument the legal, valid and binding obligations of Mortgagor. (b) Mortgagor warrants and shall forever defend the Collateral against every person whomsoever lawfully claiming the same or any part thereof, and Mortgagor shall maintain and preserve the lien and security interest herein created until this instrument has been terminated as provided herein. Section 4.2 Operation of Mortgaged Property. As long as this instrument has not been released in accordance with Section 9.5, and whether or not Mortgagor is the operator of all or any part of the Oil and Gas Property, Mortgagor shall, at Mortgagor's own expense: (a) comply, or cause the operator to comply, fully with all of the terms and conditions of all leases, mineral agreements and other instruments of title described in Exhibit A and all rights-of-way, easements and privileges necessary for the proper operation of such leases and instruments, and otherwise do all things necessary to keep Mortgagor's rights and Debenture Mortgagees' interest in the Collateral unimpaired; (b) except to the extent a prudent operator would do so, not abandon any well which is producing or capable of production or forfeit, surrender or release any lease, sublease, mineral agreement or farmout or any operating agreement or other agreement or instrument comprising or affecting the Oil and Gas Property without Debenture Mortgagees's prior written consent, which consent shall not be withheld unreasonably; (c) cause the Oil and Gas Property to be maintained, developed and protected against drainage and continuously operated for the production of Hydrocarbons in a good and workmanlike manner as a prudent operator would in accordance with generally accepted practices, applicable operating agreements and all applicable federal, state, tribal and local laws, rules, regulations and orders; - 9 - (d) promptly pay or cause to be paid when due and owing all rentals, other payments and royalties payable in respect of the Oil and Gas Property, if any; all expenses incurred in or arising from the operation or development of the Collateral; and all taxes, assessments and governmental charges imposed upon the Collateral or Mortgagor; (e) cause the Operating Equipment to be kept in good and effective operating condition and cause to be made all repairs, renewals, replacements, additions and improvements thereof or thereto necessary or appropriate for the production Hydrocarbons from the Oil and Gas Property and permit the Debenture Mortgagees (through its agents and employees), upon reasonable prior notice and during normal business hours, to enter upon the Oil and Gas Property for the purpose of investigating and inspecting the condition and operation of the Collateral; (f) cause the Collateral to be kept free and clear of liens, charges, security interests, encumbrances, adverse claims and title defects of every character other than (i) the lien and security interest created by this instrument, (ii) taxes constituting a lien but not due and payable, (iii) defects or irregularities in title which are not such as interfere materially with the development, operation or value of the Collateral and not such as to materially affect title thereto, (iv) those set forth or referred to in Exhibit A hereto, (v) those being contested in good faith by Mortgagor and which do not, in the judgment of Debenture Mortgagees, jeopardize the Debenture Mortgagees's rights in and to the Collateral, and (vi) those consented to in writing by Debenture Mortgagees; provided, however, that Debenture Mortgagees may take such reasonable independent action in connection with any such matters affecting the Collateral as it deems advisable, and all costs and expenses thereof, including, without limitation, attorneys' fees incurred by Debenture Mortgagees in taking such action, shall be part of the Obligations hereunder; (g) defend, indemnify and hold harmless the Debenture Mortgagees and other Secured Parties, and their respective employees, agents, officers and directors, from and against any claims, demands, penalties, fines, liabilities, settlements, damages, costs and expenses of whatever kind or nature known or unknown, contingent or otherwise, arising out of, or in any way relating to the violation of or noncompliance with any Environmental Laws applicable to the properties owned or operated by the Mortgagor, or any orders, requirements or demands of governmental authorities related thereto, including, without limitation, attorney's and consultant's fees, investigation and laboratory fees, environmental response and cleanup costs, court costs and litigation expenses, except to the extent that any of the foregoing arise out of the gross negligence or willful misconduct of the party seeking indemnification therefor; and (h) execute, acknowledge and deliver to Debenture Mortgagees such other and further instruments and do such other acts as in the opinion of Debenture Mortgagees are necessary or desirable to effect the intent of this instrument or otherwise protect and preserve the interests of - 10 - Debenture Mortgagees hereunder, promptly upon request of Debenture Mortgagees. Section 4.3 Recording and Filing. Mortgagor shall pay all costs of filing, registering and recording this and every other instrument in addition or supplemental hereto and all financing state ments Debenture Mortgagees may require, in such offices and places and at such times and as often as may be, in the judgment of Debenture Mortgagees, necessary to preserve, protect and renew the lien and security interest herein created as a second lien and second-in-priority security interest on and in the Collateral and otherwise do and perform all matters or things necessary or expedient to be done or observed by reason of any law or regulation of any state or of the United States or of any other competent authority for the purpose of effectively creating, maintaining and preserving the lien and security interest created herein and on the Collateral and the priority thereof. Mortgagor shall also pay the costs of obtaining reports from appropriate filing officers concerning financing statement filings in respect of any of the Collateral in which a security interest is granted herein. Section 4.4 Debenture Mortgagees' Right to Perform Mortgagor's Obligations. Mortgagor agrees that, if Mortgagor fails to perform any act which Mortgagor is required to perform under this instrument, any Debenture Mortgagees or any receiver appointed hereunder may, but shall not be obligated to, perform or cause to be performed such act, and any expense incurred by Debenture Mortgagees in so doing shall be a demand obligation owing by Mortgagor to Debenture Mortgagees, shall bear interest at an annual rate equal to the maximum interest rate provided in the Note until paid and shall be a part of the Obligations, and Debenture Mortgagees, or any receiver shall be subrogated to all of the rights of the party receiving the benefit of such performance. The undertaking of such performance by Debenture Mortgagees or any receiver as aforesaid shall not obligate such person to continue such performance or to engage in such performance or performance of any other act in the future, shall not relieve Mortgagor from the observance or performance of any covenant, warranty or agreement contained in this instrument or constitute a waiver of default hereunder and shall not affect the right of Debenture Mortgagees to accelerate the payment of all indebtedness and other sums secured hereby or to resort to any other of its rights or remedies hereunder or under applicable law. In the event the Debenture Mortgagees or any receiver appointed hereunder undertakes any such action, no such party shall have any liability to the Mortgagor in the absence of a showing of gross negligence or willful misconduct of such party, and in all events no party other than the acting party shall be liable to Mortgagor. ARTICLE 5 - DEFAULT Section 5.1 Events of Default. The term "Event of Default" means the occurrence of any of the following events or the existence of any of the following conditions: - 11 - (a) failure by Mortgagor to make any payment when due of any of the Obligations provided for herein or other failure to keep, punctually perform or observe any of the covenants, obligations or prohibitions contained herein or in any other agreement with Debenture Mortgagees (whether now existing or entered into hereafter) or the occurrence of any other event which is, or is deemed to be, an Event of Default under and as that term is defined in any such other written instrument or agreement; or (b) any warranty, information, representation or statement by Mortgagor made or furnished to Debenture Mortgagees by or on behalf of Mortgagor in connection with the Obligations is determined by Debenture Mortgagees to be untrue or misleading in any material respect. Section 5.2 Acceleration Upon Default. Upon the occurrence of any Event of Default, or at any time thereafter, the holders of at least 25% of the outstanding principal amount of the Debentures may, at their option, on behalf of all Debenture Mortgagees pari passu, by notice to Mortgagor, declare the entire unpaid principal of and the interest accrued on the Obligations to be due and payable forthwith without any further notice, presentment or demand of any kind, all of which are hereby expressly waived. Section 5.3 Possession and Operation of Property. Upon the occurrence of any Event of Default, or at any time thereafter, and in addition to all other rights therein conferred on the Debenture Mortgagees, the Debenture Mortgagees or any person, firm or corporation designated by Debenture Mortgagees, will have the right and power, but will not be obligated, to have an audit performed, at Mortgagor's expense, of the books and records of Mortgagor, and to enter upon and take possession of all or any part of the Collateral, to exclude Mortgagor therefrom, and to hold, use, administer, manage and operate the same (in compliance with the terms of contracts binding on the Oil and Gas Property known to the Debenture Mortgagees and all applicable laws) to the extent that Mortgagor could do so. The Debenture Mortgagees or any person, firm or corporation designated by the Debenture Mortgagees, may operate and develop the Collateral, or any portion thereof, without any liability to Mortgagor in connection with the operations except with respect to gross negligence and willful misconduct; and the Debenture Mortgagees or any person, firm or corporation designated by Debenture Mortgagees will have the right to collect, receive and receipt for all Hydrocarbons produced and sold from the Oil and Gas Property, to make repairs, to purchase machinery and equipment, to conduct workover operations, to drill additional wells as necessary in Debenture Mortgagees's good faith judgment for the protection of the Collateral, and to exercise every power, right and privilege of Mortgagor with respect to the Collateral. Providing there has been no foreclosure sale, when and if the expenses of the operation and development (including costs of unsuccessful workover operations or additional wells) have been paid and the Obligations paid in full, the remaining Collateral shall be returned to the Mortgagor. - 12 - Section 5.4 Ancillary Rights. Upon the occurrence of an Event of Default, or at any time thereafter, and in addition to all other rights of Debenture Mortgagees hereunder, Debenture Mortgagees may, without notice, demand or declaration of default, all of which are hereby expressly waived by Mortgagor, proceed by a suit or suits in equity or at law, (i) for the seizure and sale of the Collateral or any part thereof, (ii) for the specific performance of any covenant or agreement herein contained or in aid of the execution of any power herein granted, (iii) for the foreclosure or sale of the Collateral or any part thereof under the judgment or decree of any court of competent jurisdiction, (iv) without regard to the solvency or insolvency of any person, and without regard to the value of the Collateral, and without notice to Mortgagor (notice being hereby expressly waived), for the ex parte appointment of a receiver to serve without bond pending any foreclosure or sale hereunder, or (v) for the enforcement of any other appropriate legal or equitable remedy. Notwithstanding the foregoing, the Debenture Mortgagees agrees to give reasonable efforts to give Mortgagor prior notice of any of the foregoing actions, provided that the failure of Debenture Mortgagees to use such reasonable efforts to give prior notice shall not invalidate any action so taken by Debenture Mortgagees. It is hereby expressly agreed that Mortgagor's sole remedy for any such failure by Debenture Mortgagees shall be an action for damages suffered by Mortgagor as a direct and proximate result of such failure. ARTICLE 6 - DEBENTURE MORTGAGEES'S RIGHTS AS TO REALTY COLLATERAL UPON DEFAULT Section 6.1 Foreclosure. Upon the occurrence of an Event of Default, or at any time thereafter, Debenture Mortgagees may, subject to any mandatory requirements of applicable law, proceed by suit to foreclose its lien hereunder and to sell or have sold the Realty Collateral or any part thereof at one or more sales, as an entirety or in parcels, at such place or places and otherwise, in such manner and upon such notice as may be required by law, or, in the absence of any such requirement, as Debenture Mortgagees may deem appropriate, and Debenture Mortgagees shall thereafter make or cause to be made a conveyance to the purchaser or purchasers thereof. Debenture Mortgagees may postpone the sale of the real property included in the Collateral or any part thereof by public announcement at the time and place of such sale, and from time to time thereafter may further postpone such sale by public announcement made at the time of sale fixed by the preceding postponement. Sale of a part of the Realty Collateral will not exhaust the power of sale, and sales may be made from time to time until all such property is sold or the Obligations are paid in full. ARTICLE 7 - DEBENTURE MORTGAGEES'S RIGHTS AS TO PERSONALTY AND FIXTURE COLLATERAL UPON DEFAULT Section 7.1 Personalty Collateral. Upon the occurrence of an Event of Default, or at any time thereafter, Debenture Mortgagees may, without notice to Mortgagor, exercise their rights to declare all of the Obligations to be immediately due and payable, in which case Debenture Mortgagees will have all rights and remedies granted by law, and particularly by the Uniform Commercial Code, including, but not limited to, the right to take possession of the Personalty Collateral, and for this purpose Debenture Mortgagees may enter upon any premises on which any or all of the Personalty Collateral is situated and take possession of and operate the Personalty Collateral or remove it therefrom. - 13 - Debenture Mortgagees may require Mortgagor to assemble the Personalty Collateral and make it available to Debenture Mortgagees or a representative of the Debenture Mortgagees at a place to be designated by Debenture Mortgagees which is reasonably convenient to all parties. Unless the Personalty Collateral is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market, Debenture Mortgagees will give Mortgagor reasonable notice of the time and place of any public sale or of the time after which any private sale or other disposition of the Personalty Collateral is to be made. This requirement of sending reasonable notice will be met if the notice is mailed, postage prepaid, to Mortgagor at the address designated above at least five days before the time of the sale or disposition. Section 7.2 Sale with Realty Collateral. In the event of foreclosure, whether judicial or nonjudicial, at Debenture Mortgagees's option it may proceed under the Uniform Commercial Code as to the Personalty Collateral or Debenture Mortgagees may proceed as to both Realty Collateral and Personalty Collateral in accordance with their rights and remedies in respect of the Realty Collateral. Section 7.3 Fixture Collateral. Upon the occurrence of an Event of Default, or at any time thereafter, Debenture Mortgagees may elect to treat the Fixture Collateral as either Realty Collateral or as Personalty Collateral and proceed to exercise such rights as apply to the type of Collateral selected. ARTICLE 8 - OTHER PROVISIONS CONCERNING FORECLOSURE Section 8.1 Possession and Delivery of Collateral. It shall not be necessary for Debenture Mortgagees to have physically present or constructively in their possession any of the Collateral at any foreclosure sale, and Mortgagor shall deliver to the purchasers at such sale on the date of sale the Collateral purchased by such purchasers at such sale, and if it should be impossible or impracticable for any of such purchasers to take actual delivery of the Collateral, then the title and right of possession to the Collateral shall pass to the purchaser at such sale as completely as if the same had been actually present and delivered. Section 8.2 Debenture Mortgagees as Purchaser. Debenture Mortgagees will have the right to become the purchaser at any foreclosure sale, and it will have the right to credit upon the amount of the bid the amount payable to it out of the net proceeds of sale. Section 8.3 Recitals Conclusive: Ratification. Recitals contained in any conveyance to any purchaser at any sale made hereunder will conclusively establish the truth and accuracy of the matters therein stated, including, without limiting the generality of the foregoing, nonpayment of the unpaid principal sum of, and the interest accrued on, the written instruments constituting part or all of the Obligations after the same have become due and payable, nonpayment of any other of the Obligations or advertisement and conduct - 14 - of the sale in the manner provided herein. Mortgagor ratifies and confirms all legal acts that Debenture Mortgagees may do in carrying out the provisions of this instrument. Section 8.4 Effect of Sale. Any sale or sales of the Collateral or any part thereof will operate to divest all right, title, interest, claim and demand whatsoever, either at law or in equity, of Mortgagor in and to the premises and the property sold, and will be a perpetual bar, both at law and in equity, against Mortgagor, Mortgagor's successors or assigns and against any and all persons claiming or who shall thereafter claim all or any of the property sold from, through or under Mortgagor, or Mortgagor's successors or assigns. The purchaser or purchasers at the foreclosure sale will receive immediate possession of the property purchased; and if Mortgagor retains possession of the Realty Collateral, or any part thereof, subsequent to sale, Mortgagor will be considered a tenant at sufferance of the purchaser or purchasers, and if Mortgagor remains in such possession after demand of the purchaser or purchasers to remove, Mortgagor will be guilty of forcible detainer and will be subject to eviction and removal, forcible or otherwise, with or without process of law, and without any right to damages arising out of such removal. Section 8.5 Application of Proceeds. The proceeds of any sale of the Collateral or any part thereof will be applied as follows: (a) first, to the payment of all expenses incurred by the Debenture Mortgagees in connection therewith, including, without limiting the generality of the foregoing, court costs, legal fees and expenses, fees of accountants, engineers, consultants, agents or managers and expenses of any entry or taking of possession, holding, valuing, preparing for sale, advertising, selling and conveying; (b) second, to the payment of the Obligations; and (c) third, any surplus thereafter remaining to Mortgagor or Mortgagor's successors or assigns, as their interests may be established to Debenture Mortgagees' reasonable satisfaction. Section 8.6 Deficiency. Mortgagor will remain liable for any deficiency owing to Debenture Mortgagees or any other Secured Party after application of the net proceeds of any foreclosure sale. Section 8.7 Mortgagor's Waiver of Appraisement, Marshalling, etc. Mortgagor agrees that Mortgagor will not at any time insist upon or plead or in any manner whatsoever claim the benefit of any appraisement, valuation, stay, extension or redemption law now or hereafter in force, in order to prevent or hinder the enforcement or foreclosure of this instrument, the absolute sale of the Collateral or the possession thereof by any purchaser at any sale made pursuant to this instrument or pursuant to the decree of any court of competent - 15 - jurisdiction. Mortgagor, for Mortgagor and all who may claim through or under Mortgagor, hereby waives the benefit of all such laws and to the extent that Mortgagor may lawfully do so under applicable state law, waives any and all right to have the Realty Collateral marshalled upon any foreclosure of the lien hereof or sold in inverse order of alienation. ARTICLE 9 - MISCELLANEOUS Section 9.1 Pooling and Unitization. The interest of Mortgagor in any unit, pooling agreement or other similar arrangement, whether voluntary or involuntary, to which the Oil and Gas Property (or any part thereof) is or may be subject will become a part of the Realty Collateral and the Personalty Collateral, as the case may be, and will be subject to the lien and security interest hereof in the same manner and with the same effect as though the unit, pooling agreement or other arrangement and the interest of Mortgagor therein were specifically described in Exhibit A. Section 9.2 Discharge of Purchaser. Upon any sale made under the powers of sale herein granted and conferred, the receipt of Debenture Mortgagees will be sufficient discharge to the purchaser or purchasers at any sale for the purchase money, and such purchaser or purchasers and the heirs, devisees, personal representatives, successors and assigns thereof will not, after paying such purchase money and receiving such receipt of Debenture Mortgagees, be obliged to see to the application thereof or be in anyways answerable for any loss, misapplication or nonapplication thereof. Section 9.3 Indebtedness of Obligations Absolute. Nothing herein contained shall be construed as limiting Debenture Mortgagees to the collection of any indebtedness of Mortgagor to Debenture Mortgagees only out of the income, revenue, rents, issues and profits from the Collateral or as obligating Debenture Mortgagees to delay or withhold action upon any default which may be occasioned by failure of such income or revenue to be sufficient to retire the principal or interest when due on the indebtedness secured hereby. It is expressly understood between Debenture Mortgagees and Mortgagor that any indebtedness of Mortgagor to Debenture Mortgagees secured hereby shall constitute an absolute, unconditional obligation of Mortgagor to pay as provided herein or therein in accordance with the terms of the instrument evidencing such indebtedness in the amount therein specified at the maturity date or at the respective maturity dates of the installments thereof, whether by acceleration or otherwise. Section 9.4 Defense of Claims. Mortgagor will promptly notify Debenture Mortgagees in writing of the commencement of any material proceedings or any litigation affecting Debenture Mortgagees' interest in the Collateral, or any part thereof, and shall take such action, employing attorneys (which must be reasonably acceptable to Debenture Mortgagees), as may be necessary to preserve Mortgagor's and Debenture Mortgagees's rights affected thereby; and should Mortgagor fail or refuse to take any such action, Debenture Mortgagees may take the action on behalf of and in the name of Mortgagor and at Mortgagor's expense. - 16 - Moreover, Debenture Mortgagees may take independent action in connection therewith as it may in its discretion deem proper, and Mortgagor hereby agrees to make reimbursement for all sums advanced and all expenses incurred in such actions plus interest at a rate equal to the maximum interest rate provided in the Debentures. Section 9.5 Termination. If (i) all amounts of principal and interest due under all the Debentures, (ii) all other fees and expenses payable by Mortgagor under the Debentures and hereunder, and (iii) all other Obligations which are in sum certain amounts have been paid in full and no Claims have been identified, then Debenture Mortgagees shall, upon the request of Mortgagor and at Mortgagor's cost and expense, deliver to Mortgagor proper instruments executed by or on behalf of the holders of at least eighty percent (80%) of the principal amount of the Debentures evidencing the release of this instrument. Mortgagor shall be authorized to file and record such instruments and upon delivery thereof to Mortgagor, this instrument shall be terminated. Until such delivery, this instrument shall remain and continue in full force and effect. Section 9.6 Renewals, Amendments and Other Security. Renewals and extensions of the Obligations may be given at any time, amendments may be made to the agreements relating to any part of the Obligations or the Collateral in accordance with the terms of the Debentures. Section 9.7 Effect of Instrument. This instrument shall be deemed and construed to be, and may be enforced as, an assignment, chattel mortgage or security agreement, contract, deed of trust, financing statement, financing statement filed as a fixture filing, and real estate mortgage, and as any one or more of them if appropriate under applicable state law. This instrument shall be effective as a financing statement filed as a fixture filing with respect to all Fixture Collateral and is to be filed for record in the Office of the County Clerk or other appropriate office of each county where any part of the Collateral, including Fixture Collateral, is situated. This instrument shall also be effective as a financing statement covering minerals or the like (including oil and gas) and accounts subject to Section 9-103(5) (or corresponding provision) of the Uniform Commercial Code as enacted in the appropriate jurisdiction and is to be filed for record in the Office of the County Clerk or other appropriate office of each county where any part of the collateral is situated. A carbon, photographic, or other reproduction of this Mortgage or of any financing statement relating to this Mortgage shall be sufficient as a financing statement. Section 9.8 Unenforceable or Inapplicable Provisions. If any provision hereof or of any of the written instruments constituting part or all of the Obligations is invalid or unenforceable in any jurisdiction, whether with respect to all parties hereto or with respect to less than all of such parties, the other provisions hereof and of the written instruments will remain in full force and effect in that jurisdiction with respect to the parties as to which such provision is valid and enforce able, and the remaining provisions hereof will be liberally construed in favor of Debenture Mortgagees in order to carry out the provisions hereof. The invalidity of any provision of this instrument in any jurisdiction will not affect the validity or enforceability of any provision in any other jurisdiction. - 17 - Section 9.9 Rights Cumulative. Each and every right, power and remedy given to Debenture Mortgagees herein or in any other written instrument relating to the Obligations will be cumulative and not exclusive; and each and every right, power and remedy whether specifically given herein or otherwise existing may be exercised from time to time and as often and in such order as may be deemed expedient by Debenture Mortgagees, and the exercise, or the beginning of the exercise, of any such right, power or remedy will not be deemed a waiver of the right to exercise, at the same time or thereafter, any other right, power or remedy. A waiver by Debenture Mortgagees of any right or remedy hereunder or under applicable law on any occasion will not be a bar to the exercise of any right or remedy on any subsequent occasion. Section 9.10 Non-Waiver. No act, delay, omission or course of dealing between Debenture Mortgagees and Mortgagor will be a waiver of any of Debenture Mortgagees' rights or remedies hereunder or under applicable law. No waiver, change or modification in whole or in part of this instrument or any other written instrument will be effective unless in a writing signed by Debenture Mortgagees. Section 9.11 Debenture Mortgagees's Expenses. Mortgagor agrees to pay in full all expenses and reasonable attorneys' fees of Debenture Mortgagees which may have been or may be incurred by Debenture Mortgagees in connection with the collection of the Obligations and the enforcement of any of Mortgagor's obligations hereunder and under any documents executed in connection with the Obligations. Section 9.12 Partial Releases. In the event Mortgagor sells for monetary consideration or otherwise any portion of the Oil and Gas Property, Debenture Mortgagees shall release the lien of this instrument with respect to the portion sold, at the request of Mortgagor. No release from the lien of this instrument of any part of the Collateral by Debenture Mortgagees shall in anyways alter, vary or diminish the force, effect or lien of this instrument on the balance or remainder of the Collateral. Section 9.13 Notice. All notices and deliveries of information hereunder shall be deemed to have been duly given if to the Debenture Mortgagees at the addresses of the holders of the Debentures set forth on Exhibit B or at such subsequent addresses as may be furnished to Mortgagor in writing by any holder of a Debenture. Notwithstanding the provisions of Section 5.4 and Articles 6 and 7 wherein Debenture Mortgagees is authorized to exercise certain rights or take certain actions without notice to Mortgagor, Debenture Mortgagees agrees to use reasonable efforts to give Mortgagor prior notice of any such exercise of rights or action. It is expressly agreed, however, that any failure by Debenture Mortgagees to use reasonable efforts to give Mortgagor prior notice of an exercise of rights or action shall not invalidate or preclude such exercise of rights or action, but shall merely entitle the Mortgagor to recover from Debenture Mortgagees any actual damages suffered by Mortgagor as the proximate and direct result of such failure by Debenture Mortgagees. - 18 - Section 9.14 Successors. This instrument shall bind and inure to the benefit of the respective successors and assigns of the parties. Section 9.15 Interpretation. (a) Article and section headings used in this instrument are intended for convenience only and shall be given no significance whatever in interpreting and construing the provisions of this instrument. (b) As used in this instrument, "Debenture Mortgagees" and "Mortgagor" include their respective successors and assigns. Unless context otherwise requires, words in the singular number include the plural and in the plural number include the singular. Words of the masculine gender include the feminine and neuter gender and words of the neuter gender may refer to any gender. Section 9.16 Inconsistencies with Related Documents. To the extent, if any, the provisions hereof are inconsistent with the provisions of the Debentures, such inconsistencies shall be resolved by giving controlling effect to the Debentures. Section 9.17 Counterparts. This instrument may be executed in any number of counterparts, each of which will for all purposes be deemed to be an original, and all of which are identical except that to facilitate recordation, in particular counterparts hereof used for recordation, portions of Exhibit A hereto which describe properties situated in counties other than the county in which the counterpart is to be recorded have been omitted. Executed as of the Effective Date. MORTGAGOR: ATTEST PEASE OIL AND GAS COMPANY By - ------------------------------------- --------------------------------- Secretary Willard H. Pease, Jr., President - 19 - DEBENTURE MORTGAGES: By: PEASE OIL AND GAS COMPANY By --------------------------------- Willard H. Pease, Jr., as attorney-in-fact on behalf of all holders of Debentures as identified on Exhibit B. STATE OF COLORADO ) ) ss. COUNTY OF MESA ) The foregoing instrument was acknowledged before me this ____ day of ___________, 1996, by Willard H. Pease, Jr. as President of Pease Oil and Gas Company, a Nevada corporation. Witness my hand and official seal. My commission expires: S E A L -------------------------------------- Notary Public - 20 - EXHIBIT B Holders of 1996 10% Collateralized Subordinated Convertible Debentures of Pease Oil and Gas Company (herein referred to as "Debenture Mortgagees"): Name and Address of Holders Principal Amount of Debenture --------------------------- ----------------------------- - 21 - EX-4 5 EXHIBIT 23.1--CONSENT OF MCCARTNEY ENGINEERING CONSENT OF McCARTNEY ENGINEERING, LLC As Oil and gas consultants, McCartney Engineering, LLC hereby consents to: (a) the use of our reserve report dated February 17, 1997 entitled "Pease Oil and Gas Company's Estimated Remaining Reserves and Future Net Revenue Pursuant to SEC Guidelines as of December 31, 1996"; (b) all references to our firm included in or made a part of Pease Oil and Gas Company's Annual Report on Form 1O-KSB to be filed with the Securities and Exchange Commission on or about March 27,1997; and (c) the incorporation by reference of the said Form 10-KSB with and into Registration Statements 33-44536 dated July 24, 1996 and 333-19589 dated February 10, 1997. /s/ Jack A. McCartney, Manager ----------------------------------- McCARTNEY ENGINEERING, LLC EX-5 6 EXHIBIT 23.2--CONSENT OF HEIN + ASSOCIATES LLP INDEPENDENT CERTIFIED PUBLIC ACCOUNTANT'S CONSENT We consent to the incorporation by reference in the Registration Statements of Pease Oil and Gas Company on Form S-3 (SEC File Nos. 33-94536 with an effective date of July 24, 1996, and 333-19589 with an effective date of February 10, 1997) of our report dated February 21, 1997 on our audits of the consolidated statements of Pease Oil and Gas Company as of December 31, 1996, and for the years ended December 31, 1996 and 1995, which report is included in the Annual Report of Pease Oil and Gas Company on Form 10-KSB. /s/ Hein + Associates LLP HEIN + ASSOCIATES LLP Denver, Colorado March 26, 1997 EX-27 7 FINANCIAL DATA SCHEDULE
5 YEAR DEC-31-1996 DEC-31-1996 1,995,860 0 624,948 25,000 408,787 3,060,622 15,476,273 5,323,128 14,901,149 1,152,928 5,000,000 0 1,799 752,682 0 14,901,149 6,050,636 6,165,664 4,189,850 7,150,715 2,960,865 0 502,428 (1,452,991) (41,409) (1,411,582) 0 0 0 (1,614,270) (0.22) (0.22)
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