-----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, MDrLqi3pvHFQZ9NlsHeMGmRyghB90Fsad3rm1pfkDh2Z5xkQaZjkV2PlCkK4EmJ8 qeDytaeZuL/7Ej7a1TjlEA== 0001015402-04-001502.txt : 20040414 0001015402-04-001502.hdr.sgml : 20040414 20040414172444 ACCESSION NUMBER: 0001015402-04-001502 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040414 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INFINITY INC CENTRAL INDEX KEY: 0000822746 STANDARD INDUSTRIAL CLASSIFICATION: OIL, GAS FIELD SERVICES, NBC [1389] IRS NUMBER: 841070066 STATE OF INCORPORATION: CO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-17204 FILM NUMBER: 04734067 BUSINESS ADDRESS: STREET 1: 211 W 14TH ST STREET 2: STE 260 CITY: CHANUTE STATE: KS ZIP: 66720 BUSINESS PHONE: 3164316200 MAIL ADDRESS: STREET 1: 211 WEST 14TH STREET CITY: CHANUTE STATE: KS ZIP: 66720 10-K 1 doc1.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 ___________________ FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year ended: December 31, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 0-17204 ______________________ INFINITY, INC. (Exact Name of Small Business Issuer as Specified in its Charter) Colorado 84-1070066 (State or of Incorporation) (I.R.S. Employer Identification Number) 211 West 14th Street, Chanute, Kansas 66720 (Address of Principal Executive Offices, Including Zip Code) (620) 431-6200 (Registrant'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 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K, is not contained herein and will not 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-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12B-2 of the Act). Yes [ ] No [X] As of April 12, 2004, 9,396,091 of the Registrant's $0.0001 Par Value Common Stock were outstanding. The aggregate market value of voting and non-voting common equity held by non-affiliates as of June 30, 2003 was approximately $49,456,971 based upon a closing price of $6.05 per share as reported on the NASDAQ National Market. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A in connection with the 2004 Annual Meeting of Shareholders are incorporated by reference in Part III of this Report on Form 10-K. PART I ITEM 1. DESCRIPTION OF BUSINESS BUSINESS DEVELOPMENT Infinity, Inc. ("Infinity") was organized as a Colorado corporation on April 2, 1987. Infinity is an independent energy company primarily engaged in the operation, development, production, exploration and acquisition of North American unconventional natural gas properties and providing oil field services in eastern Kansas, northeastern Oklahoma and the Powder River Basin of Wyoming. As used herein, "Infinity", "we" and "our" refer collectively to Infinity, Inc., its predecessors, subsidiaries and affiliates as to one or more of them as the context may require. The following table sets forth the operating subsidiaries of Infinity by type of business activity. Each of these subsidiaries is 100% owned. Additional information about the activities of each subsidiary follows:
OIL AND GAS OIL FIELD CORPORATE EXPLORATION AND PRODUCTION SERVICE SERVICES - -------------------------- ------------------- ------------- Infinity Oil and Gas Consolidated Oil CIS-Oklahoma, of Wyoming, Inc. Well Services, Inc. Inc. Infinity Oil and Gas of Kansas, Inc.
Consolidated Oil Well Services, Inc. ("Consolidated") acquired assets necessary to provide oil field services in Eastern Kansas and Northeastern Oklahoma in January 1994. Consolidated expanded its operations into northeastern Wyoming with the acquisition of Powder River Cementers, LLC during September 1999. In November 2001 Consolidated expanded its operations into South Central Wyoming by leasing operating facilities near, and transferring service equipment to Rock Springs, Wyoming. Due to the decrease in the number of wells being drilled by an affiliated company, Consolidated closed its Rock Springs, Wyoming facility, terminated its lease on the operating facilities and transferred its service equipment to its other locations in December 2003. This entity provides fracturing, cementing, and acidizing services as well as trucking of fluids to its oil field customers. Infinity Oil and Gas of Kansas, Inc. ("Infinity-Kansas") owns a 31.25% interest through a capital contribution in the Little Bear Creek prospect in southwest Kansas. This prospect is an undeveloped, 5,120 acre river sand prospect operated by an unrelated third party, IGWT, Inc. Infinity-Kansas has invested approximately $56,000 in leasehold and approximately $187,000 in 3-D seismic and the drilling of three wells on the prospect during the years ended December 31, 2003 and 2002. None of the wells drilled to date have been economic and the operator is evaluating the results of drilling programs on adjacent acreage before taking any further action. The results of the drilling programs on the adjacent acreage should be available in the second quarter of 2004. Depending on the results of those programs there is a potential that that the operator will abandon the prospect and Infinity-Kansas will reclassify the $56,000 in leasehold investment to the full cost pool subject to depletion. Infinity-Kansas does not have investment in any other oil and gas prospects. Infinity Oil & Gas of Wyoming, Inc. ("Infinity-Wyoming") is an independent energy company engaged in the acquisition, exploration, development, exploitation and production of crude oil and natural gas in the continental United States. Infinity-Wyoming was incorporated in January 2000 for the purpose of acquiring properties with the intent of exploring for coal bed methane. Historically, we have developed our proven oil and gas reserves and increased production primarily through acquiring oil and gas leaseholds and drilling wells to exploit and develop tight sand and coalbed methane properties. We believe the probability that such properties have hydrocarbons in place is relatively high and the viability of establishing commercially producible reserves is largely dependent on several factors, including: the market price for oil and gas; the costs of development, production and marketing; and determination of the amount of recoverable reserves and the rate at which such reserves can be extracted. To a lesser extent, we have added proved reserves through acquisition of properties with proved developed reserves. At December 31, 2003, Infinity-Wyoming had 8.7 billion cubic feet equivalent ("Bcfe") of proved reserves having a pretax present value based upon a discount rate of 10% of approximately $23.0 million based upon unescalated prices and costs. This valuation reflected average wellhead prices of $6.06 per Mcf for natural gas and $31.34 per barrel for crude oil at year-end. Approximately 95% of our proved oil and gas reserves were associated with tight sand properties on the Wamsutter Arch in the Greater Green River Basin in Wyoming. The balance of our proved reserves at the end of 2003 related to one property in the Sand Wash Basin in Colorado. At December 31, 2003, Infinity-Wyoming operated 13 of the 15 properties that were assigned proved developed oil and gas reserves. Effective March 1, 2004, Infinity-Wyoming assumed operations of the two previously non-operated properties which contained proved developed oil and gas reserves. An additional 11 properties were assigned proved undeveloped reserves at December 31, 2003. Operating the oil and gas properties in which it owns an interest allows Infinity-Wyoming to exercise greater control over operating costs, capital expenditures and the timing of exploration, development and exploitation activities. During 2003, Infinity-Wyoming produced 1.4 Bcfe of gas, comprised of 1.1 Bcf of natural gas and 57,700 barrels of crude oil. Approximately 98% of this production was from the Pipeline field on the Wamsutter Arch in the Greater Green River Basin. Total revenue from product sales totaled $6.6 million, comprised of natural gas sales of $4.8 million, or $4.47 per mcf, and crude oil sales of $1.8 million, or $30.51 per barrel. CIS-Oklahoma, Inc. owns the real property and facilities that Infinity and Consolidated occupy in Chanute and Ottawa, Kansas, Bartlesville, Oklahoma and Gillette, Wyoming. In addition to the purchase of the original facilities, the Bartlesville, Oklahoma facility was expanded in 2002 with the completion of a new office and shop facility at a cost of approximately $438,000. These properties were purchased with the proceeds from and serve as collateral for loans that were established with a local bank. Infinity Nicaragua Ltd. and Infinity Nicaragua Offshore Ltd. (the Infinity Nicaragua companies) are wholly owned subsidiaries of Infinity and incorporated in the Bahamas. The Infinity Nicaragua companies together own a majority interest in Rio Grande Resources S.A. ("Rio Grande"). Rio Grande is a Nicaraguan company. Pursuant to Nicaraguan law, Nicaraguan companies must have a minimum of three shareholders and there are three shareholders of Rio Grande. The Infinity Nicaraguan companies own 98.2% of Rio Grande. Rio Grande was awarded concessions to develop two offshore blocks in Nicaragua. The Instituto Nicaraguense de Energia ("INE"), the Nicaraguan governmental entity regulating oil and gas activities, refused to recognize the concessions awarded to Rio Grande and the Nicaragua Supreme Court declared them void. As a result, the Infinity Nicaragua companies currently hold no ownership interest in valid leases in Nicaragua and are no longer active subsidiaries of Infinity. However, the relationships that were built with INE and the geological and geophysical research that was done helped Infinity to become one of only six companies qualified to bid on the first international bidding round held by INE in January 2003. Infinity was awarded the bid on 24 blocks of acreage, comprised of over one million acres, and immediately entered into negotiations with INE to finalize the initial exploration plan for the Tyra and Perlas prospects. Infinity anticipates the completion of the negotiations and the assignment of the concessions during 2004. For a discussion of the development of the Company's business and a description of the oil field service properties and oil and gas properties by geographic area, see "Item 2. Properties". BUSINESS ACTIVITIES Infinity is primarily engaged in providing oil and gas well services through Consolidated and in the identification, acquisition, and development of oil and gas properties through Infinity-Kansas and Infinity-Wyoming. Consolidated also operates a wastewater treatment facility on a limited basis. 2 Consolidated provides services associated with drilling and completion of oil and gas wells, including cementing, acidizing, fracturing, nitrogen pumping and water hauling. Consolidated previously provided on-site remediation services for hazardous and non-hazardous waste, and operated a centralized water treatment facility and facilities to treat brine water produced by oil and gas wells. The Cheyenne, Wyoming waste-water treatment facility operates on a limited basis. The Infinity-Kansas and Infinity-Wyoming subsidiaries are engaged in the acquisition and development of oil and gas properties. Infinity-Kansas' current interest is in a partner operated River Sand property in southwest Kansas. Infinity-Wyoming owns and operates the Pipeline and Labarge gas prospects in the Greater Green River Basin of southwest Wyoming and the Sand Wash and Piceance Basins of Colorado. For a complete description of the properties and the activities related to these properties see "Item 2. Description of Property - Oil and Gas Interest in Leasehold Acreage." Specific information about the revenue, profitability and assets of each business segment can be found in Note 14 to the Consolidated Financial Statements contained in this Form 10-K at page F-1. CUSTOMERS AND MARKETS Oil Field Services Consolidated provides its services to oil and gas developers and lease operators throughout eastern Kansas and northeast Oklahoma which includes the Forest City and Cherokee Basins and in the Powder River Basin of Wyoming. Consolidated also provides these services in the Arkoma basin of eastern Oklahoma and provides well cementing services to water well drillers in Missouri, Kansas and Oklahoma. Consolidated provided services to approximately 400 customers during the calendar year ended December 31, 2003, to approximately 380 customers for the calendar year ended December 31, 2002 and to over 350 customers during the nine month transition period ended December 31, 2001. The following table sets out information about Consolidated's major customers during each of these periods:
PERCENT PERCENT OF OF OILFIELD CUSTOMER AREAS OF OPERATION REVENUE TOTAL SERVICE - ---------------------- --------------------- ------------ ------- ---------- 2003 ---- A Northeastern Oklahoma $1.1 million 6% 10% B Eastern Kansas $0.9 million 5% 8% 2002 ---- C Eastern Kansas/ $1.6 million 14% 18% Northeastern Oklahoma 2001 TRANSITION PERIOD ---------------------- D Northeastern Oklahoma $1.3 million 11% 14% E Powder River, Wyoming $1.3 million 11% 14%
Consolidated also provided services to Infinity-Wyoming which resulted in eliminated inter-company revenue of approximately $2.1 million in the year ended December 31, 2002 and $0.5 million for the nine months ended December 31, 2001. The amount of revenue earned by Consolidated from inter-company sales was less than $20,000 during the year ended December 31, 2003. Consolidated has no long-term service contracts with any customers and we do not believe that a loss of any one of our customers will have a prolonged material adverse effect on Consolidated's business. However, the loss of several customers in any location or a rapid, significant change in oil and gas prices to the extent that customers curtail their development activities could have a material adverse impact on our financial and operating results. 3 EXPLORATION AND PRODUCTION Infinity-Wyoming sells gas from the Pipeline project to Duke Energy Field Services ("Duke"). A portion of its gas is sold to Duke on a forward contract basis with the remainder being sold at the Inside FERC, first of the month CIG Index, a published pricing index on which gas sales contracts in the Rocky Mountains are generally based. Infinity-Wyoming enters into the contracts to hedge its production when market conditions are deemed favorable in order to manage price fluctuations and achieve a more predictable cash flow. The following table identifies the three contracts that were in place during the year ended December 31, 2003 and the two contracts that were put in place subsequent to that date.
DAILY BEGINNING ENDING CONTRACT CONTRACT DATE DATE VOLUME PRICE - ---------------- ------------------ ----------- ----------- October 1, 2002 September 30, 2003 1,000 MMBTU $2.97/MMBTU November 1, 2002 March 31, 2003 1,000 MMBTU $3.00/MMBTU April 1, 2003 March 31, 2004 3,500 MMBTU $4.71/MMBTU April 1, 2004 March 31, 2005 2,000 MMBTU $4.40/MMBTU April 1, 2005 March 31, 2006 2,000 MMBTU $4.15/MMBTU (1) MMBTU of gas is equivalent to 1,000,000 British thermal units, a standard measure of the heating value of the gas. The gas produced from the Pipeline project contains about 1,100 British Thermal Units ("BTU") per cubic foot of gas.)
Oil production from the Pipeline wells is sold at the NYMEX posted price less $0.75 per barrel. For December 2003 this was a price of $31.51 per barrel of oil. The following table shows the total sales of oil and gas production and the percentage of consolidated revenue that the value represented for each of the years ended December 31, 2003 and 2002 and nine month transition period ended December 31, 2001.
OIL AND GAS PERCENTAGE OF PERIOD REVENUE TOTAL REVENUE - ------ ------------ -------------- 2003 $6.6 million 36% 2002 $2.4 million 22% 2001 $1.8 million 15%
Based on the general demand for oil and natural gas, Infinity does not believe that a loss of any customer would have a material adverse effect on its business. COMPETITION Infinity and its subsidiaries compete in virtually all facets of their businesses with numerous other companies, including many that have significantly greater financial and other resources. Such competitors may be able to pay more for desirable oil and gas leases and to evaluate, bid for, and purchase a greater number of properties than the financial or personnel resources of Infinity permit. The oil field service competitors may be able to invest more resources in research and development of new completion techniques and acquire additional equipment to allow them to dedicate resources to a customer in a way that Consolidated is unable to. Consolidated's competition in eastern Kansas consist mainly of Cudd Pumping Services and Blue Star Acid Services. In northeastern Oklahoma, Consolidated competes with Cudd Pumping Services, BJ Services, Oklahoma Oil Well Fracturing and several small local companies. Consolidated believes that its bulk materials facilities, experienced work force, and well maintained fleet of service vehicles puts it in a competitive position to maintain revenues in these locations. 4 Consolidated continues to see competition from three major service companies: Halliburton, BJ Services, and Schlumberger throughout Wyoming; and numerous smaller cementing companies in northeastern Wyoming. Consolidated may be at a competitive disadvantage when compared to the major companies that are well established with substantial financial resources. These companies can redirect assets and manpower, much like Consolidated has done, to insure that resources to meet the growing demand are available. Some of the exploration and development companies in this area also have the resources available to develop their own service providers. Consolidated's ability to provide services that meet the market demand in a timely manner while providing quality service to the wells will be crucial to its ability to compete in this market. Infinity's growth strategy includes the acquisition of oil and gas properties. There can be no assurance, however, that Infinity or its subsidiaries will be able to successfully acquire identified targets, or have the financing available for the acquisitions. We operate in the highly competitive areas of oil and natural gas exploration, exploitation, acquisition and production with other companies. We face intense competition from a large number of independent companies as well as major oil and gas companies in a number of areas such as: - Acquisition of desirable producing properties or new leases for future exploration; - Marketing our oil and natural gas production; and - Seeking to acquire the equipment, labor and materials necessary to operate and develop those properties. Many of our competitors have financial and technological resources substantially exceeding those available to Infinity. Many oil and gas properties are sold in a competitive bidding process in which we may lack technological information or expertise available to other bidders. We cannot be sure that we will be successful in acquiring and developing profitable properties in the face of this competition. GOVERNMENT REGULATION OF THE OIL AND GAS INDUSTRY General Infinity's business is affected by numerous laws and regulations, including, among others, laws and regulations relating to energy, environment, conservation and tax. Failure to comply with these laws and regulations may result in the assessment of administrative, civil and/or criminal penalties, the imposition of injunctive relief or both. Moreover, changes in any of these laws and regulations could have a material adverse effect on our business. In view of the many uncertainties with respect to current and future laws and regulations, including their applicability to Infinity, we cannot predict the overall effect of such laws and regulations on our future operations. Infinity believes that its operations comply in all material respects with applicable laws and regulations and that the existence and enforcement of such laws and regulations have no more restrictive effect on our method of operations than on other similar companies in the energy industry. The following discussion contains summaries of certain laws and regulations and is qualified as mentioned above. Federal Regulation of the Sale of Oil and Gas Various aspects of the Infinity's oil and natural gas operations are regulated by agencies of the federal government. The Federal Energy Regulatory Commission ("FERC") regulates the transportation and sale for resale of natural gas in interstate commerce pursuant to the Natural Gas Act of 1938 ("NGA") and the Natural Gas Policy Act of 1978 ("NGPA"). In the past, the federal government has regulated the prices at which oil and gas could be sold. While "first sales" by producers of natural gas and all sales of crude oil, condensate and natural gas liquids can currently be made at uncontrolled market prices, Congress could reenact price controls in the future. Deregulation of wellhead sales in the natural gas industry began with the enactment of the NGPA in 1978. In 1989, Congress enacted the Natural Gas Wellhead Decontrol Act (the "Decontrol Act"). The Decontrol Act removed all NGA and NGPA price and non-price controls affecting wellhead sales of natural gas effective January 1, 1993. Commencing in April 1992, the FERC issued Orders Nos. 636, 636-A, 636-B, 636-C and 636-D ("Order No. 636"), which require interstate pipelines to provide transportation services separate, or "unbundled," from the pipelines' sales of gas. Also, Order No. 636 requires pipelines to provide open access transportation on a nondiscriminatory basis that is equal for all natural gas shippers. Although Order No. 636 does not directly regulate Infinity's production activities, FERC has stated that it intends for Order No. 636 to foster increased competition within all phases of the natural gas industry. 5 Infinity conducts certain operations on federal oil and gas leases, which are administered by the Minerals Management Service ("MMS"). Federal leases contain relatively standard terms and require compliance with detailed MMS regulations and orders, which are subject to change. Among other restrictions, the MMS has regulations restricting the flaring or venting of natural gas, and the MMS has proposed to amend such regulations to prohibit the flaring of liquid hydrocarbons and oil without prior authorization. Under certain circumstances, the MMS may require any company operations on federal leases to be suspended or terminated. Any such suspension or termination could materially and adversely affect Infinity's financial condition, cash flows and operations. The MMS issued a final rule that amended its regulations governing the valuation of crude oil produced from federal leases. This rule, which became effective June 1, 2000, provides that the MMS will collect royalties based on the market value of oil produced from federal leases. On August 20, 2003, the MMS issued a proposed rule that would change certain components of its valuation procedures for the calculation of royalties owed for crude oil sales. The proposed changes included changing the valuation basis for transactions not at arm's-length from spot to NYMEX prices adjusted for locality and quality differentials, and clarifying the treatment of transactions under a joint operating agreement. Final comments on the proposed rule were due on November 10, 2003. Infinity has no way of knowing whether the MMS will implement the proposed changes in a final rule or what effect such changes, if implemented, will have on Infinity's results of operations, However, we do not believe that this proposed rule would affect us any differently than other producers of crude oil. Additional proposals and proceedings that might affect the oil and gas industry are pending before Congress, the FERC, the MMS, state commissions and the courts. Infinity cannot predict when or whether any such proposals and proceedings may become effective. In the past, the natural gas industry has been heavily regulated. There is no assurance that the regulatory approach currently pursued by various agencies will continue indefinitely. Notwithstanding the foregoing, Infinity does not anticipate that compliance with existing federal, state and local laws, rules and regulations will have a material or significantly adverse effect upon the capital expenditures, earnings or competitive position of Infinity or its subsidiaries. Environmental Matters Consolidated, Infinity-Kansas, and Infinity-Wyoming currently own or lease properties that are being used for the disposal of drilling and produced fluids from exploration, development and production of oil and gas and for other uses associated with the oil and gas industry. Although these subsidiaries follow operating and disposal practices that it considers appropriate under applicable laws and regulations, hydrocarbons or other wastes may have been disposed of or released on or under the properties owned or leased by the subsidiaries or on or under other locations where such wastes were taken for disposal. Infinity could incur liability under the Comprehensive Environmental Response, Compensation and Liability Act or comparable state statutes for contamination caused by wastes it generated or for contamination existing on properties it owns or leases, even if the contamination was caused by the waste disposal practices of the prior owners or operators of the properties. In addition, it is not uncommon for landowners and other third parties to file claims for personal injury and property damage allegedly caused by the release of produced fluids or other pollutants into the environment. The operations of Consolidated routinely involve the handling of significant amounts of oil field related materials, some of which are classified as hazardous substances. Consolidated's transportation operations are regulated under the Federal Motor Carrier Safety Regulations of the Department of Transportation as administered by the Kansas Department of Transportation, Oklahoma Department of Transportation, and Wyoming Department of Transportation. The operation of salt-water disposal wells by Consolidated is regulated by the Kansas Department of Health and Environment. Consolidated will incur an estimated $100,000 in costs associated with operating within current environmental regulations this fiscal year primarily related to transportation of hazardous substances. The Federal Water Pollution Control Act of 1972 (the "FWPCA") imposes restrictions and strict controls regarding the discharge of wastes, including produced waters and other oil and gas wastes, into navigable waters. These controls have become more stringent over the years, and it is probable that additional restrictions will be imposed in the future. Permits must be obtained to discharge pollutants into state and federal waters. The FWPCA provides for 6 civil, criminal and administrative penalties for unauthorized discharges of oil and other hazardous substances and imposes substantial potential liability for the costs of removal or remediation. State laws governing discharges to water also provide varying civil, criminal and administrative penalties and impose liabilities in the case of a discharge of petroleum or its derivatives, or other hazardous substances, into state waters. In addition, the Environmental Protection Agency has adopted regulations that require many oil and gas production sites, as well as other facilities, to obtain permits to discharge storm water runoff. Exploration and production operations of Infinity-Wyoming and Infinity-Kansas are subject to various types of regulation at the federal, state, and local levels. Such regulations include requiring permits and drilling bonds for the drilling of wells, regulating the location of wells, the method of drilling and casing wells, and the surface use and restoration of properties upon which wells are drilled. Many states also have statutes or regulations addressing conservation matters, including provisions for the unitization or pooling of oil and gas properties, the establishment of maximum rates of production from oil and gas wells and the regulation of spacing, plugging and abandonment of such wells. The operation and production of Infinity-Wyoming's properties is subject to the rules and regulations of the Wyoming Oil and Gas Conservation Commission (WYOGCC) and the Colorado Oil and Gas Conservation Commission (COGCC). In addition a portion of the properties are on federal lands and are subject to Onshore Orders 1 and 2, The National Historic Preservation Act (NHPA), National Environmental Policy Act (NEPA) and the Endangered Species Act. Infinity-Wyoming is producing up to 750 barrels of water per day from coal bed methane wells that it operates. Infinity-Wyoming currently uses injection wells to dispose of the water into underground rock formations and plans to continue to use this method for disposal of the water produced from its operated wells. If the future wells produce water of lesser quality than allowed under state law for injection in underground rock formations or at a volume greater than can be injected into the current disposal wells, Infinity-Wyoming could incur costs of up to $7.50 per barrel of water to dispose of the produced water. At current production rates, this would cost Infinity-Wyoming approximately an additional $165,000 a month in water disposal costs. If Infinity-Wyoming's wells produce water in excess of the limits of its permitted facilities, Infinity-Wyoming may have to drill additional disposal wells. Each additional disposal well could cost Infinity-Wyoming up to $1,200,000. It costs Infinity-Wyoming approximately $50,000 per year to operate these disposal wells. Bureau of Land Management Of Infinity-Wyoming's Pipeline acreage, approximately 14,200 gross acres, are leases that the Company acquired through the auction process and are administered by the Bureau of Land Management ("BLM"). Approximately 3,080 acres of 11,200 total acres of Infinity-Wyoming's Labarge acreage are part of federal units for which Infinity-Wyoming is the operator for the development of the resources to certain depths. The Piceance and Sandwash Basin acreage also include acreage that is administered by the BLM. TITLE TO PROPERTIES As is customary in the oil and gas industry, only a preliminary title examination is conducted at the time Infinity acquires leases of properties believed to be suitable for drilling operations. Prior to the commencement of drilling operations, a thorough title examination of the drill site tract is conducted by independent attorneys. Once production from a given well is established, Infinity prepares a division order title report indicating the proper parties and percentages for payment or production proceeds, including royalties. Infinity believes that the titles to its leasehold properties are good and defensible in accordance with standards generally acceptable in the oil and gas industry. EMPLOYEES Infinity and its subsidiaries currently have approximately 107 employees. Consolidated has 96 employees in its oil field services business, Infinity-Wyoming has 7 employees in its oil and gas exploration business, and Infinity has 4 employees in administrative positions. 7 RISK FACTORS We have a history of operating losses and we may be unable to achieve long-term profitability. We incurred a loss in our fiscal years ended December 31, 2003 and 2002 of approximately $9,925,000 and $1,557,000, respectively. Our losses may impair our ability to obtain financing for drilling and other business activities on favorable terms. It may also impair our ability to attract investors if we attempt to raise additional capital by selling additional securities in a private or public offering. If needed in the future, we may not be able to obtain additional capital for our business to grow. Our ability to achieve a profit from operations on a long-term basis will depend on whether we are successful in exploring for and producing oil and gas from our existing properties. We face the following potential risks in developing our oil and gas properties: - prices for oil and gas we produce may be lower than expected; - the capital required to develop the leases for production may not be available; - we may not find oil and gas reserves in the quantities anticipated; - the reserves we find may not produce oil and gas at the rate anticipated; - the cost of producing oil and gas may be higher than expected; and - there are many operating risks associated with drilling for and producing oil and gas. Oil and gas prices are volatile, and an extended decline in prices would hurt our ability to achieve profitable operations. Our future oil and gas revenues, operating results, profitability, future rate of growth and the carrying value of oil and gas properties will depend heavily on prevailing market prices for oil and gas. We expect the market for oil and gas to continue to be volatile. During the year ended December 31, 2003 we received revenue per barrel of oil as low as $28.12 in May 2003 and as high as $35.63 in February 2003. The Inside FERC, first of the month CIG Index, the pricing index on which our gas sales are based, fluctuated from a low of $3.14 per 1,000 cubic feet (MCF) in January 2003 to a high of $5.01 per MCF during March 2003. At March 15, 2004 production levels, each $1.00 decrease in the price of crude oil would reduce Infinity's oil revenue by approximately $3,000 per month and if none of the gas produced were being sold under fixed price contracts, each $0.10 decrease in natural gas price would reduce Infinity's gas revenue by approximately $10,000 per month. Revenue generated from oil field services provided by Consolidated has increased to as much as $1.6 million per month when oil prices have been above $31.50 per barrel compared to revenue of $400,000 to $450,000 per month when prices reached historic lows of approximately $8.00 per barrel of oil in 1998. Any substantial or extended decline in the price of oil or gas would reduce our cash flow and borrowing capacity, as well as the value and the amount of our oil and gas reserves. Most of our proved reserves are natural gas. Therefore, the volatility in the price of natural gas will have the greatest impact on us. Various factors beyond our control affect prices of oil and gas, including: - worldwide and domestic supplies of oil and gas; - the ability of the members of the Organization of Petroleum Exporting Countries to agree to and maintain oil prices; - production controls; - political instability or armed conflict in oil or gas producing regions; - the price and level of foreign imports; 8 - worldwide economic conditions; - marketability of production; - the level of consumer demand; - the price, availability and acceptance of alternative fuels; - the price, availability and capacity of commodity processing and gathering, and pipeline transportation; - weather conditions; and - actions of federal, state, local and foreign authorities. These external factors and the volatile nature of the energy markets generally make it difficult to estimate future prices of oil and gas. Significant declines in oil and natural gas prices for an extended period may cause various negative effects on our business, including: - impairing our financial condition, cash flows and liquidity; - limiting our ability to finance planned capital expenditures; - reducing our revenues and operating income; and - reducing the carrying value of our oil and natural gas properties. A charge to earnings and book value would occur if there is a further ceiling write down of the carrying value of Infinity-Wyoming's or Infinity-Kansas' oil and gas properties. Impairments can occur when oil and gas prices are depressed or unusually volatile. Once incurred, a ceiling write-down of oil and gas properties is not reversible at a later date. Infinity-Wyoming and Infinity-Kansas review, on a quarterly basis, the carrying value of their oil and gas properties under the full cost accounting rules of the Securities and Exchange Commission ("SEC"). Under these rules, costs of proved oil and gas properties may not exceed the present value of estimated future net revenues from proved reserves, after giving effect to cash flow from hedges, discounted at 10%, net of taxes less the liability for asset retirement obligations. Application of the ceiling test generally requires pricing future revenue at the un-escalated prices in effect as of the end of each fiscal quarter, after giving effect to the Company's cash flow hedge positions, and requires a write-down for accounting purposes if the ceiling is exceeded, even if prices were depressed for only a short period of time. Revenues may be affected by the gas prices in the Rocky Mountain Region. The prices to be received for the natural gas production from our Wyoming and Colorado properties will be determined mainly by factors affecting the regional supply of and demand for natural gas. Based on recent experience, regional differences could cause a negative basis differential of $0.30 per MCF (1,000 cubic feet) and $1.50 per MCF between the published indices generally used to establish the price received for regional natural gas production and the actual price received by Infinity for its natural gas production. Forward sales transactions may limit our potential gains or expose us to loss. To manage our exposure to price risks in the marketing of our natural gas, we enter into natural gas fixed price physical delivery contracts from time to time with respect to a portion of our current or future production. These transactions could limit our potential gains if natural gas prices were to rise substantially over the price established by the contracts. In addition, such transactions may expose us to the risk of financial loss in certain circumstances, including instances in which: - our production is less than expected; 9 - the counterparties to our futures contracts fail to perform under the contracts; or - our production costs on the hedged production significantly increase. Development of our oil and gas projects will require large amounts of capital which we may not be able to obtain. Full development of Infinity's properties would require drilling a maximum of 740 production wells, 160 disposal wells to handle produced water, and the construction of 130 production facilities. This would require capital expenditures of approximately $600 million. Currently, our potential sources of financing for these activities are cash generated by operations, future sales of equity or debt securities, obtaining additional debt financing or additional borrowings on the existing line of credit with U.S. Bank through the expansion of our borrowing base. The additional borrowing base is dependent on a number of factors including the price of natural gas, our ability to hedge future production, cost of operations and proved reserves. Additional borrowings on the line of credit may not be available if the borrowing base cannot be expanded, and other financing may not be available to Infinity on terms that are acceptable. Future cash flows and the availability of financing are subject to a number of variables, such as: - our coalbed methane gas projects in the Green River Basin of Wyoming and Sandwash and Piceance Basins of Colorado achieving a level of production that provides sufficient cash flow to support additional borrowings; - our success in locating and producing new reserves; - prices of crude oil and natural gas; and - the level of production from existing wells. Issuing equity securities to satisfy our financing requirements could cause substantial dilution to existing shareholders. Debt financing could lead to: - a substantial portion of our operating cash flow being dedicated to the payment of principal and interest; - an increase in interest expense as the amount of debt outstanding increases or as variable interest rates increase; - Infinity being more vulnerable to competitive pressures and economic downturns; and - restrictions on our operations that may be contained in any contract entered into with lenders. We could also consider entering into a partnership with another oil and gas company or companies in which we would maintain a carried or reduced working interest in the oil and gas properties to provide the funds for future capital needs on the projects. However this would reduce our ownership and control over the projects and could significantly reduce our future revenues generated from gas production. If projected revenues were to decrease due to lower oil and natural gas prices, decreased production or other reasons, and if we were not able to obtain the necessary capital, our ability to execute development plans or maintain production levels could be limited. Our leverage and debt service obligations may adversely affect our cash flow and our ability to make payments on our long-term debt. As of December 31, 2003, we had total long-term debt of approximately $28.0 million and stockholders' equity of approximately $22.9 million. Our level of debt could have important consequences to our business, including the following: - it may be more difficult for us to satisfy our debt repayment obligations; - future covenant violations, if any, could result in accelerated payment terms on existing debt; 10 - we may have difficulties borrowing money in the future for acquisitions, to meet our operating expenses or for other purposes; - the amount of our interest expense may increase because certain of our borrowings are at variable rates of interest, which, if interest rates increase, could result in higher interest expense; - we will need to use a portion of the money we earn to pay principal and interest on our debt which will reduce the amount of money we have to finance our operations and other business activities; - significantly all of our properties are pledged as collateral to lenders and failure to pay could result in foreclosure and loss of assets; - we may have a higher level of debt than some of our competitors, which may put us at a competitive disadvantage; - we may be more vulnerable to economic downturns and adverse developments in our industry; and - our debt level could limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate. Information concerning our reserves, future net revenue estimates, and potential future ceiling write-downs are uncertain. There are numerous uncertainties inherent in estimating quantities of proved oil and natural gas reserves and their values. Actual production, revenues and reserve expenditures will likely vary from estimates. Estimates of oil and natural gas reserves, by necessity, are projections based on available geologic, geophysical, production and engineering data, and there are uncertainties inherent in the interpretation of such data as well as the projection of future rates of production and the timing of development expenditures. Estimates of economically recoverable oil and natural gas reserves and future net cash flows necessarily depend upon a number of factors and assumptions based on existing conditions, all of which may vary considerably from actual future results and from one professional engineer to another. In addition, investors should not construe the present value of future cash flows as the current market value of the estimated oil and natural gas reserves attributable to our properties. The estimated discounted future net cash flows from proved reserves are based on prices and costs as of the date of the estimate, in accordance with applicable regulations, whereas actual future prices and costs may be materially higher or lower. Factors that will affect actual future net cash flows include: - the amount and timing of actual production; - the price for which that oil and gas production can be sold for - supply and demand for natural gas; - curtailments or increases in consumption by natural gas purchasers; and - changes in government regulations or taxation. As a result of these and other factors, we will be required to periodically reassess the amount of our reserves, which may require us to recognize a ceiling write-down of our oil and gas properties. Such factors could cause us to have to write down the value of some of our properties in future periods. Infinity-Wyoming has approximately $9.4 million invested in unproved oil and gas properties not subject to amortization on its Labarge project and expects to incur an additional $3.6 million in costs under an agreement to further develop the property. In order to further evaluate and develop the Labarge project, Infinity-Wyoming entered into an agreement with Schlumberger Technology Corporation ("Schlumberger") and Red Oak Capital Management LP ("Red Oak"). At the conclusion of the 2004 evaluation activity, a significant portion of the investment in unproved oil and gas properties will be reclassified to the full cost pool subject to depletion and the ceiling test. If 11 the 2004 evaluation and exploration activity at Labarge do not result in additional proved reserves, or if proved reserves are not significant, Infinity could be required to write-down a portion of the full cost pool of oil and gas properties subject to amortization upon reclassification of the Labarge unproved oil and gas property costs. The oil and gas exploration business involves a high degree of business and financial risk. The business of exploring for and developing oil and gas properties is an activity that involves a high degree of business and financial risk. Property acquisition decisions generally are based on assumptions about the quantity, quality, cost to produce, market availability and sales price for the reserves being acquired. Although available geological and geophysical information can provide information about the potential of a property, it is impossible to predict accurately the ultimate production potential, if any, of a particular property or well. Any decision to acquire a property is also influenced by our subjective judgment as to whether we will be able to locate the reserves, drill and equip the wells to produce the reserves, operate the wells economically, and market the production from the wells. The successful completion of an oil or gas well does not ensure a profit on investment. A variety of geophysical factors may negatively affect the commercial viability of any particular well, including: - the absence of producible quantities of oil and gas; - insufficient formation attributes, such as porosity, to allow production; - excess water production requiring disposal; and - improperly pressured reservoirs from which to produce the reserves. In addition, market-related factors may cause a well to become uneconomic or only marginally economic, such as: - availability of transportation for the production; - demand for the oil and gas produced; and - price for the oil and gas produced. Our business is subject to operating hazards that could result in substantial losses. The oil and natural gas business involves operating hazards such as: - well blowouts; - craterings; - explosions; - uncontrollable flows of oil, natural gas or well fluids; - fires; - formations with abnormal pressures; - pipeline ruptures or spills; - pollution; and 12 - releases of toxic gas and other environmental hazards and risks any of which could cause substantial losses. As protection against operating hazards, we maintain insurance coverage against some, but not all, potential losses. This insurance has deductibles or self-insured retentions and contains certain coverage exclusions. Infinity's insurance premiums can be increased or decreased based on the claims made by Infinity under its insurance policies. The insurance does not cover damages from breach of contract by Infinity or based on alleged fraud or deceptive trade practices. Whenever possible, Infinity obtains agreements from customers that limit its liability; however, insurance and customer agreements do not provide complete protection against losses and risks and losses could occur for uninsurable or uninsured risks, or in amounts in excess of existing insurance coverage. The occurrence of an event that is not fully covered by insurance could harm our financial conditions and results of operations. Our operations are dependent upon the availability of certain resources, including drilling rigs, water, chemicals, and other materials necessary to support our capital development plans and maintenance requirements. The lack of availability of one or more of these resources at an acceptable price could have a material adverse affect on our business. In addition, we may be liable for environmental damage caused by previous owners of property we own or lease. As a result, we may face substantial potential liabilities to third parties or governmental entities that could reduce or eliminate funds available for exploration, development or acquisitions or cause Infinity to incur losses. An event that is not fully covered by insurance -- for instance, losses resulting from pollution and environmental risks that are not fully insured -- could cause us to incur material losses. Exploratory drilling is an uncertain process with many risks. Exploratory drilling involves numerous risks, including the risk that we will not find any commercially productive natural gas or oil reservoirs. The cost of drilling, completing and operating wells is often uncertain, and a number of factors can delay or prevent drilling operations, including: - unexpected drilling conditions; - pressure or irregularities in formations; - equipment failures or accidents; - adverse weather conditions; - compliance with governmental requirements, rules and regulations; and - shortages or delays in the availability of drilling rigs and the delivery of equipment. Infinity's future drilling activities may not be successful, and we cannot be sure of our overall drilling success rate. Unsuccessful drilling activities would result in significant expenses being incurred without any financial gain. Our business will depend on transportation facilities owned by others. The marketability of gas production will depend in part on the availability, proximity and capacity of pipeline systems owned by third parties. Federal and state regulation of gas and oil production and transportation, tax and energy policies, changes in supply and demand, pipeline pressures, and general economic conditions could adversely affect our ability to gather and transport natural gas. The oil and gas industry is heavily regulated and we must comply with complex governmental regulations. Federal, state and local authorities extensively regulate the oil and gas industry and the drilling and completion of oil and gas wells. Legislation and regulations affecting the industry are under constant review for amendment or expansion, raising the possibility of changes that may affect, among other 13 things, the pricing or marketing of oil and gas production. Noncompliance with statutes and regulations may lead to substantial penalties, and the overall regulatory burden on the industry increases the cost of doing business and, in turn, decreases profitability. State and local authorities regulate various aspects of oil and gas drilling and production activities, including the drilling of wells through permit and bonding requirements, the spacing of wells, the unitization or pooling of oil and gas properties, environmental matters, safety standards, the sharing of markets, production limitations, plugging and abandonment, and restoration. Infinity's operations are subject to complex and constantly changing environmental laws and regulations adopted by federal, state and local government authorities. Infinity-Wyoming estimates it will spend approximately $10,000 per well for containment facilities during drilling operations and approximately $3.6 million to obtain permits for, drilling and equipping up to three water disposal wells to handle water produced from oil and gas wells during the current fiscal year. It will cost Infinity-Wyoming approximately $50,000 per year to operate each disposal well. In addition to the environmental costs that will be incurred by our oil and gas production operations, Consolidated will incur an estimated $100,000 in costs associated with operating within current environmental regulations this fiscal year. New laws or regulations, or changes to current requirements, could result in Infinity having to incur significant additional costs. We could face significant liabilities to the government and third parties for discharges of oil, natural gas or other pollutants into the air, soil or water, and we could have to spend substantial amounts on investigations, litigation and remediation. Our well service operations routinely involve the handling of significant amounts of waste materials, some of which are classified as hazardous substances. Our operations and facilities are subject to numerous environmental laws, rules and regulations, including laws concerning: - the containment and disposal of hazardous substances, oilfield waste and other waste materials; - the use of underground storage tanks; and - the use of underground injection wells. Laws protecting the environment are becoming stricter. Sanctions for failure to comply with these laws, rules and regulations, many of which may be applied retroactively, may include: - administrative, civil and criminal penalties; - revocation of permits; and - corrective action orders. In the United States, environmental laws and regulations typically impose strict liability. Strict liability means that in some situations we could be exposed to liability for cleanup costs and other damages as a result of our conduct that was lawful at the time it occurred or conduct of prior operators or other third parties. Cleanup costs, natural resource damages and other damages arising as a result of environmental laws, and costs associated with changes in environmental laws and regulations, could be substantial. From time to time, claims have been made against us and our subsidiaries under environmental laws. Changes in environmental regulations may also negatively impact oil and natural gas exploration and production companies, which in turn could reduce the demand for our well services. Large volumes of water produced from coalbed methane wells and discharged onto the surface in the Powder River Basin of Wyoming have drawn the attention of government agencies, gas producers, citizens and environmental groups which may result in new regulations for the disposal of produced water. Infinity-Wyoming intends to use injection wells to dispose of water into underground rock formations. If our wells produce water of lesser quality than allowed under Wyoming state law for injection into underground rock formations, Infinity-Wyoming could incur costs of up to $7.50 per barrel of water to dispose of the produced water. At current production rates, this would cost Infinity an additional $165,000 a month in water disposal costs. If Infinity's wells produce water in excess of the limits of its disposal facilities, Infinity may have to drill additional disposal wells. Each additional disposal well could cost Infinity up to $1,200,000. 14 The oil and gas industry is highly competitive. We operate in the highly competitive areas of oil and natural gas exploration, exploitation, acquisition and production with other companies. We face intense competition from a large number of independent companies as well as both major and other independent oil and natural gas companies in a number of areas such as: - acquisition of desirable producing properties or new leases for future exploration; - marketing our oil and natural gas production; and - seeking to acquire the equipment, labor and materials necessary to operate and develop those properties. Many of our competitors have financial and technological resources substantially exceeding those available to Infinity. Many oil and gas properties are sold in a competitive bidding process in which we may lack technological information or expertise available to other bidders. We cannot be sure that we will be successful in acquiring and developing profitable properties in the face of this competition. We depend on key personnel. The loss of key members of our management team, or difficulty attracting and retaining experienced technical personnel, could reduce our competitiveness and prospects for future success. Infinity's success will depend on the continued services of its executive officers and a limited number of other senior management and technical personnel. Loss of the services of any of these people could have a material adverse effect on our operations. Infinity maintains "key man" life insurance on the lives of Stanton E. Ross and Jon D. Klugh, but only in the amount of $250,000 each. Infinity does not have employment agreements with any of its executive officers. Infinity's exploratory drilling success and the success of other activities integral to our operations will depend, in part, on our ability to attract and retain experienced explorationists, engineers and other professionals. Competition for experienced explorationists, engineers and some other professionals is extremely intense. If we cannot retain our technical personnel or attract additional experienced technical personnel, our ability to compete could be harmed. FORWARD-LOOKING STATEMENTS This report on Form 10-K, including information incorporated by reference, contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. The use of any statements containing the words "anticipate," "intend," "believe," "estimate," "project," "expect," "plan," "should" or similar expressions are intended to identify such statement. Forward-looking statements include, among other items: - Infinity's growth strategies, - anticipated trends in Infinity's business and its future results of operations, - market conditions in the oil and gas industry, - the ability of Infinity to make and integrate acquisitions, - the availability of financing on acceptable terms, - the impact of governmental regulation, - the timing of engineering studies and permitting, and - world financial market conditions. Forward-looking statements inherently involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to: - fluctuations in oil and natural gas production, 15 - fluctuations in oil and natural gas prices, - incorrect estimations of required capital expenditures, - uncertainties inherent in estimating quantities of oil and gas reserves and projecting future rates of production and timing of development activities, - increases in the cost of drilling and completing wells, - an increase in the cost of oil and gas production operations, - the availability, conditions and timing of required government approvals, - the availability, conditions and timing of third party financing, - an increase in materials, fuel and labor costs, - a decline in demand for Infinity's oil and gas production or oil field services, and - changes in general economic conditions. ITEM 2. DESCRIPTION OF PROPERTY BUSINESS PROPERTIES Infinity's headquarters are located at 211 West 14th Street, Chanute, Kansas 66720, along with the headquarters and some of the operating facilities of Consolidated. This facility and other Consolidated facilities in Bartlesville, Oklahoma and Ottawa, Kansas were purchased in November of 1999 by the CIS-Oklahoma, Inc. subsidiary. CIS-Oklahoma also acquired facilities in Gillette, Wyoming for $140,000 during 2001, which includes office and shop facilities for Consolidated's operations. Funds for the acquisitions were obtained through a loan from a local bank, secured by the Kansas and Wyoming oil field service facilities. The loan was for $350,000 for a period of seven years with an initial adjustable interest rate of 8.5% per annum based on Wall Street Prime plus 1%. Effective November 2003, the interest rate was reduced to 4.25%. Payments on this loan are currently $5,635 per month, including interest, with an outstanding loan balance of approximately $185,000 at December 31, 2003. The shop and office facility that were built in Bartlesville, Oklahoma during 2001 for the operations of Consolidated were financed from cash flow and with a ten-year, 9.25% note with a local bank. The note had an outstanding balance of approximately $330,000 at December 31, 2003, requires monthly payments of approximately $4,900, and is collateralized by the Bartlesville, Oklahoma facility. Consolidated provides numerous services associated with drilling and completion of oil and gas wells, including cementing, acidizing, fracturing, nitrogen pumping and water hauling. Consolidated provides these services out of service facilities it owns in Chanute and Ottawa, Kansas; Bartlesville, Oklahoma; and Gillette, Wyoming. Due to the decrease in the number of wells being drilled and the schedule on which wells would be drilled by Infinity-Wyoming and an increase in service requests and equipment demand in other services areas, Consolidated closed its Rock Springs, Wyoming facility, terminated its lease on the operating facilities and transferred its service equipment to its other locations in December 2003. Consolidated operates a fleet of approximately 150 vehicles specifically designed to provide service to oil and gas well operators working at depths ranging from 100 to 5,000 feet as is usually the case in eastern Kansas, northeastern Oklahoma, and the coal bed methane development of the Powder River Basin of Wyoming. The service vehicles are part of the collateral for a revolving note, capital expenditures note and term loan due in January 2005 with outstanding balances on the revolving note, capital expenditures note and term loan of approximately $0.1 million, $0.4 million and $0.9 million, respectively at December 31, 2003. The capital expenditures and term loan require monthly payments totaling approximately $0.1 million per month. Consolidated has also purchased vehicles using financing from manufacturers. These loans and leases typically have terms of 12 to 60 months with interest rates ranging from 6.0% to 9.5%. As of December 31, 2003, Consolidated was making monthly payments of approximately $24,000 under these loans and leases. 16 Consolidated leases property near Cheyenne, Wyoming, which is the site of the brine water treatment facility. Rent on this land lease is $1,000 per year. The lease is for a term of twenty-five years beginning July 1994, but may be terminated by Consolidated at any time on written notice. In February of 2003 Consolidated signed a letter of intent to sell these facilities and transfer the lease on the property to the new owner. However, the potential purchaser to the letter of intent was unable to finance the acquisition and the sale has not been completed. Consolidated is working with the potential purchaser to identify a structure which will allow the sale to be completed. We do not know when the sale might be completed. Oil and Gas Interest in Leasehold Acreage Infinity-Wyoming engaged Netherland, Sewell & Associates, Inc., independent petroleum engineers to prepare estimates of proved reserves, projected future production and related future net revenue for our properties as of December 31, 2003. Estimates prepared by Netherland, Sewell & Associates, Inc. were based upon review of production histories and other geologic, economic, ownership, volumetric and engineering data. In estimating reserve quantities that are economically recoverable, oil and gas prices and estimated development and production costs as of December 31, 2003 were utilized. The following table sets forth estimates as of December 31, 2003 derived from the Netherland, Sewell & Associates, Inc. reserve report. The present value (discounted at 10 percent) of estimated future net revenue before income taxes shown in the table is not intended to represent the current market value of our estimated proved oil and gas reserves. For additional information concerning the present value of future net revenue from these proved reserves, see Note 19 - Supplemental Oil and Gas Information (Unaudited) in the Notes to the Consolidated Financial Statements.
Developed Undeveloped Total ----------- ------------ ----------- Natural gas (mcf) 4,724,523 2,786,372 7,510,895 Crude oil (barrels) 124,968 68,170 193,138 Total (mcfe) 5,474,331 3,195,392 8,669,723 Future net revenue before income taxes $21,557,500 $ 10,916,700 $32,474,200 Present value of future net revenue before income taxes $16,383,600 $ 6,561,500 $22,945,100
See "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the caption "Overview of Oil and Gas Production Activity" for a discussion of the variables that resulted in the reduction of reserves at December 31, 2003. There are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting future rates of production and timing of development expenditures, including many factors beyond the control of the producer. The reserve data set forth herein represents only estimates. Reserve engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact way, and the accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment and the existence of development plans. In addition, results of drilling, testing and production subsequent to the date of an estimate may justify revision of such estimates. Accordingly, the reserve estimates are often different from the quantities of oil and gas that are ultimately recovered. Further, the estimated future net revenue from proved reserves and the present value thereof are based upon certain assumptions, including future geologic success, prices, production levels and costs that may not prove correct. Predictions about prices and future production levels are subject to great uncertainty and the meaningfulness of such estimates is highly dependent upon the accuracy of the assumptions upon which they are based. Oil and gas prices have fluctuated widely in recent years. There is no assurance that prices will not be materially higher or lower than the prices utilized in estimating the reserves of Infinity-Wyoming. The weighted average sales prices utilized for purposes of estimating our proved reserves and future net revenue therefrom as of December 31, 2003 were $6.06 per Mcf of natural gas and $31.34 per barrel of crude oil. As an operator of domestic oil and gas properties, Infinity-Wyoming annually files Department of Energy Form EIA-23, "Annual Survey of Oil and Gas Reserves," as required by Public Law 93-275. There are differences between the reserves as reported in Form EIA-23 and as reported herein. The differences are attributable to the fact that Form EIA-23 requires that an operator report total reserves attributable to wells that it operates; without regard to ownership (i.e. reserves are reported on a gross operated basis, rather than on a net interest basis). 17 Acreage The following table sets forth the gross and net acres of developed and undeveloped oil and gas leases held by Infinity-Wyoming as of December 31, 2003. Developed acreage is acreage assigned to producing wells for the spacing unit of the producing formation.
Developed Acreage Undeveloped Acreage ------------------ ------------------ Gross Net Gross Net -------- -------- -------- -------- Greater Green River Basin Wamsutter Arch 3,520 3,360 16,030 15,790 Labarge 1,763 1,763 9,967 9,436 Sand Wash Basin 640 640 160,689 112,193 Piceance Basin - - 20,020 20,020 -------- -------- -------- -------- Total 5,923 5,763 206,706 157,439 ======== ======== ======== ========
Leases covering 57,097 gross (45,705 net) undeveloped acres included as a part of the Sand Wash Basin prospect above expire during the year ending December 31, 2004, and therefore the related capitalized costs were reclassified to the full cost pool at December 31, 2003. Infinity-Wyoming held options on an additional 26,330 gross acres as of December 31, 2003. Options on approximately 8,300 of such acres were relinquished on February 29, 2004, and therefore the related capitalized costs were reclassified to the full cost pool at December 31, 2003. Major properties Greater Green River Basin - Wamsutter Arch At December 31, 2003, Infinity-Wyoming held leases on approximately 19,000 net acres on the Wamsutter Arch in the Greater Green River Basin of South Central Wyoming. Infinity-Wyoming currently seeks to exploit hydrocarbons in the Cretaceous-aged Upper Almond sand at varying depths between 2,900 and 3,600 feet. At December 31, 2003, Infinity-Wyoming operated 36 wells in the field, of which 10 were active producers, 13 were shut-in, 6 were waiting completion operations, 3 were water disposal wells, and 4 were waiting plugging and abandonment. All six wells waiting completion at year end have been completed as producers during the first quarter of 2004. During March 2004, Infinity-Wyoming assumed operations of two additional wells in the field following the acquisition of additional working interests in those wells. During 2003, Infinity-Wyoming produced approximately 1,051,200 mcf of natural gas and 57,400 barrels of crude oil, or 1,395,700 mcfe from the field. Production during 2003 represented a 62% increase over 2002, but production has declined on a quarterly basis since the quarter ended March 31, 2003 when production reached 408,100 mcfe. At December 31, 2003, Infinity-Wyoming held options on an additional 8,300 gross acres in the field. The options were relinquished on February 29, 2004. Greater Green River Basin - Labarge At December 31, 2003, Infinity-Wyoming held leases on approximately 11,000 net acres located on the northern extension of the Moxa Arch in southwestern Wyoming. Infinity-Wyoming currently seeks to exploit hydrocarbons in the Cretaceous Upper Mesaverde coals at varying depths between 3,400 and 4,200 feet. At December 31, 2003, Infinity-Wyoming operated 12 wells in the field, of which 2 were active producers, 5 were shut-in, 3 were waiting completion operations, and 2 were water disposal wells. During 2003, Infinity-Wyoming produced approximately 29,000 mcf of natural gas and 300 barrels of crude oil, or 30,700 mcfe from the field. Production during 2003 represented a 27% decrease as compared to 2002, and production has declined on a quarterly basis since the quarter ended September 30, 2002 when production reached 20,600 mcfe. Production at Labarge has continued to be uneconomic. Infinity-Wyoming believes that this may be due in part to down-hole operational problems and as a result in December 2003, Infinity-Wyoming entered into an agreement with Schlumberger Technology Corporation and Red Oak Capital Management LLC for the further evaluation and development of the Labarge acreage. 18 Sand Wash Basin At December 31, 2003, Infinity-Wyoming held leases on approximately 112,000 net undeveloped acres in the Sand Wash Basin of northwest Colorado and south central Wyoming. This prospect seeks to exploit the Williams Fork and Iles coals at varying depths between 2,500 and 3,000 feet. Secondary objectives include hydrocarbons in the fractured Niobrara calcareous shale. Leases covering 57,097 gross (45,705 net) undeveloped acres included as a part of the Sand Wash Basin prospect expire during the year ending December 31, 2004. Infinity-Wyoming is currently seeking offers from other industry operators for interests in the acreage in exchange for cash and a carried-interest in drilling operations. No assurance can be given that any such transactions will be consummated on terms acceptable to Infinity-Wyoming. At December 31, 2003, Infinity-Wyoming operated 4 wells in the field, all of which were shut-in. Piceance Basin At December 31, 2003, Infinity-Wyoming held leases on approximately 20,000 net undeveloped acres in the northeastern corner of the Piceance Basin in northwestern Colorado. This prospect seeks to exploit the Williams Fork and Iles coals at varying depths between 1,000 and 3,000 feet. Under the terms of the lease agreement covering approximately 16,000 acres, Infinity-Wyoming is required to drill and complete five wells by November 20, 2005, or relinquish the acreage to the seller. Infinity-Wyoming is currently seeking offers from other industry operators for interests in the acreage in exchange for cash and a carried-interest in drilling operations. No assurance can be given that any such transactions will be consummated on terms acceptable to Infinity-Wyoming. Stanton County, Kansas Infinity-Kansas acquired a 31.25% interest in a 5,120 acre river sand prospect in Stanton County, Kansas for $56,000, or $35.00 per acre, in November 2001. Infinity-Kansas has incurred approximately $187,000 for the drilling of three exploratory wells and for a 3-D seismic study across the acreage. The three exploratory wells have been uneconomical and the operator of the property is evaluating the results of drilling programs on adjacent acreage before taking any further action. The results of the drilling programs on the adjacent acreage should be available in the second quarter of 2004. Depending on the results of those programs, there is a potential that that the operator will abandon the prospect and Infinity-Kansas will write off its investment in the additional acreage. Infinity-Kansas does not have investment in any other oil and gas prospects. Offshore Nicaragua During 2003 and into the first quarter of 2004, Infinity has renegotiated a number of key terms and conditions of the exploration contract covering the approximate 1,400,000-acre Tyra and Perlas concession areas offshore Nicaragua, including an extension of the exploration period from six to eight years with four sub-phases, and is awaiting final approvals by the Nicaraguan government. Upon approval, the initial capital cost during the first twelve months would be approximately $800,000, with an additional $1,600,000 during the second twelve months to cover the costs of environmental studies, geological and geophysical analysis, acquisition of seismic data and other operational expenses. Exploration offshore Nicaragua will focus on Eocene and Cretaceous carbonate reservoirs and Infinity's management and consultants believe (i) numerous analogies can be made between the Infinity concession block and production from fractured Cretaceous carbonates in Mexico, Venezuela and Guatemala, and (ii) the presence of Cretaceous source rocks onshore Honduras and Nicaragua can be projected into the offshore Caribbean Shelf. 19 Production The following table sets forth Infinity-Wyoming's net oil and gas production, average sales prices, and costs and expenses associated with such production during the periods indicated. Information presented for 2001 pertains to the nine-month transition period ended December 31, and includes results for Infinity-Kansas. Information presented for 2002 and 2003 pertains to the years ended December 31, and includes only the results for Infinity-Wyoming.
2003 2002 2001 ---------- -------- -------- Production: Natural gas (mcf) 1,080,456 676,879 128,998 Crude oil (barrels) 57,654 53,122 74,812 Total (mcfe) 1,426,380 995,611 577,870 Average daily production: Natural gas (mcf) 2,960 1,854 469 Crude oil (barrels) 158 145 270 Total (mcfe) 3,908 2,727 2,101 Average sales price per unit: Natural gas (mcf) $ 4.47 $ 1.88 $ 1.76 Crude oil (barrels) 30.51 $ 17.14 $ 20.46 Total (mcfe) $ 4.62 $ 2.38 $ 3.04 Production costs per mcfe $ 2.05 $ 1.83 $ 1.97
Infinity-Wyoming owned 14 gross (12 net) producing wells and 5 gross (5 net) service wells as of December 31, 2003. Infinity-Wyoming owned an additional 33 gross (33 net) wells which were shut in, waiting completion or plugging and abandonment as of December 31, 2003. Development, Exploration and Acquisition Expenditures The following table sets forth certain information regarding the costs incurred by Infinity in its development, exploration and acquisition activities during the periods indicated. Information presented for 2001 pertains to the nine-month transition period ended December 31. Information presented for 2002 and 2003 pertains to the years ended December 31.
2003 2002 2001 ---------- ----------- ---------- Property acquisition costs: Proved $1,099,120 $ 72,383 $ 223,319 Unproved 661,224 2,279,587 1,291,126 ---------- ----------- ---------- Total acquisitions costs 1,760,344 2,351,970 1,514,445 Development costs 3,167,700 786,095 721,760 Exploration costs 3,491,953 11,955,351 6,957,735 ---------- ----------- ---------- Total $8,419,997 $15,093,416 $9,193,940 ========== =========== ==========
Drilling Activity The following table sets forth certain information regarding the wells completed during the periods indicated. Frequently wells are spud or drilled in one period and completed in the subsequent period. Information presented for 2001 pertains to the nine-month transition period ended December 31. Information presented for 2002 and 2003 pertains to the years ended December 31. Certain 2002 and 2001 information has been restated to conform to the current year presentation. 20
2003 2002 2001 ---- ---- ---- GROSS NET GROSS NET GROSS NET ----- ---- ----- ---- ----- ---- Development: Service 1 1 2 2 1 1 Productive - - 2 2 - - Non-productive - - - - - - ----- ---- ----- ---- ----- ---- Total 1 1 4 4 1 1 ===== ==== ===== ==== ===== ==== Exploratory: Productive - - 13 13 - - Non-productive - - 9 9 1 1 ----- ---- ----- ---- ----- ---- Total - - 22 22 1 1 ===== ==== ===== ==== ===== ====
As of December 31, 2003, Infinity-Wyoming had an additional thirteen wells which were awaiting completion, including four wells waiting plugging and abandonment operations and six others that were completed by March 19, 2004. Delivery Commitments Infinity-Wyoming entered into a gas gathering and transportation contract with Duke in which Duke will build gas gathering laterals and install compression facilities to deliver gas produced from the Pipeline wells to the Overland Trail Transmission pipeline. During 2002, the contract was amended to include additional compression and gathering facilities installed by Duke and delivery points for the additional production being generated by Infinity-Wyoming. Infinity-Wyoming will pay a gathering fee of $0.40 per MCF until 7,500,000 MCF have been produced at which time the fee is reduced to $0.25 per MCF. Infinity-Wyoming was obligated to deliver 600,000 MCF the first year, 1,600,000 MCF the second year and 2,000,000 the third and fourth years and 1,800,000 in the fifth and final year of the contract. To date, Infinity-Wyoming has delivered approximately 2,060,000 MCF on this contract. The Pipeline sales volumes will also be subject to a $0.15 per Million British Thermal Units (MMBTU) charge for access onto the Overland Trail Transmission line. While Infinity-Wyoming has failed to deliver the volumes required under the terms of the contract, the pipeline operator has also not provided the compression and gathering capabilities they were required to provide under the contract. Management has received a verbal commitment from the operator that the volume commitments will be adjusted and management does not believe there will be a contract shortfall under the renegotiated volumes. Beginning April 1, 2003 and effective through March 31, 2004, Infinity-Wyoming had contracted to sell 3,500 MMBTU per day to Duke at a price of $4.71 per MMBTU, which equates to $5.16 per MCF. Subsequent to December 31, 2003 Infinity-Wyoming entered into two additional contracts with Duke for the sale of 2,000 MCF per day. The first contract is for the period April 1, 2004 through March 31, 2005 and sets a price of $4.40 per MCF. The second contract is for the period beginning April 1, 2005 and ending March 31, 2006 and is for $4.15 per MCF. Infinity-Wyoming will receive the Colorado Interstate Gas (CIG) Pipeline first of the month index price for each MCF of gas in excess of the contracted volume delivered onto the Overland Trail Transmission line. Infinity and its subsidiaries presently have no agreements or commitments, other than those shown above, to provide quantities of oil or gas in the future. ITEM 3. LEGAL PROCEEDINGS There are currently no pending material legal proceedings to which we are a party. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Company's shareholders during the fourth quarter of 2003. 21 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS Principal Market and Price Range of Common Stock Infinity's Common Stock began trading on the Nasdaq Small-Cap Market on June 29, 1994, under the symbol "IFNY." In August 2002, Infinity became listed on the Nasdaq National Market. The following table sets forth the high and low closing sale prices for Infinity's Common Stock as reported by the Nasdaq Stock Market. The closing price of the Common Stock on March 31, 2004 was $3.36.
Quarter Ended High Low - ------------------ ------- ------ March 31, 2002 $ 7.34 $ 5.03 June 30, 2002 11.38 7.72 September 30, 2002 8.19 5.95 December 31, 2002 9.00 7.11 March 31, 2003 9.74 7.75 June 30, 2003 8.83 5.50 September 30, 2003 6.01 4.30 December 31, 2003 4.90 3.31
APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK The number of record holders of Infinity's $0.0001 par value Common Stock at April 12, 2004, was 187 and the Company believes it has over 1,500 beneficial owners of such stock. DIVIDENDS Holders of common stock are entitled to receive such dividends as may be declared by Infinity's Board of Directors. Infinity has not declared nor paid and does not anticipate declaring or paying an dividends on its common stock in the near future. Any future determination as to the declaration and payment of dividends will be at the discretion of Infinity's board of directors and will depend on then-existing conditions, including Infinity's financial condition, results of operations, contractual restrictions, capital requirements, business prospects and such other factors as the board deems relevant. Pursuant to the terms of the Loan Agreement with LaSalle Bank, N.A., Consolidated is prohibited from paying any dividends to Infinity during the term of the agreement and under the terms of the Loan Agreement with U.S. Bank National Association, Infinity-Wyoming is restricted in the amount of distributions it can make to Infinity, Inc. ITEM 6. SELECTED FINANCIAL DATA The selected consolidated financial information presented below for the years ended December 31, 2003 and 2002 and March 31, 2001 and 2000 and, the nine month transition period ended December 31, 2001 is derived from the audited consolidated financial statements of Infinity for all periods. Infinity changed its fiscal year end to December 31 fiscal year end from a March 31 fiscal year end effective December 31, 2001. Certain reclassifications have been made to prior financial statements to conform with the current presentation. The table gives effect to the two-for-one split of Infinity's common stock effective May 13, 2002 for all periods presented. 22
FOR THE PERIOD ENDED DECEMBER 31, MARCH 31, ----------------------------- ------------------ 2003 2002 2001 2001 2000 -------- --------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) STATEMENT OF OPERATIONS DATA Revenue: Oil field service revenue $11,634 $ 8,570 $ 9,854 $ 8,476 $ 5,122 Oil and gas revenue 6,589 2,368 1,759 376 8 -------- --------- -------- -------- -------- Total revenue $18,223 $ 10,938 $11,613 $ 8,852 $ 5,130 ======== ========= ======== ======== ======== Expenses: Oil and gas service operations $ 6,223 $ 4,621 $ 5,154 $ 4,666 $ 3,027 Oil and gas production expense 2,161 1,583 1,074 207 7 Production taxes 759 238 66 14 - Operating expenses 5,311 4,647 2,789 2,460 2,231 Depreciation, depletion and amortization 3,074 1,783 1,063 922 781 Ceiling write-down of oil and gas properties 2,975 - - - - -------- --------- -------- -------- -------- Total expenses $20,503 $ 12,872 $10,146 $ 8,269 $ 6,046 ======== ========= ======== ======== ======== Other income (expense) Interest expense and amortization of loan costs $(7,794) $ ( 837) $(1,866) $(1,062) $ (517) Impairment of other assets $ - $ - $( 600) $ - $ - Gain on sale of securities $ - $ - $ 5,128 $ 2,780 $ - Other, net $ 149 $ 69 $ 1 $ 176 $ 40 Income (loss) before income taxes $(9,925) $ (2,701) $ 4,130 $ 2,477 $(1,393) Income tax (expense) benefit - 1,144 (1,590) (710) 641 -------- --------- -------- -------- -------- Net income (loss) $(9,925) $ (1,557) $ 2,540 $ 1,767 $ (752) ======== ========= ======== ======== ======== Basic income (loss) per common share $ (1.23) $ (0.22) $ 0.39 $ 0.29 $ (0.13) Diluted income (loss) per common share $ (1.23) $ (0.22) $ 0.37 $ 0.27 $ (0.13) STATEMENT OF CASH FLOWS DATA Net cash provided by (used in): Operating activities $ 2,845 $ 136 $ 1,361 $ 1,157 $ (996) Investing activities $(6,902) $(16,218) $(3,232) $ (715) $(3,691) Financing activities $ 3,917 $ 16,283 $ 2,381 $(1,003) $ 5,367 BALANCE SHEET DATA Cash and cash equivalents $ 727 $ 867 $ 666 $ 155 $ 716 Accounts receivable, net of allowance $ 1,767 $ 1,514 $ 1,600 $ 1,488 $ 588 Investment in securities $ - $ - $ - $ 8,509 $10,885 Net property and equipment $10,169 $ 10,315 $10,343 $ 6,107 $ 4,231 Net oil and gas properties $36,262 $ 32,284 $17,191 $ 8,127 $ 1,959 Net intangible assets $ 3,953 $ 5,300 $ 1,527 $ 305 $ 298 Total assets $55,266 $ 53,130 $33,097 $26,013 $19,379 Current portion of long-term debt $ 1,763 $ 2,227 $ 3,342 $ 3,520 $ 2,174 Accounts payable $ 2,645 $ 2,876 $ 2,591 $ 1,879 $ 510 Long-term debt, net of current portion $26,230 $ 24,247 $10,421 $ 5,552 $ 6,411 Stockholders' equity $22,911 $ 22,810 $15,207 $13,596 $ 9,982
23 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following information should be read in conjunction with the Consolidated Financial Statements and Notes presented elsewhere in the this Form 10-K. Infinity follows the full-cost method of accounting for oil and gas properties. See "Organization and Summary of Significant Accounting Policies," included in Note 1 to the Consolidated Financial Statements. Infinity and its operating subsidiaries Infinity-Wyoming, Infinity-Kansas and Consolidated are engaged in identifying and acquiring oil and gas acreage, exploring and developing acquired acreage, and providing oil and gas well services. Infinity's primary focus is on the development of its properties in the Green River Basin of Wyoming, Piceance Basin of Colorado and in the Sand Wash Basin of Wyoming and Colorado. Infinity's involvement in the wastewater disposal industry through its wastewater division has been scaled back significantly with only maintenance operations occurring at the Cheyenne, Wyoming facility. Infinity expects to dispose of these facilities and has signed a letter of intent to sell the properties contingent upon the purchaser obtaining financing. OVERVIEW OF OIL FIELD SERVICE OPERATIONS Consolidated continued to develop its business relationships as the largest oil field service provider in eastern Kansas and northeastern Oklahoma by servicing over 400 customers during the year ended December 31, 2003. The continued strong price of natural gas and the focus on development of the coal bed methane potential of the Cherokee basin in southeast Kansas and northeast Oklahoma contributed to the overall increase in activity for Consolidated. During the year ended December 31, 2003 Consolidated achieved several operational milestones: - provided services to over 400 customers, - achieved gross sales of $11.6 million, - subsidiary level earnings before interest, taxes, depreciation and amortization of approximately $2.8 million, and - subsidiary level income before taxes of over $1.0 million Consolidated is actively seeking opportunities through acquisitions or mergers to expand its service area, increase its market share or enhance the services it provides to its customers. At December 31, 2003, Consolidated had outstanding debt of approximately $2.9 million secured by its fleet of service trucks and real estate with an appraised market value in excess of $10.0 million. Management believes that it can use the excess value as collateral to quickly fund acquisitions as they might occur. OVERVIEW OF OIL AND GAS PRODUCTION ACTIVITY In the Fall of 2002, Infinity began working with First Albany Corporation to identify and evaluate strategic divestiture, financing and merger alternatives for Infinity. Infinity was approached about the possible sale of our interest in certain of Infinity-Wyoming's properties, the merger of Infinity with another public company, or the acquisition of Infinity by a third party. After several months of evaluation, Infinity was contacted about a potential merger. Management believed the potential merger would be beneficial and entered into detailed negotiations with the third party. After several months of negotiations and reaching what Infinity believed to be satisfactory terms for a merger, the third party withdrew from the discussions in April 2003. Infinity had believed that the merger would provide adequate resources for the future development of its assets and had focused its limited resources on completing the merger. Subsequently, when the negotiations were terminated, Infinity was not in a position to act timely on any alternatives to the merger and was limited on the resources it could immediately bring to the development of its properties. Facing deadlines under the Labarge farm out agreement for earning acreage through drilling wells while at the same time in detailed negotiations with the potential merger partner and with the anticipation that additional resources would be available upon the completion of the merger, Infinity-Wyoming drilled five production wells and one injection well on acreage it had acquired adjacent to the Labarge acreage it currently owned. When the merger negotiations were terminated, Infinity had outstanding unsecured past due payables associated with the drilling activities of approximately $1.8 million. Due to a lack of financial resources, the wells were not completed. Three of these wells have been included in the initial recompletion phase under the Schlumberger agreement. 24 As Infinity was unable to complete the merger and the fact that Infinity needed resources to continue development of its acreage, in June 2003, Infinity began discussions with several traditional lending institutions in order to develop a credit relationship that would recognize the value of Infinity-Wyoming's developing assets. The intent was to find a financial partner that would allow for future expansion as the assets were developed and to provide cash to pay Infinity's current outstanding payables. Understanding that the future success of development activities on its properties were dependent on its relationships with the service providers in the area of its operations, Infinity-Wyoming worked diligently to secure financing that would allow payment of its past due obligations. On June 5, 2003 Infinity-Wyoming entered into a $3.8 million loan agreement secured by its interest in the producing properties. The proceeds were used to pay $1.0 million of outstanding bridge loan notes, outstanding payables related to the development of the gas properties of Infinity-Wyoming, and for additional development work on the properties. The loan was repaid on September 4, 2003 when Infinity-Wyoming entered a credit agreement with U.S. Bank National Association that provided a three year, $25.0 million revolving line of credit based principally on the production and reserves associated with Infinity-Wyoming's Pipeline project. The initial borrowing base on the facility was $5.5 million. Infinity-Wyoming immediately drew the full amount available on the facility and repaid the June 5 loan and began drilling six additional wells on its Pipeline acreage. All of these wells were completed subsequent to December 31, 2003 and have began production. In 2003, Infinity faced several financing, development and operating issues associated with drilling, completing and operating its coal bed methane wells on its acreage in the Greater Green River Basin of Wyoming: - Limited capital resources for the further development of the projects, - Production volumes on the Labarge property had declined dramatically after work was done on the wells in December 2002, - The disposal well on the Labarge property was experiencing increasing injection pressures, - Significant production was occurring from only a limited number of wells on the Pipeline acreage, and - Reservoir tests on the Almond coals in the Pipeline project were indicating permeability issues. Each of these issues potentially had a significant impact on Infinity-Wyoming's ability to develop the properties, attract potential partners for future development and to fund future development activities. Production from the original five wells drilled on the Labarge acreage continues to be uneconomical due to what management believes are down hole mechanical issues related to high parifin oil that was encountered in the wells and down hole treatments that were done in December 2002. The uneconomic results of these wells along with the lack of resources to address the mechanical issues on the wells has forced the reclassification of the reserves associated with the wells and the surrounding drilling locations from proved to probable and possible, resulting in a substantial reduction in Infinity-Wyoming's proved reserves at December 31, 2003. In order to further evaluate and develop the Labarge project, Infinity-Wyoming entered into an agreement with Schlumberger and Red Oak. The agreement calls for re-completion of five existing wells and the drilling of up to 90 additional wells on the Labarge acreage over the next five years. The first 10 wells will be drilled in a bundle and the remaining 80 wells will be drilled in bundles of 20 wells. Schlumberger has the exclusive right to provide certain of its services on a risked basis and may withdraw its participation after the completion of any bundle of wells or after the re-completion of five of the 10 existing wells. Red Oak has the right to provide financing on a portion of the cost of drilling and completing the wells. Disclosure of the terms of this agreement is restricted by provisions in the agreement. Infinity-Wyoming has approximately $9.4 million invested in unproved oil and gas properties not subject to amortization on its Labarge project and expects to incur an additional $3.6 million during 2004 in costs under an agreement to further explore the property. At the conclusion of the 2004 evaluation and exploration activity, a significant portion of the investment in unproved oil and gas properties not subject to amortization will be reclassified to properties subject to depletion and the ceiling test. If the 2004 evaluations and exploration activity at Labarge do not result in additional proved reserves, or if proved reserves are not significant, Infinity could be required to write-down a portion of the full cost pool of oil and gas properties subject to amortization upon the reclassification of the Labarge unproved oil and gas property costs. Although operations at Pipeline continue to be profitable, production has not met management's expectations. Infinity-Wyoming has been unable to consistently produce gas from all of the wells in the project. However, certain wells have been very successful with production from those wells exceeding 1,500 MCF per day. Further evaluation of the geology associated with the successful wells indicates that these wells appear to be producing from the Almond Sand rather than from the Almond Coals. The Almond Sand is a geological sandstone formation that lays directly on top of the Almond Coals. This sandstone formation is much more porous than the Almond Coals allowing hydrocarbons trapped within the geological formation to be produced. However, the Almond Sand formation developed in channels through the geological formations and does not cover the entire area like coals traditionally cover. Drilling logs from the 25 Pipeline drilled wells and the further evaluation of additional seismic data have allowed Infinity-Wyoming to better define the area that contains the Almond Sand. Since management currently believes the Almond Sand to be the major gas producing formation, Infinity will be aggressively developing the remaining acreage where there is sufficient geological information to indicate the presence of the sand formation. The change in classification from a coal bed methane play to a conventional sand play has had a significant impact on the acreage from which hydrocarbons will be producible and accordingly on the reserves associated with the project. As a result, in 2004, management determined it was not economically beneficial to re-new an option on approximately 8,300 acres of undeveloped acreage. The above operational, geological and geophysical, financial, and other issues resulted in significant revisions to year end reserves. As a result of these revisions and other economic decisions, Infinity-Wyoming realized a $2,975,000 ceiling write-down during 2003. Infinity-Wyoming has selected Netherland, Sewell and Associates, Inc. to prepare its January 1, 2004 third party reserve evaluation. Results of this evaluation are disclosed in the "Supplemental Oil and Gas Disclosures" in Infinity's Consolidated Financial Reports and in the "Oil and Natural Gas Reserves" section of Item 2. Description of Properties. Wells, Chappel and Company, Inc. prepared the reserve evaluation for the periods ended December 31, 2002 and December 31, 2001. 2004 OPERATIONAL AND FINANCIAL OBJECTIVES Oil Field Services Consolidated expects to increase its oil field service revenue during 2004 due to the increase in the number of wells being drilled by property owners in our service areas and through strategic acquisitions. These acquisitions would be done in order to: - expand the services that are provided, - expand the area that is serviced, - gain market share by providing complimentary services to our existing services, and - gain market share by eliminating competition. Revenues from oil field services are expected to be between $12.5 million and $14.5 million with income before taxes of approximately $1.7 to $2.2 million from existing business. Management expects that it will make acquisitions that will cost between $1.2 million and $2.0 million during 2004 and expects to fund the acquisitions through financing secured by the acquired assets. Consolidated also expects to have other capital expenditures of about $1.0 million related to equipment and facilities. These capital expenditures would be financed through cash flow or vendor financing. Oil and Gas Production Infinity-Wyoming will focus on increasing production through development of acreage and acquiring additional interest in wells within its Pipeline area of operations. Subsequent to December 31, 2003, Infinity-Wyoming completed six wells drilled during the fourth quarter of 2003 and acquired an additional 49% working interest in two existing wells and 960 acres of undeveloped leasehold adjacent to the Pipeline project. With the acquisition, Infinity-Wyoming assumed operations of the two wells. Infinity-Wyoming expects to drill two wells on the newly acquired acreage during 2004. Infinity-Wyoming anticipates capital expenditures will be approximately $0.5 million to drill the two wells. In the first quarter of 2004, Schlumberger began re-completion activities on two of the original Riley Ridge wells on the Labarge project by perforating additional areas of the well bore and re-fracing the wells. Schlumberger also began completion activities on one of the wells on the Thompson acreage that had been drilled in the fourth quarter of 2002. Depending on the results of these activities, Infinity-Wyoming, through the agreement, could drill an additional five to six wells on the Thompson acreage during 2004. Infinity-Wyoming also expects to complete the Environmental Impact Study ("EIS") on the Labarge acreage during the fourth quarter of 2004 or early in 2005. Management believes that it will require between $4.0 million and $4.5 million in capital to pay for the un-risked services for the drilling and completion work on wells drilled in 2004, if any, and the completion of the EIS. 26 The ability of Infinity-Wyoming to complete these activities is dependent on a number of factors including, but not limited to: - The availability of the capital resources required to fund the activity. Infinity completed a private placement of 1,000,000 shares of Infinity common stock in January 2004 which generated proceeds of approximately $4.0 million (before offering costs) a portion of which will help fund the development activities. Infinity-Wyoming also expects to generate between $4.0 and $5.0 million in cash flow from operations in 2004. - The availability of third party contractors for drilling rigs and completion services. Infinity-Wyoming has reduced the impact this could have by contracting with Schlumberger to provide certain of these services for the development of the Labarge acreage. - The success of the completion efforts on the existing Labarge wells. If Schlumberger is not satisfied with, or successful in its efforts then they may elect not to risk their services and Red Oak may be unwilling to secure financing for the further development of the property. If this occurs, Infinity-Wyoming will be required to fund the all of the development activities and may not be able to do so on terms that are acceptable to management. Infinity, Inc. Activity Infinity continues to negotiate the final development agreement with INE for the Perlas and Tyra blocks offshore Nicaragua. Management believes that it should be able to complete the negotiations sometime in 2004. Upon completion of the negotiations, Infinity will be required to post a performance bond for the initial work to be done on the leases which will include an environmental study and the development of geological information developed from additional seismic evaluation. Infinity estimates the performance bond will approximate $0.7 million and that Infinity will incur additional costs to complete the negotiations and finalize the leases of approximately $0.1 million. Infinity is also pursuing the acquisition of 25,000 acres in the Fort Worth Basin of Texas. Development opportunities on the acreage will target principally the Barnett Shale formation. As final terms of the agreement have not been reached Infinity cannot determine what financial resources might be required to complete the acquisition and exploration. RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2003 COMPARED TO THE YEAR ENDED DECEMBER 31, 2002 Infinity incurred a net loss after taxes of $9.9 million, or $1.23 per fully diluted share, in the year ended December 31, 2003 compared to a net loss after taxes of $1.6 million, or $0.22 per fully diluted share in the year ended December 31, 2002. Infinity achieved a $4.6 million increase in gross profit to $9.1 million in the year ended December 31, 2003 from $4.5 million for the year December 31, 2002. The increase in gross profit during the period ended December 31, 2003 compared to the period ended December 31, 2002 was the result of a $3.0 million, or approximately 36%, increase in oil field service revenue to $11.6 million from $8.6 million. The increase in revenue was partially offset by a $1.6 million, or 35%, increase in oil field service cost of services provided (See "Oil Field Services" discussion below). Oil field service revenue for the year ended December 31, 2002 was reduced by the elimination of $2.1 million of oil field service sales that were provided to Infinity-Wyoming by Consolidated for the development of its oil and gas properties and the cost of services provided was reduced by $1.1 million for the cost of those services provided to Infinity-Wyoming. The oilfield service subsidiary provided minimal services to Infinity-Wyoming in the period ended December 31, 2003. Additionally, gross profit comparisons were affected by a $4.2 million, or approximately 178% increase in sales of oil and gas from $2.4 million for the period ended December 31, 2002 to $6.6 million in the period ended December 31, 2003 with a corresponding increase of $0.6 million in oil and gas production costs and $0.5 million increase in production taxes in the 2003 period (See "Oil and Gas Production" discussion below). 27 Operating expenses for the year ended December 31, 2003 increased $0.7 million from $4.6 million in the 2002 period to $5.3 million in the 2003 period. In 2003, Infinity incurred approximately $0.6 million in expenses associated with the detailed negotiations relating to a potential merger, which negotiations were terminated in April 2003, and the process leading up to those negotiations in which Infinity solicited and reviewed strategic alternatives. Infinity and its subsidiaries also recognized additional depreciation, depletion and amortization ("DD&A") expense of approximately $1.3 million during the year ended December 31, 2003, an increase to approximately $3.1 million for the period compared to DD&A of approximately $1.8 million for the period ended December 31, 2002. The increase in DD&A was due to the increase in the investment in Consolidated's fleet in 2002 and the increase in the depletion rate on the oil and gas producing properties. Infinity-Wyoming also recognized a $3.0 million ceiling write-down of its oil and gas properties based on the full cost ceiling test for oil and gas properties subject to depletion. As a result, Infinity recognized an operating loss of $2.3 million for the period ended December 31, 2003, compared to an operating loss of $1.9 million for the period ended December 31, 2002. Interest expense and finance charges increased by $7.0 million to $7.8 million for the year ended December 31, 2003 compared to $0.8 million for the year ended December 31, 2002. The increase was primarily due to the recognition of $5.6 million of amortization of loan costs associated with the value of warrants and options granted in conjunction with obtaining new debt financing and the amortization of $0.6 million of cash loan costs paid when those same loans were obtained. Infinity also experienced a $0.9 million increase in interest expense in the 2003 period compared to the 2002 period due to the increase in debt outstanding, higher interest rates on certain of the new notes and a decrease in the amount of interest that was capitalized to undeveloped properties as Infinity experienced a period of development inactivity during a significant portion of 2003. Infinity recognized a deferred income tax benefit of $1.1 million in the year ended December 31, 2002. The net operating losses generated in the year ended December 31, 2003 increased Infinity's net deferred tax asset. Due to uncertainty as to the ultimate utilization of the net operating losses, the net deferred tax asset has been fully reserved by a valuation allowance as discussed in Note 11 of the consolidated financial statements. Therefore, Infinity has reflected no net tax expense or benefit for the year ended December 31, 2003. Oil Field Services Sales for the year ended December 31, 2003 increased to $11.6 million from $8.6 million, net of inter-company eliminations, in the year ended December 31, 2002. Infinity eliminated oil field services sales of $2.1 million from revenues for sales of services to Infinity-Wyoming during the year ended December 31, 2002. There were no material inter-company sales in 2003. Sales of cementing services from Consolidated's Bartlesville, Oklahoma camp increased by approximately $0.8 million and revenue from fracturing services from that camp increased by approximately $1.3 million in the year December 31, 2003 compared to the comparable period in 2002. The increase in revenue was primarily due to an increase in development activity during the second and third quarters of 2003 as customers moved from the evaluation of their prospects to the full scale development of their prospects in areas serviced from the Bartlesville facility. Revenue from cementing services provided from Consolidated's Gillette, Wyoming facility increased by approximately $1.3 million, due to the Powder River Basin of Wyoming becoming an active coal bed methane development play again. Crews from the Gillette facility cemented over 400 wells in the twelve months ended December 31, 2003 compared to 78 in the comparable period of 2002. The following table details the increase in gross revenue in millions of dollars, before discounts and inter-company eliminations, for the periods, based on the number and type of core service jobs performed (due to rounding the sum of the individual amounts presented may not equal the totals):
OIL FIELD SERVICE STATISTICS ($ IN MILLIONS, BEFORE DISCOUNTS) 2003 2002 CHANGE ----------------- ----------------- ------------------ JOB TYPE JOBS REVENUE JOBS REVENUE JOBS REVENUE Cementing 1,740 $ 4.8 1,002 $ 3.4 738 $ 1.4 Acidizing 931 1.4 773 1.1 158 0.3 Fracturing 1,011 6.1 981 6.5 30 (0.4) Discounts and Eliminations (0.7) (2.4) 1.7 --------- --------- --------- $ 11.6 $ 8.6 $ 3.0 ========= ========= =========
The increase in the number of cementing jobs performed reflects the increase in the number of wells being drilled in eastern Kansas and northeastern Oklahoma as well as in Wyoming. As well testing is completed on the newly drilled wells, completion and stimulation activities such as acidizing and 28 fracturing should increase. Management believes that the increase in the number of wells cemented by Consolidated during the year and the continued high prices for oil and natural gas are good indicators of future increases in its acidizing and fracturing activities as well. The additional activity also led to an increase in the cost of goods sold of approximately $1.6 million. The increase in cost of goods sold was primarily due to the increase in materials of approximately $0.7 million, labor expense of approximately $0.4 million, and an increase in equipment operating costs and maintenance of approximately $0.3 million. General and administrative expenses for oil field services for 2003 were comparable to the same period in 2002. Oil and Gas Production During the year ended December 31, 2003, Infinity-Wyoming recorded approximately $1.8 million in revenue on the sale of 57,654 barrels of oil, (345,924 MCF equivalents) and approximately $4.8 million in revenue on the gas sales of 1,080,456 MCF from its Pipeline and Labarge projects. Infinity-Wyoming incurred $1.4 million in lease operating expenses, $0.8 million in production taxes, and $0.7 million in transportation fees to produce the oil and gas during the year ended December 31, 2003. The total production expense, transportation and production taxes of approximately $2.9 million equates to approximately $2.04 in lifting costs on total MCF equivalents of 1,426,380. Infinity-Wyoming also incurred $0.8 million in general and administrative costs and $1.6 million in DD&A expense, or approximately $1.63 per MCF equivalent for the period. The general and administrative expense included approximately $0.2 million in costs associated with the detailed negotiations relating to a potential merger, which negotiations were terminated in May 2003, and the process leading up to those negotiations in which Infinity solicited and reviewed strategic alternatives. Excluding these costs, general and administrative expenses for Infinity-Wyoming were unchanged when compared to the prior year period. DD&A costs for the period increased by $1.3 million due to the increased depletion rate associated with the investment in developed oil and gas properties. The higher rate was the result of the increase in oil and gas production and the decrease in the proved reserves from 2002 to 2003. Infinity also recognized a ceiling write-down of its oil and gas properties under the full cost ceiling test of approximately $3.0 million. Under the full cost accounting rules of the SEC, Infinity reviews, on a quarterly basis, the carrying value of its oil and gas properties. Under these rules, capitalized costs of proved oil and gas properties, as adjusted for estimated asset retirement obligations, may not exceed the present value of estimated future revenue at the un-escalated prices in effect as of the end of each fiscal quarter, after giving effect to Infinity-Wyoming's cash flow hedge positions, and requires a write-down for accounting purposes if the ceiling is exceeded. Infinity-Wyoming is also required to evaluate the value of its approved oil and gas properties and adjust the value to the lower of the cost or market value of the properties. Due to the limited availability of capital for development of its properties, the decision not to re-new a portion of Infinity-Wyoming's leases during 2004, and the condemnation of leases due to geological and geophysical evaluation, Infinity-Wyoming reclassified approximately $5.0 million of its investment in oil and gas properties not subject to depletion to subject to amortization. During the year ended December 31, 2002, Infinity-Wyoming recorded $0.9 million in revenue on the sale of 42,525 barrels of oil, (255,150 MCF equivalent) and $1.3 million in revenue on the sale of 648,160 MCF of natural gas from its Pipeline and Labarge projects. Infinity-Wyoming incurred approximately $1.1 million in lease operating expenses, $0.2 million in production taxes and $0.3 million in transportation fees to produce the oil and gas during the period ended December 31, 2002. The total production expense, transportation and production taxes of approximately $1.6 million equates to $1.79 in lifting costs on total MCF equivalents of 903,310. Infinity-Wyoming also incurred approximately $0.7 million in general and administrative costs and $0.2 million in DD&A expense, or approximately $1.00 per MCF equivalent for the period. 29 The following table provides statistical information by field for production volumes, revenue and production costs for the year ended December 31, 2003 and 2002 (due to rounding and other operating expenses the sum of the individual amounts presented may not equal the totals):
INFINITY-WYOMING PRODUCTION STATISTICS PIPELINE LABARGE TOTAL ------------------ -------------- ------------------ 2003 2002 2003 2002 2003 2002 -------- -------- ------ ------ -------- -------- Volumes in 000's: - ----------------- Oil Sales Volumes (bls) 57.4 42.2 0.3 0.3 57.7 42.5 Gas Sales Volumes (mcf) 1,051.2 607.9 29.0 40.2 1,080.5 648.2 MCF Equivalent 1,395.7 861.2 30.7 42.1 1,426.4 903.3 Values in 000's: - ---------------- Oil Revenue $1,751.6 $ 899.1 $ 7.2 $ 11.5 $1,758.8 $ 910.6 Gas Revenue $4,701.4 $1,198.9 $129.1 $ 74.8 $4,830.5 $1,273.7 Production Expense $ 573.6 $ 543.3 $819.9 $463.7 $1,393.5 $1,007.0 Production Taxes $ 739.0 $ 227.4 $ 31.2 $ 9.3 $ 770.3 $ 236.7 Transportation Expense $ 737.0 $ 279.2 $ 11.3 $ 14.9 $ 748.3 $ 294.1 Per MCF Equivalent: - ------------------- Revenue $ 4.62 $ 2.44 $ 4.45 $ 2.05 $ 4.62 $ 2.42 Production Expense $ 0.41 $ 0.63 $26.75 $11.02 $ 0.98 $ 1.11 Production Taxes $ 0.53 $ 0.26 $ 1.02 $ 0.22 $ 0.54 $ 0.26 Transportation Expense $ 0.53 $ 0.32 $ 0.37 $ 0.35 $ 0.52 $ 0.33
The increase in production was primarily a result of the increased production time for wells in each period. Several wells began production in the third and fourth quarters of 2002. These wells produced for all of 2003 while producing for only a short period and at lower volumes during 2002. Infinity-Kansas recorded net revenue of $0.2 million from its Kansas properties and operating expenses and production taxes of $0.2 million during the year ended December 31, 2002. Effective May 1, 2002 Infinity-Kansas sold its interest in the Owl Creek and Manson properties to West Central Oil, LLC for cash and a note receivable. Under the full cost method of accounting for oil and gas properties, Infinity and its subsidiaries did not recognize a gain or loss on the sale of its oil and gas properties since the sale did not have a material impact on the relationship between the oil and gas property values and the value of the reserves associated with those properties. Infinity reduced its investment in the remaining oil and gas properties by approximately $244,000 on the sale of the property. During 2003, production, oil and gas prices, operating expenses and development expenditures, for Infinity-Wyoming's Labarge and Pipeline projects have varied from those estimated in reserve reports at December 31, 2002 and additional geological, geophysical, and engineering data has become available and been analyzed. Production at Labarge continues to be uneconomic. Infinity-Wyoming believes that this may be due in part to down-hole operational problems and as a result in December 2003, Infinity-Wyoming entered into an agreement with Schlumberger and Red Oak for the further evaluation and development of the Labarge acreage. Additional information about that agreement was discussed in the "Overview of Oil and Gas Production Activity" section of "Management's Discussion and Analysis of Financial Conditions and Results of Operations." Quantities of proved oil and gas reserves as evaluated by Netherland Sewell and Associates at December 31, 2003 were substantially less than our previous estimates which in turn resulted in a higher depletion rate for the last part of 2003. The 58% increase in production during 2003 combined with the significant reduction in proved reserves at January 1, 2004 resulted in a $1.2 million increase in depletion of developed oil and gas properties in 2003 compared to the 2002 period. At current production levels of approximately 3,400 MCFE per day and proved reserves of 8,669,723 MCFE, Infinity-Wyoming will experience approximately a 14% depletion of its proved oil and gas property investment in 2004. 30 Infinity-Wyoming experienced a $0.3 million increase in administrative expenses in the year ended December 31, 2003 compared to the year ended December 31, 2002. This increase in administrative expense was primarily legal, accounting, and consulting fees associated with the detailed negotiations relating to a potential merger, which negotiations were terminated in May 2003, and the process leading up to those negotiations in which Infinity solicited and reviewed strategic alternatives. Corporate Activities Infinity and its subsidiaries incurred approximately $2.1 million in expenses associated with corporate activities during the year ended December 31, 2003 compared to approximately $1.9 million in the period ended December 31, 2002. Included in the $0.2 million increase was approximately $0.3 million in legal, accounting, and consulting fees associated with the detailed negotiations relating to a potential merger, which negotiations were terminated in May 2003, and the process leading up to those negotiations in which Infinity solicited and reviewed strategic alternatives. Other Income and Expenses Other income and expenses was a net expense of $7.6 million for the year ended December 31, 2003 compared to $0.8 million for the year ended December 31, 2002. Infinity recognized a $7.0 million increase in interest expense of which $6.0 million was associated with the amortization of financing costs. $5.4 million of the increase in amortization of loan costs was associated with non-cash compensation related to options and warrants granted in conjunction with obtaining new debt financing and the remainder of the increase was related to cash loan costs paid when those same loans were obtained. There was also a $0.9 million increase in interest expense in the 2003 period compared to the 2002 period due to the increase in debt outstanding, higher interest rates on certain of the new notes and a decrease in the amount of interest that was capitalized to undeveloped properties as Infinity experienced a period of development inactivity during a significant portion of 2003. Income Tax Infinity recognized a deferred tax benefit of approximately $1.1 million in the year ended December 31, 2002. The net operating losses generated in the year ended December 31, 2003 increased Infinity's net deferred tax asset. Due to uncertainty as to the ultimate utilization of the net operating losses, the net deferred tax asset has been fully reserved by a valuation allowance as described in Note 11 of the consolidated financial statements. Therefore, Infinity has reflected no net tax expense or benefit for the year ended December 31, 2003. RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE NINE-MONTH TRANSITION PERIOD ENDED DECEMBER 31, 2001 Infinity incurred a net loss of $1.6 million, or $0.22 per fully diluted share, in the year ended December 31, 2002 compared to net income of $2.5 million, or $0.37 per fully diluted share in the nine-month transition period ended December 31, 2001. Infinity's gross profit decreased by $0.8 million to gross profit of $4.5 million in the year ended December 31, 2002 from $5.3 million for the nine-month transition period ended December 31, 2002. The decrease in gross profit during the period ended December 31, 2002 compared to the period ended December 31, 2001 was the result of a $1.3 million, or approximately 13%, decrease in oil field service revenue to $8.6 million from $9.9 million. The decrease in revenue was partially offset by a $0.5 million, or 10%, decrease in oil field service cost of services provided (See "Oil Field Services" discussion below). Oil field service revenue for the year ended December 31, 2002 was reduced by the elimination of $2.1 million of oil field service sales that were provided to Infinity-Wyoming by Consolidated for the development of its oil and gas properties and the cost of services provided was reduced by $1.1 million for those services provided to Infinity-Wyoming. In the nine-month transition period ended December 31, 2001, $0.5 million of oil field service revenue and $0.4 million in costs for providing those services were eliminated for inter-company sales. Additionally, gross profit comparisons were affected by a $0.7 million increase in production costs and taxes associated with a $0.6 million increase in revenue from the sale of oil and gas production in the year ended December 31, 2002 compared to the nine-month transition period ended December 31, 2001. (See "Oil and Gas Production" discussion below). 31 Operating expenses for the year ended December 31, 2002 increased $1.9 million from $2.8 million in the nine month transition period ended December 31, 2001 to $4.6 million in the 2002 period. Infinity and its subsidiaries also recognized depreciation, depletion and amortization ("DD&A") expense of approximately $1.8 million during the year ended December 31, 2002, an increase of approximately $0.7 million for the period compared to DD&A of approximately $1.1 million for the nine month period ended December 31, 2001. The increase in DD&A was due to the increase in the investment in Consolidated's fleet, the increase in depreciation associated with aviation assets and the increase in the depletion associated with the increased investment in oil and gas properties. Infinity recognized an operating loss $1.9 million for the period ended December 31, 2002 compared to operating income of $1.5 million for the nine month period ended December 31, 2001. Interest expense and finance charges decreased by $1.0 million to $0.8 million for the year ended December 31, 2002 compared to $1.9 million for the nine month period ended December 31, 2001. The decrease was primarily due to the increased capitalization of interest expense to undeveloped properties in the 2002 period while in 2001 Infinity had interest expense associated with the payoff of debt tied to investment stock that was sold during the 2001 period. During the nine-month transition period ended December 31, 2001, Infinity recognized a gain of $5.1 million on the sale of 225,000 shares of Evergreen Resources common stock. The gain on the sale of the Evergreen Resources stock was partially offset by $1.8 million in interest expense on the loans that were secured by the securities in the none-month transition period. Costs of $1.0 million were also incurred for unwinding the financing agreements secured by the Evergreen Resources common stock, which were capitalized to undeveloped properties of Infinity-Wyoming. Infinity recognized a deferred income tax benefit of $1.1 million, or 42.4% of the pre-tax loss, in the year ended December 31, 2002 compared to an income tax expense of $1.6 million, or 38.5% of pre-tax income in the nine-month transition period ended December 31, 2001. Oil Field Services During the year ended December 31, 2002, Consolidated generated $8.6 million in net revenue and cost of goods sold of $4.6 million compared to $9.9 million in net revenue and cost of goods sold of $5.2 million for the nine-month transition period ended December 31, 2001. Revenue for the year ended December 31, 2002 on sales to third parties was negatively impacted by environmental issues in the Powder River Basin of Wyoming which is serviced by the Gillette, Wyoming camp. Due to the requirement for an Environmental Impact Study across the Powder River Basin, very few drilling permits were issued for new wells. Consolidated performed approximately 770 less cement jobs in the 12 month period ended December 31, 2002 than in the nine-month transition period ended December 31, 2001. Because of the lack of drilling activities revenue from the Gillette, Wyoming, operations of Consolidated were reduced by $1.9 million from $2.3 million in the nine month transition period ended December 31, 2001 compared to $0.4 million in the year ended December 31, 2002. Cost of goods sold were reduced to $0.7 million for the year ended December 31, 2002, a $0.7 million decrease from $1.4 million in the nine month transition period ended December 31, 2001. Revenue for the period ended December 31, 2002 increased by $0.6 million at Consolidated's facilities in Kansas and Oklahoma while the cost of goods sold increased by $0.2 million due to the longer period recognized during 2002 compared to the nine-month transition period in 2001. For the year ended December 31, 2002 Consolidated also generated $2.1 million in revenue and $1.1 million in cost of goods sold related to inter-company sales to Infinity-Wyoming compared to inter-company sales and cost of goods sold for the nine-month transition period ended December 31, 2001 of $0.5 million and $0.4 million. The sales to Infinity-Wyoming are eliminated in the accompanying consolidated statement of operations. The following table details the change in gross revenue in millions of dollars, before discounts and inter-company eliminations, for the periods based on the number and type of core service jobs performed (due to rounding the sum of the individual amounts presented may not equal the totals): 32
OIL FIELD SERVICE STATISTICS ($ IN MILLIONS, BEFORE DISCOUNTS) 2001 2002 (9 MONTH PERIOD) CHANGE ----------------- ----------------- ------------------- JOB TYPE JOBS REVENUE JOBS REVENUE JOBS REVENUE Cementing 1,002 $ 3.4 1,781 $ 5.2 (779) $ (1.8) Acidizing 773 1.1 665 0.9 108 0.2 Fracturing 981 6.5 776 4.6 205 1.9 Discounts and Eliminations (2.4) (0.8) (1.6) -------- -------- --------- $ 8.6 $ 9.9 $ (1.3) ======== ======== =========
Oil and Gas Production During the year ended December 31, 2002, Infinity-Wyoming recorded $0.9 million in revenue on the sale of oil and $1.3 million in revenue on the sale of natural gas from its Pipeline and Labarge projects. Infinity-Wyoming incurred approximately $1.0 million in lease operating expenses, $0.2 million in production taxes and $0.3 million in transportation fees to produce the oil and gas during the period ended December 31, 2002. The total production expense, transportation and production taxes of approximately $1.5 million equates to $1.70 in lifting costs on total MCF equivalents of 903,310. Infinity-Wyoming also incurred approximately $0.7 million in general and administrative costs and $0.2 million in DD&A expense, or approximately $1.00 per MCF equivalent for the period. Infinity-Wyoming began selling oil and gas production from its Pipeline project and generated $1.1 million in revenue and incurred operating and transportation expenses of approximately $0.6 million and production taxes of approximately $0.1 million for the nine-month transition period ended December 31, 2001. Due to the sporadic production associated with the new wells calculation of a per MCFE lifting or overhead cost for the nine-month transition period is meaningless. Statistics based on a per MCFE basis for the year ended December 31, 2002 can be found in the previous discussion comparing the 2003 operations to the 2002 operations. Infinity-Kansas recorded net revenue of $0.2 million for sales of oil production from its Kansas properties and operating expenses and production taxes of $0.2 million during the year ended December 31, 2002. Effective May 1, 2002 Infinity-Kansas sold its interest in the Owl Creek and Manson properties to West Central Oil, LLC for cash and a note receivable. During the nine-month transition period ending December 31, 2001, Infinity-Kansas recorded net revenue of $0.6 million from its Kansas properties and operating expenses and production taxes of $0.5 million. Infinity-Wyoming experienced a $0.2 million increase in administrative expense in the year ended December 31, 2002 compared to the nine-month transition period ended December 31, 2002. This increase in administrative expense was primarily related to an increase in costs associated with increased staffing such as auto expenses, computer services and rent. Corporate Activities Infinity and its subsidiaries incurred approximately $1.9 million in expenses associated with corporate activities during the year ended December 31, 2002 compared to approximately $0.8 million in the nine-month transition period ended December 31, 2001. Included in the $1.1 million increase in corporate costs were approximately $0.4 million in increased shareholder maintenance costs, $0.1 million increase in legal and accounting fees and $0.3 million in increased staffing costs including salaries, benefits, and travel costs. Other Income and Expense Other income and expense was a net expense of $0.8 million for the year ended December 31, 2002 compared to other income of approximately $2.7 million for the nine-month transition period ended December 31, 2001. Interest expense and finance charges decreased by $1.1 million to $0.8 million for the year ended December 31, 2002 compared to $1.9 million for the nine month period ended December 31, 2001. The decrease was primarily due to the increased capitalization of interest expense to undeveloped properties in the 2002 period and an increased expense associated with the payoff of debt associated with investment stock that was sold during the 2001 period. During the nine-month transition period ended December 31, 2001, Infinity recognized a gain of $5.1 million on the sale of 225,000 shares of Evergreen Resources common stock. The 33 gain on the sale of the Evergreen Resources stock was partially offset by $1.8 million in interest expense on the loans that were secured by the securities in the none-month transition period. Costs of $1.0 million were also incurred for unwinding the financing agreements secured by the Evergreen Resources common stock, which were capitalized to undeveloped properties of Infinity-Wyoming. Infinity recognized a deferred income tax benefit of $1.1 million, or 42.4% of the pre-tax loss, in the year ended December 31, 2002 compared to an income tax expense of $1.6 million, or 38.5% of the pre-tax income, in the nine-month transition period ended December 31, 2001. LIQUIDITY AND CAPITAL RESOURCES Infinity's primary sources of liquidity are cash provided by operations, debt financing, and the equity market. Infinity's primary needs for cash are for the operation, development, production, exploration and acquisition of oil and gas properties, for fulfillment of working capital obligations, and for the operation and development through acquisitions of the oil field service business. As of December 31, 2003, the Company had a working capital deficit of $2.2 million compared to a working capital deficit of $3.0 million at December 31, 2002. The increase in the working capital was the result of an increase in current assets of $0.2 million and a decrease in current liabilities of $0.3 million. The increase in current assets was mainly due to an increase of $0.2 million in oil field service receivables and an increase of $0.1 million in oil and gas revenue receivables during the period. These increases in receivables were partially offset by a reduction in cash of approximately $0.1 million from December 31, 2003 to December 31, 2002. In addition to the increase in current assets, Infinity also reduced its current liabilities through payment of accounts payable which resulted in a net decrease of $0.2 million, repayments of long term debt and refinancing current notes into long term debt which resulted in a reduction in current liabilities of approximately $0.5 million. These decreases in current liabilities were partially offset by a $0.4 million increase in accrued expenses associated with oil and gas revenues payable and production and severance taxes payable as production increased. During the year ended December 31, 2003, cash provided by operations was $2.8 million compared to cash provided by operating activities during the year ended December 31, 2002 of $0.1 million. The increase is primarily due to the increase in income/(loss) before non-cash expenses of $3.0 million from a loss before non-cash expenses of $0.7 million in 2002 to income of $2.3 million in 2003. There was also a $0.2 million decrease in the amount of cash provided as a result of the changes in operating assets (accounts receivable, inventories and prepaid expenses) and operating liabilities (accounts payable and accrued expenses) during the 2003 period compared to the 2002 period. Infinity utilized cash of approximately $0.5 million due to the change in operating assets and liabilities in the year ended December 31, 2003 compared to generating $0.8 million in the comparable 2002 period. During the year ended December 31, 2003, Infinity used $6.9 million in investing activities by investing $5.7 million in developing oil and gas properties, $1.1 million in property and equipment, and $0.2 million in other assets and intangibles. This compares to Infinity investing $14.4 million in oil and gas properties, $2.7 million in property and equipment, and $0.1 million in other assets and intangibles during the year ended December 31, 2002. Offsetting the use of cash in investing activities in 2002 was the receipt of $0.8 million from the sale of marketable securities and $0.2 million from the sale of property and equipment and oil and gas properties. As a result, Infinity used a total of $16.2 million in investing activities during the year ended December 31, 2002. Infinity received $11.5 million from financing activities and $0.8 million from the exercise of options which was used to pay $8.4 million in outstanding debt, to pay interest on convertible notes, and development costs related to its oil and gas properties during the year ended December 31, 2003. During the comparable period of 2002, Infinity received $21.7 million from financing activities (including the sale of the 7% convertible notes) and $1.9 million from the exercise of options which was used to pay $7.4 million on outstanding debt and development exploration and development costs on its oil and gas properties. In January 2002, Consolidated established a three year term loan collateralized by substantially all of its oil field service equipment, a revolving line of credit secured by the eligible receivables of Consolidated and a $1.0 million capital expenditures line of credit with LaSalle Bank, N.A. The notes bear interest at 1% over the prime rate with the notes due January, 2005. At December 31, 2003 Consolidated owed $1.4 million on the notes to LaSalle 34 Bank. Principal payments of $80,626 and $15,626 are made monthly on the term loan and capital expenditures loan respectively. Consolidated expects to utilize the excess equity in its equipment that secures this loan to expand its borrowing base in order to fund future equipment needs and to provide working capital to the parent and affiliates. On July 3, 2003 Infinity borrowed $3.85 million to pay outstanding payables, $1.0 million outstanding on the 12% bridge loan notes that were issued in April 2003, and to pay for completion work on existing gas wells. These notes were repaid from the proceeds of the U.S. Bank National Association Facility discussed below. On September 4, 2003, Infinity-Wyoming established a Secured Revolving Borrowing Base Credit Facility ("Facility") whereby U.S. Bank National Association ("U.S. Bank") will provided debt financing. The Facility provides for funding of up to $25.0 million. The total amount made available to Infinity-Wyoming under the Facility was based on an initial borrowing base determination which was in turn based on the volume of oil and gas production expected, the term and price of hedging contracts in place, and the costs associated with producing the oil and gas and associated general and administrative expense. The facility is subject to semi-annual borrowing base determinations based on the same criteria as the original determination. Infinity-Wyoming and U.S. Bank will each have the option to request one additional re-determination during each calendar year. U.S. Bank has the sole discretion on increasing the borrowing base if the semi-annual determination indicates that there is additional borrowing base available. The initial amount made available under the facility and drawn by the Company was $5.5 million. Interest on the Facility accrues and is payable monthly at the rate of the U.S. Bank Prime Rate plus 100 basis points. Interest is currently 5% per annum on the Facility. The initial advance on the Facility was used to repay $3.85 million in bridge loans issued in July 2003, $0.75 million notes issued in January, 2003, initial loan costs and legal fees associated with the negotiation and closing of the Facility, property development costs, and working capital. Subsequent to December 31, 2003 Infinity-Wyoming re-paid $0.4 million of the debt associated with this facility and requested a $0.3 million letter of credit to secure our gas marketing contracts. The loan is subject to various restrictive and financial covenants. At December 31, 2003, the Company was in violation of the working capital covenant. Subsequent to December 31, 2003, the Company was granted a waiver of the violation as of December 31, 2003 and through April 30, 2004 at which time management believes it will be in compliance and remain in compliance for the remainder of the year. Infinity's anticipated cash needs for 2004 do not contemplate any acceleration of all or part of the payment of the outstanding balance due to a future violation, if any. At December 31, 2003, Infinity had $2.8 million of 8% Subordinated Convertible Notes outstanding. During the year ended December 31, 2003 the holders of approximately $1.5 million of the notes, which are due in June 2006, converted their notes to common stock. Subsequent to December 31, 2003 an additional $0.1 million of the notes were converted, leaving approximately $2.7 million in notes outstanding at March 31, 2004. These notes accrue approximately $19,000 in interest monthly which is payable in June and December. There are no payment obligations, other than interest, on the notes until June 2006. Subsequent to December 31, 2003, in accordance with the provisions of the notes, the conversion price of the notes was adjusted to $4.88 per share of common stock. The original conversion price of $5.00 per share was adjusted in accordance with anti-dilution provisions of the note agreement upon the private placement of 1,000,000 shares of Infinity common stock for $4.00 per share. As of December 31, 2003 Infinity had $11.2 million in 7% Subordinated Convertible Notes Payable outstanding. Infinity issued $379,000 in additional notes in lieu of cash to pay accrued interest on the outstanding notes on October 15, 2003. There are no payment obligations, other than interest, on the notes until April of 2007. Including the additional $379,000 in notes issued on October 15, 2003, interest on these notes accrues at approximately $65,500 per month and is due in April and October. Due to current cash constraints, Infinity expects that it will issue additional notes in lieu of a cash interest payment on April 15, 2004. Subsequent to December 31, 2003 in accordance with the provisions of the notes, the conversion price of the notes was adjusted to $8.067 per share of common stock. The original conversion price of $8.625 per share was adjusted in accordance with anti-dilution provisions of the note agreement upon the private placement of 1,000,000 shares of Infinity common stock for $4.00 per share. In November 2002, Infinity borrowed $3.0 million from a stockholder in order to pay current payables. The bridge loan, which was originally due January 5, 2004 and had a 5.25% interest rate, was extended until January 30, 2005 and the interest rate was adjusted to 7% in September 2003. Subsequent to December 31, 2003, Infinity repaid $1,250,000 of this loan with $750,000 in cash and 125,000 shares of Infinity common stock valued at $4.00 per share. Interest on the loan is paid monthly with current payments being approximately $10,000 per month. In conjunction with the amendments to extend the due date, waive rights to early payment and subordinate to other lenders, Infinity issued options to purchase 375,000 shares of Infinity, Inc. common stock at $8.75 per share for five years during 2003. 35 Infinity, Inc. and its subsidiaries owe approximately $4.0 million for real estate and equipment loans secured by assets of Infinity and its subsidiaries. These notes mature in one to eighteen years and bear interest from 6.0% to 9.50% and have monthly payments of approximately $34,800. One of the notes requires a payment of 5% of the outstanding loan balance each January which resulted in a payment of approximately $123,000 in January of 2004. Infinity received proceeds from the issuance of common stock, upon the exercise of 146,169 options, of $0.8 million during the year ended December 31, 2003. Beginning in June of 2001 with the issuance of the 8% Subordinated Convertible Notes, Infinity has utilized stock options and warrants as an inducement to lenders to lend money to Infinity and its subsidiaries. The options and warrants are non-cash compensation and are valued using the Black-Scholes valuation model. The value is recorded as capitalized loan costs and amortized as interest expense using the effective interest method. When a loan is repaid, the loan costs associated with that loan are fully amortized in that period. Infinity has capitalized $7.0 million, $5.0 million, and $0.9 million of non-cash compensation during the years ended December 31, 2003 and 2002, and the nine month period ended December 31, 2001, respectively. In addition to the non-cash compensation, Infinity has capitalized $0.5 million, $1.0 million, and $0.7 million in cash loan costs in the respective periods which are also amortized to interest expense using the effective interest method. During the period ended December 31, 2003, Infinity recognized interest expense for the amortization of non-cash loan costs of $5.4 million and of cash loan costs of $0.6 million. Infinity also capitalized $2.7 million in amortization to undeveloped oil and gas properties as capitalized interest. Subsequent to December 31, 2003, Infinity repaid $1.25 million, or 42%, of $3.0 million loans due January 5, 2005. As a result of the partial payment, Infinity will amortize 42%, or $0.7 million, of the remaining unamortized loan costs, as interest expense in January, 2004. The remaining unamortized loan costs will be amortized using the effective interest method. Infinity expects to recognize approximately $0.2 million per month in interest expense during 2004 in association with amortization of capitalized loan costs based on loans currently outstanding. In the first quarter of 2004, Infinity-Wyoming completed six wells drilled during the fourth quarter of 2003 and acquired an additional 49% working interest in two existing wells and 960 acres of undeveloped leasehold adjacent to the Pipeline project at a cost of approximately $1.0 million. With the acquisition, Infinity-Wyoming assumed operations of the wells. In the first quarter of 2004, Schlumberger began re-completion activities on two of the original Riley Ridge wells on the Labarge project by perforating additional areas of the well bore and re-fracing the wells. Schlumberger also began completion activities on one of the wells on the Thompson acreage that had been drilled in the fourth quarter of 2002. Depending on the results of these activities, Infinity-Wyoming, through the agreement, could drill an additional five to six wells on the Thompson acreage during 2004. Infinity-Wyoming also expects to complete the Environmental Impact Study ("EIS") on the Labarge acreage during the fourth quarter of 2004 or early in 2005. Management believes that it will require between $4.0 million and $4.5 million in capital to pay for the un-risked services for the drilling and completion work on wells drilled in 2004, if any, and the completion of the EIS. Infinity anticipates it will incur approximately $1.6 million in interest on its current outstanding notes, incur $1.0 million in other corporate usage, and an additional $0.8 million related to the Nicaragua leases (when finalized) during 2004. Infinity, Inc. issued 1,000,000 shares of common stock in January of 2004 in a private placement for which it received net proceeds after offering costs of approximately $3.9 million. The proceeds of this offering, after making a $750,000 payment on notes, are being used to pay costs associated with the completion of the Pipeline wells drilled in the fourth quarter of 2003, to pay for the un-risked services associated with the Labarge well completion activities and for working capital. Consolidated expects to generate approximately $3.6 million in operating cash flow from the oil field service business through the next twelve months. The cash flow from this business segment is expected to be driven by an increase in business in the Powder River Basin of Wyoming as drilling activity increases as a result of the completion of the Powder River environmental impact study and an increase in oil field service operations in eastern Kansas and northeastern Oklahoma as customers move forward with development activities on leases that will be expiring within the next two years. 36 Infinity-Wyoming is also expected to generate approximately $4.0 to $5.0 million in operating cash flow from oil and gas production operations during the same period. Infinity-Wyoming estimates production to be approximately 3,500 MCF per day of gas and approximately 120 barrels of oil per day through December 2004. Infinity-Wyoming has a contract in place to sell the first 3,500 MMBTU per day at $4.71 per MMBTU through March, 2004, 2,000 MMBTU per day for $4.40 per MMBTU through March 2005, and 2,000 MMBTU per day through March 2006. The volumes represented by these contracts are subject to a $0.55 per MCF gathering and transportation fee. Infinity utilized a Henry Hub futures price of $5.67 on the date of its estimate of expected 2004 operating cash flow, less $0.70 estimated pricing differential for location and $0.55 gathering and transportation fee for calculating the revenue for April 2004 until December 2004 on estimated volumes in excess of the contracted volumes. Infinity-Wyoming also used an average oil price of $34.42 based on a NYMEX strip price less the $0.75 contract differential. Production expenses and overhead are expected to comparable in 2004 to what was experienced in 2003. The following amounts represent management's current estimates of certain expenses and sources of cash, from which actual expenditures and cash may vary materially. There can be no assurance that Infinity will not be required to obtain additional external financing in 2004. It does not include the Nicaragua lease which is not currently completed, nor acquisitions, capital expenditures, or other development and exploration activities that are not currently completed:
Recap of Expected Minimum Cash Requirements For the Year Ending December 31, 2004 (In millions) Current working capital deficit $ 2.2 Pipeline development and acquisition 1.0 Labarge development and exploration 3.7 Labarge environmental impact study 0.3 Interest on notes 1.6 Corporate cash usage 1.3 Lease rental and farm out agreement 0.1 -------- Total requirements 10.2 Sources of Cash Consolidated operations 3.6 Infinity-Wyoming operations 4.0 Anticipated issuance of notes in lieu of cash payment of interest 0.8 Proceeds available from equity placement net of costs and payment of long-term debt 3.2 -------- Total sources $ 11.6 -------- Potential Surplus $ 1.4 ========
Depending on its success in negotiations and the availability of acquisition candidates, Consolidated anticipates making strategic acquisitions of approximately $1.2 million to $2.0 million over the next year and having capital expenditures of approximately $1.0 million related to equipment and facilities. Management is also negotiating to increase its borrowings through its existing facility with LaSalle Bank or a new facility with LaSalle Bank. Consolidated believes it will be able to borrow an additional $1.5 million on this facility, which, along with credit available to Consolidated through local sources and vendors will be sufficient to meet Consolidated's anticipated capital expenditure needs, including acquisitions, of approximately $3.0 million. 37 In addition to the acquisition in 2004 discussed above, Infinity-Wyoming expects to drill two wells on the newly acquired acreage during 2004 at a cost of approximately $0.5 million. To the extent the potential surplus from operations is not available, Infinity will be required to obtain additional debt or equity financing to complete these wells. Infinity-Wyoming could potentially have capital expenditures, subject to permitting requirements, of up to approximately $10.6 million as follows: - drill and complete eight wells in the Pipeline field for the development of reserves at a cost of $3.8 million; - complete five additional production wells and two disposal wells and install the related facilities on the Labarge acreage at a cost of approximately $4.2 million; - drill and complete an exploratory well and one disposal well and the related facilities on the Sand Wash Basin at a cost of $1.6 million; - drill and complete an exploratory well and one disposal well and the related facilities on the Antelope acreage at a cost of $1.0 million. In order to fund Infinity-Wyoming's potential additional capital expenditures of $10.6 million, Infinity-Wyoming will be required to pursue funding through the increase of the borrowing base on the U.S. Bank Facility or other conventional bank financing, the forward sale of its oil and gas production, partnerships or strategic alliances for the development of its undeveloped acreage or through the public or private equity or debt market pursued by the parent. The amount of progress that Infinity-Wyoming will be able to make on the development of its properties will be dependent upon its ability to obtain the proper permits for the development and to fund the development. Obtaining permits and sufficient funding to meet these additional capital expenditures cannot be assured. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Infinity believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. Reserve Estimates Infinity's estimated quantities of proved reserves at December 31, 2003 were prepared by independent petroleum engineers Netherland, Sewell and Associates, Inc. and at December 31, 2002 and 2001 were prepared by independent petroleum engineers Wells Chappell and Company, Inc. Infinity's estimates of oil and natural gas reserves, by necessity, are projections based on geologic and engineering data, and there are uncertainties inherent in the interpretation of such data as well as the projection of future rates of production and the timing of development expenditures. Reserve engineering is a subjective process of estimating underground accumulation of oil and natural gas that are difficult to measure. The accuracy of any reserve estimate is a function of the quality of available data, engineering and geological interpretation and judgment. Estimates of economically recoverable oil and natural gas reserves and future net cash flows necessarily depend upon a number of variable factors and assumptions, such as historical production from the area compared with production from other producing areas, the assumed effects of regulations by governmental agencies and assumptions governing future oil and natural gas prices, future operating costs, severance, ad-valorem and excise taxes, development costs and work-over and remedial costs, all of which may in fact vary considerably from actual results. For these reasons, estimates of the economically recoverable quantities of oil and natural gas attributable to any particular group of properties, classifications of such reserves based on risk of recovery, and estimates of the future net cash flows expected there from may vary substantially. Any significant variance in the assumptions could materially affect the estimated quantity and value of the reserves, which could affect the carrying value of Infinity's oil and gas properties and the rate of depletion of the oil and gas properties. Actual production, revenues and expenditures with respect to Infinity's reserves will likely vary from estimates, and such variances may be material. 38 Oil and Gas Properties, Depreciation and Full Cost Ceiling Test Infinity follows the full-cost method of accounting for oil and gas properties. Under this method, all productive and nonproductive costs incurred in connection with the exploration for and development of oil and gas reserves are capitalized. Such capitalized costs include lease acquisition, geological and geophysical work, delay rentals, drilling, completing and equipping oil and gas wells, and salaries, benefits and other internal salary-related costs directly attributable to these activities. The capitalized costs are amortized over the life of the reserves associated with the assets with the amortization being expensed as depletion in the period that the reserves are produced. This depletion expense is calculated by dividing the period's production volumes by the estimated volume of reserves associated with the investment and multiplying the calculated percentage by the capitalized investment. Costs associated with production and general corporate activities are expensed in the period incurred. Interest costs related to unproved properties and properties under development are also capitalized to oil and gas properties. If the net investment in oil and gas properties less asset retirement obligations, exceeds an amount equal to the sum of (1) the standardized measure of discounted future net cash flows from proved reserves including the effect of cash flow hedges, and (2) the lower of cost or fair market value of properties in process of development and unexplored acreage, the excess is charged to expense as additional depletion. Infinity is required to review the carrying value of its oil and gas properties each quarter under the full cost accounting rules of the Securities and Exchange Commission. Under these rules, capitalized costs of proved oil and gas properties, less asset retirement obligations, may not exceed the present value of estimated future net revenues from proved reserves, discounted at 10%. Application of the ceiling test generally requires pricing future revenue at the un-escalated prices in effect as of the last day of the quarter, including the effects of cash flow hedges, and requires a write-down for accounting purposes if the ceiling is exceeded. Unproved oil and gas properties are not amortized, but are assessed for impairment either individually or on an aggregated basis using a comparison of the carrying values of the unproved properties to net future cash flows. Infinity recognized a ceiling write down of $2,975,000 during 2003. A decline in prices received for oil and gas sales or an increase in operating costs subsequent to December 31, 2003 or reductions in estimated economically recoverable quantities could result in a requirement that Infinity recognize an additional ceiling write-down of oil and gas properties in a future period. Normal dispositions of oil and gas properties are accounted for as adjustments of capitalized costs, with no gain or loss recognized. Property, Equipment And Depreciation Equipment utilized in the oil field service business and to support operations on Infinity's oil and gas properties is stated at cost. This equipment is depreciated using the straight-line method over the estimated useful lives of the assets of three to 30 years. Valuation of Tax Asset The deferred tax assets and liabilities represent the future tax return consequences of those temporary differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that are not expected to be realized based on available evidence that is more likely than not to be realized in the form of a deferred tax valuations allowance. OFF-BALANCE SHEET ARRANGEMENTS Infinity has no material off-balance sheet arrangements. CONTRACTUAL OBLIGATIONS Infinity's contractual obligations, including those of its consolidated subsidiaries, include long-term debt, equipment and operating leases and other non-current obligations. The following table lists Infinity's significant contractual obligations at December 31, 2003.
- ------------------------------------------------------------------------------------------------- Payments Due by Period - ------------------------------------------------------------------------------------------------- Contractual Obligations Total Less than 1-3 years 3-5 years After 1 year 5 years - ------------------------------------------------------------------------------------------------- (in thousands) - ------------------------------------------------------------------------------------------------- 7% and 8% subordinated convertible notes $13,977 $ - $ 2,793 $ 11,184 $ - - ------------------------------------------------------------------------------------------------- Revolving credit facilities 5,596 96 5,500 - - - ------------------------------------------------------------------------------------------------- Term loans 5,215 1,619 1,224 451 1,921 - ------------------------------------------------------------------------------------------------- Note payable - related party 3,000 - 3,000 - - - ------------------------------------------------------------------------------------------------- Asset retirement obligations 521 - - - 521 - ------------------------------------------------------------------------------------------------- Office lease 334 89 184 61 - - ------------------------------------------------------------------------------------------------- Equipment leases 232 61 171 - - - ------------------------------------------------------------------------------------------------- Non-current production and property taxes 230 230 - - - ------- ---------- ---------- ----------- -------- - ------------------------------------------------------------------------------------------------- Total contractual obligations $29,105 $ 2,095 $ 12,872 $ 11,696 $ 2,442 ======= ========== ========== =========== ======== - -------------------------------------------------------------------------------------------------
For purposes of this table, Infinity is assuming that the holders of the 7% and 8% subordinated convertible notes will not exercise the conversion feature. In addition periodic interest payments required under the credit facilities and the 7% and 8% subordinated convertible notes are not reflected in the table. This table does not reflect the obligations associated with the gas gathering contract that Infinity-Wyoming has related to its Pipeline property. That contract is subject to certain delivery commitments that Infinity-Wyoming has not met. However, the gas gatherer has also not been able to supply the additional system capacity to allow Infinity-Wyoming to meet its delivery obligations and, therefore, discussions are under way to amend the contract to volumes that are consistent with deliveries. Recently Issued Accounting Pronouncements Proposed FASB Staff Positions ("FSP") No. FAS 141-a and FAS 142-a were recently issued with a comment deadline of April 16, 2004. These proposed FSPs would amend SFAS No. 141, "Business Combinations" and No. 142, "Goodwill and Intangible Assets" in order to resolve a recent reporting issue. There is an inconsistency between the recent Financial Accounting Standards Board ("FASB") consensus that such mineral rights should be considered tangible assets for accounting purposes and the characterization of mineral rights as intangible assets in SFAS No. 141 and No. 142. Under the proposed FSPs, mineral rights would continue to be considered tangible assets for accounting purposes with disclosure of the amount of the mineral rights disclosed on the balance sheet or in the notes to the consolidated financial statements. Assuming that the proposed FSPs are finalized, the guidance would be effective for the quarter ended June 30, 2004 and prior period amounts would also need to be disclosed in the consolidated financial statements. At December 31, 2003 and 2002, the Company has included $9,500,000 and $7,500,000, including capitalized interest, in oil and gas properties in the accompanying consolidated balance sheets of which approximately $3,972,000 and $684,000 respectively are subject to amortization. 39 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Infinity's major market risk exposure is in the pricing applicable to its oil and gas production. Realized pricing is primarily driven by the prevailing price for crude oil and spot prices applicable to Infinity's United States crude oil and natural gas production. Historically, prices received for gas production have been volatile and unpredictable. Pricing volatility is expected to continue. Gas price realizations ranged from a low of $3.27 to a high of $5.51 per MCF during the year ended December 31, 2003. Oil price realizations ranged from a low of $27.37 per barrel to a high of $35.08 per barrel during the period. Infinity-Wyoming periodically enters into hedging activities on a portion of its projected natural gas production in accordance with its Energy Risk Management Policy. These activities are intended to support cash flow at certain levels in order to manage Infinity-Wyoming's cash flow by reducing the exposure to gas price fluctuations. Realized gains or losses from Infinity-Wyoming's cash flow risk management activities are recognized in gas production revenues. In the year ended December 31, 2003, the effect of Infinity-Wyoming hedging its gas production compared to if it had sold the gas on the spot market was an increase in revenue of approximately $133,000. At December 31, 2003 Infinity-Wyoming had a derivative asset of approximately $97,000. ITEM 8. FINANCIAL STATEMENTS. The consolidated financial statements and supplementary information filed as part of this Item 8 are listed under Part IV, Item 15, "Exhibits, Financial Statement Schedules, and Reports on Form 8-K" and contained in this Form 10-K at page F-1. ITEM 9. CHANGE IN INDEPENDENT ACCOUNTANTS Infinity's previous auditor, Sartain Fischbein & Co., was dismissed as our independent auditor on January 24, 2002. The reports on Infinity's financial statements for the fiscal years ended March 31, 2001 and 2000 prepared by Sartain Fischbein & Co. did not contain any adverse opinion or disclaimer of opinion nor were they qualified as to audit scope or accounting principles. In connection with the prior audits for the fiscal years ended March 31, 2001 and 2000, and from March 31, 2001 to January 25, 2002, there were no disagreements with Sartain Fischbein & Co. on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure. The decision to change accountants was not considered separately by Infinity's Audit Committee but each member of the Audit Committee approved the decision. Effective January 24, 2002, Ehrhardt Keefe Steiner & Hottman P.C. was engaged as the Company's independent auditor. ITEM 9A. CONTROLS AND PROCEDURES Evaluation of disclosure controls and procedures Infinity's Chief Executive Officer and the Chief Financial Officer evaluated the effectiveness of Infinity's disclosure controls and procedures as of December 31, 2003 in accordance with Rule 13a-15 under the Exchange Act. Based on their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that Infinity's disclosure controls and procedures enable Infinity to: - record, process, summarize and report within the time periods specified in the Security and Exchange Commission's rules and forms, information required to be disclosed by Infinity in the reports it files or submits under the Exchange Act; and - accumulate and communicate to management, as appropriate to allow timely decisions regarding required disclosure, information required to be disclosed by Infinity in the reports that it files or submits under the Exchange Act. 40 Changes in internal control over financial reporting There were no changes in Infinity's internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the quarter ended December 31, 2003 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 41 PART III ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding directors of Infinity is incorporated by reference to the section entitled "Election of Directors" in our definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A in connection with the 2004 annual meeting of shareholders (the "Proxy Statement"). ITEM 11: EXECUTIVE COMPENSATION Reference is made to the information set forth under the caption "Executive Compensation and Other Information" in our proxy statement, which information (except for the report of the board of directors on executive compensation and the performance graph) is incorporated by reference in this report on Form 10-K. ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Reference is made to the information set forth under the caption "Security Ownership of Principal Shareholders and Management" in our proxy statement, which information is incorporated by reference in this report on Form 10-K. ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Reference is made to the information contained under the caption "Certain Transactions" contained in our proxy statement, which information is incorporated by reference in this report on Form 10-K. ITEM 14: PRINCIPAL ACCOUNTANT FEES AND SERVICES Reference is made to the information contained under the caption "Appointment of Independent Accountant" contained in our proxy statement, which information is incorporated by reference in this report on Form 10-K. 42 PART IV ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Documents filed as part of this report on Form 10-K or incorporated by reference. (1) Our consolidated financial statements are listed on the "index to Financial Statements" on Page F-1 to this report. (2) Financial Statement Schedules (omitted because not applicable or not required. Information is disclosed in the notes to the financial statements). (3) The following exhibits are filed with this report on Form 10-K or incorporated by reference. EXHIBITS EXHIBIT NUMBER DESCRIPTION OF EXHIBITS - ------- ----------------------------------------------------------------------- 3.1 Articles of Incorporation and Bylaws (1) 3.2 Articles and Amendment to Articles of Incorporation (1) 4.1 Form of 8% Convertible Subordinated Note (1) 4.2 Form of Trust Indenture for 8% Convertible Subordinated Notes with the Wilmington Trust Company (3) 4.3 Form of Placement Agent Warrant in connection with 8% Convertible Subordinated Notes (1) 4.4 Trust Indenture for 7% Convertible Subordinated Notes with Wilmington Trust Company (1) 4.5 Form of Placement Agent Warrants in connection with 7% Convertible Subordinated Notes (4) 4.6 Form of Warrant Agreement for 12% Bridge Note Financing (1) 10.1 Stock Option Plan (1) 10.2 1999 Stock Option Plan (2) 10.3 Assignment of Participation Agreement, Assignment of Participation Agreement, Conveyance, and Bill of Sale between Infinity Oil and Gas, Inc. and Infinity Oil and Gas of Wyoming, Inc. (2) 10.4 Participation Agreement between Wold Oil Properties, Inc. And Infinity Oil and Gas, Inc. (2) 10.5 Assignment of Oil and Gas Leases, Operating Rights and Record Title, Conveyance and Bill of Sale between Infinity Oil and Gas, Inc. And Infinity Oil and Gas of Wyoming, Inc. (2) 10.6 Joint Operating Agreement, Manson Lease, between Verde Oil Company and Infinity Oil and Gas of Kansas, Inc. (2) 10.7 2000 Stock Option Plan (1) 10.8 2001 Stock Option Plan (6) 10.9 Purchase and Sale Agreement dated November 3, 2000 between Antelope Energy Company, LLC, Coyote Exploration Company and Melange Associates, Inc. and Infinity Oil and Gas of Wyoming, Inc. (6) 10.10 Loan and Security Agreement between LaSalle Bank N.A. and Consolidated Oil Well Services, Inc. and related guaranties (1) 10.11 2002 Stock Option Plan (7) 10.12 2003 Stock Option Plan (8) 10.13 Form of Assignment of Overriding Royalty Interest for 12% Bridge Note Financing (5) 10.14 Credit agreement dated as of September 4, 2003 between Infinity Oil and Gas of Wyoming, Inc. and U.S. Bank National Association (5) 10.15 Joint Value Enhancement Agreement dated December 3, 2003 among Infinity Oil and Gas of Wyoming, Inc., Schlumberger Technology Corporation and Red Oak Capital Management LLC* 21 Subsidiaries of the Registrant 23.1 Consent of Ehrhardt, Keefe, Steiner & Hottman, P.C. 23.2 Consent of Netherland Sewell and Associates, Inc. 31.1 Certification of Chief Executive Officer of Periodic Report Pursuant to Rule 13a_14(a) and Rule 15d-14(a) (Section 302 of the Sarbanes-Oxley act of 2002). 31.2 Certification of Chief Financial Officer of Periodic Report Pursuant to Rule 13a_14(a) and Rule 15d-14(a) (Section 302 of the Sarbanes-Oxley act of 2002). 32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. 43 Section 1350 (Section 906 of the Sarbanes-Oxley Act of 2002) 32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 (Section 906 of the Sarbanes-Oxley Act of 2002) ____________________ (1) Incorporated by reference to our Registration Statement (No. 33-17416-D) (2) Incorporated by reference to our Annual Report on Form 10-KSB for the fiscal year ended March 31, 2000. (3) Incorporated by reference to our Registration Statement on Form S-3 (File No. 333-69292). (4) Incorporated by reference to our Registration Statement on Form S-3 (File No. 333-96671). (5) Incorporated by reference to our Quarterly Report on Form 10-QSB for the quarter ended September 30, 2003. (6) Incorporated by reference to our Annual Report on Form 10-KSB for the fiscal year ended March 31, 2001. (7) Incorporated by reference to our Annual Report on Form 10-KSB for the transition period ended December 31, 2001. (8) Incorporated by reference to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2002. * Portions of this exhibit have been omitted pursuant to a request for confidential treatment. (b) Reports on form 8-K. Infinity filed a report on Form 8-K dated December 10, 2003 in which Infinity reported under Item 5 an agreement with Schlumberger Technology Corporation and Red Oak Capital Management LP to develop Infinity's Labarge Property. Infinity filed a report on Form 8-K dated November 14, 2003 in which Infinity reported under Item 7 and Item 12 the financial results for the third quarter of 2003. 44 SIGNATURES In accordance with the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Infinity has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. INFINITY, INC. Dated: April 14, 2004 By: /s/ Stanton E. Ross ------------------------------- Stanton E. Ross, President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Infinity and in the capacities and on the dates indicated: Signature Capacity Date --------- -------- ---- /s/ Stanton E. Ross President, Treasurer April 14, 2004 - --------------------------- (Principal Executive Stanton E. Ross Officer) and Director /s/ Jon D. Klugh Chief Financial April 14, 2004 - --------------------------- Officer and Secretary Jon D. Klugh (Principal Financial and Accounting Officer) /s/ Robert O. Lorenz Director April 14, 2004 - --------------------------- Robert O. Lorenz /s/ Leroy C. Richie Director April 14, 2004 - --------------------------- Leroy C. Richie /s/ O. Lee Tawes Director April 14, 2004 - --------------------------- O. Lee Tawes 45 TABLE OF CONTENTS ----------------- Page ---- Independent Auditors' Report. . . . . . . . . . . . . . . . . . . . . . F-2 Financial Statements: Consolidated Balance Sheets - December 31, 2003 and 2002. . . . . F-3 Consolidated Statements of Operations - For the Years Ended December 31, 2003 and 2002 and the Nine Months Ended December 31, 2001. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-4 Consolidated Statements Changes in Stockholders' Equity - For the Years Ended December 31, 2003 and 2002 and the Nine Months Ended December 31, 2001 . . . . . . . . . . . . . . . . . . . . . F-5 Consolidated Statements of Cash Flows - For the Years Ended December 31, 2003 and 2002 and the Nine Months Ended December 31, 2001 . . . . . . . . . . . . . . . . . . . . . . . . F-7 Notes to Consolidated Financial Statements. . . . . . . . . . . . . . . F-9 F-1 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders Infinity, Inc. and Subsidiaries Chanute, Kansas We have audited the consolidated balance sheets of Infinity, Inc. and Subsidiaries as of December 31, 2003 and 2002 and the consolidated statements of operations, changes in stockholders' equity and cash flows for the years ended December 31, 2003 and 2002 and the nine months ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated 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 condition of Infinity, Inc. and Subsidiaries, as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the years ended December 31, 2003 and 2002 and the nine months ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1 to the consolidated financial statements, effective January 1, 2003, the Company changed its method of accounting for asset retirement obligations and effective April 1, 2001, the Company changed its method of accounting for derivative instruments. Ehrhardt Keefe Steiner & Hottman PC April 8, 2004 Denver, Colorado F-2
INFINITY INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, -------------------------- 2003 2002 ------------ ------------ ASSETS Current assets Cash and cash equivalents $ 727,134 $ 867,017 Accounts receivable, less allowance for doubtful accounts of $80,000 (2003) and $25,000 (2002) 1,766,642 1,514,159 Inventories 351,197 340,217 Prepaid expenses and other 222,625 257,575 Derivative asset 97,624 - ------------ ------------ Total current assets 3,165,222 2,978,968 Property and equipment, at cost, less accumulated depreciation 10,169,159 10,315,068 Oil and gas properties, using full cost accounting net of accumulated depreciation, depletion, amortization and write-down Subject to amortization 23,446,343 19,107,427 Not subject to amortization 12,815,834 13,176,850 Intangible assets, at cost, less accumulated amortization 3,952,989 5,299,881 Note receivable, less current portion 1,580,742 1,597,053 Other assets, net 135,989 655,022 ------------ ------------ Total assets $55,266,278 $53,130,269 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Current portion of long-term debt $ 1,762,777 $ 2,227,195 Accounts payable 2,645,277 2,875,900 Accrued expenses 966,769 889,894 ------------ ------------ Total current liabilities 5,374,823 5,992,989 Long-term liabilities Production taxes payable 229,889 79,632 Asset retirement obligations 520,638 - Long-term debt, less current portion 9,252,872 4,464,156 8% subordinated convertible notes payable 2,793,000 4,243,000 7% subordinated convertible notes payable 11,184,000 12,540,000 Note payable - related party 3,000,000 3,000,000 ------------ ------------ Total liabilities 32,355,222 30,319,777 ------------ ------------ Commitments and contingencies Stockholders' equity Common stock, par value $.0001, authorized 300,000,000 shares, issued and outstanding 8,204,032 (2003) and 7,558,462 (2002) shares 820 756 Additional paid-in-capital 32,720,904 22,870,449 Accumulated other comprehensive income (loss) 97,624 (77,301) (Accumulated deficit) retained earnings (9,908,292) 16,588 ------------ ------------ Total stockholders' equity 22,911,056 22,810,492 ------------ ------------ Total liabilities and stockholders' equity $55,266,278 $53,130,269 ============ ============ See notes to consolidated financial statements.
F-3
INFINITY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended For the Nine December 31, Months Ended -------------------------- December 31, 2003 2002 2001 ------------ ------------ ------------ Revenue Oil and gas service operations $11,634,457 $ 8,570,631 $ 9,853,624 Oil and gas sales 6,589,281 2,367,713 1,759,095 ------------ ------------ ------------ Total revenue 18,223,738 10,938,344 11,612,719 Cost of revenue Oil and gas service operations 6,222,919 4,620,663 5,154,495 Oil and gas production expenses 2,161,666 1,582,816 1,074,460 Oil and gas production taxes 758,827 237,876 66,290 ------------ ------------ ------------ Total cost of revenue 9,143,412 6,441,355 6,295,245 ------------ ------------ ------------ Gross profit 9,080,326 4,496,989 5,317,474 Operating expenses 5,311,080 4,647,062 2,789,026 Depreciation, depletion and amortization 3,074,247 1,782,586 1,010,811 Ceiling write-down of oil and gas properties 2,975,000 - - ------------ ------------ ------------ 11,360,327 6,429,648 3,799,837 ------------ ------------ ------------ Operating (loss) income (2,280,001) (1,932,659) 1,517,637 Other (expense) income Interest and other income 129,599 102,460 81,212 Amortization of loan costs (6,200,633) (234,680) (52,832) Interest expense (1,593,765) (602,350) (1,866,155) Impairment of other assets - - (600,050) Gain on sale of investments - - 5,128,280 Gain (loss) on sale of other assets 19,920 (33,665) (77,641) ------------ ------------ ------------ Total other (expense) income (7,644,879) (768,235) 2,612,814 ------------ ------------ ------------ (Loss) income before income taxes (9,924,880) (2,700,894) 4,130,451 Income tax benefit (expense) - 1,144,028 (1,590,056) ------------ ------------ ------------ Net (loss) income $(9,924,880) $(1,556,866) $ 2,540,395 ============ ============ ============ Basic (loss) earnings per share $ (1.23) $ (.22) $ .39 ============ ============ ============ Diluted (loss) earnings per share $ (1.23) $ (.22) $ .37 ============ ============ ============ Weighted average basic shares outstanding 8,047,688 7,202,844 6,501,104 ============ ============ ============ Weighted average diluted shares outstanding 8,047,688 7,202,844 6,965,922 ============ ============ ============ See notes to consolidated financial statements.
F-4
INFINITY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002 AND THE NINE MONTHS ENDED DECEMBER 31, 2001 Accumulated (Accumulated Total Other Common Stock Additional Deficit) Compre- Compre- ------------------ Paid-in Retained hensive hensive Stockholders' Shares Amount Capital Earnings Loss Income(Loss) Equity --------- ------- ----------- ------------ ------------ ------------- ------------ Balance, March 31, 2001 6,449,874 $ 644 $11,416,720 $ (966,941) $ 3,145,975 $13,596,398 Issuance of common stock for cash upon the exercise of options 65,350 8 126,062 - - 126,070 Warrants granted in connection with 8% subordinated convertible notes - - 924,717 - - 924,717 Beneficial conversion feature - - 1,165,500 - - 1,165,500 Comprehensive loss: Net income - - - 2,540,395 $ 2,540,395 - 2,540,395 Embedded derivative liability - - - - - (1,793,426) (1,793,426) Other comprehensive income; unrealized holding gains in securities during the period, net of income taxes of $123,587 - - - - 238,690 238,690 238,690 Reclassification gains on sales of securities, net of taxes of $1,743,615 - - - - (3,384,665) (3,384,665) (3,384,665) Embedded derivative liability reclassified to earnings - - - - - 1,793,426 1,793,426 --------- ------- ----------- ------------ ------------ ------------- ------------ Comprehensive loss $ (605,580) ============ Balance, December 31, 2001 6,515,224 652 13,632,999 1,573,454 - 15,207,105 Issuance of common stock for cash upon the exercise of options and warrants 588,264 58 1,947,147 - - 1,947,205 Conversion of 8% subordinated convertible notes and accrued interest into common stock 454,974 46 2,274,813 - - 2,274,859 Warrants granted in connection with $2,000,000 bridge loan - - 1,347,728 - - 1,347,728 Warrants granted in connection with 7% subordinated convertible notes - - 1,386,044 - - 1,386,044 Warrants granted in connection with $3,000,000 bridge loan - - 2,281,718 - - 2,281,718 Comprehensive loss: Net loss - - - (1,556,866) $(1,556,866) - (1,556,866) Change in fair value of fixed price delivery contract, net of tax benefit of $60,712 - - - - (96,981) (96,981) (96,981) Reclassifications, net of income tax expense of $12,320 - - - - 19,680 19,680 19,680 --------- ------- ----------- ------------ ------------ ------------- ------------ Comprehensive loss $(1,634,167) ============ Balance, December 31, 2002 7,558,462 756 22,870,449 16,588 (77,301) 22,810,492 Issuance of common stock upon the exercise of options and warrants 146,169 15 824,219 - - 824,234 See notes to consolidated financial statements.
F-5
INFINITY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002 AND THE NINE MONTHS ENDED DECEMBER 31, 2001 Accumulated (Accumulated Total Other Common Stock Additional Deficit) Compre- Compre- ------------------ Paid-in Retained hensive hensive Stockholders' Shares Amount Capital Earnings Loss (Loss) Equity --------- ------- ----------- ------------ ------------ --------- ------------- Conversion of 8% subordinated convertible notes and accrued interest into common stock 295,689 29 1,478,521 - - 1,478,550 Conversion of 7% subordinated convertible notes and accrued interest into common stock 203,712 20 1,756,996 - - 1,757,016 Options granted in connection with $1,050,000 of new bridge loans - - 1,050,000 - - 1,050,000 Options granted in connection with amendments and agreements related to a $3,000,000 bridge loan - - 2,493,329 - - 2,493,329 Warrants granted in connection with $4,850,000 of bridge loans - - 2,247,390 - - 2,247,390 Comprehensive loss: Net loss - - - (9,924,880) $(9,924,880) - (9,924,880) Change in fair value of fixed price delivery contract, net of tax expense of $151,573 - - - - 256,500 256,500 256,500 Reclassifications net of income tax benefit of $51,068 - - - - (81,575) (81,575) (81,575) --------- ------- ----------- ------------ ------------ --------- ------------- Comprehensive loss $(9,749,955) ============ Balance, December 31, 2003 8,204,032 $ 820 $32,720,904 $(9,908,292) $ 97,624 $(22,911,056) ========= ======= =========== ============ ========= ============= See notes to consolidated financial statements.
F-6
INFINITY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended For the Nine December 31, Months Ended --------------------------- December 31, 2003 2002 2001 ------------ ------------- ------------ Cash flows from operating activities Net (loss) income $(9,924,880) $ (1,556,866) $ 2,540,395 ------------ ------------- ------------ Adjustments to reconcile net (loss) income to net cash provided by operating activities Depreciation, depletion, amortization, impairment and ceiling write-down 6,049,247 1,782,586 1,610,861 Amortization of loan costs included in interest expense 6,200,633 234,680 52,832 Deferred income taxes - (1,144,028) 1,590,056 Gain on sale of investments - - (5,128,280) (Gain) loss on sale of other assets (19,920) 33,665 77,641 Change in assets and liabilities (Increase) decrease in accounts receivable (252,483) 85,724 (111,393) (Increase) decrease in inventories (10,980) 9,999 (85,967) (Increase) decrease in prepaid expenses and other (12,234) (89,985) 4,541 Increase in accounts payable 32,758 284,657 712,671 Increase in accrued expenses 782,391 495,383 97,564 ------------ ------------- ------------ 12,769,412 1,692,681 (1,179,474) ------------ ------------- ------------ Net cash provided by operating activities 2,844,532 135,815 1,360,921 ------------ ------------- ------------ Cash flows from investing activities Purchase of property, equipment, and intangibles (1,089,863) (2,695,382) (3,432,959) Proceeds from the sale of investments and marketable securities - 750,000 8,871,017 Purchase of marketable securities - - (750,000) Proceeds from sale of property and equipment, oil and gas properties and other assets 104,911 235,000 143,808 Investment in oil and gas properties (5,743,649) (14,426,524) (7,845,918) Payments on note receivable 15,103 7,844 - Increase in other assets (188,093) (88,547) (217,459) ------------ ------------- ------------ Net cash used in investing activities (6,901,591) (16,217,609) (3,231,511) ------------ ------------- ------------ Cash flows from financing activities Proceeds from borrowings on long-term debt 11,452,861 21,749,993 7,393,047 Sale of common stock 824,234 1,947,205 126,070 Principal payments on long-term debt (8,359,919) (7,414,285) (5,137,987) ------------ ------------- ------------ Net cash provided by financing activities 3,917,176 16,282,913 2,381,130 ------------ ------------- ------------ Net (decrease) increase in cash and cash equivalents (139,883) 201,119 510,540 Cash and cash equivalents, beginning of period 867,017 665,898 155,358 ------------ ------------- ------------ Cash and cash equivalents, end of period $ 727,134 $ 867,017 $ 665,898 ============ ============= ============ See notes to consolidated financial statements.
F-7
INFINITY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Supplemental cash flow disclosures: For the Years Ended For the Nine December 31, Months Ended ---------------------- December 31, 2003 2002 2001 ---------- ---------- ---------- Cash paid for interest, net of amounts capitalized $1,589,606 $ 383,449 $2,171,029 ========== ========== ========== Non-cash transactions: Non-cash costs, including amortization of loan costs included in full cost pool for oil and gas properties $2,714,974 $2,056,283 $1,570,377 ========== ========== ========== Property and equipment acquired through capital leases or seller financed debt $ 967,975 $ - $2,437,138 ========== ========== ========== Oil and gas properties acquired through seller financed debt $ 263,381 $ 607,236 $ - ========== ========== ========== Stock-based compensation for options and warrants granted in connection with debt, recorded as loan costs $5,790,719 $5,015,490 $ 924,717 ========== ========== ========== Conversion of 8% subordinated convertible notes and accrued interest to common stock $1,478,550 $2,274,859 $ - ========== ========== ========== Conversion of 7% subordinated convertible notes and accrued interest to common stock $1,757,016 $ - $ - ========== ========== ========== Issuance of additional notes in lieu of cash interest payment on 7% subordinated convertible notes $ 379,000 $ - $ - ========== ========== ========== Sale of oil and gas property for note receivable $ - $1,620,000 $ - ========== ========== ========== Change in accumulated other comprehensive loss, net of income taxes $ 174,925 $ 77,301 $3,145,975 ========== ========== ========== Reclassify other assets to oil and gas properties not subject to amortization $ 707,126 $ - $ - ========== ========== ========== Asset retirement obligation upon adoption $ 503,365 $ - $ - ========== ========== ========== See notes to consolidated financial statements.
F-8 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 1 - Organization and Summary of Significant Accounting Policies - -------------------------------------------------------------------- The Company and its subsidiaries are engaged in providing oil and gas production enhancement services in northeastern Oklahoma, eastern Kansas, and the Powder River Basin of Wyoming and in oil and gas exploration, development and production activities in southeast Kansas, south central Wyoming, and northwestern Colorado. Effective with the period ended December 31, 2001, the Company elected to begin utilizing a December 31 year-end. Therefore, the period ended December 31, 2001 represents a nine-month period and the years ended December 31, 2002 and 2003 represent twelve-month periods. Basis of Presentation - ----------------------- The consolidated financial statements include the accounts of Infinity, Inc. and its wholly owned subsidiaries, Consolidated Oil Well Services, Inc., Infinity Oil and Gas of Wyoming, Inc., Infinity Oil and Gas of Kansas, Inc., CIS - Oklahoma, Inc., Infinity Research and Development, Inc., L.D.C. Food Systems, Inc., Consolidated Pipeline Company, Inc., CIS Oil and Gas, Inc., Infinity Nicaragua, Ltd., and Infinity Nicaragua Offshore, Ltd. Infinity Nicaragua, Ltd., and Infinity Nicaragua Offshore, Ltd. own a 98.2% interest in Rio Grande Resources, SA, which is also consolidated. All significant intercompany balances and transactions have been eliminated in consolidation. Reclassifications - ----------------- Certain reclassifications have been made to the balances for the nine months ended December 31, 2001 and the year ended December 31, 2002 to make them comparable to those presented for the year ended December 31, 2003, none of which change the previously reported net income (loss). Accounts Receivable - -------------------- Revenue producing activities are conducted primarily in Kansas, Oklahoma, and Wyoming. The Company grants credit to all qualified customers which potentially subjects the Company to credit risk resulting from, among other factors, adverse changes in the industries in which the Company operates and the financial condition of its customers. However, management regularly monitors its credit relationships and provides adequate allowances for potential losses. Hedging Activities - ------------------- The Company accounts for derivative instruments or hedging activities under the provisions of Statement of Financial Accounting Standards No 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No 133"). SFAS No 133 requires the Company to record derivative instruments at their fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in other comprehensive income (loss) and are recognized in the statement of operations when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges, if any, are recognized in earnings. The Company periodically enters into fixed price delivery contracts to manage price risk with regard to a portion of its natural gas production. Fixed price F-9 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) delivery contracts that do not meet certain requirements are accounted for using cash flow hedge accounting. Under this method, realized gains and losses on qualifying hedges are recognized in gas revenues when the associated revenue stream occurs and the resulting cash flows are reported as cash flows from operations. To qualify as a hedge, these contracts must be designated as a cash flow hedge and changes in their value must correlate with changes in the price of anticipated future production such that the Company's exposure to the effects of commodity price is reduced. If the contract is not a hedge, changes in the fair value are recorded in the Company's statement of operations currently. If a derivative financial instrument, such as the contracts discussed above, is settled before the date of the anticipated transaction, the Company carries forward the accumulated change in value of the contract and includes it in the measurement of the related transaction. During the years ended December 31, 2003 and 2002, the Company had fixed price delivery contracts that were designated as hedges as follows:
MMBTU Amount Per Effective Dates Per Day MMBTU - ------------------------------------ ------- ----------- April 1, 2002 - October 31, 2002 1,000 $ 1.80 October 1, 2002 - September 30, 2003 1,000 2.97 November 1, 2002 - March 31, 2003 1,000 3.00 April 1, 2003 - March 31, 2004 3,500 4.71
During the years ended December 31, 2003 and 2002, the Company reclassified out of other comprehensive income, income of approximately $133,000 and losses of approximately $32,000, respectively, on the contracts, which have been included in natural gas revenues in the accompanying consolidated statement of operations and in cash provided by operating activities in the accompanying consolidated statement of cash flows. At December 31, 2003 and 2002, the Company had a derivative asset of approximately $98,000 and a derivative liability of $126,000, respectively, related to the financial hedges. The fair value of the fixed price delivery contracts was calculated using the twelve month forecasted sales price for the Henry Hub gas delivery point less a historical differential for the actual delivery point and the quantities and prices fixed in the contracts. Upon the adoption of SFAS No 133 during the period ended December 31, 2001, the Company recorded a derivative liability of approximately $1,800,000 related to certain of the Company's debt obligations which were tied to the market value of the Company's marketable securities. The adjustment was recorded as a reduction in accumulated other comprehensive income on April 1, 2001, and the entire amount was transferred to earnings in April 2001, when the related debt instruments were satisfied. Revenue Recognition - -------------------- The Company recognizes sales of oil when the product is delivered and recognizes enhancement service revenue when the services are performed. The Company uses the sales method for recording natural gas sales. This method allows for recognition of revenue, which may be more or less than the Company's share of pro-rata production from certain wells. During the years ended December 31, 2003 and 2002 and the nine months ended December 31, 2001, there were no material natural gas imbalances. Environmental Costs - -------------------- The Company expenses, on a current basis, recurring costs associated with managing hazardous substances and pollution in ongoing operations. The Company F-10 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) also accrues for costs associated with the remediation of environmental pollution when it becomes probable that a liability has been incurred and its proportionate share of the amount can be reasonably estimated. Management Estimates - --------------------- The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates with regard to the consolidated financial statements include the estimated carrying value of unproved properties, the estimate of proved oil and gas reserve volumes and the related present value of estimated future net cash flows and the ceiling test applied to capitalized oil and gas properties and the realization of deferred tax assets. Inventories - ----------- Inventories, consisting primarily of cement mix, sand, fuel and chemicals, are stated at the lower of cost or market. Cost has been determined on the first-in, first-out method. Property and Equipment - ------------------------ Depreciation and amortization are computed using the straight-line method over the following estimated useful lives:
Assets Useful Lives - --------------------------------- ------------ Buildings 30 years Site improvements 15 years Machinery, equipment and vehicles 5 - 10 years Office furniture and equipment 5 - 10 years
Oil and Gas Properties - ------------------------- The Company follows the full cost method of accounting for oil and gas properties. Accordingly, all productive and non-productive costs associated with acquisition, exploration, and development of oil and gas reserves, including directly related internal costs, are capitalized. The Company capitalized $49,221, $1,444,238 and $684,843 of internal costs during the years ended December 31, 2003 and 2002 and the nine months ended December 31, 2001, respectively. Costs associated with production and general corporate activities are expensed in the period incurred. The Securities and Exchange Commission's full cost accounting rules prohibit recognition of income in current operations for services performed on oil and natural gas properties in which the Company has an interest, but rather require amounts to be treated as a reimbursement of costs with any excess of fees over costs credited to the full cost pool and recognized through lower cost amortization only as production occurs. In addition, the capitalized costs are subject to a "ceiling test," which basically limits such costs to the aggregate of the "estimated present value," F-11 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) discounted at a 10-percent interest rate of future net revenues from proved reserves, adjusted for cash flow hedges, net of estimated future income taxes, based on current economic and operating conditions, plus the lower of cost or fair market value of unproved properties. For the period ended December 31, 2003 the Company had a ceiling write-down of $2,975,000. For purposes of calculating the ceiling test, the Company has elected to subtract the fair value of the estimated asset retirement obligation from the capitalized costs. Depreciation and depletion of proved oil and gas properties is computed on the units-of-production method based upon estimates of proved reserves with oil and gas being converted to a common unit of measure based on their relative energy content. Unproved oil and gas properties, including any related capitalized interest expense, are not amortized, but are assessed for impairment either individually or on an aggregated basis. At December 31, 2003, the Company reclassified approximately $5,029,000 from unproved oil and gas properties to oil and gas properties subject to amortization. Sales of proved and unproved properties are accounted for as adjustments of capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and gas, in which case the gain or loss is recognized in income. Abandonments of properties are accounted for as adjustments of capitalized costs with no loss recognized. Capitalized Interest - --------------------- The Company capitalizes interest costs to oil and gas properties on expenditures made in connection with exploration and development projects that are not subject to current depreciation and depletion. Interest is capitalized only for the period that activities are in progress to bring these projects to their intended use. Total interest costs incurred for the years ended December 31, 2003 and 2002 and the nine months ended December 31, 2001 were $1,976,001, $1,612,469 and $2,321,056 (including a $1,793,426 charge to interest expense upon payoff of certain debt during the nine-month period ended December 31, 2001), respectively. Interest costs capitalized were $382,236, $1,010,119 and $454,901 for the years ended December 31, 2003 and 2002 and the nine months ended December 31, 2001, respectively. Long-Lived Assets - ------------------ Long-lived assets to be held and used in the Company's business are reviewed for impairment whenever events or changes in circumstances indicate that the related carrying amount may not be recoverable. When the carrying amount of the long-lived assets exceeds the discounted expected future cash flows, the Company records an impairment. The Company recorded a $600,050 impairment during the nine months ended December 31, 2001 to write other assets down to estimated net realizable value. No impairment was recorded during the years ended December 31, 2003 or 2002. Transportation Costs - --------------------- The Company accounts for transportation costs under Emerging Issues Task Force ("EITF") 00-10, "Accounting for Shipping and Handling Fees and Costs," whereby amounts paid for transportation costs are classified as operating expense and not netted against natural gas revenues. Intangible Assets - ------------------ The Company has adopted SFAS No 142 "Goodwill and Other Intangible Assets," effective January 1, 2001. As a result, the Company no longer amortizes F-12 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) goodwill, but instead, reviews goodwill for impairment on at least an annual basis. Amortization costs for the nine months ended December 31, 2001 were $8,438. Other intangibles are recorded at cost and are amortized on the straight-line basis over the contractual or estimated useful life of the asset, which ranges from one to five years or the effective interest method. Amortization of loan costs associated with debt obtained in connection with exploration and development projects that are not subject to current amortization is capitalized to oil and gas properties. Amortization of loan costs is capitalized only for the period activities are in progress to bring these projects to their intended use. Total loan amortization costs capitalized for the years ended December 31, 2003 and 2002 and the nine months ended December 31, 2001 were $2,714,974, $2,023,373 and $147,239, respectively (See Note 5 for total loan costs classified as intangibles). Per Share Information - ----------------------- Basic earnings (loss) per common share are computed as net income (loss) divided by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common share is computed as net income (loss) divided by the weighted average number of common shares and potential common shares, using the treasury stock method, outstanding during the period. Cash and Cash Equivalents - ---------------------------- For purposes of reporting cash flows, cash generally consists of cash on hand and demand deposits with financial institutions. At times, the Company maintains deposits in financial institutions in excess of federally insured limits. Management monitors the soundness of the financial institutions and believes the Company's risk is negligible. The Company considers all highly liquid investments with an original maturity of three months or less to be a cash equivalent. Investment Securities - ---------------------- Investment securities that are held for short-term resale are classified as trading securities and carried at fair value. Debt securities that management has the ability and intent to hold to maturity are classified as held-to-maturity and carried at cost, adjusted for amortization of premium and accretion of discounts using methods approximating the interest method. Other marketable securities are classified as available-for-sale and are carried at fair value, based on quoted market prices. Unrealized gains and losses on securities available-for-sale are reported as a component of comprehensive income, net of applicable income taxes. Costs of securities sold are recognized using the specific identification method. Stock Options - -------------- The Company applies Accounting Principles Board Opinion No 25 "Accounting for Stock Issued to Employees," and related interpretations in accounting for its stock option plans. Accordingly, no compensation cost has been recognized for options granted to employees under the stock option plans because the fair value of the stock equaled or was less than the option exercise price at the date of grant. Had compensation costs for employee stock options under the Company's plan been determined based upon the fair value at the grant date for awards under the plan consistent with the methodology prescribed under SFAS No 123, "Accounting for Stock-Based Compensation", the Company's net income (loss) and earnings (loss) per share would have been as follows (See Note 10): F-13 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the Years Ended For the Nine December 31, Months Ended ------------------------- December 31, 2003 2002 2001 ------------ ------------ ----------- Net (loss) income as reported $(9,924,880) $(1,556,866) $2,540,395 Deduct: Total stock-based employee compensation expense, determined under fair value based method for all awards, net of tax (26,244) (2,448,341) (684,265) ------------ ------------ ----------- Pro forma net (loss) income $(9,898,636) $(4,005,207) $1,856,130 ============ ============ =========== Basic (loss) earnings per share as reported $ (1.23) $ (.22) $ .39 Diluted (loss) earnings per share as reported $ (1.23) $ (.22) $ .37 Basic (loss) earnings per share - pro forma $ (1.23) $ (.56) $ .29 Diluted (loss) earnings per share - pro forma $ (1.23) $ (.56) $ .27
For options granted during the year ended December 31, 2003 and 2002 and the nine months ended December 31, 2001, the estimated fair value of the options granted utilizing the Black-Scholes pricing model under the Company's plan was based on a weighted average risk-free interest rate of 1.5%, 1.5% and 8.0%, expected option life of 5 years, expected volatility of approximately 131%, 117% and 83% and no expected dividends. The Company has adopted the disclosure requirements of SFAS 148, "Accounting for Stock-Based Compensation Transition Disclosure" in its consolidated financial statements. This statement amends SFAS No 123, "Accounting for Stock-Based Compensation" to provide alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock-based compensation. In addition, SFAS 148 amends the disclosure provision of SFAS 123 to require more prominent disclosure about the effects of an entity's accounting policy decisions with respect to stock-based employee compensation on reported net income. The Company will continue to account for stock-based compensation using the methods detailed in the stock-based compensation accounting policy as described earlier. Comprehensive Income (Loss) - ----------------------------- The Company has elected to report comprehensive income (loss) in the consolidated statement of stockholders' equity. Comprehensive income (loss) is composed of net income (loss) and all changes to stockholders' equity, except those due to investments by stockholders, changes in additional paid-in capital and distributions to stockholders. Income Taxes - ------------- Income taxes are provided for the tax effects of the transactions reported in the consolidated financial statements and consist of taxes currently due plus deferred taxes related primarily to temporary differences between the tax and financial basis of property and equipment and other assets, oil and gas properties, and net operating loss carry forwards using enacted tax rates in effect for the year in which the differences are expected to reverse. F-14 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The deferred tax assets and liabilities represent the future tax return consequences of those temporary differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that are not expected to be realized based on available evidence that it is more likely than not to be realized in the form of a deferred tax valuations allowance. Asset Retirement Obligations - ------------------------------ Effective January 1, 2003, the Company adopted the provisions of SFAS No 143 "Accounting for Asset Retirement Obligations." SFAS No 143 requires the Company to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the Company capitalizes cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted each period towards its future value, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, the Company will report a gain or loss upon settlement to the extent the actual costs differ from the recorded liability. Upon adoption of SFAS No 143, the Company recorded a discounted liability of approximately $503,000 for future retirement obligations and increased net oil and gas properties by approximately $503,000. The adoption of SFAS No 143 had no material effect on earnings in all periods presented. The majority of the asset retirement obligation to be recognized relates to the projected costs to plug and abandon oil and gas wells. Liabilities are also recorded for compressor and field facilities. Recently Issued Accounting Pronouncements - -------------------------------------------- Proposed FASB Staff Positions ("FSP") No. FAS 141-a and FAS 142-a were recently issued with a comment deadline of April 16, 2004. These proposed FSPs would amend SFAS No. 141, "Business Combinations" and No. 142, "Goodwill and Intangible Assets" in order to resolve a recent reporting issue. There is an inconsistency between the recent Financial Accounting Standards Board ("FASB") consensus that such mineral rights should be considered tangible assets for accounting purposes and the characterization of mineral rights as intangible assets in SFAS No. 141 and No. 142. Under the proposed FSPs, mineral rights would continue to be considered tangible assets for accounting purposes with disclosure of the amount of the mineral rights disclosed on the balance sheet or in the notes to the consolidated financial statements. Assuming that the proposed FSPs are finalized, the guidance would be effective for the quarter ended June 30, 2004 and prior period amounts would also need to be disclosed in the consolidated financial statements. At December 31, 2003 and 2002, the Company has included $9,500,000 and $7,500,000, including capitalized interest, in oil and gas properties in the accompanying consolidated balance sheets of which approximately $3,972,000 and $684,000 respectively are subject to amortization. In May 2003, the FASB issued SFAS No 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No 150 establishes standards for how an issuer measures certain financial instruments with characteristics of both liabilities and equity and requires that an issuer classify a financial instrument within its scope as a liability (or asset in some circumstances). SFAS No 150 was effective for financial instruments entered into or modified after May 31, 2003 and otherwise was effective and adopted by the Company on July 1, 2003. As the Company has no such instruments, the adoption of this statement did not have an impact on the Company's financial condition or results of operations. F-15 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 2 - Continued Operations and Realization of Assets - ------------------------------------------------------- During 2003, the Company had consolidated losses from operations of approximately $2,280,000, and a working capital deficit at December 31, 2003 of approximately $2,210,000. Subsequent to December 31, 2003, the Company completed six wells drilled on its Pipeline acreage during the fourth quarter of 2003 and acquired an additional 49% working interest in two existing wells and 960 acres of undeveloped leasehold adjacent to the Pipeline acreage. Capital expenditures associated with the development activities and acquisitions were approximately $1,000,000. The Company expects capital expenditures for unrisked services on the development of its Labarge property under an agreement with Schlumberger Technology Corporation ("Schlumberger") and Red Oak Capital Management LP ("Red Oak") (See Note 12) related to the completion or recompletion of five existing wells and the drilling of five or six new wells to be approximately $3,700,000 to $4,150,000. The total unrisked services the Company anticipates it will incur is dependent on the results of the initial rework and drilling activities. Additional costs associated with the completion of the environmental impact study and leasehold maintenance on the Labarge property during 2004 are anticipated to be approximately $300,000. In addition to its capital expenditures requirements, management estimates requirements of $1,600,000 for interest on notes, $1,300,000 for general corporate purposes and approximately $100,000 for lease rentals and farmout expenses. Thus, in total, the Company could have requirements in 2004 of approximately $10,200,000 including the working capital deficit at December 31, 2003. In January 2004, the Company issued 1,000,000 shares of common stock through a private placement for which it received approximately $3,900,000 in proceeds net of offering costs (See Note 18). The Company paid approximately $750,000 in long term debt with proceeds from the offering, leaving approximately $3,150,000 available for meeting its current development and working capital needs. In addition to these funds, the Company expects to generate approximately $3,600,000 in cash flow from oil field services and between $4,000,000 and $5,000,000 in cash flow from oil and gas production activities during 2004. Management anticipates issuing approximately $800,000 new 7% subordinated convertible notes in lieu of cash payments due April 15 and October 15, 2004 for interest due on the 7% subordinated convertible notes. Management believes it will be able to fund its 2004 minimum requirements through proceeds from the January 2004 private placement, cash flow from operations and the exercise of its option to issue additional notes rather than expend cash to satisfy interest on the 7% subordinated convertible notes. Due to the timing of development activities on the Company's properties, the Company may not have the funds available to pay for the operations immediately and may be required to obtain short term loans to pay for the development activity. It is expected that these loans would then be repaid with cash flow from operations later in the year. The Company is restricted on the amount that can be distributed to it by its subsidiaries by terms of certain loan agreement. The terms of the loan agreements for the oil field services subsidiary allow for additional amounts to be distributed with consent of the lender. The Company believes it will be able to restructure the terms of this loan agreement to allow additional funds to be distributed, or obtain the necessary consent to allow the subsidiary to distribute adequate funds to meet its general corporate needs. Future reserve reductions or ceiling write-downs could hinder the Company's ability to obtain future financing on terms acceptable to management or could result in reductions in the borrowing base on existing obligations. Note 3 - Accounts Receivable - -------------------------------- Accounts receivable consists of the following: F-16
INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, ------------------------ 2003 2002 ----------- ----------- Accounts receivable oil field services $1,171,886 $ 943,459 Revenue receivable oil and gas production 652,401 504,752 Other receivables 22,355 90,948 ----------- ----------- Total receivables 1,846,642 1,539,159 Less allowance for doubtful accounts (80,000) (25,000) ----------- ----------- Net receivables $1,766,642 $1,514,159 =========== ===========
Note 4 - Property and Equipment - ------------------------------- Property and equipment consists of the following:
December 31, -------------------------- 2003 2002 ------------ ------------ Buildings, site costs and improvements $ 2,208,587 $ 2,207,245 Machinery, equipment, vehicles and aircraft 15,884,159 15,158,783 Office furniture and equipment 276,135 239,058 ------------ ------------ Total cost 18,368,881 17,605,086 Less accumulated depreciation (8,199,722) (7,290,018) ------------ ------------ Net property and equipment $10,169,159 $10,315,068 ============ ============
Note 5 - Intangibles - ----------------------- Intangibles consist of the following:
December 31, --------------------------- 2003 2002 ------------- ------------ Loan costs $ 15,245,263 $ 7,679,249 Non-compete 300,000 300,000 Goodwill 225,000 225,000 Other 55,870 55,871 ------------- ------------ 15,826,133 8,260,120 Less accumulated amortization (11,873,144) (2,960,239) ------------- ------------ Net intangibles $ 3,952,989 $ 5,299,881 ============= ============
During the years ended December 31, 2003 and 2002 and the nine months ended December 31, 2001, the Company recorded amortization expense related to intangibles, excluding amounts capitalized, of $6,210,738, $241,272 and $75,763 respectively. Of the total amortization expense related to intangibles, the Company recorded amortization of loan costs of $6,200,633, $234,680 and $52,832, respectively, of which $5,620,300, $204,172 and $38,785 were related to non-cash loan costs resulting from options, warrants and other non-cash compensation granted in connection with obtaining financing. F-17
INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Loan costs consist of the following at December 31, 2003: Accumulated Description of Non-cash Cash Loan Total Loan Amortization Net Book Notes or Agreement Loan Costs Costs Costs 12/31/2003 Value - -------------------------- ----------- ---------- ----------- -------------- ---------- 8% subordinated convertible notes $ 1,375,464 $ 51,159 $ 1,426,623 $ (875,070) $ 551,553 Line of credit, term note and equipment note - 192,572 192,572 (128,754) 63,818 7% subordinated convertible notes 2,178,944 72,605 2,251,549 (912,771) 1,338,778 $3,000,000 bridge loan and related amendments and adjustments 4,775,047 - 4,775,047 (3,132,244) 1,642,803 $25,000,000 development credit facility - 166,506 166,506 (8,442) 158,064 Bridge loans and other debt paid in full 5,895,118 537,848 6,432,966 (6,432,966) - ----------- ---------- ----------- -------------- ---------- Total $14,224,573 $1,020,690 $15,245,263 $ (11,490,247) $3,755,016 =========== ========== =========== ============== ==========
F-18
INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Aggregate future intangible amortization expense is as follows at December 31, 2003: Other Years Ending December 31, Loan Costs (1) Intangibles Total - ------------------------- --------------- ------------ ---------- 2004 $ 2,318,385 $ 5,452 $2,323,837 2005 759,196 - 759,196 2006 543,557 - 543,557 2007 133,878 - 133,878 --------------- ------------ ---------- $ 3,755,016 $ 5,452 $3,760,468 =============== ============ ========== ____________________ (1) Includes approximately $685,000 in January 2004 when the Company repaid $1,250,000, or 42%, of the $3,000,000 bridge loans due January 30, 2005. (See Notes 9 and 18).
Note 6 - Oil and Gas Properties - ------------------------------------- Properties Subject to Amortization - ------------------------------------- Pipeline In July 2000 (original purchase) and subsequent periods (additional purchases), the Company acquired 100% working interests and 82.5% net revenue interests in leaseholds in the Greater Green River Basin of Wyoming ("Pipeline") for approximately $3,666,000. The Company has incurred approximately $17,925,000 in exploration and development costs through December 31, 2003 to develop the Pipeline acreage. In July 2003, the Company granted a 4% over-riding royalty in the property to a lender in connection with obtaining bridge financing (See Note 9). The estimated fair value of the 4% over-riding royalty of approximately $825,000 was re-classified to loan cost. The leasehold costs associated with 11,660 net acres of the original 19,150 total net acreage position and all development and exploration costs incurred to date, totaling approximately $3,144,000 and $17,133,000, respectively, on the 11,660 net acres are subject to amortization. Labarge In March 2000 (original purchase) and subsequent periods (additional purchases), the Company acquired a 100% working interest and 80.0% net revenue interests in leaseholds in the Greater Green River Basin of Wyoming ("Labarge") for approximately $2,463,000. The Company has incurred approximately $13,463,000 in exploration and development costs through December 31, 2003 to develop the Labarge acreage. The original lessor on a portion of the acreage has a 30% participation election. If the original lessor chooses not to participate in the drilling and completion of a well, then the 100% working interest and the approximately 80% associated net revenue interest will remain with the Company until the well has generated earnings to recover the well costs plus a 300% non-consent penalty. In July 2003 the Company granted a 4% over-riding royalty in the property to a lender in connection with obtaining bridge financing (See Note 9). The estimated fair value of the 4% over-riding royalty of approximately $425,000 was re-classified as loan cost. The leasehold costs F-19 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) associated with 1,763 net acres of the 11,199 total net acreage position and all development and exploration costs incurred to date, totaling approximately $223,000 and $5,879,000, respectively, on the 1,763 net acres are subject to amortization. The Company is required to perform certain Environmental Impact Study and Assessments on the Labarge and Pipeline properties. Management believes that the results of these studies will not have a material adverse impact on the continued development of these properties. Sand Wash During 2002 the Company acquired a working interest in leaseholds in the Sand Wash Basin of Colorado and Wyoming. The Company has incurred total leasehold and exploration costs of approximately $1,693,000 at December 31, 2003. The leases on approximately 57,000 gross acres of the total 161,000 gross acres expire in 2004 and, therefore, the Company has reclassified approximately $605,000 in leasehold costs and all of the exploration costs, totaling approximately $422,000, associated with that portion of the leaseholds as subject to amortization at December 31, 2003. Other Properties In November 2001, the Company acquired a 31.25% working interest in an oil and gas lease in southwest Kansas for approximately $56,000 and has incurred exploration costs of approximately $187,000. The $187,000 in exploration costs were to drill three wells which resulted in three dry holes and therefore, these costs are included in oil and gas properties subject to amortization at December 31, 2003. The Company also amortizes development and exploration costs of approximately $98,000 and the asset related to the asset retirement obligation of approximately $503,000. Total In total, the Company has approximately $3,972,000 in leasehold costs and $24,222,000 in exploration and development costs subject to amortization. At December 31, 2003 and 2002, the Company had accumulated depreciation, depletion, amortization and ceiling write-down of approximately $4,748,000 and $304,000, respectively. Sales of Proved Oil and Gas Properties In February 2000, the Company acquired a 100% working interest in a property in eastern Kansas, through a joint venture with an operator in which a former director of the Company is a partner and operations manager. The Company's total investment in the property was approximately $1,100,000. In addition, the Company had an active oil lease in the Owl Creek Field in Woodson County, Kansas which was acquired for $510,000. Effective May 1, 2002, the Company sold its interest in oil and gas properties in eastern Kansas for $180,000 cash and a $1,620,000 note receivable (See Note 7). The transaction resulted in a gain of approximately $244,000, which was recorded as a reduction in capitalized oil and gas property costs under the full cost accounting method. Ceiling Test The Company evaluates its properties subject to amortization under the full cost ceiling test on a quarterly basis. The ceiling test requires the Company to compare the unamortized capitalized cost plus the lower of cost or fair market value of the unproved properties, less any related deferred tax liability and F-20 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) less the fair value of the asset retirement obligations with the ceiling. The ceiling is calculated using present value, discounted at 10% of future net revenue to be generated by the properties net of the estimated future income taxes, plus the lower of cost or fair market value of the unproved properties. If the capitalized cost of the properties exceeds the ceiling, then the Company is required to permanently write down the value of the property to the ceiling. During 2003, the Company experienced geological and geophysical, financial and other issues which resulted in significant revisions to the year end reserves. Therefore, during the fourth quarter of the year ended December 31, 2003, the Company had a ceiling write-down of $2,975,000, which is included in accumulated depreciation, depletion, amortization and write-down in the accompanying consolidated balance sheet. There were no ceiling write-downs in the year ended December 31, 2002 or the nine-month period ended December 31, 2001. Properties Not Subject to Amortization - ------------------------------------------ Pipeline At December 31, 2003, the Company had approximately $4,491,000 in costs associated with unproved Pipeline property. Options on approximately 8,300 acres were relinquished on February 29, 2004 and therefore, approximately $4,002,000 previously reflected as not subject to amortization was reclassified to subject to amortization at December 31, 2003. The Company currently has approximately $489,000 in undeveloped leasehold costs associated with the Pipeline property that are not subject to amortization. The development of the acreage and the reclassification of the associated leasehold costs to properties subject to amortization will be contingent upon the development of a future drilling plan. Labarge The Company has incurred approximately $2,210,000 of leasehold costs on the Labarge prospects, and approximately $7,188,000 of exploration costs (including $3,666,000 of capitalized interest and amortization of loan costs) on the Labarge prospect, which are not subject to amortization, as the Company has not completed the exploration and evaluation process on the related wells, which is expected to be completed in the initial phase of the Schlumberger agreement (See Note 12). The Company entered into an agreement with Schlumberger in December 2003 for the further development of the Labarge prospect. At the conclusion of the 2004 evaluation and exploration activity a significant portion of the investment in unproved oil and gas properties will be reclassified to the full cost pool subject to depletion and the ceiling test. If proved reserves are not found, or if proved reserves are not significant, the Company could be required to write-down a portion of the full cost pool of oil and gas properties. A significant portion of the remaining leasehold costs are anticipated to be reclassified and subject to amortization during the remaining four years of the agreement with Schlumberger. Reclassification of the remaining costs to properties subject to amortization will be contingent on the development of a future drilling plan. Sand Wash The Company has incurred leasehold costs of approximately $1,693,000 and initial exploration costs of $422,000 on approximately 161,000 gross acres it has in the Sand Wash Basin. The leases on approximately 57,000 gross acres under lease are due to expire in 2004 and therefore, the Company has classified approximately $605,000 in leasehold costs and all of the approximately $422,000 in exploration costs associated with that portion of the leasehold as subject to amortization at December 31, 2003. The Company has approximately $1,088,000 of leasehold costs associated with the Sand Wash leases which are classified as not subject to amortization. F-21 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Reclassification of the remaining leasehold to properties subject to amortization will be contingent upon the development of a future drilling plan. Other Properties In November 2000, the Company acquired a 100% working interest in a coal bed methane property in northwestern Colorado for consideration of approximately $593,000. The Company has incurred approximately $199,000 of leasehold costs to acquire additional acreage, bringing the total leasehold costs to approximately $792,000 and has capitalized exploration costs of approximately $107,000 as of December 31, 2003. The lease requires the Company to drill a total of 5 wells before November 20, 2005. No wells have been drilled to date. A portion of the leasehold costs and the exploration costs associated with the drilling activity on these five wells is anticipated to be reclassified to properties subject to amortization in 2005. Reclassification of the remaining costs to properties subject to amortization will be contingent upon the development of a future drilling plan. The Company has additional leasehold costs of approximately $56,000 on an undeveloped, 5,120 acre river sand prospect in Kansas operated by an unrelated third party. The Company expects the reclassification of these costs to properties subject to amortization during 2004. Infinity was awarded the bid on 24 blocks of acreage, comprised of over one million acres in 2003, and immediately entered into negotiations with The Instituto Nicaraguense de Energia ("INE"), the Nicaraguan governmental entity that regulates oil and gas activities, to finalize the initial exploration plan for the Tyra and Perlas prospects. The Company has approximately $885,000 in undeveloped acreage costs associated with these prospects. Reclassification of the costs incurred to properties subject to amortization will be contingent upon the development of a future drilling plan after the terms of the lease are completed. Total In total, the Company has approximately $5,520,000 in leasehold costs and approximately $7,295,000 in exploration costs not subject to amortization. These properties are not subject to amortization and are being, or will be developed, completed and put into production when gas is located in apparent reasonable quantities. The geological structures on the Wyoming and Colorado properties are such that the amount of reserves cannot be evaluated with the engineering certainty necessary to be judged proven reserves. As drilling of a specific well is finished, a determination is made to complete the well and begin production or treat the well as unsuccessful. Costs of successful wells are added to the properties subject to amortization when the property is proven. Costs of unsuccessful wells are added to the properties subject to amortization when that determination is made. The Company reviews the carrying value of its properties not subject to amortization on at least an annual basis. The carrying value of the properties not subject to amortization may not exceed the fair market value of such properties. When the book value of an unevaluated property exceeds the fair market value of the property the excess book value over fair value of the property is reclassified into the properties subject to amortization. F-22 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) During the year ended December 31, 2003 the Company reclassified approximately $4,002,000 and $1,027,000 of unevaluated property cost to the properties subject to amortization associated with its Pipeline and Sand Wash properties, respectively. No reclassification based on the fair market value review was recorded during the year ended December 31, 2002 and the nine months ended December 31, 2001. Any cost related to exploratory dry wells is included in properties subject to amortization when that determination is made. Any costs associated with geophysical and geological costs that are not associated with specific unevaluated properties are included in the properties subject to amortization as incurred. The per equivalent MCF amount of depreciation, depletion and amortization incurred during the years ended December 31, 2003 and 2002 and nine months ended December 31, 2001 was $0.92, $1.11 and $2.56, respectively. Recovery of the above acquisition and development costs is dependent on a variety of factors including actual production results, market conditions, the success of future exploration and development activities on the properties, and the availability of future financing on terms acceptable to management. Capitalized Financing Costs - ----------------------------- From inception through December 31, 2003, the Company has capitalized the following financing costs related to properties not subject to amortization. As these properties are developed, the costs are transferred to properties subject to amortization:
December 31, ---------------------- 2003 2002 ---------- ---------- Beneficial conversion feature related to the 8% subordinated convertible notes $1,165,500 $1,165,500 Capitalized interest 2,246,019 1,863,783 Capitalized amortization of loan costs 4,885,586 2,170,612 ---------- ---------- Total capitalized finance costs $8,297,105 $5,199,895 ========== ==========
Note 7 - Notes Receivable - ----------------------------- The Company issued a three year note for $1,620,000 when it sold its Kansas producing properties in May 2002. The note had an outstanding balance as of December 31, 2003 and 2002 of approximately $1,597,000 and $1,612,000, respectively. Interest accrues on the note at 7.0% per annum with quarterly payments, based on a 30 year amortization, of $35,000, including interest, due on the first day of November, February, May and August with a balloon payment due May 1, 2005. The note is collateralized by the oil producing properties that were sold. F-23
INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 8 - Accrued Expenses - ----------------------------- Accrued expenses consist of: December 31, ------------------ 2003 2002 -------- -------- Production taxes payable - current $282,752 $103,586 Oil and gas revenue payable to oil and gas property owners 158,318 86,187 Accrued interest 223,060 218,901 Derivative liability - 125,693 Other accrued expense 302,639 355,527 -------- -------- Total accrued expenses: $966,769 $889,894 ======== ========
Note 9 - Long-Term Debt - --------------------------- Long term debt consists of the following:
December 31, ------------------------- 2003 2002 ------------ ----------- 8% subordinated convertible notes payable, convertible into 572,395(1) shares of Company common stock. Due June 13, 2006. $ 2,793,000 $ 4,243,000 7% subordinated convertible notes payable, convertible into 1,386,389(1) shares of Company common stock. Due April 22, 2007. 11,184,000 12,540,000 25,000,000 development credit facility with a bank, $5,500,000 borrowing base at December 31, 2003 to be redetermined on a semi-annual basis on April 1 and October 1; accrued interest at the prime rate plus 1% (totaling 5% at December 31, 2003) is due on a monthly basis with principal and unpaid interest due June 30, 2006; collateralized by all of the Company's interest in its Pipeline and Labarge properties. 5,500,000 - Bridge loan with related party; interest at 7% due and payable on January 30, 2005; collateralized with a second mortgage on the Company's Pipeline and Sand Wash oil and gas properties. Subsequent to December 31, 2003, $1,250,000 of this loan was repaid. 3,000,000 3,000,000 Note payable to seller (for a 50% interest in an airplane), with interest at 7% due on a quarterly basis. The Company is required to make annual principal payments equal to 5% of the current outstanding principal until paid in full. The seller can call the note if the bank calls its note for the original purchase of the airplane. The note is collateralized by the Company's 50% interest in the airplane with a net book value of approximately $2,300,000. 2,326,201 - 2,000,000 revolving credit note with interest at prime plus 1.0% (totaling 5% at December 31, 2003); due in December 2004. The note is cross-collateralized by substantially all the assets of the oil and gas service subsidiary. 96,367 6,506 F-24 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, ------------------------- 2003 2002 ------------ ----------- 2,900,000 term loan with interest at prime plus 1.0% (totaling 5% at December 31, 2003), due in monthly installments of $80,626 plus interest, through December 2004. The note is cross-collateralized by substantially all the assets of the oil and gas service subsidiary. 905,138 1,960,651 1,000,000 term loan with interest at prime plus 1.0% (totaling 5% at December 31, 2003), due in monthly installments of $15,626 plus interest, through December 2004. The note is cross-collateralized by substantially all the assets of the oil and gas service subsidiary. 390,000 570,000 Various fixed rate notes collateralized by vehicles and equipment with interest rates ranging from 6.0% to 9.5%; payable in monthly installments of principal and interest totaling $19,203, with payments due between June 2002 and July 2008. 1,053,022 1,228,519 Note payable to a bank with interest at Wall Street Prime plus .25% (totaling 4.25% at December 31, 2003); payable in monthly installments of $5,635 including interest through November 2006; collateralized by real property. 185,383 249,081 Note payable to a bank with interest at 9.25%, payable in monthly installments of $4,883 including interest through December 2011; collateralized by real estate. 330,228 335,035 Capital leases, with monthly installments totaling $5,064, including interest and expiring through November 2006. 204,310 245,197 Note payable to a bank with interest at 6.25%, due in monthly principal installments at $25,000 plus interest through January 2004. The note was paid in full subsequent to December 31, 2003. 25,000 - Note payable to seller (for a 50% interest in an airplane). The interest in the plane was forfeited as full satisfaction for the note in 2003. - 1,489,125 Notes payable to sellers of oil and gas properties paid in full in 2003. - 607,236 ------------ ------------ Total long-term obligations 27,992,649 26,474,351 Less current portion (1,762,777) (2,227,195) ------------ ------------ $26,229,872 $24,247,156 ============ ============ ____________________ (1) Taking into effect the change in conversion price subsequent to December 31, 2003
F-25
INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Maturities of long-term obligations are as follows: Long-Term Debt Years Ending and Convertible December 31, Notes Capital Leases Total - ------------------------ ----------------- ---------------- ------------ 2004 $ 1,714,902 $ 60,776 $ 1,775,678 2005 3,731,019 60,776 3,791,795 2006 8,786,228 110,000 8,896,228 2007 11,478,561 - 11,478,561 2008 156,433 - 156,433 Thereafter 1,921,196 - 1,921,196 Less amount representing interest - (27,242) (27,242) ----------------- ---------------- ------------ Total principal 27,788,339 204,310 27,992,649 Less current portion (1,714,901) (47,876) (1,762,777) ----------------- ---------------- ------------ $ 26,073,438 $ 156,434 $26,229,872 ================= ================ ============
Included in equipment in the accompanying consolidated balance sheet as of December 31, 2003 and 2002, are assets held under capital leases in the amount of approximately $297,000 net of accumulated amortization of approximately $70,000 and $41,000, respectively. Convertible Subordinated Notes - -------------------------------- 8% Convertible Subordinated Notes Effective June 13, 2001, the Company sold $6,475,000 in 8% Subordinated Convertible Notes in a private placement in which C.E. Unterberg, Towbin acted as the placement agent. Interest on the notes accrues at a rate of 8% per annum and is payable in arrears on each December 15 and June 15 commencing December 15, 2001. The notes were originally convertible to one share of common stock at $5 per share and mature on June 13, 2006. The notes are subordinated to substantially all the Company's other existing or future notes payable, capital leases, debentures, bonds or other such securities. In addition, the Company can redeem, at its option, all or a portion of the notes as follows: Redemption Price Percentage of Year Principal ------------------- ------------- 2004 103.2% 2005 and thereafter 101.6% If at any time the Company's stock price exceeds 300% of the conversion price for 20 consecutive days, the Company can redeem, at its option, all or a portion of the notes for the principal balance and accrued interest outstanding. If there is a change in control of the Company, the Company must redeem the notes at the rates noted above. F-26 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company incurred costs of $501,906 associated with the placement, which has been capitalized as loan costs and is being amortized using the effective interest method. The Company also issued warrants to purchase 220,000 shares of common stock at $5.99. The Company capitalized additional loan costs of $924,717 related to the fair value of the warrants as determined using the Black-Scholes pricing model assuming a five year life, weighted average risk-free interest rate of 8%, expected volatility of 80.66% and no expected dividend yield. Proceeds from the offering were used in the development of the Company's oil and gas properties. As the conversion feature of the convertible notes was below the market value of the stock on the date of issue, the Company recorded a discount of $1,165,500 related to the intrinsic value of the beneficial conversion feature. The notes are immediately convertible and therefore, the discount was immediately amortized. The Company capitalized the amortization of the beneficial conversion feature into oil and gas properties not subject to amortization as the debt was issued in order to continue exploration and development of projects that were not currently subject to amortization, and was not used for general operating purposes. During 2003 and 2002, the holders of $1,450,000 and $2,232,000 of 8% subordinated convertible notes converted the debt and accrued interest into 295,689 and 454,974 shares of the Company's common stock, respectively. Subsequent to December 31, 2003, the holders of $130,000 of 8% subordinated convertible notes converted the debt into 27,059 shares of the Company's common stock. Subsequent to December 31, 2003, the Company issued 1,000,000 shares of common stock at $4.00 per share in a private placement (See Note 18). The loan indenture contains anti-dilution provisions that require the Company to adjust the conversion price of the notes if stock is sold at a price less than the conversion price. Therefore, the conversion price was adjusted to $4.88 per share. In connection with the adjustment of the conversion price, the Company recorded an approximately $54,000 charge related to the additional shares issuable at the new conversion price. 7% Convertible Subordinated Notes Effective April 22, 2002, the Company sold $12,540,000 in 7% Subordinated Convertible Notes in a private placement in which C.E. Unterberg, Towbin acted as the placement agent. A director of the Company is also an officer with C.E. Unterberg, Towbin. In addition, to the extent a holder of the Company's 8% Subordinated Convertible Notes converted any of their notes and the accrued interest to stock, and purchased 7% Subordinated Convertible Notes, these parties would be related parties. Interest on the 7% subordinated notes accrues at a rate of 7% per annum and is payable in arrears on each April 15 and October 15. The Company can elect to pay the accrued interest in cash or in the form of additional notes issued in increments of $1,000 with residual interest due in cash. In December 2003, the Company issued $379,000 in new notes as payment for interest due at that time. The Company expects it will issue additional notes in April and October 2004 as payment for interest then due. The notes were originally convertible to one share of common stock at $8.625 per share and mature on April 22, 2007. F-27 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The notes are subordinated to substantially all the Company's other existing or future notes payable, capital leases, debentures, bonds or other such securities. In addition, after April 22, 2004, the Company can redeem, at its option, all or a portion of the notes as follows: Redemption Price Percentage of Year Principal ------------------- ------------- 2004 104.2% 2005 102.8% 2006 and thereafter 101.4% Currently if the Company's stock price exceeds 300% of the conversion price for 20 consecutive days, the Company can redeem, at its option, all or a portion of the notes for the principal balance and accrued interest outstanding. If there is a change in control of the Company, the Company must redeem the notes at the rates noted above if after April 22, 2004 or 101% of principal plus accrued interest if before April 22, 2004. The Company incurred costs of $865,505 associated with the issuance of the 7% convertible notes, which have been capitalized as loan costs and are being amortized using the effective interest method. The Company also issued warrants to purchase 200,000 shares of common stock at $9.058. The Company capitalized additional loan costs of $1,386,044 related to the fair value of the warrants as determined using the Black-Scholes pricing model assuming a five year life, weighed average risk-free interest rate of 7%, expected volatility of 98.30% and no expected dividend yield. A portion of the proceeds from the offering was used in the development of the Company's oil and gas properties. As the conversion feature of the 7% convertible notes was above the market value of the stock on the date of issue, the Company did not record a beneficial conversion feature. During 2003, the holders of $1,735,000 of the 7% subordinated convertible notes converted the debt and accrued interest into 203,712 shares of the Company's common stock. Subsequent to December 31, 2003, the Company issued 1,000,000 shares of common stock at $4.00 per share in a private placement (See Note 18). The loan indenture for the 7% notes contains anti-dilution provisions that require the Company to adjust the conversion price of the notes if stock is sold at a price less than the conversion price. Therefore, the conversion price was adjusted to $8.067 per share. In connection with the adjustment of the conversion price, the Company recorded an approximately $354,000 charge related to the additional shares issuable at the new conversion price. $25,000,000 Development Credit Facility - ------------------------------------------ In September 2003, the Company established a Secured Revolving Borrowing Base Credit Facility ("Facility") with a bank. The Facility provides for funding of up to $25,000,000 with an initial borrowing base for the facility at $5,500,000. Borrowing base determinations are based on the volume of oil and gas production expected, the term and price of hedging contracts in place, and the costs associated with producing the oil and gas and associated general and administrative expense. The Facility is subject to semi-annual borrowing base determinations based on the same criteria as the original determination. The Company and the bank each have the option to request one additional F-28 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) re-determination during each calendar year. The bank has the sole discretion regarding any increase in the borrowing base if the semi-annual determination indicates that there is additional borrowing base available. Interest on the Facility accrues and is payable monthly at prime rate plus 1.0% (totaling 5.0% at December 31, 2003). The Company incurred $110,000 in loan costs and approximately $57,000 in legal costs to establish the Facility. These costs were capitalized as loan costs and will be amortized using the effective interest method. The initial proceeds were used to pay initial loan costs, repay $3,850,000 of new bridge loans obtained during 2003, for development of oil and gas properties and for working capital. The loan is subject to various restrictive and financial covenants. At December 31, 2003 the Company was in violation of the working capital covenant. Subsequent to December 31, 2003, the Company was granted a waiver of the violation as of December 31, 2003, and through April 30, 2004, when management believes it will be in, and stay in compliance for the remainder of 2004. This Facility limits the amount of cash distribution from Infinity Oil and Gas of Wyoming, Inc. ("Infinity-Wyoming") to Infinity, Inc. to the pro-rata share of tax expense generated by the net taxable income of Infinity-Wyoming and additional cash distributions of $300,000 per fiscal year. Bridge Loan and Related Agreements - Related Party - -------------------------------------------------- On November 25, 2002, the Company obtained a $3,000,000 one year bridge loan from a related party with an annual interest rate at Wall Street prime plus 1.0% in order to pay outstanding payables associated with the development of its oil and gas properties. In March 2003, the note was extended to January 2004. In May 2003, the note was amended to extend the maturity to January 30, 2005 and to place requirements for accelerated payment should the Company raise in excess of $3,500,000 in debt or equity financing. In June 2003, the loan agreement was amended to waive a portion of the accelerated payment requirements and to increase the interest rate to 7%. The note holder was also granted a first priority security interest in the Company's Sand Wash property and a subordinated security interest in the Pipeline property. The Company also entered into a consulting agreement with the related party in June 2003 under which the related party would facilitate a $3,850,000 bridge loan that was obtained and paid off in 2003 and other future financings, if any. The table below sets forth information about options that were granted in conjunction with these transactions. All of the options issued were valued using the Black-Scholes pricing model assuming a five year life, weighted average risk free interest rate of 1.5%, expected volatility rates between 125% and 132% and no expected dividend yield. The option value was capitalized as loan costs and is being amortized using the effective interest method. The amortization is treated as interest in the Company's consolidated statement of operations with a portion capitalized to the non-producing properties developed with the proceeds of the loan. F-29 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following is a summary of the options granted in connection with the loan and related agreements:
Date of Options Option Loan Grant Granted Price Costs ----------------- ------- ------- ---------- November 25, 2002 320,000 $ 8.75 $2,281,718 May 23, 2003 150,000 8.75 730,130 June 18, 2003 125,000 8.75 642,841 June 26, 2003 225,000 8.75 1,120,358 ------- ---------- 820,000 $4,775,047 ======= ==========
Subsequent to December 31, 2003, the Company repaid $1,250,000 of the loan balance outstanding with $750,000 in cash and the issuance of 125,000 shares of common stock valued at $4.00 per share (See Note 19). Revolving Credit and Term Loans - ----------------------------------- In January 2002, the Company refinanced a portion of its long-term debt. The Company entered into a financing agreement with a bank whereby the Company executed the following: - A $2,000,000 revolving credit note cross-collateralized by substantially all the Company's assets except oil and gas properties; with interest at prime plus 1.0%. The note is due December 31, 2004. - An approximately $2,900,000 term note with interest at prime plus 1.0%, due in monthly installments of $80,626 plus interest, through December 2004. The note is cross-collateralized by substantially all the assets of the Company except oil and gas properties. - A $1,000,000 capital expenditure line with interest at prime plus 1.0%, due in monthly installments of $15,626 plus interest through December 31, 2004 when unpaid principal and interest are due. The note is cross-collateralized by substantially all the assets of the Company except oil and gas properties. The Company borrowed $720,000 under the line. The notes require the Company to comply with certain financial and restricted covenants and are guaranteed by an officer of the Company up to $1,000,000. This facility limits the amount of distributions that can be made, other than through the normal course of business, to Infinity, Inc. and affiliated companies to $250,000 per fiscal year without the prior consent of the lender. 2003 Debt Paid in Full - -------------------------- In 2003, the Company issued 201,000 five year options and 462,500 five year warrants to purchase common stock at $8.75 per share and granted a 4% over-riding royalty in certain producing properties when it obtained three bridge loans totaling $5,900,000 with interest rates ranging from 2% per month to 12% per year. The Company capitalized loan costs of $3,297,390 for the options and warrants and $1,250,000 based on the estimated fair value for the 4% over-riding royalty conveyed. The Company used the Black-Scholes pricing model assuming a five year life, weighted average risk-free interest rates of 1.5% to 4%, expected volatility between 126.11 % and 131.96 % and no expected F-30 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS dividend yield to calculate the fair value of the options and warrants at the date of grant. The Company repaid all of the loans during 2003 and all of the loan costs were fully amortized during the year. 2002 Debt Paid in Full - -------------------------- In March 2002, the Company issued five-year options to purchase 250,000 shares of common stock at $7.34 per share when it obtained a $2,000,000, bridge loan from a related party, with an annual interest rate of 8%, in order to pay outstanding payables associated with the development of its oil and gas properties. The Company capitalized loan costs of $1,347,728 related to the fair value of the options as determined using the Black-Scholes pricing model assuming a five year life, weighted average risk-free interest rate of 8%, expected volatility of 89.55% and no expected dividend yield. The loans were repaid in full in April 2002 with proceeds from the sale of the 7% subordinated convertible notes. Note 10 - Stockholder's Equity - ------------------------------ Stock Split - ------------ In May 2002, the Company effected a 2:1 stock split effective May 13, 2002. All shares and per share amounts have been restated to give effect to the stock split. Warrants and Options to Non-Employees - ----------------------------------------- The Company, in conjunction with a public stock offering in September 1988, issued Class A and Class B warrants to purchase 425,918 shares of common stock. The 223,496 Class A warrants have expired. During 2002, 163,264 shares of common stock were issued upon the exercise of Class B warrants for proceeds of $977,911. The remaining 39,158 Class B warrants expired in June 2002. During 2001, in connection with the sale of $6,475,000 8% subordinated convertible notes, the Company granted 220,000 warrants to purchase the Company's common stock at $5.99 per share. The warrants expire in June 2006 (See Note 9). During 2002, in connection with the sale of $12,540,000, 7% subordinated convertible notes, the Company granted 200,000 warrants to purchase the Company's common stock at $9.058 per share. The warrants expire in April 2007 (See Note 9). In connection with obtaining $5,000,000 of bridge loans in March and November 2002, the Company granted 570,000, five year options to purchase the Company's common stock at $7.34 (250,000 of the options) or $8.75 (320,000 of the options) per share (See Note 9). During 2003, in connection with the issuance of $1,000,000 of bridge notes, which were paid in full in 2003, the Company granted 212,500 warrants to purchase the Company's common stock at $8.75 per share. The warrants expire in April 2008 (See Note 9). During 2003, in connection with the issuance of $3,850,000 in bridge notes which were paid in full in 2003, the Company granted 250,000 warrants to purchase the Company's common stock at $8.75 per share. Subsequent to December 31, 2003, the Company issued 1,000,000 shares of common stock at $4.00 per share in a private placement. (See Note 18). The warrant agreement contains anti-dilution provisions that require the Company to adjust the exercise price and change the number of warrants outstanding if the Company sells stock at less than the exercise price. Therefore, in January the warrants F-31 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS were increased by 17,500 warrants to 267,500 warrants with an exercise price of $8.18 per share. The warrants expire July 2, 2008 (See Note 9). In connection with obtaining $1,050,000 of bridge loans in January and April of 2003 (which were paid in full during 2003), the amendments of an existing $3,000,000 loan agreement, and a consulting contract to assist with the facilitation of a $3,850,000 loan agreement, the Company granted options to purchase the Company's common shares at $8.75 per share (See Note 9). A summary of warrant and option activity with non-employees is as follows:
Warrant/Option Price Weighted Average Number of Shares Per Share Price Per Share ----------------- -------------------- ----------------- Outstanding, March 31, 2001 269,922 $ 1.75 - $6.00 $ 5.16 Granted 220,000 5.99 5.99 Canceled or forfeited (25,000) 1.75 1.75 Exercised (2,500) 2.63 2.63 ----------------- -------------------- ----------------- Outstanding, December 31, 2001 462,422 3.22 - 6.00 5.75 Granted 770,000 7.34 - 9.06 8.37 Canceled or forfeited (39,158) 6.00 6.00 Exercised (163,264) 6.00 6.00 ----------------- -------------------- ----------------- Outstanding, December 31, 2002 1,030,000 3.22 - 9.06 7.66 Granted 1,163,500 8.75 8.75 Exercised (83,350) 7.34 7.34 ----------------- -------------------- ----------------- Outstanding, December 31, 2003 2,110,150 $ 3.22 - $9.06 $ 8.27 ================= ==================== =================
Number Weighted Number Outstanding at Average Weighted Exercisable at Weighted Range of Exercise December 31, Remaining Average December 31, Average Prices 2003 Contractual Life Exercise Price 2003 Exercise Price - ------------------ -------------- ---------------- --------------- -------------- -------------- $3.22 40,000 2 years $ 3.22 40,000 $ 3.22 $5.99 220,000 3 years $ 5.99 220,000 $ 5.99 $7.34 - 9.06 686,650 4 years $ 9.06 686,650 $ 8.50 $8.75 1,163,500 5 years $ 8.75 1,163,000 $ 8.75 -------------- -------------- 2,110,150 2,110,150 ============== ==============
The following is the weighted average fair value of warrants and options granted to non-employees:
Period Ending December 31, Weighted Average Fair Value -------------------------- --------------------------- 2001 (nine months) $ 9.50 2002 $ 6.51 2003 $ 4.98
F-32 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Options Under Employee Option Plans - --------------------------------------- The Company has adopted stock option plans containing both incentive and non-statutory stock options. All options allow for the purchase of common stock at prices not less than the fair market value of such stock at the date of grant. If the optionee owns more than 10% of the total combined voting power of all classes of the Company's stock, the exercise price can not be less than 110% of the fair market value of such stock at the date of grant. Options granted under the plans become exercisable immediately or as directed by the Board of Directors and generally expire five or ten years after the date of grant, unless the employee owns more than 10% of the total combined voting power of all classes of the Company's stock, in which case they must be exercised within five years of the date of grant. Pursuant to the plans, an aggregate of 1,928,047 options were available for grant. The Company granted 10,000, 345,000, and 330,000 options to employees under the Plans during the years ended December 31, 2003 and 2002, and the nine months ended December 31, 2001, respectively. At December 31, 2003, there were 95,720 shares remaining available under the plans. A summary of stock option activity is as follows:
Option Price Weighted Average Number of Shares Per Share Price Per Share ----------------- -------------- ----------------- Outstanding, March 31, 2001 789,750 $1.50 - $5.25 $ 2.48 Granted 330,000 5.00 5.00 Canceled or forfeited (7,300) 3.82 3.82 Exercised (62,850) 1.50 - 5.25 1.93 ----------------- --------------- ----------------- Outstanding, December 31, 2001 1,049,600 1.50 - 5.00 3.30 Granted 345,000 7.00 - 8.70 8.70 Canceled or forfeited (6,200) 3.00 - 5.00 3.59 Exercised (247,500) 1.50 - 5.00 1.93 ----------------- --------------- ----------------- Outstanding, December 31, 2002 1,140,900 1.50 - 8.70 5.23 Granted 10,000 8.75 8.75 Canceled or forfeited (61,781) 3.82 - 8.70 7.28 Exercised (62,819) 1.50 - 5.00 3.38 ----------------- --------------- ----------------- Outstanding, December 31, 2003 1,026,300 $1.50 - $8.75 $ 5.25 ================= =============== =================
F-33
INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Weighted Number Average Weighted Number Weighted Outstanding Remaining Average Exercisable at Average Range of at December Contractual Exercise December 31, Exercise Exercise Prices 31, 2003 Life Price 2003 Price ---------------- ----------- ----------- --------- -------------- --------- $ 1.50 62,000 1 year $ 1.50 62,000 $ 1.50 $ 1.50 119,500 2 years $ 1.50 119,000 $ 1.50 $ 3.00-3.82 219,800 2 years $ 3.80 219,800 $ 3.80 $ 5.00 304,000 3 years $ 5.00 304,000 $ 5.00 $ 5.00 8,000 4 years $ 5.00 8,000 $ 5.00 $ 8.70 303,000 4 years $ 8.70 303,000 $ 8.70 $ 8.75 10,000 5 years $ 8.75 5,000 $ 8.75 ----------- -------------- 1,026,300 1,021,300 =========== ==============
The following is the weighted average fair value of options granted from stock option plans: Period Ending December 31, Weighted Average Fair Value --------------------------- ----------------------------- 2001 (nine months) $3.37 2002 $7.10 2003 $5.25 Subsequent to December 31, 2003, 40,000 options were exercised for proceeds of approximately $60,000. Options - ------- The Company granted 177,500 options to employees outside its stock option plans prior to March 31, 2001 with exercise prices ranging from $1.55 to $4.00 and a weighted average price per share of $2.76. These options were exercised during 2002. At December 31, 2003, the Company had no options to employees outside of the stock option plans. F-34 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 11- Income Taxes - ------------------------ The provision for income taxes consists of the following:
For the Years Ended For the Nine December 31, Months Ended -------------------------- December 31, 2003 2002 2001 ------------ ------------ ------------- Current income tax expense $ - $ - $ - Deferred income tax (benefit) expense (4,003,321) (1,226,874) 1,590,056 Change in deferred tax asset valuation allowance 4,003,321 82,846 - ------------ ------------ ------------- Total income tax (benefit) expense $ - $(1,144,028) $ 1,590,056 ============ ============ =============
The effective income tax rate varies from the statutory federal income tax rate as follows:
For the Year Ended For the Nine December 31, Months Ended ---------------------- December 31, 2003 2002 2001 ---------- ---------- ------------- Federal income tax rate (34)% (34)% 34% State income tax rate (6) (6) 6 Other temporary and permanent differences - 1 (1) Change in valuation allowance 40 (3) - ---------- ---------- ------------- Effective tax rate 0% (42)% 39% ========== ========== =============
The significant temporary differences and carry forwards and their related deferred tax asset (liability) and deferred tax asset valuation allowance balances are as follows:
December 31, -------------------------- 2003 2002 ------------ ------------ Deferred tax assets Accruals and impairment $ 257,000 $ 252,000 Net operating loss carry-forward 9,551,000 4,601,000 Permanent differences 366,000 202,000 Other 118,000 18,000 ------------ ------------ Gross deferred tax assets 10,292,000 5,073,000 ------------ ------------ Deferred tax liabilities Intangible drilling costs 4,190,000 3,191,000 Property and equipment 682,000 682,000 ------------ ------------ Gross deferred tax liabilities 4,872,000 3,873,000 ------------ ------------ Net deferred tax asset 5,420,000 1,200,000 Less valuation allowance (5,420,000) (1,200,000) ------------ ------------ Deferred tax asset $ - $ - ============ ============
F-35 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For income tax purposes, the Company has approximately $24,807,000 of net operating loss carry-forwards expiring from 2015 through 2023. During 2003 and 2002, the Company realized certain tax benefits related to stock option plans in the amounts of $164,000 and $232,000, respectively. Such benefits were recorded as a deferred tax asset as they increased the Company's net operating losses and an increase in additional paid in capital. The recognition of the valuation allowance offset the impact of this benefit. The Company has provided for a valuation allowance of $5,420,000 due to the uncertainty of realizing the tax benefits from its net operating loss carry-forwards. Note 12 - Commitments and Contingencies - --------------------------------------- Gas Gathering Contract - ------------------------ In June 2001, the Company entered into a long-term gas gathering contract, which expires in December 2008. This contract was amended April 4, 2003. Under the amended contract, the Company will pay gas gathering fees per thousand cubic feet ("MCF") delivered. The Company is obligated to pay a fee of $.40 per MCF on the first 7,500,000 MCF and $.25 per MCF thereafter. Additionally, the Company has an annual volume commitment for the first 3 years starting September 1, 2001. The Company's minimum volume for the first three years is (i) Year one 600,000 MCF, (ii) Year two 1,600,000 MCF, (iii) Year three 2,000,000 MCF, (iv) Year four 1,800,000 MCF, and (v) Year five 1,500,000 MCF. If the Company exceeds the minimum in any year, the excess reduces the following year's commitment. If the Company does not meet the minimum in any year, the shortfall is added to the following years and at the end of the three years, the Company has to pay additional costs for the shortfall. Through December 31, 2003, the Company had delivered approximately 2,060,000 MCF. While the Company has failed to deliver the volumes required under the contract, the pipeline operator has also not provided the compression and gathering capabilities it was required to provide under the contract. Management has received a verbal commitment from the operator that the volume commitments will be adjusted and management does not believe there will be a contract shortfall under the renegotiated volumes and therefore, anticipates no additional costs under the contract. Financial Consulting Agreement - -------------------------------- In July 2003 the Company entered into a eighteen month financial consulting agreement with a related party. The Company issued options to purchase 125,000 shares of common stock that were valued at approximately $1,094,000 using the Black-Scholes valuation model, as compensation for entering into the agreement. (See Note 9) The related party helped facilitate the $3,850,000 bridge loan that was obtained in July 2003. Labarge Evaluation and Development Agreement - ------------------------------------------------ In December 2003, the Company entered into an agreement with both Schlumberger Technology Corporation and Red Oak Capital Management LLC to develop its Labarge coal bed methane project. The agreement provides for the completion or recompletion of five to ten of the Company's existing well bores, the anticipated drilling of ten new wells in 2004, and the anticipated drilling of twenty wells in each of the years 2005 through 2008. F-36 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Based on the success of the initial completion program, and after each yearly development phase, the project will be evaluated for continuation. Work on the existing well bores began in January 2004 and is expected to be completed in the second quarter of 2004. Schlumberger has the exclusive right to provide completion services and supplies for each development phase and Red Oak has the exclusive right to finance a portion of the cost of wells drilled in the 2004, 2005 and 2006 drilling phases. The Company will be required to finance approximately 50% of the drilling and other costs for each phase. Payment for the services provided by Schlumberger and Red Oak will be made from net proceeds, after operating costs from the wells completed or re-completed in each development phase. This method of payment for the services provided results in a substantial portion of the net profits from the wells included in each bundle being paid to Schlumberger and Red Oak until the obligation on each bundle is satisfied. The agreement is secured by a pledge of the wells completed or recompleted, and does not burden the ownership of or profits from any other assets of the Company. The Company has approximately $9,399,000 invested in unproved oil and gas properties not subject to amortization on the Labarge project and expects to incur approximately an additional $3,600,000 in costs during 2004 under the agreement to evaluate and explore the property. At the conclusion of the 2004 evaluation and exploration activity, a significant portion of the investment in unproved oil and gas properties will be reclassified to the full cost pool subject to depletion and the ceiling test. If proved reserves are not found or if reserves are not significant, the Company could be required to write-down a portion of the full cost pool of oil and gas properties. Regulations - ----------- The Company's oil and gas operations are subject to various Federal, state and local laws and regulations. The Company could incur significant expense to comply with new or existing laws and non-compliance could have a material adverse effect on the Company's operations. Environmental - ------------- The Company uses injection wells to dispose of water into underground rock formations. If future wells produce water of lesser quality than allowed under state laws or if water is produced at rates greater than can be injected, the Company could incur additional costs to dispose of its water. Note 13 - Retirement Plan - ------------------------- The Company has a 401(k) plan covering substantially all of the employees of the oil field services subsidiary. There were no Company contributions made to the plan during the year ended December 31, 2003 and 2002 and the nine months ended December 31, 2001. Effective January 1, 2004 the Company began matching, dollar for dollar, employee contributions up to 4% of their gross pay. At the current rate of participation, this benefit will cost the Company approximately $105,000 during 2004. Note 14 - Industry Segments - --------------------------- The Company reports segment information in accordance with SFAS No 131, which requires disclosure of information related to certain operating segments of the Company. The Company's operations have been classified into two industry segments: (i) Oil Field Services; and (ii) Oil and Gas Production. The Oil Field Services segment of the Company is directed at maintaining and enhancing production obtained from oil and gas wells and currently has operations in Kansas, Oklahoma, and Wyoming. The Oil and Gas Production segment of the Company has acquired interests in undeveloped leaseholds in Wyoming, Colorado and Kansas of which a portion have been developed into producing properties. F-37 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Oil Field Oil & Gas Corporate and Services Production Other Total ----------- ------------- --------------- ------------ Revenue December 31, 2001 (nine months) $ 9,853,624 $ 1,759,095 $ - $11,612,719 December 31, 2002 8,570,631 2,367,713 - 10,938,344 December 31, 2003 11,634,457 6,589,281 - 18,223,738 Depreciation, amortization, depletion and impairment (1) December 31, 2001 (nine months) 842,694 136,649 631,518 1,610,861 December 31, 2002 1,485,495 273,936 223,155 1,782,586 December 31, 2003 1,420,952 1,561,247 92,048 6,049,247 Ceiling write-down December 31, 2001 (nine months) - - - - December 31, 2002 - - - - December 31, 2003 - 2,975,000 - 2,975,000 Operating income (loss) December 31, 2001 (nine months) 2,163,119 143,118 (841,432) 1,464,805 December 31, 2002 37,285 (299,079) (1,670,865) (1,932,659) December 31, 2003 1,411,218 (1,629,866) (2,061,353) (2,280,001) Total assets, net December 31, 2002 9,967,770 35,566,847 7,595,652 53,130,269 December 31, 2003 9,069,144 40,220,115 5,977,019 55,266,278 Capital expenditures December 31, 2001 (nine months) 2,524,719 7,982,573 7,710 10,515,002 December 31, 2002 1,561,357 14,695,044 865,505 17,121,906 December 31, 2003 459,820 6,175,325 197,567 6,832,712 ____________________ (1) Excludes amortization of loan costs included in interest expense in the accompanying consolidated statements of operations.
Note 15 - Significant Customers - ------------------------------- During the nine months ended December 31, 2001, the Company had oil field service sales to two unrelated third parties of approximately $2,640,000, representing approximately 23% of net sales. During the year ended December 31, 2002, the Company had oil field service sales to one unrelated third party of approximately $1,569,000, representing approximately 14% of net sales. In addition, during 2002, the Company sold 89% of its oil and gas to three unrelated companies. During the year ended December 31, 2003, the Company had oil field service sales to one unrelated third party of approximately $1,150,000, representing approximately 10% of net sales. In addition, during 2003, the Company sold approximately $6,453,000, or 98% of its oil and gas revenue, to two unrelated customers. Receivables outstanding from the December 31, 2003 and 2002 significant customer sales were approximately $529,000 and $586,000, respectively. F-38 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 16 - Fair Value of Financial Instruments - --------------------------------------------- The carrying value of the Company's cash balance, accounts receivable, accounts payable and accrued expenses represents the fair value of the accounts as of December 31, 2003 and 2002. The fair value of the Company's long-term debt with financial institutions and equipment financing companies approximates the carrying value because (i) interest rates are variable or (ii) the debt instruments were executed at rates comparable to current rates for similar notes. The fair value of the Company's other long-term debt obligations cannot be determined due to the nature of the transactions which created the debt, and comparable market value information is not readily determinable without incurring excessive costs. See Note 9 for the terms of the long-term debt obligations. Note 17 - Earnings Per Share - ---------------------------- At December 31, 2003 and 2002, all potential Company shares of common stock are anti-dilutive. At December 31, 2001, the following shows the amounts used in computing earnings per share and the effects on income and the weighted average number of shares of dilutive potential common stock:
Weighted Average Income Common Shares Earnings Per Numerator Denominator Share ------------ ---------------- ------------- Basic earnings per share (December 31, 2001) Income available to common stockholders $2,540,395 6,501,104 $ .39 ============= Plus: Impact of assumed conversion of warrants and options - 455,816 Impact of assumed conversion of 8% subordinated convertible notes -* 9,002 ---------- ---------------- Diluted earnings per share $2,540,395 6,965,922 $ .37 ========== ================ ============= ____________________ * Interest on 8% subordinated convertible notes was capitalized.
As of December 31, 2003, 2002 and 2001, the impact of 4,991,746, 4,473,413 and 344,090, respectively, of potential shares of common stock were not included because their effect was anti-dilutive. Note 18- Subsequent Events - -------------------------- In January 2004, the Company issued 1,000,000 shares of common stock at $4.00 per share in a private placement. The Company used $750,000 of the proceeds from the private placement, plus 125,000 shares of common stock valued at $4.00 per share to pay down a portion of the $3,000,000 bridge loan (See Note 9). In February 2004, the Company entered into a $250,000 note agreement with a bank. The proceeds of the loan were used to pay outstanding payables. The note bears interest at 6.25% and is due in 10 monthly installments of $25,000 plus interest. In addition, the Company financed $169,532 of 2003 and 2004 payables related to drilling wells at Pipeline, into a 1-year note payable. The note bears interest at 6.5% and is due in monthly installments of $14,623, including interest through February 2005. During 2004, the Company entered into fixed price delivery contracts for 2,000 MMBTU per day from April 1, 2004 until March 31, 2006. The price for the period April 1, 2004 until March 31, 2005 is $4.40 per MMBTU and the price for the period April 1, 2005 until March 31, 2006 is $4.15 per MMBTU. F-39 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Subsequent to obtaining the new contracts, the Company was required to obtain a $300,000 letter-of-credit with a bank. The Company paid back $400,000 on the $5,500,000 outstanding on its bank credit facility in order to allow for the letter-of-credit under the current borrowing base. In March, 2004 the Company acquired an additional working interest in two partner operated wells and 960 gross acres of leasehold immediately offsetting the Pipeline field. The purchase increased the Company's working interest in the wells to 50% from an approximate 1.5% interest at December 31, 2003 and the Company assumed operations on the properties. Note 19 - Supplemental Oil and Gas Information (Unaudited) - ---------------------------------------------------------- Proved Oil and Gas Reserves (Unaudited) - -------------------------------------------- The following information was developed from reserve reports prepared by independent reserve engineers:
Natural Gas Crude Oil (MCF) (Barrels) ------------ ---------- Proved reserves as of March 31, 2001 9,144,761 444,573 Revisions of previous estimates 208,837 (277,120) Production (128,998) (29,289) ------------ ---------- Proved reserves as of December 31, 2001 9,224,600 138,164 Sales or other deletions - (128,788) Revisions of previous estimates (2,042,255) 85,277 Extension, discoveries and other additions 84,284,734 14,169 Production (676,879) (53,122) ------------ ---------- Proved reserves as of December 31, 2002 95,790,200 182,700 Revisions of previous estimates (90,374,776) 1,990 Extension, discoveries and other additions 3,175,927 66,102 Production (1,080,456) (57,684) ------------ ---------- Proved reserves as of December 31, 2003 7,510,895 193,138 ============ ==========
The 2003 revision to the previous estimate of reserves is due primarily to the following factors: - operational issues at the existing Labarge wells; - a lack of financial resources to rectify the operational issues on a timely basis or to complete exploration on other wells; and - geological studies that indicate the producing Pipeline wells were producing from the sands rather than the coals thus leading the Company to change the classification of Pipeline from a coal play to a sand play. Proved reserves are 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. There are uncertainties inherent in estimating quantities of proved oil and gas reserves, projecting future production rates, and timing of development expenditures. Accordingly, reserve estimates are often different from the quantities of oil and gas that are ultimately recovered. All proved reserves are located in the United States. F-40 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Proved Developed Oil and Gas Reserves - ------------------------------------------ The following information sets forth the estimated quantities of proved developed oil and gas reserves of the Company as of the end of each year.
-------------- Crude Oil and Natural Gas Condensate (MCF) (Barrels) ------------ -------------- Proved Developed Reserves ------------------------- December 31, 2001 4,112,300 138,864 December 31, 2002 38,590,600 182,700 December 31, 2003 4,724,523 124,968
Costs Incurred in Oil and Gas Activities - ---------------------------------------------- Costs incurred in connection with the Company's oil and gas acquisition, exploration and development activities are shown below.
For the Nine For the Years Ended Months Ended December 31, December 31, ----------------------- ------------- 2003 2002 2001 ---------- ----------- ------------- Property acquisition costs Proved $1,099,120 $ 72,383 $ 223,319 Unproved 661,224 2,279,587 1,291,126 ---------- ----------- ------------- Total property acquisition costs 1,760,344 2,351,970 1,514,445 Development costs 3,167,700 786,095 721,760 Exploration costs 3,491,953 11,955,351 6,957,735 ---------- ----------- ------------- Total costs $8,419,997 $15,093,416 $ 9,193,940 ========== =========== =============
F-41 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Aggregate Capitalized Costs - ----------------------------- Aggregate capitalized costs relating to the Company's oil and gas producing activities, and related accumulated depreciation, depletion, amortization and ceiling write-down are as follows:
For the Nine For the Years Ended Months Ended December 31, December 31, ------------ ------------ -------------- 2003 2002 2001 ------------ ------------ -------------- Proved oil and gas properties $28,194,858 $19,411,845 $ 5,009,661 Unproved oil and gas properties (1) 12,815,834 $13,176,850 12,404,906 ------------ ------------ -------------- Total 41,010,692 32,588,645 17,414,567 Less accumulated depreciation, depletion, amortization and ceiling write-down (4,748,515) (304,418) (223,706) ------------ ------------ -------------- Net capitalized costs $36,262,177 $32,284,277 $ 17,190,861 ============ ============ ==============
(1) 2003 includes approximately $885,000 in unproved oil and gas properties in Nicaragua. From inception through December 31, 2003, the Company has capitalized the following financing costs related to properties not subject to amortization. As these properties are developed, the costs are transferred to properties subject to amortization:
December 31, ---------------------- 2003 2002 ---------- ---------- Beneficial conversion feature related to the 8% subordinated convertible notes $1,165,500 $1,165,500 Capitalized interest 2,246,019 1,863,783 Capitalized amortization of loan costs 4,885,586 2,170,612 ---------- ---------- Total capitalized finance costs $8,297,105 $5,199,895 ========== ==========
Oil and Gas Operations - ------------------------- Aggregate results of operations in connection with the Company's oil producing activities are shown below:
For the Years Ended For the Nine -------------------------- Months Ended December 31, December 31, -------------------------- -------------- 2003 2002 2001 ------------ ------------ -------------- Revenue $ 6,589,281 $ 2,367,713 $ 1,759,095 Production costs and taxes 2,920,493 (1,820,692) (1,140,750) Depreciation, depletion, amortization and ceiling write-down (4,442,097) (196,627) (130,232) ------------ ------------ -------------- Results of operations from producing activities (excluding corporate overhead and interest costs) $ (773,309) $ 350,394 $ 488,113 ============ ============ ==============
F-42 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil - -------------------------------------------------------------------------------- and Gas Reserves (Unaudited) - ------------------------------- The following information is based on the Company's best estimate of the required data for the Standardized Measure of Discounted Future Net Cash Flows as of December 31, 2003, 2002 and 2001 as required by SFAS No 69. The Statement requires the use of a 10 percent discount rate. This information is not the fair market value nor does it represent the expected present value of future cash flows of the Company's proved oil and gas reserves.
As of December 31, -------------------------------------------- 2003 2002 2001 ------------- -------------- ------------- Future cash inflows $ 51,591,800 $ 303,392,537 $ 27,499,212 Future production costs (16,204,800) (109,060,912) (11,493,932) Future development costs (2,912,800) (16,424,600) (500,000) Future income tax expense (2,765,267) (59,269,174) (5,969,531) ------------- -------------- ------------- Future net cash flows 29,708,938 118,637,851 9,535,749 10% annual discount for estimated timing on cash flows (8,887,283) (63,585,181) (3,913,266) ------------- -------------- ------------- Standardized measure of discounted future cash flows $ 20,821,655 $ 55,052,670 $ 5,622,483 ============= ============== =============
Future cash inflows are computed by applying a year end weighted average spot market gas price and oil price for the areas of production. The following table shows the prices that have been used for each of the periods:
As of December 31, ------------------------ 2003 2002 2001 ------ ------ -------- Weighted average gas price per MCF $ 6.06 $ 3.11 $ 2.74 Weighted average oil price per barrel $31.34 $31.20 $ 16.71
A subsequent decline in prices received for oil and gas sales from those used to compute cash inflows could result in a requirement that the Company recognize a ceiling write-down to oil and gas properties in a future period. Future production and development costs are computed by estimating the expenditures to be incurred in developing and producing the Company's proved oil and gas reserves at December 31, 2003, 2002 and 2001 assuming continuation of existing economic conditions. F-43 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following reconciles the change in the standardized measure of discounted future net cash flow:
For the Nine For the Years Ended Months Ended December 31, December 31, ----------------------------- -------------- 2003 2002 2001 -------------- ------------- -------------- Beginning of period $ 55,052,670 $ 5,622,483 $ 13,009,222 Extensions, discoveries and other additions 9,004,500 77,054,495 - Sales and transfers - (547,245) - Net change in sales and transfer prices, net of production costs 76,822,907 371,265 (7,315,638) Revision of previous quantity estimates (170,455,255) (1,590,027) (753,656) Development costs incurred during the period 976,462 786,095 - Sales of oil and gas, net of production costs and taxes (3,678,788) (547,021) (618,345) Changes in future development costs 13,143,811 (252,092) - Net change in income taxes 26,834,091 (25,423,023) - Changes in production rates and other 4,718,632 (1,337,938) - Accretion of discount 8,392,625 915,698 1,300,900 -------------- ------------- -------------- End of period $ 20,821,655 $ 55,052,670 $ 5,622,483 ============== ============= ==============
Future income tax expenses are computed by applying the appropriate period-end statutory tax rates to the future pretax net cash flow relating to the Company's proved oil and gas reserves, less the tax basis of the properties involved. The future income tax expenses do not give effect to tax credits, allowances, or the impact of general and administrative costs of ongoing operations relating to the Company's proved oil and gas reserves. F-44 INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 20 - Quarterly Consolidated Financial Information (Unaudited) - ------------------------------------------------------------------ The following table provides selected quarterly consolidated financial results for the years ended December 31, 2003 and 2002:
Quarter ---------------------------------------------- First Second Third Fourth ---------- ---------- ---------- ---------- ($ in thousands, except per share information) 2003 - ---- Total revenue $ 3,605 $ 5,003 $ 5,241 $ 4,375 Gross profit $ 1,450 $ 2,706 $ 2,764 $ 2,160 Net (loss) income $ (622) $ (224) $ (4,525) $ (4,554) (Loss) earning per share $ (0.08) $ (0.03) $ (0.55) $ (0.57) (Loss) earning per fully diluted share $ (0.08) $ (0.03) $ (0.55) $ (0.57) 2002 - ---- Total revenue (1) $ 2,126 $ 2,580 $ 2,817 $ 3,415 Gross profit (1) $ 808 $ 1,023 $ 1,163 $ 1,503 Net (loss) income $ (308) $ (415) $ (294) $ (540) (Loss) earning per share $ (0.05) $ (0.06) $ (0.04) $ (0.07) (Loss) earning per fully diluted share $ (0.05) $ (0.06) $ (0.04) $ (0.07) ========== ========== ========== ==========
- ------------------- (1) Includes the following reclassifications of other revenue and other costs of revenue to interest and other income as reflected in the following table:
Quarter --------------------------------------------- First Second Third Fourth --------- ---------- ---------- ---------- ($ in thousands, except per share information) Total 2002 revenue as previously reported $ 2,126 $ 2,583 $ 2,822 $ 3,420 Reclassifications $ - $ (3) $ (5) $ (5) --------- ---------- ---------- ----------- Total 2002 revenue $ 2,126 $ 2,580 $ 2,817 $ 3,415 ========= ========== ========== =========== 2002 Gross profits as previously reported $ 800 $ 1,016 $ 1,156 $ 1,504 Reclassifications $ 8 $ 7 $ 7 $ (1) --------- ---------- ---------- ----------- 2002 Gross profit $ 808 $ 1,023 $ 1,163 $ 1,503 ========= ========== ========== ===========
F-45 INFINITY INC AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 21 - Schedule of Condensed Financial Information - ----------------------------------------------------- The oil and gas production subsidiary of the Company that owns more than 25% of the net assets of the Company is restricted from distributing more than $300,000 to the parent at December 31, 2003 under the $25,000,000 development credit facility executed in September 2003. Accordingly, the condensed balance sheet, statement of operations and cash flow statement for the parent are being provided as of and for the period ended December 31, 2003. There were no restrictions on the distribution of dividends to the parent by the subsidiary in the prior two periods.
INFINITY, INC. CONDENSED BALANCE SHEET December 31, 2003 ASSETS Current assets Cash and cash equivalents $ 22,019 Prepaid expenses and other 40,839 ------------- Total current assets $ 62,858 Property and equipment, at cost, less accumulated depreciation of $179,825 2,293,881 Oil and gas properties, not subject to amortization 884,790 Intangible assets, at cost less accumulated amortization of $9,716,459 3,534,449 Other assets 135,989 Cumulative investment in or advances to subsidiaries 29,009,328 ------------- Total assets $ 35,921,295 ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Current portion of long-term debt $ 122,855 Accounts payable 371,867 Accrued expenses 240,187 ------------- Total current liabilities 734,909 Long-term liabilities Long-term debt, less current portion 2,203,346 8% subordinated convertible notes payable 2,793,000 7% subordinated convertible notes payable 11,184,000 Note payable - related party 3,000,000 ------------- Total liabilities $ 19,915,255 ------------- Commitments and contingencies Stockholders' equity Common stock, par value $.0001, authorized 300,000.000 shares, issued and outstanding 8,204,032 820 Additional paid-in-capital 32,720,904 Accumulated deficit (16,715,684) ------------- Total stockholders' equity $ 16,006,040 ------------- Total liabilities and stockholders' equity $ 35,921,295 =============
F-46
INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS INFINITY, INC. CONDENSED STATEMENT OF OPERATIONS Year ended December 31, 2003 Operating expenses $ 1,945,134 Depreciation, depletion and Amortization 378,034 ------------ 2,323,168 ------------ Operating loss (2,323,168) Other (expense) income Interest income 522 Amortization of loan costs (5,856,442) Interest expense (868,718) ------------ Total other (expense) income (6,724,638) ------------ Loss before income taxes (9,047,806) Income tax benefit - ------------ Net loss $(9,047,806) ============ Basic loss per share $ (1.12) ============ Diluted loss per share $ (1.12) ============ Weighted average basic shares outstanding 8,047,688 ============ Weighted average diluted shares outstanding 8,047,688 ============
F-47
INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS INFINITY, INC. CONDENSED STATEMENT OF CASH FLOWS Year ended December 31, 2003 Cash flows from operating activities Net loss $(9,047,806) ------------ Adjustments to reconcile net loss to net cash used by operating activities Depreciation, depletion and amortization 105,983 Amortization of loan costs included in interest expense 5,888,393 Change in assets and liabilities Increase in prepaid expenses and other (16,980) Increase in accounts payable 339,855 Increase in accrued expenses 425,238 ------------ 6,742,489 ------------ Net cash used by operating activities (2,305,317) ------------ Cash flows from investing activities Purchase of property, equipment, and intangibles (139,857) Investment in oil and gas properties (177,664) Increase in other assets (5,000) Decrease in investment in and advances to subsidiaries 1,861,176 ------------ Net cash provided by investing activities 1,538,655 ------------ Cash flows from financing activities Proceeds from borrowings on long-term debt 824,234 Principal payments on long-term debt (130,899) ------------ Net cash provided by financing activities 693,335 ------------ Net decrease in cash and cash equivalents (73,327) Cash and cash equivalents, beginning of period 95,346 ------------ Cash and cash equivalents, end of period 22,019 ============
F-48
INFINITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS INFINITY, INC. CONDENSED STATEMENT OF CASH FLOWS (CONTINUED) Year ended December 31, 2003 Supplemental cash flow disclosures: Cash paid for interest, net of amounts capitalized $ 578,248 ============= Non-cash transactions: Property and equipment acquired through capital leases or seller financed debt $ 967,975 ============= Stock-based compensation for options and warrants granted in connection with debt, recorded as loan costs $ 5,790,719 ============= Conversion of 8% subordinated convertible notes and accrued interest to common stock $ 1,478,550 ============= Conversion of 7% subordinated convertible notes and accrued interest to common stock $ 1,757,016 ============= Issuance of additional notes in lieu of cash interest payment or 7% subordinated convertible notes $ 379,000 ============= Reclassify other assets to oil and gas properties not subject ot amortization $ 707,126 =============
The debt of the parent at December 31, 2003 consisted of the following:
8% subordinated convertible notes $ 2,793,000 7% subordinated convertible notes 11,184,000 Note payable to a related party 3,000,000 Note payable to seller (airplane) 2,326,201 ----------- Total Debt $19,303,201 ===========
For additional information related to the terms of individual notes, see Note 9. During the period ended December 31, 2003, subsidiaries of the parent distributed approximately $1,861,000 to the parent. Distributions exceed the amounts allowed under debt agreement during 2003 as prior to September 2003, when the loan was executed, the subsidiary had no restrictions on cash distributions to the parent. The proceeds from these distributions were used to pay interest on outstanding debt and for working capital purposes. The parent also provides a corporate guarantee on the revolving credit and term notes held by oil well service subsidiary and the $25,000,000 development credit facility obtained by the oil and gas production subsidiary. F-49 EX-10.15 3 doc2.txt JOINT VALUE ENHANCEMENT AGREEMENT BY AND AMONG INFINITY OIL & GAS OF WYOMING, INC. AND RED OAK CAPITAL MANAGEMENT, LP AND SCHLUMBERGER TECHNOLOGY CORPORATION DATED DECEMBER 3, 2003 SUBLETTE COUNTY, WYOMING * Certain material marked with an asterisk on p. 9 and 10 of this Agreement has been omitted pursuant to a request for confidential treatment. This Agreement, with the omitted material included, has been filed separately with the Commission. TABLE OF CONTENTS ----------------- 1. DEFINITIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2. THE PROJECT WELLS. . . . . . . . . . . . . . . . . . . . . . . . . . 4 3. PROJECT GOVERNANCE . . . . . . . . . . . . . . . . . . . . . . . . . 6 4. THE SERVICES . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 5. SERVICE PARTY COMPENSATION . . . . . . . . . . . . . . . . . . . . . 10 6. OPERATION OF THE PROJECT WELLS . . . . . . . . . . . . . . . . . . . 12 7. EARLY BUYOUT OR DISPOSAL . . . . . . . . . . . . . . . . . . . . . . 14 8. TERM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 9. GENERAL TERMS AND CONDITIONS . . . . . . . . . . . . . . . . . . . . 16 10. CONFIDENTIAL INFORMATION AND INTELLECTUAL PROPERTY . . . . . . . . . 16 11. NOTICES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 12. MISCELLANEOUS PROVISIONS . . . . . . . . . . . . . . . . . . . . . . 20 13. SEVERABILITY; SAVINGS CLAUSE . . . . . . . . . . . . . . . . . . . . 22 14. WARRANTIES/DISCLAIMERS . . . . . . . . . . . . . . . . . . . . . . . 22 15. FORCE MAJEURE. . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 16. RELATIONSHIP OF THE PARTIES. . . . . . . . . . . . . . . . . . . . . 23 17. CAPACITY OF IOGW . . . . . . . . . . . . . . . . . . . . . . . . . . 24 18. REASONABLENESS . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 19. CONFLICTS OF INTEREST. . . . . . . . . . . . . . . . . . . . . . . . 24 20. CORPORATE POWER AND AUTHORITY. . . . . . . . . . . . . . . . . . . . 24 21. GOVERNMENT APPROVALS . . . . . . . . . . . . . . . . . . . . . . . . 25 22. PUBLIC ANNOUNCEMENTS . . . . . . . . . . . . . . . . . . . . . . . . 25 23. MODIFICATION OF EXHIBITS . . . . . . . . . . . . . . . . . . . . . . 25 24. NO LIABILITY; INDEMNITY. . . . . . . . . . . . . . . . . . . . . . . 25 i 25. COUNTERPARTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 EXHIBITS Exhibit A Contract Area Exhibit B Project Governance Exhibit C Master Services Agreement Exhibit D Engagement Letter Exhibit E Computations Exhibit F Financial Accounting Procedures Exhibit G Form of IOGW Collateral Documents Exhibit H COPAS Form Exhibit I Well Costs Excluding Completion Costs ii JOINT VALUE ENHANCEMENT AGREEMENT --------------------------------- This JOINT VALUE ENHANCEMENT AGREEMENT (the "Agreement") is entered into this 3rd day of December, 2003, by, between and among Infinity Oil & Gas of Wyoming, Inc. ("IOGW"), a Wyoming corporation; Red Oak Capital Management LP, a Delaware corporation ("Red Oak"); and Schlumberger Technology Corporation, a Texas corporation ("Schlumberger"). Red Oak and Schlumberger may be referred to herein individually as a "Service Party" and collectively as the "Service Parties." WHEREAS, the Parties desire to work together to align their common commercial objectives for the purpose of increasing the hydrocarbon potential from IOGW's current and/or future oil and gas interests in certain properties owned or operated by IOGW located in Sublette County, Wyoming as more particularly described in Exhibit A attached hereto ("Contract Area"); WHEREAS, the Parties have the stated preference of working with each other within a contractual and operational framework (the "Project") based on specific principles that are intended to align their common commercial objectives in a manner that will encourage the most efficient use of equipment, personnel, know-how and other technology; WHEREAS, Schlumberger has entered into or will enter into a Master Service Agreement (defined below) with IOGW that sets out the specific terms and conditions of the provision of goods and services by Schlumberger to IOGW with respect to the Contract Area; WHEREAS, Red Oak has entered into or will enter into an Engagement Letter (defined below) with IOGW that sets out the specific terms and conditions of the provision of certain capital resources by Red Oak to IOGW for the development of the Contract Area; WHEREAS, the Parties intend that this Agreement set out and govern the relationship of the Parties with respect to the Contract Area; and WHEREAS, the Parties desire to state the terms and conditions under which the activities described in this Agreement will be conducted by each of them. NOW, THEREFORE, in consideration of the mutual promises, conditions and agreements herein contained, the sufficiency of which is hereby acknowledged, the Parties agree as follows: 1. DEFINITIONS ----------- For purposes of this Agreement, including the Exhibits, except as otherwise expressly provided or unless the context otherwise requires, the terms-defined in this Article have the meanings assigned to them herein and the capitalized terms defined elsewhere in this Agreement by inclusion in quotation marks have the meanings so ascribed to them. 1.1 "AFE" means an Authority for Expenditure prepared for the purpose of estimating the costs to be incurred in connection with a proposal to drill, deepen, plug back, complete, recomplete, sidetrack or rework a Project Well. 1 1.2 "Affiliate" means, with respect to any Person, any other Person controlling or controlled by or under common control with such Person, with the concept of control in such context meaning the possession, directly or indirectly, of the power to direct the management and policies of another, whether by. ownership of voting securities, contract or otherwise. With respect to a corporation, partnership or limited liability company, control is conclusively deemed to exist where a Person owns fifty percent (50%) or more of the voting stock in such corporation or of the voting interest as a partner in such partnership or as a member of such limited liability company. 1.3 "Agreement" means this Joint Value Enhancement Agreement between and among the Parties, including the Exhibits attached hereto or referred to herein. 1.4 "Bundle" means a specific group of Project Wells. The Evaluation Wells selected by Schlumberger for completion shall be referred to as the "First Bundle". The First Bundle may include, at Schlumberger's sole discretion, as few as five (5) or as many as ten (10) Project Wells. The next ten (10) Project Wells that are completed, whether as producers or dry holes, shall be referred to as the "Second Bundle", and successive groups of up to twenty (20) Project Wells that are completed, whether as producers or dry holes, shall be referred to as subsequently numbered Bundles; provided, however, that if for any reason the full number of Project Wells are not drilled, in the final Bundle, then the final Bundle shall consist only of such lesser number of Project Wells as were actually commenced. 1.5 "Business Day" means any day other than a Saturday, a Sunday, or a day on which the United States Postal Service is not scheduled to deliver ordinary first class mail. 1.6 "Deferred Payment" means the payment due a Service Party under the terms of this Agreement in consideration of its provision of Risked Services. 1.7 "Deferred Payment Account" is defined in Article 5.4. 1.8 "Effective Date" means the effective date of this Agreement, being December 3, 2003. 1.9 "Engagement Letter" means that certain letter agreement dated December 3, 2003, entered into between Red Oak Capital Management, LP and IOGW, pursuant to which Red Oak will, at IOGW's request, arrange for financing for a portion of the services provided on the Project Wells within the Contract Area, a copy of which is attached hereto as Exhibit D. 1.10 "Evaluation Wells" means the first group of wells selected by Schlumberger from those listed in Exhibit I to be completed, or recompleted, pursuant to this Agreement. These wells may also be referred to as the First Bundle. 1.11 "Exhibits" means the exhibits to this Agreement, as such exhibits may be amended from time to time. 2 1.12 "Hydrocarbon Production" means all crude oil, natural gas, condensate and other liquid and gaseous hydrocarbons produced from the Contract Area. 1.13 "Master Service Agreement" means, that certain service agreement dated December 3, 2003, entered into between Schlumberger and IOGW, pursuant' to which Schlumberger will provide Services in connection with the Project Wells, a copy of which is attached hereto as Exhibit C. 1.14 "Month" means the period beginning at 7:00 a.m. Mountain time on the first day of any calendar month and ending at the same time on the first day of the next succeeding calendar month. 1.15 "Negative Account Balance" means, at any given time, the amount by which the cumulative value of the Risked Services provided by the Service Parties exceeds the cumulative amount of the Deferred Payments received by the Service Parties. 1.16 "Net Profits" for the Project Wells for any Month shall have the meaning set forth in Exhibit E attached hereto. 1.17 "IOGW's Working Interest" means that portion of the working interest ownership in a given Project Well, (determined according to industry custom and practice) attributable to IOGW's ownership of the lease on which such well is located or the lease in the pooled, unitized or communitized unit associated with such well (including farm-in interests and other related interests). 1.18 "Party" means IOGW, Red Oak or Schlumberger, individually; "Parties" means IOGW, Red Oak and Schlumberger, collectively. 1.19 "Payout" means, with respect to each Bundle, that point in time at which the total of the Deferred Payments received by the Service Parties is equal to the Service Parties' Expenditures on the Project Wells in such Bundle. 1.20 "Percentage" means, as to each Service Party and as to each Bundle, the percentage determined by dividing that Service Party's Expenditures on such Bundle by the Total Well Construction and Completion Costs attributable to that Bundle. The quantum of each Service Party's Percentage shall vary as to a Bundle until all Project Wells in that Bundle have been completed, at which time it will become a fixed percentage as to that Bundle. 1.21 "Person" means any individual, governmental agency, corporation, partnership, joint venture, trust, estate, joint venture, unincorporated organization, or other entity or organization. 1.22 "Project Well" means a well drilled, completed, reworked; deepened, sidetracked or recompleted under the terms of this Agreement. For the avoidance of doubt, each Evaluation Well is a Project Well. 1.23 "Production Costs" shall have the meaning set forth in Exhibit E attached hereto. 3 1.24 "Prudent Standards" means the standards of reasonable and prudent business judgment and sound oil and gas field practices, in compliance with applicable federal, state and local laws, rules and regulations. 1.25 "Recompletion Costs" shall have the meaning set forth in Exhibit E attached hereto. 1.26 "Risked Services" means those Services that a Service Party agrees to provide in exchange for Deferred Payments in accordance with the terms of this Agreement. 1.27 "Representative" means a director, officer, supervisor, employee, partner, technical consultant, attorney, accountant, lender, financial advisor, marketing representative or other consultant or agent of a Party. 1.28 "Service Party Expenditures" means, as to each Service Party, the cumulative value of the Risked Services provided by such Service Party on a given Bundle. 1.29 "Services" means those products, goods and services supplied by the Service Parties to IOGW as set out in Articles 4.1 and 4.2. 1.30 "Third Party" means a Person who is not a Party or an Affiliate of a Party. 1.31 "Total Well Construction and Completion Costs" means the actual charges allocated to IOGW's Working Interest in the Project Well. in connection with the drilling and completing of a Project Well. Such costs shall include without limitations all equipment for which one hundred percent (100%) of the costs of such equipment are allocable to a single Project Well; provided, however, that no portion of Total Well Construction and Completion Costs shall ever duplicate amounts that have been included in the Production Costs or Recompletion Costs for that same well. For purposes of calculating Schlumberger's Percentage in the First Bundle, the Total Well Construction and Completion Costs shall be calculated as the total of Schlumberger's Expenditures and the Well Costs Excluding Completion Costs set out in Exhibit I, each attributable to the applicable Evaluation Well. 1.32 "Unrisked Services" means the Services for which Schlumberger has elected to receive payments under the terms of the Master Service Agreement, rather than Deferred Payments. 2. THE PROJECT WELLS ------------------- 2.1 Overview. IOGW and the Service Parties will work together, using the -------- project governance principles set forth in Article 3, to develop the oil and gas resources contained in that portion of the Contract Area in which IOGW may conduct oil and gas operations, whether through ownership of oil and gas leasehold interests or through communitization, pooling or unitization agreements. 4 2.2 The Evaluation Wells. IOGW and Schlumberger will begin the development --------------------- of the Contract Area by designing a completion program for five (5) of the ten (10) wells listed in Exhibit l. Such wells shall be selected by Schlumberger. 2.3 Operations on the Evaluation Wells are anticipated to provide sufficient data so that the Service Parties may determine whether to proceed with further development under the terms of this Agreement. No later than April 1, 2004,-each Service Party shall notify IOGW whether it wishes to proceed under the terms of this Agreement or whether it wishes to terminate this Agreement' in accordance with Section 8.2.1 below. A Service Party's failure to provide such notice shall be deemed an election by that Service Party to proceed under the terms of this Agreement. 2.4 Field Development Plan. As Services are underway on the Evaluation ------------------------ Wells, the Technical Committee will begin to generate a Field Development Plan, which will identify all prospective drilling locations in the Contract Area, the sequence of drilling these wells, and anticipated drilling and completion protocols for each well. All Project Wells will be drilled and completed in accordance with the Field Development Plan, as approved by the Executive Committee from time to time. 2.5 Election to Participate. The Technical Committee shall provide to the ------------------------ Executive Committee its proposed Field Development Plan for the Second Bundle no later than March 1, 2004. The Executive Committee shall approve such plan, along with any necessary modifications, and shall provide such plan to the Service Parties no later than April 1, 2004. The Service Parties shall notify the Executive Committee in writing of their election to provide Risked Services for, such Bundle no later than May 1, 2004. For each subsequent Bundle of Project Wells, the following shall apply: a) Presentation of the Field Development Plan for the Bundle to the Executive Committee no later than December 1 of the year preceding the calendar year in which drilling is to commence; b) Approval, with necessary modification, by the Executive Committee and provision of such plan to the Service Parties no later than January 1 of the year in which drilling is to commence; and c) Notification by the Service Parties to the Executive Committee of their election to provide Risked Services for such Bundle no later than February 1 of the year in which drilling is to commence. 2.6 Project Coordination Services. Schlumberger agrees, subject to the ------------------------------- direction of IOGW as operator, to provide project coordination services ("Project Coordination Services") with respect to the Contract Area subject to and in accordance with the terms of this Agreement. 5 3. PROJECT GOVERNANCE ------------------- 3.1 Principles. The Parties will work together in a spirit of openness and ---------- cooperation in an effort to achieve efficient Hydrocarbon Production from the Project Wells. A graphic illustration of the Parties' anticipated responsibilities appears in the attached Exhibit B. 3.2 IOGW as Operator. Based upon existing joint operating agreements and ------------------ leasehold ownership, the Parties anticipate that IOGW will be and remain the operator of all of the Project Wells. Nothing in this Agreement shall have the effect of modifying or superseding IOGW's position as operator. It is the stated policy of Schlumberger not to take any equity interest in the leases in the Contract Area, the production or reserves associated therewith or other property of IOGW in consideration for providing the Risked Services; instead, the sole compensation to Schlumberger for providing Risked Services shall be the Deferred Payments. 3.3 Schlumberger as Project Well Coordinator. Schlumberger, acting under ------------------------------------------ the direction of IOGW in its capacity as operator, shall coordinate and facilitate the effective collaboration of IOGW, the Service Parties and any Third Party service providers in the supply of the proposed products and services for the Project Wells. In consideration of its performance of these coordination services; Schlumberger will earn a fee determined by the Executive Committee and included in the approved AFE for each Project Well, the full amount of which shall be included as part of Schlumberger's Service Party Expenditures for that Project Well. 3.4 Executive Committee. Promptly following the execution of this -------------------- Agreement, IOGW and Schlumberger shall establish an Executive Committee consisting of four (4) members, two (2) of which shall be appointed by IOGW from its management and two (2) of which shall be appointed by Schlumberger from its or its Affiliate's management. The Executive Committee shall meet at least once each calendar quarter in Denver, Colorado or as otherwise set out herein. Within seven (7) days after the execution of this Agreement, the Parties will exchange a list of their respective appointments, as well as any designated alternates. IOGW shall designate one (1) of its two (2) members as the Chairman of the Executive Committee (the "Chairman"). The Chairman shall schedule meetings of the Executive Committee, arrange for the preparation and distribution of notices as well as an agenda of the meetings and preside and keep minutes. Special meetings shall be held upon the request of any two (2) members of the Executive Committee under this Agreement. The Chairman shall transmit written notices of all meetings to each member at least seven (7) days in advance of the meeting. A quorum for the conduct of Executive Committee business shall consist of three (3) members, and such quorum may be by person, by proxy, or by telephone. The Executive Committee shall generally oversee all hydrocarbon development and production activities occurring pursuant to this 6 Agreement. Without limiting the generality of the foregoing, the Executive Committee shall have the authority and responsibility to: a. Appoint a committee composed of IOGW and Schlumberger technical personnel ("Technical Committee"), the responsibilities of which shall include, but not be limited to, the preparation and presentation of a plan for completing or recompleting, as applicable, the Evaluation Wells and, if the Executive Committee elects to proceed with further activities, the subsequent development of the Contract Area ("Field Development Plan"), with both IOGW and Schlumberger earning a fee determined by the Executive Committee for their work on the Technical Committee (including any start-up costs) and included (without duplication in subsequent AFEs) in the approved AFE for the next Project Well actually drilled, Schlumberger's share of which shall be included as part of Schlumberger's Service Party's Expenditures for that Project Well and IOGW's share of which shall simply be an accounting entry in determining the Total Well Construction and Completion Cost for such Project Well; b. Approve, with necessary modifications, the Field Development Plan for each Bundle of Project Wells as set out in Article 2.4; c. Approve or disapprove an AFE for each single operation (whether drilling, completing, deepening, plugging back, recompleting, sidetracking or reworking) anticipated to cost more than Fifty Thousand Dollars ($50,000) in connection with a Project Well, with the understanding that such operation will not be undertaken unless there is an approved AFE; d. Attempt to resolve conflicts between the Parties concerning this Agreement and the activities contemplated hereby; e. Recommend appropriate actions to optimize the performance of each Project Well in accordance with good production practices; and f. Provide IOGW and Schlumberger quarterly reports on the activities conducted pursuant to this Agreement, the Service Parties' Expenditures in respect of each Bundle, and a computation of each Service Party's Percentage in respect of each Bundle. Matters requiring Executive Committee action shall be decided by unanimous vote of the Executive Committee members present at a meeting and voting in person, by proxy or by telephone. All proxies shall be in writing. Any action permitted to be taken by the Executive Committee may also be taken without a meeting by means of a written consent to the action signed by all members of the Executive Committee. 7 3.5 Field Development Plan Amendments. From time to time, the Executive ------------------------------------ Committee will review the proposals submitted by the Technical Committee, including the information and recommendations derived by the Technical Committee, and will establish a Field Development Plan that ultimately will provide for the drilling and completion of all of the Project Wells. The Executive Committee shall provide to each Service Party a copy of the initial Field Development Plan following its adoption by the Executive Committee and shall thereafter timely inform each Service Party of all amendments and additions to the Field Development Plan. 3.6 Recommendation Not To Complete. If, following formation evaluation and ------------------------------ production forecasting, Schlumberger reasonably determines that the present value of the future Net Profits from Hydrocarbon Production from a Project Well, discounted at ten percent (10%), is less than one hundred percent (100%) of the total expected AFE amount, Schlumberger will recommend that IOGW not complete such well. Schlumberger and Red Oak shall receive Deferred Payments for Risked Services provided on such well both prior to and following Schlumberger's recommendation not to complete in accordance with this Agreement. If IOGW elects to complete such well then all Deferred Payments (determined by the Service Parties' Percentages on the date of their election not to complete) attributable to such well shall be paid to IOGW until IOGW has received an amount equal to the value of the Unrisked Services provided to IOGW on such well after Schlumberger elects not to complete such well times the applicable multiplier for such Bundle as set out in Section 5.2.1. 4. THE SERVICES ------------- 4.1 Schlumberqer's Services and Exclusivity. IOGW hereby grants to ------------------------------------------ Schlumberger for the term of this Agreement the exclusive right to provide the following Services in the Contract Area, so long as Schlumberger can deliver its Services as reasonably requested by the Executive Committee at Schlumberger's prevailing market price: i. coordination of field services ii. well cementing products and services iii. formation evaluation logging products and services iv. well completion products and services v. data management and consulting services vi. well perforating products and services vii. well testing and evaluation products and services viii. directional drilling and measurement products and services ix. well stimulation fracturing and acidizing products and services x. coiled tubing products and services xi. supply of downhole pumps xii. slickline products and services xiii. well/field monitoring and measurement products and services 8 IOGW shall not enter into any agreement that conflicts with the exclusivity granted to Schlumberger herein, although IOGW does reserve the right freely to contract with Third Parties for such Services as Schlumberger may be unable to provide as reasonably requested by the Executive Committee at Schlumberger's prevailing market price. 4.2 Red Oak's Services. Upon Schlumberger's designation of the percentage ------------------- of its Services it will provide as Risked Services, Red Oak shall have the exclusive right to provide funding, as described in the Engagement Letter for any Unrisked Services described in Article 4.1 required on any Bundle. 4.3 Identification of Risked Services. Schlumberger shall provide * ------------------------------------ percent (*%) of its Services in connection with the First Bundle as Risked Services. If the Service Parties elect to provide Risked Services on subsequent Bundles, the Service Parties shall participate in each such Bundle as follows: (i) Schlumberger shall risk payment for * percent (*%) of the value of the Services it provides on each Project Well and (ii) Red Oak shall provide funding, as Risked Services, for * percent (*%) of the AFE costs of the Services provided by Schlumberger on each Project Well. The Parties estimate that the Risked Services provided by the Service Parties will be approximately * percent (*%) of the total Well Construction and Completion Costs. Schlumberger shall notify the Executive Committee of its and Red Oaks' election to provide Risked Services on or before the deadline for the applicable Bundle as set out in Article 2.5. The notice shall indicate the Service Parties' availability and the proposed timing for the provision of such Services. 4.4 Limitation on Amount of Risked Services. ---------------------------------------- 4.4.1 Service Parties Limitations. Notwithstanding the provisions of --------------------------- Section 4.3, the Service Parties shall be under no obligation to undertake Risked Services that are anticipated to produce more than (i) an anticipated US Two Million Five Hundred Thousand Dollar ($2,500,000) Negative Account Balance in connection with the Risked Services they propose to provide for the Evaluation Wells; (ii) more than a US Three Million Dollar ($3,000,000) Negative Account Balance in connection with the Risked Services they propose to provide for all Project Wells in the first Bundle; (iii) more than a US Six Million Dollar ($6,000,000) Negative Account Balance in connection with the Risked Services they propose to provide for all Project Wells in each Bundle thereafter. Finally, the Service Parties shall have no obligation to provide any Risked Services in connection with any proposed Project Well unless each is satisfied in its reasonable discretion that IOGW has or will have appropriate means to satisfy all cash expenditure requirements associated with all Project Wells in that Bundle. 9 4.4.2 Absolute Limitation. The Service Parties shall in no event be -------------------- obligated to provide Risked Services in an amount which results in the Service Parties' Percentages in a Project Well exceeding fifty percent (50%) of IOGW's Working Interest in such well. Notwithstanding any other provision of this Agreement, the Percentages of all Service Parties in a Project Well may never exceed IOGW's Working Interest in that well. 5. SERVICE PARTY COMPENSATION ---------------------------- 5.1 Unrisked Services. Any Unrisked Services provided by Schlumberger ------------------ shall not be governed by this Agreement, but instead shall be governed by the Master Service Agreement. 5.2 Risked Services. ----------------- 5.2.1 Service Parties' Deferred Payments. In consideration for the ------------------------------------ performance of Risked Services on a Bundle, IOGW shall pay to the Service Parties Deferred Payments equal to (i) * percent (*%) of the Net Profits of each Project Well multiplied by the applicable Service Party's Percentage from the date of first sale of production from the first Project Well completed or recompleted in a given Bundle until Payout and (ii) * percent (*%) of the Net Profits of each Project Well multiplied by each Service Party's Percentage after Payout . The Service Parties' right to Deferred Payments as to such Bundle shall commence in the month that Hydrocarbon Production is first sold from a Project Well in that Bundle and shall end: (i) for the Evaluation Wells (the First Bundle), when Schlumberger has received Deferred Payments equal to * percent (*%) of Schlumberger's Service Party Expenditures on such Bundle; (ii) for the Second, Third and Fourth Bundles, when each Service Party has received Deferred Payments equal to * percent (*%) of such Service Party's Expenditures on each Bundle; and (iii) for the Fifth and any subsequent Bundles, when each Service Party has received Deferred Payments equal to * percent (*%) of such Service Party's Expenditures on each Bundle. 5.2.2 Red Oaks' Net Profit Interest. In consideration for Red Oak's ------------------------------ Expenditures, IOGW hereby GRANTS, BARGAINS, SELLS, CONVEYS, ASSIGNS, TRANSFERS, SETS OVER AND DELIVERS unto Red Oak an interest in the Project Wells equal to the Net Profits multiplied by Red Oak's Percentage until Red Oak has received Deferred Payments in the amounts set out in Article 5.2.1 (the "Net Profits Interest"). 10 5.3 Deferred Payment Timing. IOGW shall pay Deferred Payments to each ------------------------- Service Party no later than the 15th day of the second Month following the Month during which the sale of Hydrocarbon Production occurred. For example, if the first sale of Hydrocarbon Production from a Project Well in a Bundle occurs on January 15, then the first Deferred Payment calculated on Net Profits, if any, shall be due no later than March 15. Such Deferred Payments shall be accomplished by wire transfer pursuant to instructions given by each Service Party to IOGW. 5.4 Deferred Payment Account. IOGW shall maintain an account (the -------------------------- "Deferred Payment Account") on its books and records for each Service Party in respect of each Bundle. Each Deferred Payment Account shall be credited with the aggregate of any Gross Proceeds received by IOGW after the Effective Date for each Project Well in the Bundle, and shall be charged with the aggregate Production Costs incurred after the Effective Date. On or before the date of payment as set forth in Article 5.3 hereof, IOGW shall furnish to each Service Party a detailed statement clearly reflecting the credits and debits against and the balance of the Deferred Payment Account as of the close of business on the last day of the preceding Month. Any Excess Production Costs reflected by any such statement shall be carried forward to the next and succeeding month or months until the Excess Production Costs shall have been liquidated. 5.5 Deed of Trust. As security for the payment and performance of all of --------------- IOGW's obligations to Schlumberger hereunder, IOGW shall, upon request by Schlumberger, execute and acknowledge a Mortgage, Assignment of Production and Security Agreement as to each Bundle in the form of the attached Exhibit G1 together with such financing statements and other instruments as Schlumberger may reasonably request in order properly to perfect the lien and security interests created by the Mortgage. Schlumberger shall file the Mortgage in all appropriate records to properly perfect the lien and security interest created thereunder. In addition, IOGW shall, from time to time, execute all such further and additional instruments including, without limitation, financing statements, as Schlumberger may reasonably request in order to properly perfect the lien and security interests created under the Deed of Trust. IOGW agrees that Schlumberger may at any time assign, transfer or otherwise convey all or part of its right to receive Deferred Payments pursuant to this Agreement to any Person (herein called the "Deferred Payment Assignee"). Concurrently with any such conveyance to Deferred Payment Assignee, (a) Schlumberger's right to receive the applicable Deferred Payments pursuant to this Agreement shall be automatically converted to a net profits interest, (b) IOGW shall execute and deliver to such Deferred Payment Assignee an assignment of net profits interest in substantially the same form as set forth in Exhibit G-2, (c) IOGW shall amend the Memorandum of Assignment of Net Profits Interest described in Section 5.6 below to reflect the Deferred Payment Assignee's Percentage, and (d) Schlumberger shall terminate the liens created by the Security Agreement as they relate to the applicable Deferred Payments and deliver to IOGW executed releases, in form and substance reasonably satisfactory to IOGW, to evidence such termination. 11 5.6 Memorandum of Assignment. IOGW shall, contemporaneously with the ------------------------- completion of Services on an Evaluation Well or any subsequent Project Well, execute and file a Memorandum of Assignment of Net Profits Interest substantially in the form attached as Exhibit G-2. IOGW shall from time to time amend such Memorandum of Assignment of Net Profits Interest to reflect Red Oak's Percentage. Final adjustment to Red Oak's Percentage and payments to reallocate payments made under inaccurate interim percentages shall be made by the Parties not more than ninety (90) days after completion of the Services on a given Bundle. 5.7 Schlumberger Production Facilities Audit. At any time during which ------------------------------------------- Schlumberger is entitled to receive Deferred Payments, Schlumberger shall have the right to enter the Contract Area and to audit the surface facilities to assess the performance of such facilities. Schlumberger may provide to the Executive Committee a recommendation regarding improvements or modifications to the facilities with a view to improving the flow of Hydrocarbon Production for eventual sale. The Executive Committee will review on a timely basis any such recommendations by Schlumberger and, if approved by the Executive Committee, the Field Development Plan shall be amended to include such activities. 5.8 Payment for Unrisked Services. Payment for all Unrisked Services -------------------------------- provided by Schlumberger on each Bundle shall be due and payable according to the terms of the Master Service Agreement. 5.9 Interest on Past Due Payments. Any amount not paid by IOGW when due -------------------------------- shall bear, and IOGW will pay, interest at the interest rate set forth in the Master Service Agreement or Engagement Letter, as applicable, for late payments. 6. OPERATION OF THE PROJECT WELLS ---------------------------------- 6.1 Prudent Operator Standard. IOGW will conduct and carry on or cause to -------------------------- be conducted and carried on the exploration, development, maintenance and operation of the Project Wells in compliance with applicable federal, state, and local laws, rules, and regulations and in accordance with the standards of reasonable and prudent business judgment and sound oil and gas field practices customarily employed by oil and gas operators in the Contract Area. 6.2 Cost Overruns. Subject to emergency responses identified by IOGW in accordance with its obligations under Section 6.1, IOGW may incur expenditures of up to one hundred ten percent (110%) of the total amount anticipated in the AFE for a particular operation without consultation with the Executive Committee. When IOGW reasonably anticipates that the one hundred ten percent (110%) limit set forth in the preceding sentence will be exceeded, however, IOGW shall furnish to the Technical Committee a reasonably detailed estimate of the 12 anticipated overexpenditure and the reasons therefor. Following consultation with the Technical Committee, IOGW shall revise the AFE and provide the revised AFE to the Executive Committee for its approval or modification. 6.3 Production Monitoring and Surveillance. Schlumberger shall monitor the -------------------------------------- relevant production and parameters from the appropriate number of nodes (selected individual wells and field level gathering points) using its proprietary real time web based system to provide data in order continually to assist in the optimization of the Contract Area. 6.4 Partial Disposal of Properties. IOGW shall have the right in its sole -------------------------------- discretion at any time and from time to time to dispose of its oil and gas interests in the Contract Area, whether by farmout, exchange, assignment or otherwise, free and clear of the terms of this Agreement; provided, however, that IOGW shall not dispose of so much of its interest that its loses control of the right to operate the properties in the Contract Area. In addition, this Article 6.4 shall not permit IOGW's disposal at any time of either a Project Well or a drill site and the immediately surrounding offset locations of an anticipated Project Well that has been identified as a possible well location in the Field Development Plan. 6.5 Abandonment of Properties. Nothing herein contained shall obligate ---------------------------- IOGW to drill or complete any well in the Contract Area, to continue to operate any well in the Contract Area, or to operate or maintain in force or attempt to maintain in force any lease when the Executive Committee determines that such well or lease is not economical. No Service Party shall ever have any liability for the plugging, abandonment or reclamation of any Project Well, although plugging, abandonment and reclamation costs are included as Production Costs. 6.6 Development of Formations Outside this Agreement. IOGW shall have the ------------------------------------------------- right in its sole discretion at any time and from time to time to drill, complete and operate oil and gas wells in the Contract Area, free and clear of the terms of this Agreement; provided, however, that this Article 6.6 shall not permit the drilling by IOGW of a well within the spacing unit (or the 40-acre quarter-quarter section of the government survey, if no spacing has been adopted) of either a Project Well or an anticipated Project Well that has been approved by the Executive Committee for inclusion in a Bundle, unless IOGW's well is drilled solely to test and produce formations that are not subject to this Agreement and such testing or drilling does not affect Hydrocarbon Production from any Project Well. 6.7 Delay Rentals, Minimum Royalties, and Shut-in Gas Payments. IOGW shall ---------------------------------------------------------- use reasonable commercial efforts to pay or cause to be paid in a proper and timely manner all delay rentals, minimum royalties, and shut-in gas payments which may be necessary to maintain its leases in the Contract Area in full force and effect, except to the extent that IOGW has decided to dispose of or abandon such leases. Notwithstanding anything to the contrary herein, IOGW shall not be liable to any Service Party for failure to pay or for incorrect payment of delay rentals, minimum royalties, shut-in gas payments, or any other contractual obligations. 13 6.8 Marketing Hydrocarbon Production. IOGW shall market Hydrocarbon ---------------------------------- Production in accordance with Prudent Standards, taking into account relevant locations, qualities and other circumstances. IOGW shall never market Hydrocarbon Production to its Affiliates or in any transaction other than an arms'-length transaction. 6.9 Insurance. IOGW shall maintain or cause to be maintained, during the --------- period of time that any of the Service Parties are entitled to receive Deferred Payments, insurance coverage that is consistent with the requirements of the joint operating agreement applicable to the concerned Project Well. 7. EARLY BUYOUT OR DISPOSAL --------------------------- 7.1 Disposal Notice. After the completion of fifty (50) Project Wells, ---------------- excluding the Evaluation Wells, IOGW may elect to dispose, by sale, transfer, assignment, conveyance or otherwise, of all or any part of the Contract Area in an arm's length transaction to a non-Affiliate (a "Permitted Disposal"). If IOGW makes such election during the term of this Agreement, or at any time during which the Service Parties are entitled to receive Deferred Payments, IOGW shall provide the Service Parties not less than sixty (60) days prior written notice of IOGW's intention to make such a disposal ("Disposal Notice"). Except for a Permitted Disposal, IOGW may not sell, transfer, assign, convey or otherwise dispose of all or any part of the Contract Area during the term of this Agreement or at any time during which the Service Parties are entitled to receive Deferred Payments. 7.2 Disposal Payment. In the event IOGW consummates a Permitted Disposal, ----------------- each Service Party shall terminate its Net Profits Interest or Mortgage insofar as it burdens the property included in the Permitted Disposal upon the Service Party's receipt of a lump sum payment from IOGW calculated as set out in Article 7.4 below ("Disposal Payment") in lieu of its entitlement to any further Deferred Payments under this Agreement attributable to the property included in the Permitted Disposal. The Disposal Payment shall be made by IOGW directly to each Service Party by wire transfer in immediately available funds on the same date that IOGW receives funds or other consideration attributable to such Permitted Disposal. 7.3 Early Buyout Notice. If, at any time after the termination of this --------------------- Agreement, IOGW desires to buyout a Service Party's remaining entitlement to receive future Deferred Payments, IOGW shall provide sixty (60) days advance written notice to the Service Party of its intent to exercise such an early buyout ("Early Buyout Notice"). Upon such election, the Service Party shall be entitled to receive an amount equal to the Disposal Payment. Such amount shall be paid by IOGW to Service Party within forty-five (45) days of the date of IOGW's Early Buyout Notice. 7.4 Determination of the Disposal Payment. The "Disposal Payment" shall be ------------------------------------- calculated at any time and as to each Service Party as the total of all Deferred Payments that the Service Party would otherwise be 14 entitled to receive pursuant to Article 5.2.1 hereof less any Deferred Payments that have been made to such Service Party through the date of the Disposal or Early Buyout Notice, as applicable. 8. TERM ---- 8.1 Term. This Agreement shall remain in force and effect for six (6) ---- years after the Effective Date, unless earlier terminated pursuant to Article 8.2. 8.2 Termination. This Agreement may be terminated by written notice from ----------- the terminating Party to all other Parties in accordance with the following provisions: 8.2.1 Immediately by any Service Party pursuant to Article 2.3 no later than April 1, 2004; 8.2.2 Upon thirty (30) days notice by any Party, after the Project Wells in five (5) Bundles have been completed; 8.2.3 Upon thirty (30) days notice by any Service Party, if, through no fault of such Service Party, at least ten (10) Project Wells have not been commenced in a calendar year; 8.2.4 Immediately by any Party, without prejudice to its other rights, if another Party becomes insolvent, makes a general assignment for the benefit of its creditors, applies for or consents to the appointment of a receiver, trustee or liquidation of all or substantially all of its assets, has an involuntary petition in bankruptcy filed against it which is not dismissed within sixty (60) days or fails to pay its debts and obligations as they become due, or if the terminating Party reasonably believes that any of the above events is likely to occur; 8.2.5 Immediately by any Party, without prejudice to its other rights, if another Party fails to pay any obligation under this Agreement within thirty (30) Business Days after the same shall become due and payable, or if such other Party fails to duly observe, perform or comply with any other covenant, agreement, condition or provision of this Agreement and such failure remains unremedied for a period of thirty (30) days after written notice of such failure is given by the non-breaching Party to the breaching Party; or. 8.2.6 By mutual agreement of the Parties, on such terms as they may agree. 8.3 Survival. Notwithstanding any termination of this Agreement in -------- accordance with Section 8.2, (i) the obligation of IOGW to make Deferred Payments under Article 5 in respect of each Bundle shall continue for the full period provided by Article 5.2 for that Bundle 15 and (ii) the confidentiality provisions of Article 10 shall continue for a period of eighteen (18) months following the termination of this Agreement. 8.4 Return of Property. IOGW shall promptly return all property of each -------------------- Service Party, if any, that is in IOGW's possession or under its control upon termination of this Agreement. Similarly, each Service Party shall promptly return to IOGW all property of IOGW, and to each Service Party all property belonging to that Service Party, which is in such Service Party's possession or under its control upon termination of this Agreement. 9. GENERAL TERMS AND CONDITIONS ------------------------------- 9.1 Effect of Master Service Agreement. IOGW agrees that the provision of ----------------------------------- Services by Schlumberger shall be governed by the terms and conditions contained in the Master Service Agreement. To the extent that any term or condition set forth in the Master Service Agreement is not addressed in this Agreement, the Master Service Agreement shall apply. To the extent that any indemnity is extended by any Party in the Master Service Agreement, it is agreed that, for the purposes of this Agreement, such indemnities shall apply to the extent they are applicable. To the extent that any term or condition set forth in the Master Service Agreement conflicts with the provisions of this Agreement, the provisions of this Agreement shall control. The Master Service Agreement is incorporated herein by reference thereto for all purposes and is made a part hereof. 9.2 Other Documents. In the event any Party issues any acknowledgment, ---------------- delivery ticket, invoice, purchase order or other instrument whose terms are inconsistent with any of the terms or provisions of this Agreement, such terms shall be unenforceable and the terms of this Agreement shall control. 10. CONFIDENTIAL INFORMATION AND INTELLECTUAL PROPERTY ------------------------------------------------------ 10.1 Confidential Information. "Confidential Information" means information ------------------------ unavailable from public sources that any of the Parties considers confidential and proprietary information, including, but not limited to, seismic records and tapes, interpreted well logs, maps, engineering data, and financial information relating to the Contract Area, together with nonproprietary seismic data that has been licensed from Third Parties under terms which restrict the licensee's use, disclosure, or display of such data. 10.2 Nondisclosure. Each Party agrees that any Confidential Information ------------- obtained by it from any other under the terms of this Agreement will be held in strict confidence and will not be disclosed by it to any Third Party without written authorization from the originating Party, unless such information (i) is in the public domain through no fault of the disclosing Party, (ii) is required to be publicly disclosed under applicable securities laws, or (iii) is acquired independently from a Third Party that represents that it has the right to disseminate such information at the time it is acquired. Each Party agrees to limit access to such Confidential Information only to those of its Affiliates and Representatives who have a need under or in furtherance of this Agreement to review such Confidential Information. 16 10.3 Other Working Interest Owners. Notwithstanding the foregoing, the -------------------------------- terms of this Agreement and all related financial information may be disclosed by IOGW to Third Parties owning working interests in a Project Well, but only if such working interest owners are entitled to such information under agreements existing as of the Effective Date hereof and have agreed to be bound by the confidentiality provisions of this Agreement. 10.4 Confidential Procedures of Schlumberger. IOGW acknowledges that the ------------------------------------------ procedures, processes, methods and know-how used in rendering the Services and the formulas, components, mixtures, specifications and other descriptions of the oilfield products are considered confidential and proprietary to Schlumberger and will not be divulged to IOGW. IOGW agrees that it and its' Affiliates shall hold the same in strictest confidence and shall not to attempt to analyze or test any oilfield products provided by Schlumberger, including mixtures, to determine their formula or components. 10.5 Confidential Procedures of IOGW. The Service Parties acknowledge that -------------------------------- their personnel will have access to certain procedures, processes, methods, know how and practices used by IOGW in its business planning and its development of the Contract Area. Each Service Party agrees that it and its Affiliates shall treat IOGW's information provided to such personnel as confidential and proprietary, shall not use the Confidential Information for any purpose other than to render its Services to IOGW, and shall not disclose the same to Third Parties or to any of its' or its' Affiliates personnel, other than those of its Representatives who have a need to review such Confidential Information for the purposes stated herein. 10.6 Confidential Designs, Drawings, Information and Data. IOGW shall treat ---------------------------------------------------- as secret and confidential, and shall not, except in connection with this Agreement, make any use whatsoever of any designs, drawings, information or data furnished to IOGW by the Service Parties hereunder. Similarly, the Service Parties shall treat as secret and confidential, and shall not, except in connection with this Agreement, make any use whatsoever of any designs, drawings, information or data furnished by IOGW hereunder. 10.7 No Intellectual Property Assignments. Nothing in this Agreement shall ------------------------------------- be deemed to constitute or result in an assignment to one Party of any trademarks or Confidential Information owned or used by any other Party, or the creation of any equitable or other interest therein, or to grant one Party any right to use the trademarks owned or used by any other Party or the other Party's Confidential Information. Each Party agrees never to impugn or challenge, or to assist in any challenge to the validity of, the trademarks, any registration thereof or any other Party's ownership thereof. 17 10.8 New Copyrights and Patents. Schlumberger shall have the right to ----------------------------- obtain copyrights or patents on any method, material or equipment originating in whole or in part from Schlumberger arising in the course of or out of this Agreement. 10.9 Copyright and Patent Cooperation and Use. IOGW shall provide --------------------------------------------- reasonable cooperation in all efforts by Schlumberger to obtain such patents and copyrights, and will be reimbursed a reasonable amount for the time and expense required in providing such cooperation. If requested by IOGW, Schlumberger shall grant to IOGW an irrevocable, royalty-free license to use any patents developed out of this Agreement exclusively for IOGW's use in the normal course of its business, but any such license shall not be sold, licensed or otherwise transferred to a Third Party without the approval of Schlumberger. If requested by IOGW, Schlumberger shall grant to IOGW an irrevocable license, free from royalty, for IOGW's internal use only of any copyrighted process, method or the like developed hereunder. It is understood and agreed that IOGW shall have no right to grant any sublicense to Third Parties. 10.10 Proceedings to Compel Disclosure. If a Party hereto, or its ----------------------------------- Representative, is required by any court or legislative or administrative body to disclose any Confidential Information belonging to any other Party, the Party required to make such disclosure shall provide the disclosing Party with prompt notice of such requirement in order to afford the disclosing Party the opportunity to seek an appropriate protective order. If, however, the Party seeking to prevent the disclosure does not seek or is unable to obtain such protective order, then the Party required to compel such Confidential Information may disclose such Confidential Information, without liability to the other Party, if such disclosure is, in the opinion of counsel, compelled under pain of liability for contempt or other penalty. 10.11 Injunctive Relief. In the event of breach or threatened breach by one ----------------- Party or its Representatives of the provisions of this Article 10, the disclosing Party shall be entitled to an injunction or judicial order equivalent thereto restraining that Party or its Representatives from using or disclosing, in whole or in part, such Confidential Information. Nothing herein shall be construed as prohibiting any Party from pursuing any other remedies available to it for such breach or threatened breach, including recovery of damages from the other Party. 10.12 Indemnification. Schlumberger will defend, at its sole expense, legal --------------- proceedings brought within the United States against IOGW or Schlumberger claiming direct infringement of copyright, theft of trade secret or violation of other intellectual property rights based upon any method, material or equipment used or provided by Schlumberger in performance of the Services, excluding however any method, material or equipment provided by IOGW to Schlumberger. Schlumberger will indemnify and hold IOGW harmless from and against any judgment by a court of competent jurisdiction for damages arising from any such claim, provided that Schlumberger will have no liability or obligation 18 to IOGW under this Agreement for infringement of any patent, intellectual property or other proprietary right or claim thereof which is based upon Schlumberger's compliance with IOGW's specifications or if IOGW makes any admission regarding infringement. Furthermore, Schlumberger shall have no liability or obligation to defend or indemnify IOGW under this Article 10 unless Schlumberger: (i) is notified promptly in writing by IOGW of each notice and communication regarding any claim, (ii) is given the complete authority, information and assistance necessary for such defense and (iii) is given sole control of the defense of any action and of all negotiations for its settlement or compromise. 11. NOTICES ------- Any notice required under the terms of this Agreement shall be in writing, addressed to the Party to whom sent, and transmitted prepaid by air courier, telecopy, or email or other facsimile transmission with confirmed answerback and with signed original to follow by air courier. All such notices in compliance with this provision shall be deemed given when actually delivered to the recipient's address. For purposes of this Agreement, the addresses of the Parties are as follows until changed by written notice from the Party desiring to change its address to the other Parties: If to Schlumberger: Schlumberger Technology Corporation 6501 South Fiddler's Green Circle, Greenwood Village, Colorado 80111, Telephone: 303 486 3253 Facsimile: 303 486 3249 Attention: Paul DeBonis Email: debonis1@denver.oilfield.slb.com cc: NAM General Counsel 300 Schlumberger Drive Sugar Land, Texas 77478 If to IOGW: Infinity Oil & Gas of Wyoming, Inc. 950 17th Street, Suite 800 Denver, Colorado 80202 Telephone: 720-932-7800 Facsimile: 720-932-5409 Attention: Stanton E. Ross Email: cc: Infinity Inc. 211 West 14th Chanute, Kansas 66720 Telephone: 620-431-6200 Facsimile: 620-431-6262 Attention: Stanton E. Ross cc: Davis, Graham & Stubbs LLP 1550 17th Street Suite 500 Denver, Colorado 80202 19 Telephone: 303-892-9400 Facsimile: 303-892-1379 Attention: Deborah Friedman If to Red Oak: Red Oak Capital Management, LLC 11757 Katy Freeway, Suite 300 Houston, Texas 77079 Telephone: 281-493-4450 Facsimile: 281-493-4490 Attention: James Whipkey Email: whipkey@redoakcap.com 12. MISCELLANEOUS PROVISIONS ------------------------- 12.1 Governing Law. This. Agreement shall be governed by and construed in -------------- accordance with the laws of the State of Colorado. 12.2 Dispute Resolution. Any controversy, dispute or claim arising out of ------------------- or relating to this Agreement (a "Dispute") shall be resolved in accordance with this Section 12.2. Any Party may give to another Party written notice (a "Dispute Notice") of any Dispute which has not been resolved in the normal course of business. Within fifteen (15) Business Days after delivery of the Dispute Notice, the receiving Party shall submit to the other Party a written response (the "Response"). The Dispute Notice and the Response shall each include (i) a statement setting forth the position of the Party giving such notice, a summary of the arguments supporting such position and, if applicable, the relief sought and (ii) the name and title of a senior manager of such Party who has authority to settle the Dispute and will be responsible for the negotiations related to the settlement of the Dispute (the "Senior Manager"). Within ten (10) days after delivery of the Response, the Senior Managers of the disputing Parties shall meet or communicate by telephone at a mutually acceptable time and place, and thereafter as often as they reasonably deem necessary, and shall negotiate in good faith to attempt to resolve the Dispute that is the subject of such Dispute Notice. If such Dispute has not been resolved within sixty (60) days after delivery of the Dispute Notice, then the Parties shall submit the Dispute for arbitration administered by the American Arbitration Association (the "AAA") in accordance with the terms of this Section 12.2, the Commercial Arbitration Rules of the AAA, and, to the maximum extent applicable, the United States Arbitration Act. Judgment on any matter rendered by arbitrators may be entered in any court having jurisdiction. Any arbitration shall be conducted before one (1) arbitrator. The arbitrator shall be an individual knowledgeable in the subject matter of the Dispute. If the disputing Parties are not able to agree upon an arbitrator within thirty (30) Business Days after the request for an arbitration, then any 20 Party may request the AAA to select the arbitrator. The arbitrator may engage engineers, accountants or other consultants he or she deems necessary to render a conclusion in the arbitration proceeding. To the extent practicable, an arbitration proceeding hereunder shall be concluded within ninety (90) Business Days of filing a Dispute with the AAA. Arbitration proceedings shall be conducted in Houston, Texas. At the conclusion of any arbitration proceeding, the arbitrator shall make specific written findings of fact and conclusions of law. The arbitrator shall have the power to award recovery of all costs and fees to the, prevailing party. All fees of the arbitrator and any engineer, accountant or other consultant engaged by the arbitrators, shall be shared equally unless otherwise awarded by the arbitrators All negotiations between the Senior Managers pursuant to this Section 12.2 shall be treated as compromise and settlement negotiations. Nothing said or disclosed, nor any document produced, in the course of such negotiations that is not otherwise independently discoverable shall be offered or received as evidence or used for impeachment or for any other purpose in any current or future arbitration or litigation. 12.3 Compliance with Laws. Each Service Party agrees to comply in material --------------------- respects with all laws, statutes, codes, rules, and regulations, which are now or may become applicable to its Services or arising out of the performance of its Services. 12.4 Amendment; Entire Agreement; No Waiver. No modification of this ------------------------------------------ Agreement shall be of any force or effect unless in writing and signed by an authorized signatory of all Parties. This Agreement, together with any service orders, service requests and the Exhibits attached hereto, constitutes the entire understanding between the Parties with respect to the subject matter hereof and supersedes all prior agreements, negotiations and discussions of the Parties in relation to its contents. Failure to enforce any or all of the terms and conditions of this Agreement in a particular instance or instances shall not constitute a waiver thereof or preclude subsequent enforcement thereof. 12.5 Assignment. IOGW may not assign its rights or obligations under this ---------- Agreement without the prior written consent of the Service Parties, which shall not be unreasonably withheld. Each Service Party shall have the right to assign all rights and obligations under this Agreement to an Affiliate, without prior consent of IOGW. No Service Party will transfer or assign its respective rights and obligations under this Agreement, except its right to receive payments hereunder, to a non-Affiliate without the prior written consent of IOGW. 12.6 Rules of Construction. All references in this Agreement to articles, ----------------------- sections, subsections and other subdivisions refer to corresponding articles, sections, subsections and other subdivisions of this Agreement unless expressly provided otherwise. Titles appearing at the beginning of any of such subdivisions are for convenience only and shall not constitute part of such subdivisions and shall be disregarded in construing the language contained in such subdivisions. The words "this Agreement", "this instrument", "herein", "hereof", "hereunder"' and words of similar import refer to this Agreement as a whole and not to any particular subdivision unless expressly so limited. Unless the context otherwise requires: "including" and its grammatical variations mean "including without limitation"; "or" is not exclusive; words in the singular form shall be construed to include the plural and vice versa; words in any gender include all 21 other genders; references herein to any instrument or agreement refer to such instrument or agreement as it may be from time to time amended or supplemented; and references herein to any Person include such Person's successors and assigns. All references in this Agreement to exhibits and schedules refer to exhibits and schedules to this Agreement unless expressly provided otherwise, and all such exhibits and schedules are hereby incorporated herein by reference and made a part hereof for all purposes. 13. SEVERABILITY; SAVINGS CLAUSE ------------------------------ Any provision or term of this Agreement that is or may be void or unenforceable shall, to the extent of such invalidity or unenforceability, be deemed severable and shall not affect any other provision of this Agreement. All Parties agree that the exculpatory, indemnification and hold harmless provisions herein, or in the Master Service Agreement which is incorporated herein by reference, shall be modified or altered only insofar as required by a jurisdiction purporting to limit such provisions, it being the intention of the Parties to enforce to the fullest extent all terms and conditions herein agreed to. 14. WARRANTIES/DISCLAIMERS ---------------------- 14.1 Service Party Disclaimer. In preparing technical recommendations, -------------------------- Schlumberger shall provide IOGW the benefit of its best judgment based on its experience. All such technical recommendations are opinions only, and it may not be possible for Schlumberger to obtain first-hand knowledge of the many variable conditions that could affect the outcome of the services. NO WARRANTY IS GIVEN AS TO THE EFFECTIVENESS OR RESULTS OF THE SERVICES THAT WILL BE RENDERED HEREUNDER, NOR AS TO THE OUTCOME OF IMPLEMENTATION OF ANY TECHNICAL RECOMMENDATION. SCHLUMBERGER MAKES NO WARRANTY, EXPRESS OR IMPLIED, WITH RESPECT TO THE SERVICES, EXCEPT TO THE EXTENT, IF ANY, SET FORTH IN THE MASTER SERVICE AGREEMENT. MOREOVER, SCHLUMBERGER MAKES NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, COMPLETENESS OR MATERIALITY OF ANY DATA, INFORMATION OR RECORDS FURNISHED TO ANY OTHER PARTY IN CONNECTION WITH THIS AGREEMENT. 14.2 IOGW Title Warranty. IOGW represents and warrants to the Service --------------------- Parties that it will be the owner (or have appropriate operational rights under a farmout or earning agreement from the owner) of the leasehold interests constituting the drill site of a Project Well, but only to extent indicated and subject to the encumbrances identified in 22 the drilling opinion furnished by IOGW to the Service Parties with the AFE for such Project Well. IOGW will take appropriate steps to maintain such interest in good standing and free and clear of all liens, charges, encumbrances and claims whatsoever. To the best of IOGW's knowledge, there is no claim, action or administrative proceeding pending which may jeopardize title to any interest IOGW holds on the Effective Date. IOGW shall provide such documentation to the Service Parties as they may reasonably require to satisfy themselves that IOGW owns such interests. 14.3 Overriding Royalty Interests. IOGW represents and warrants that ------------------------------ neither it nor its Affiliates, nor its or their officers, directors or, to the best of its knowledge, employees holds, either directly or indirectly, or has the right to receive an overriding royalty interest in the Contract Area. 15. FORCE MAJEURE -------------- If, as a result of an event of Force Majeure, any Party is rendered unable, wholly or in part, to carry out its obligations under this Agreement, other than the obligation to pay any amounts due or to furnish security, then the obligations of that Party, so far as and to the extent that the obligations are affected by such event of Force Majeure, shall be suspended during the continuance of any inability so caused, but for no longer period. The Party claiming Force Majeure shall notify the other Parties of the Force Majeure situation within a reasonable time after the occurrence of the cause relied on and shall keep the other Parties timely informed of all significant developments. Such notice shall give reasonably full particulars of said event of Force Majeure, and also estimate the period of time that said Party likely will require to remedy the Force Majeure. The affected Party shall use all reasonable diligence to remove or overcome the Force Majeure situation as quickly as possible in an economic manner, but shall not be obligated to settle any labor dispute except on terms acceptable to it and all such disputes shall be handled within the sole discretion of the affected Party. For the purposes of this Agreement, "Force Majeure" shall mean an act of God, strike, lock-out or other industrial disturbance, act of the public enemy, war, blockade, public riot, lightning, fire, storm, flood or other adverse weather condition, explosion, governmental action, governmental inaction, restraint or delay, unavailability of equipment or any other cause, whether of the kind specifically enumerated above or otherwise, which is not reasonably within the control of the Party claiming Force Majeure. 16. RELATIONSHIP OF THE PARTIES ------------------------------ This Agreement is not intended to create, nor shall it be construed as creating, any joint venture, association, partnership, trust or fiduciary relationship nor shall it give rise to the imposition of a fiduciary obligation or liability with regard to any one or more of the Parties. In this Agreement, the Parties agree that where decisions are to be taken hereunder by unanimous agreement, agreement thereto shall not be unreasonably withheld. 23 17. CAPACITY OF IOGW ------------------ The Service Parties shall look only to IOGW for the due performance of this Agreement and nothing herein contained shall impose any liability upon, or entitle the Service Parties to commence any proceedings against any working interest owner ("Owner") other than IOGW. Only IOGW shall be entitled to enforce this Agreement on behalf of all Owners as well as for itself and, for this purpose only, IOGW may commence proceedings in its own name to enforce all obligations and liabilities of the Service Parties and to make any claim which any of the said Owners may have against the Service Parties in relation to or arising out of this Agreement. 18. REASONABLENESS -------------- Each of the Parties undertakes to do all things reasonably within its power that are necessary to give effect to the spirit and intent of this Agreement. None of the Parties shall act unreasonably or without giving due regard to the representations of the other Party when reaching any decision as to the giving or withholding of consent or approval or when exercising any other discretion pursuant to this Agreement. 19. CONFLICTS OF INTEREST ----------------------- Conflicts of interest relating to this Agreement are strictly prohibited. Except as otherwise expressly provided herein, no Service Party and no director, employee or agent of a Service Party or its subcontractors shall give to or receive from any director, employee or agent of IOGW any gift, entertainment or other favor of significant value, or any commission, fee or rebate. Likewise, no Service Party and no director, employee or agent of a Service Party or its subcontractors shall, without prior written notification thereof to IOGW, enter into any business relationship with any director, employee, or agent of IOGW or any of its Affiliates, unless such person is acting for and on behalf of IOGW. Each Service Party undertakes promptly to notify IOGW of any violation of this Article, with the understanding that any consideration received as a result of such violation shall be paid over or credited to IOGW. Additionally, in the event of any violation of this Article, including any violation occurring prior to the date of this Agreement, resulting directly or indirectly in IOGW's consent to enter into this Agreement, IOGW may, at IOGW's sole option, terminate this Agreement at any time and notwithstanding any other provision of this Agreement, pay each Service Party only for that part of the services provided prior to the date of termination. Any representatives authorized by either Party hereto may audit any and all records of the other Party, as well as applicable subcontractors, for the sole purpose of determining whether there has been compliance with this Article 19. 20. CORPORATE POWER AND AUTHORITY -------------------------------- Each of the Parties represents and warrants to the other that it has full power to enter into and perform its obligations under this Agreement and 24 that, when executed, this Agreement will constitute such Party's legal, valid and binding obligations in accordance with its terms. 21. GOVERNMENT APPROVALS --------------------- From and after the execution hereof, each of the Parties hereto, without further consideration, shall use its best efforts to execute, deliver, submit, gain approvals of, and record, or cause to be executed, delivered, submitted, and recorded, good and sufficient permits, designations of operator forms, other regulatory documents and instruments, as applicable, and take such other action as may be reasonably required to carry out the purposes of this Agreement and to give effect to the covenants, stipulations and obligations of the Parties hereto. 22. PUBLIC ANNOUNCEMENTS --------------------- No Party will issue, or permit any agent or Affiliate of it to issue, any press releases or otherwise make, or cause any agent or Affiliate of it to make, any public statements with respect to this Agreement and the transactions contemplated herein without the prior written approval of the other Parties, which approval may not be unreasonably withheld. In the event any Party reasonably believes that it is required by applicable governmental regulations to disclose any part of this Agreement, it shall notify the other Parties of its belief and shall seek appropriate confidentiality protections for the information required to be disclosed. 23. MODIFICATION OF EXHIBITS -------------------------- Additional Exhibits or amendments may be necessary to fully address the financial and operational details of the various activities under this Agreement. The Parties agree to cooperate to obtain the execution of any documents necessary to carry out the intention of this Article 23. 24. NO LIABILITY; INDEMNITY ------------------------- EXCEPT TO THE EXTENT OF THE SERVICE PARTIES' EXPENDITURES AND LIABILITIES ASSUMED BY THE SERVICE PARTIES PURSUANT TO THE MASTER SERVICE AGREEMENT OR ENGAGEMENT LETTER, AS APPLICABLE, THE SERVICE PARTIES SHALL NEVER BE RESPONSIBLE FOR ANY PART OF THE COSTS, EXPENSES OR LIABILITIES INCURRED IN CONNECTION WITH: (A) THE EXPLORING, DEVELOPING, OPERATING, OWNING, MAINTAINING, REWORKING OR RECOMPLETING OF THE EVALUATION WELLS OR ANY PROJECT WELL, THE PHYSICAL CONDITION OF THE CONTRACT AREA, OR THE HANDLING, TREATING OR TRANSPORTING OF HYDROCARBONS PRODUCED FROM THE CONTRACT AREA (INCLUDING ANY COSTS, EXPENSES, LOSSES OR LIABILITIES RELATED TO VIOLATION OF AN ENVIRONMENTAL LAW OR 25 OTHERWISE RELATED TO DAMAGE TO OR REMEDIATION OF THE ENVIRONMENT, WHETHER THE SAME ARISE OUT OF A SERVICE PARTY'S LIEN ON ANY PROPERTY OR OUT OF THE ACTIONS OF IOGW OR THE SERVICE PARTIES OR OF THIRD PARTIES OR ARISE OTHERWISE), OR (B) THE FAILURE BY IOGW TO HAVE GOOD AND DEFENSIBLE TITLE TO THE PROJECT WELLS AS SET FORTH IN ARTICLE 14.2, FREE AND CLEAR OF ALL BURDENS, ENCUMBRANCES, LIENS AND TITLE DEFECTS (INCLUDING ANY COSTS, EXPENSES, LOSSES OR LIABILITIES SUFFERED BY THE SERVICE PARTIES AS A RESULT OF ANY CLAIM THAT ANY SERVICE PARTY MUST DELIVER OR PAY OVER TO ANY PERSON ANY PART OF THE PROCEEDS OF HYDROCARBON PRODUCTION THEREOF AT ANY TIME PREVIOUSLY RECEIVED OR THEREAFTER TO BE RECEIVED BY ANY SERVICE PARTY), AND IOGW AGREES TO INDEMNIFY AND HOLD THE SERVICE PARTIES HARMLESS FROM AND AGAINST ALL COSTS, EXPENSES, LOSSES AND LIABILITIES INCURRED BY THE SERVICE PARTIES IN CONNECTION WITH ANY OF THE FOREGOING OR THIS AGREEMENT, OR THE TRANSACTIONS AND EVENTS (INCLUDING THE ENFORCEMENT OR DEFENSE THEREOF OR HEREOF) AT ANY TIME ASSOCIATED WITH OR CONTEMPLATED IN ANY OF THE FOREGOING. SUCH INDEMNITY SHALL ALSO COVER ALL REASONABLE COSTS AND EXPENSES OF THE SERVICE PARTIES, INCLUDING REASONABLE LEGAL FEES AND EXPENSES, WHICH ARE INCURRED INCIDENT TO THE MATTERS INDEMNIFIED AGAINST. AS USED IN THIS ARTICLE 24, "SERVICE PARTY" MEANS EACH SERVICE PARTY AND ITS' SUCCESSORS AND ASSIGNS, ALL OF THEIR RESPECTIVE AFFILIATES, AND ALL OF THE OFFICERS, DIRECTORS, AGENTS, BENEFICIARIES, TRUSTEES, ATTORNEYS AND EMPLOYEES OF THEMSELVES AND THEIR AFFILIATES. THE FOREGOING INDEMNITY SHALL APPLY WHETHER OR NOT ARISING OUT OF THE SOLE, --------------------------------------------------------------------------- JOINT OR CONCURRENT NEGLIGENCE, FAULT OR STRICT LIABILITY OF ANY SERVICE --------------------------------------------------------------------------- PARTY AND SHALL APPLY, WITHOUT LIMITATION, TO ANY LIABILITY IMPOSED UPON --------------------------------------------------------------------------- ANY SERVICE PARTY AS A RESULT OF ANY THEORY OF STRICT LIABILITY OR ANY --------------------------------------------------------------------------- OTHER DOCTRINE OF LAW, PROVIDED THAT THE FOREGOING INDEMNITY SHALL NOT ------------------------ APPLY TO ANY COSTS, EXPENSES, LOSSES OR LIABILITIES INCURRED BY ANY SERVICE PARTY TO THE EXTENT PROXIMATELY CAUSED SOLELY BY THE GROSS NEGLIGENCE OR WILLFUL MISCONDUCT OF SUCH SERVICE PARTY. THE FOREGOING INDEMNITY SHALL SURVIVE THE TERMINATION OF THIS AGREEMENT AND THE OTHER DOCUMENTS RELATED HERETO. 26 25. COUNTERPARTS ------------ This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, and all of which taken together shall constitute one agreement. IN WITNESS WHEREOF, this Agreement is executed as of the date first above written, but is effective as of the Effective Date. INFINITY OIL & GAS OF WYOMING, INC. SCHLUMBERGER TECHNOLOGY CORPORATION By: /s/ Stanton E. Ross /s/ Gary A. Kolstad ------------------------------- ---------------------------------- Name: Stanton E. Ross Gary A. Kolstad ----------------------------- ---------------------------------- Title: President Vice President --------------------------- ---------------------------------- RED OAK CAPITAL MANAGEMENT, LP By: /s/ J.M. Whipkey ------------------------------- Name: J.M. Whipkey ----------------------------- Title: Managing Director ---------------------------- 27 EX-21 4 doc8.txt EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT Name State of Incorporation - ---- ---------------------- Consolidated Oil Well Services, Inc. Kansas CIS-Oklahoma, Inc. Kansas Infinity Oil & Gas of Wyoming, Inc. Wyoming Infinity Oil & Gas of Kansas, Inc. Kansas EX-23.1 5 doc7.txt EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS We hereby consent to the incorporation of our report dated April 8, 2004, appearing in the Annual Report on Form 10-K of Infinity, Inc. for the year ended December 31, 2003 in the following Registration Statements: Form SEC File Number Description ---- --------------- ------------ S-8 33-90878 Stock option plan S-8 333-31950 1999 stock option plan S-8 333-44898 2000 stock option plan S-8 333-71590 2001 stock option plan S-8 333-96691 2002 stock option plan S-3 333-52742 Selling shareholders S-3 333-69292 8% Convertible notes S-8 333-96671 7% Convertible notes S-8 333-107838 2003 stock option plan /s/ Ehrhardt Keefe Steiner & Hottman PC ------------------------------------------------ Ehrhardt Keefe Steiner & Hottman PC Denver, Colorado April 14, 2004 EX-23.2 6 doc9.txt EXHIBIT 23.2 CONSENT OF NETHERLAND SEWELL AND ASSOCIATES INC. We hereby consent to the incorporation by reference of the statements of reserves and references to us appearing in the Annual Report on Form 10-K of Infinity, Inc. for the year ended December 31, 2003 in the following Registration Statements: Form SEC File Number Description ---- --------------- ------------ S-8 33-90878 Stock option plan S-8 333-31950 1999 stock option plan S-8 333-44898 2000 stock option plan S-8 333-71590 2001 stock option plan S-8 333-96691 2002 stock option plan S-3 333-52742 Selling shareholders S-3 333-69292 8% Convertible notes S-8 333-96671 7% Convertible notes S-8 333-107838 2003 stock option plan By: /s/ Netherland Sewell and Associates, Inc. ------------------------------------------- Name: Netherland Sewell and Associates, Inc. Denver, Colorado April 14, 2004 EX-31.1 7 doc3.txt EXHIBIT 31.1 Certification I, Stanton E. Ross, certify that: 1. I have reviewed this annual report on Form 10-K of Infinity, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and c. Disclosed in this annual report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors: a. All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: April 14, 2004 /s/ Stanton E. Ross ------------------------------ Stanton E. Ross Chief Executive Officer EX-31.2 8 doc4.txt EXHIBIT 31.2 Certification I, Jon D. Klugh, certify that: 1. I have reviewed this annual report on Form 10-K of Infinity, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and c. Disclosed in this annual report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors: a. All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: April 14, 2004 /s/ Jon D. Klugh ------------------------------ Jon D. Klugh Chief Financial Officer EX-32.1 9 doc5.txt EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Infinity, Inc. (the "Company") on Form 10-K for the year ended December 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned hereby certifies, pursuant to 18 U.S.C. Sec.1350, as adopted pursuant to Sec. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Stanton E. Ross - ----------------------------------- Stanton E. Ross Chief Executive Officer April 14, 2004 A signed original of this written statement required by Section 906 has been provided to Infinity, Inc. and will be retained by Infinity, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. EX-32.2 10 doc6.txt EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Infinity, Inc. (the "Company") on Form 10-K for the year ended December 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned hereby certifies, pursuant to 18 U.S.C. Sec.1350, as adopted pursuant to Sec. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Jon D. Klugh - ----------------------------------- Jon D. Klugh Chief Financial Officer April 14, 2004 A signed original of this written statement required by Section 906 has been provided to Infinity, Inc. and will be retained by Infinity, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----