-----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, RRbPHGbrm+I/yD+SzLItBz6/KY29dGgtAv2ofihh0h+P/MAdncsnZW9VptGYKTCi jhh30rahsJAhyJpgurz5XA== 0000930661-97-001480.txt : 19970610 0000930661-97-001480.hdr.sgml : 19970610 ACCESSION NUMBER: 0000930661-97-001480 CONFORMED SUBMISSION TYPE: 10KSB40/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970606 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: GOTHIC ENERGY CORP CENTRAL INDEX KEY: 0000878482 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 222663839 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB40/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-19753 FILM NUMBER: 97620219 BUSINESS ADDRESS: STREET 1: 5727 S LEWIS AVE STE 700 STREET 2: P O BOX 186 CITY: TULSARD STATE: OK ZIP: 74105 BUSINESS PHONE: 9187495666 FORMER COMPANY: FORMER CONFORMED NAME: TNC MEDIA INC DATE OF NAME CHANGE: 19930328 10KSB40/A 1 FORM 10-KSB405 AMENDMENT NO. 2 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-KSB/A AMENDMENT NO. 2 [Mark One] [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1996 ----------------- [ ] TRANSITION REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from ____ to ____. Commission File Number 0-19753 GOTHIC ENERGY CORPORATION ------------------------- (Name of small business issuer in its charter) OKLAHOMA 22-2663839 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5727 SOUTH LEWIS AVENUE - SUITE 700 TULSA, OKLAHOMA 74105 ----------------------------------- --------- (Address of principal executive (Zip Code) offices) Issuer's telephone number, including area code: (918) 749-5666 -------------- SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: Title of Each Class Name of each exchange on which registered ------------------- ----------------------------------------- None SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT: Common Stock (Title of class) Redeemable Common Stock Purchase Warrants expiring January 24, 2001 (Title of class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ X ] State issuer's revenues for its most recent fiscal year $11,515,470 State the aggregate market value of the voting stock held by non-affiliates computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of February 14, 1997 was $22,937,089. Non-affiliates have been determined on the basis of holdings set forth under Item 11 of this Annual Report on Form 10-KSB. The number of shares outstanding of each of the issuer's classes of common equity, as of February 14, 1997 was 12,381,857. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the Issuer's Annual Meeting of Stockholders to be held on April 22, 1997, are incorporated by reference herein as portions of Part III of this Annual Report on Form 10-KSB. PART I ------ ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION: - ------------------------------------------------------------------ RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1996 COMPARED WITH YEAR ENDED DECEMBERE31, 1995 Revenues were $11,515,470 for the year ended December 31, 1996, as compared to $2,037,950 for the year ended December 31, 1995. This represents a 465% increase in total revenue for the period. Oil and gas sales for the year ended December 31, 1996 increased to $10,385,382, with $3,488,021 from oil sales and $6,897,361 from gas sales, as compared to oil and gas sales of $1,893,717 for the year ended December 31, 1995, with $1,282,787 from oil sales and $610,930 from gas sales. Of this $8,491,665 increase in oil and gas sales, approximately $1,546,000 and $4,187,000 related to increases in volumes of oil and gas sold, respectively, and $659,000 and $2,110,000 related to increases in the average prices of oil and gas sold, respectively. The increase in volumes of oil and gas sold resulted primarily from the 1996 Acquisitions. Of the $8,491,665 increase in oil and gas sales approximately $6,913,000 is a direct result of properties acquired in the 1996 Acquisitions and $1,579,000 is a result of increased production and prices from continuing properties acquired in 1995. Oil sales in 1996 were based on the sale of 163,978 barrels at an average price of $21.27 per barrel as compared to 74,370 barrels at an average price of $17.25 per barrel in 1995. Gas sales in 1996 were based on the sale of 3,403,943 mcf at an average price of $2.03 per mcf compared to 434,153 mcf at an average price of $1.41 per mcf in 1995. The Company incurred lease operating expenses for the year ended December 31, 1996 of $4,806,741 compared with lease operating expenses of $1,202,535 for the year ended December 31, 1995. Lease operating expenses include approximately $567,000 and $98,000 in production taxes which the Company incurred from its share of production in 1996 and 1995, respectively. This increase in lease operating expenses is a result of the 1996 Acquisitions. Lease operating expenses as a percentage of oil and gas sales were 46.3% in 1996 as compared to 63.5% in 1995. Depreciation, depletion and amortization expense was $2,856,000 for the year ended December 31, 1996 as compared to $882,450 for the prior year. The increase resulted primarily from the increased production associated with the 1996 Acquisitions. Selling, general and administrative costs were $1,781,739 for the year ended December 31, 1996, as compared to $1,009,539 for the year ended December 31, 1995. This increase was primarily the result of additional personnel and other costs related to the 1996 Acquisitions. The Company added six employees as a direct result of the 1996 Acquisitions at an approximate cost of $240,000. This increase also includes certain non-recurring costs related to the completion of the Buttonwood transaction of approximately $51,000. The remaining increase relates to administrative costs incurred in operating the wells acquired in the 1996 Acquisitions. The Company accounts for its oil and gas exploration and development activities using the full cost method of accounting prescribed by the Securities and Exchange Commission ("SEC"). Accordingly, all productive and non-productive costs incurred in connection with the acquisition, exploration and development of oil and gas reserves are capitalized and depleted using the units-of- production method based on proved oil and gas reserves. The Company capitalizes costs including; salaries and related fringe benefits of employees directly engaged in the acquisition, exploration and development of oil and gas properties, as well as other directly identifiable general and administrative costs associated with such activities. Such costs do not include any costs related to production, general corporate overhead, or similar activities. The Company's oil and gas reserves are estimated annually by petroleum engineers. The Company's calculation of depreciation, depletion and amortization ("DD&A") includes estimated future expenditures to be incurred in developing proved reserves and estimated dismantelment and abandonment costs, net of salvage values. In the event the unamortized cost of oil and gas properties being amortized exceeds the full cost ceiling as defined by the SEC, the excess is charged to expense in the period during which such excess occurs. The full cost ceiling is based principally on the estimated future discounted net cash flows from the Company's oil and gas properties. Changes in the estimates or declines in oil and natural gas prices could cause the Company in the near-term to reduce the carrying value of its oil and natural gas properties. See Note 1 and Note 10 to Notes to Consolidated Financial Statements. During the first quarter of 1996, the Company recorded a $5,050,000 pre-tax provision for impairment of oil and gas properties, primarily related to properties acquired in the Buttonwood Acquisition. Such provision resulted from a full cost ceiling write-down and was reflected in the balance sheet as a reduction of the cost of oil and gas properties. The operating results for the year ended December 31, 1995 reflect a similar provision for impairment of oil and gas properties in the amount of $2,247,083, including a full cost ceiling write-down of oil and gas properties in the amount of $1,052,000 resulting from lower oil and gas prices at December 31, 1995 and $1,195,083 relating to the write-off of a $1,000,000 deposit for the Buttonwood Acquisition and related deferred acquisition costs. The Buttonwood Acquisition deposit and the deferred acquisition costs write-off was a result of the expected full cost ceiling write-down related to the Buttonwood properties upon completion of the acquisition. On September 27, 1995, the Company and Buttonwood entered into a new option for the Company to acquire Buttonwood and terminated the prior option for which the Company paid $1,850,000. Accordingly, the Company recognized a loss on the termination of the option in the amount of $1,850,000 during the year ended December 31, 1995. As a result of the $5,050,000 impairment provision and the aggregate $2,850,000 of deposits written off, the Company recorded a tax benefit of $2,992,547 which offset the deferred tax liability related to the acquired Buttonwood oil and gas properties. The Company also recorded an extraordinary loss of $1,432,973 on the early extinguishment of debt during the quarter ended March 31, 1996, associated with the repayment of the Stratum loan. -2- Management of the Company evaluates oil and gas reserve acquisition opportunities in the light of many factors only a portion of which may be reflected in the amount of proved oil and gas reserves proposed to be acquired. In determining the purchase price to be offered, the Company does not solely rely on proved oil and gas reserves or the value of such reserves, as defined in and determined in accordance with Rule 4-10 of Regulation S-X adopted under the Securities Exchange Act of 1934, as amended. Factors considered include, among others, the probable reserves of the interests intended to be acquired, anticipated efficiencies and cost reductions that can be made in operating the producing properties, additional reserves that management believes can be proven relatively inexpensively based on management's knowledge of the area where the interests are located and existing producing properties owned by the Company. Management does not necessarily conclude that an acquisition is not favorable because there may be a full cost ceiling write-down associated with it. The Company does not perform a ceiling test for specific properties acquired because the ceiling test is performed at each quarter and year end for all of the Company's properties included in its cost center and is based on prices for oil and gas as of that date which may be higher or lower than the prices used when evaluating potential acquisitions. Management reviews the transaction in the light of proved and probable reserves, historic and seasonal fluctuations in the prices of oil and gas, anticipated future prices for oil and gas, the factors described above as well as other factors that may relate to the specific properties under review. Accordingly, although the Company does not anticipate any further full cost ceiling write-downs which may be attributed to the Buttonwood Acquisition, the Company may, however, experience ceiling test write- downs in the future arising out of other acquisitions. During the third quarter of 1995, the Company determined that its investment in Vista Technologies, Inc. common stock had a carrying value on its books above the current estimated net realizable value. The shares were "restricted securities" as defined under Federal securities laws. In October 1995, the Company was informed of a five to one reverse common stock split by Vista and a post-reverse split private placement at $2.50 per share of common stock. Based upon this current information, and consideration of the diminished value due to the restriction on the sale of the shares, the Company recorded a $802,287 provision for impairment in the third quarter of 1995, reducing such investment to $200,000. Interest and financing costs were $1,528,598 for the year ended December 31, 1996 as compared to $1,627,402 for 1995. The decrease was the result of the Company's debt restructuring during the year. The Company incurred interest costs of $1,322,262 with Bank One, Texas, N.A., $55,100 with Stratum, $72,467 with Quest, $69,314 as amortization of loan costs and $9,455 with other parties. During the year ended December 31, 1996, the Company spent $1,177,327 on capital enhancements and $35,047,825 on acquiring additional producing properties, as compared to $402,662 and $11,605,326 spent on capital enhancements and property acquisitions, respectively, during 1995. The increase in 1996 was primarily due to the Buttonwood, Comstock -3- and Athena Acquisitions. The Company also recognized $380,875 in preferred dividends and amortization of preferred discount on its 7 1/2% Cumulative Convertible Preferred Stock during the year ended December 31, 1996. Because the initial conversion price of the Company's outstanding 7 1/2% Cumulative Convertible Preferred Stock was a discount of 12 1/2% less that the $2.00 market price for the Company's Common Stock on January 30, 1996, the date of issuance, the Company has computed an imputed dividend of $791,429 on the shares of preferred stock. The discount was treated as an imputed dividend for the period ending December 31, 1996 and, accordingly, affects income (loss) available for common shares. The profitability and revenues of the Company are dependent, to a significant extent, upon prevailing spot market prices for oil and gas. In the past, oil and gas prices and markets have been volatile. Prices are subject to wide fluctuations in response to changes in supply of and demand for oil and gas, market uncertainty and a variety of additional factors that are beyond the control of the Company. Such factors include supply and demand, political conditions, weather conditions, government regulations, the price and availability of alternative fuels and overall economic conditions. Gas prices have fluctuated significantly over the past twelve months. The Company uses the sales method for recording natural gas sales. The Company's oil and condensate production is sold, title passed, and revenue recognized at or near its wells under short-term purchase contracts at prevailing prices in accordance with arrangements which are customary in the oil industry. Sales of gas applicable to the Company's interest in producing oil and gas leases are recorded as revenues when the gas is metered and title transferred pursuant to the gas sales contracts covering its interest in gas reserves. During such times as the Company's sales of gas exceed its pro rata ownership in a well, such sales are recorded as revenues unless total sales from the well have exceeded the Company's share of estimated total gas reserves underlying the property at which time such excess is recorded as a gas balancing liability. Such imbalances are incurred form time to time in the usual course of business in the operation of gas wells as a consequence of operational factors. See Note 1 to Notes to Consolidated Financial Statements. At December 31, 1996, the Company had a gas balance asset of $1,250,634 and a gas balance liability of $1,025,266. The balances that existed at December 31, 1996, except for possible immaterial amounts, were not the result of producing operations conducted by the Company, but were the results of asset acquisitions, reflected predominately through the Buttonwood and Comstock Acquisitions. It is not the Company's policy to operate wells in such a manner that imbalances are created. The Company expects that the imbalances that existed at December 31, 1996 will be settled upon abandonment of the wells or will be reflected in the price if the respective well interest is sold prior to then. -4- LIQUIDITY AND CAPITAL RESOURCES Commencing in the last quarter of 1994, the Company redirected its business efforts toward acquiring natural gas and oil reserves and the production, development and exploitation of those reserves. On January 19, 1995, the Company completed its first acquisition of oil and gas reserves, the Egolf Acquisition, and on May 31, 1995 completed a second acquisition of oil and gas properties, the Johnson Ranch Acquisition. On January 30, 1996, the Company completed the following transactions: (i) it completed the Buttonwood Acquisition; (ii) it borrowed approximately $11 million pursuant to a Credit Facility; (iii) it completed the Public Offering yielding net proceeds, including net proceeds from a subsequently exercised over-allotment option, of approximately $12,966,000; and (iv) it completed the Preferred Stock Financing for aggregate consideration of $5,540,000 inclusive of $1,290,000 principal amount of a note of the Company exchanged for such shares. Herein, the Buttonwood Acquisition, the Credit Facility, the Public Offering and the Preferred Stock Financing are referred to as the "January 1996 Transactions." Thereafter, throughout 1996, the Company completed the acquisition of various working interests in additional producing oil and gas properties. On May 16, 1996, the Company completed the Comstock Acquisition which included various working interests in 145 producing oil and gas properties for a consideration of $6,430,195 and on May 20, 1996 it completed the Stratum Acquisition including the 7% overriding royalty interest in the Johnson Ranch Acquisition properties for $800,000. It expended $3,270,000 for the acquisition of various working interests in approximately 120 wells from various sellers on August 5, 1996 and on December 27, 1996 it completed the Athena Acquisition for $4,200,000. During the year the Company realized net proceeds of approximately $3.11 million from the sale of oil and gas producing properties. Financing to complete the acquisitions completed subsequent to the January 1996 Transactions was provided under the terms of the Credit Facility, as amended. At December 31, 1996, the Company's borrowing availability under the Credit Facility was $25,000,000, of which the Company had borrowed $21,744,000. On February 18, 1997, the Company completed the following acquisitions: The Company acquired from Norse, various working interests in 11 oil and gas producing properties and, through the acquisition of the outstanding capital stock of Norse Pipeline, Inc., its 40.09% general partnership interest in the Sycamore System, an Oklahoma gathering system, processing plant and storage facility. The oil and gas wells and the gathering system are located in the Springer Field in Carter County, Oklahoma. The purchase price was $10,750,000, plus two-year warrants to purchase 200,000 shares of the Company's Common Stock at a per share -5- exercise price of $2.50, of which the Company had paid a deposit of $1,075,000 toward the purchase price in December 1996. Such warrants were valued at $254,000 (the estimated fair value of the warrants on the date of acquisition). The Company acquired from Huffman, various working interests in 13 oil and gas producing properties and an additional 10.97% interest in the Sycamore System. The oil and gas wells are located in the same producing area as the properties acquired from Norse. The total purchase price for the assets acquired was $3,950,000, of which the Company had paid a deposit of $287,500 toward the purchase price in December 1996. The Company also acquired, on February 18, 1997, from Horizon, various working and royalty interests in approximately 100 oil and gas producing properties. The producing properties are located in Major and Blaine counties of Oklahoma. The purchase price was $10,000,000. The effective date of all three acquisitions was January 1, 1997. Of the deposits paid to the sellers under these agreements, aggregating $1,362,500, $1,291,295, were paid out of the proceeds from borrowings in December 1996 from Bank One, Texas, N.A., and the financing to complete these transactions was provided by the Credit Facility and the bridge financing described below. The Company's capital requirements relate to the acquisition, exploration, enhancement, development and operation of oil and gas producing properties. In general, because the oil and gas reserves the Company has acquired and intends to acquire are depleted by production over time, the success of its business strategy is dependent upon a continuous acquisition, exploitation, enhancement, development and operation program. In order to achieve continuing profitability and generate cash flow, the Company will be dependent upon acquiring or developing additional oil and gas properties or entering into joint oil and gas well development arrangements. The Company will continue to require access to debt and equity capital or the availability of joint venture development arrangements, among other possible sources, to pursue its business strategy of additional property acquisition and development. The Company has no present arrangements to raise additional capital from the sale of its securities or to enter into joint development arrangements and no assurance can be given that the Company will be able to obtain additional capital or enter into joint venture development arrangements on satisfactory terms to implement the Company's business strategy. The Company has funded its recent capital needs through the issuance of capital stock and borrowings, principally under the Credit Facility. Without raising additional capital or entering into joint oil and gas well development arrangements, the Company will be unable to acquire additional producing oil and gas properties and its ability to develop its existing oil and gas properties will be limited to the extent of the available cash flow. No assurance can be given as to the availability or terms of any such -6- additional capital or joint development arrangements or that such terms as are available may not be dilutive to the interests of the Company's stockholders. The Company estimates that it will need approximately $6.10 million of capital to develop its undeveloped oil and gas reserves during the year ending December 31, 1997 and an additional $3.40 million to develop such reserves during the following two years. The Company expects to obtain a portion of these funds from the Special Drilling Advance of $2 million established under the terms of the Credit Facility. The Company is permitted to draw upon this advance for certain drilling costs to be incurred during 1997. Additional funds may be obtained from cash flow and the possible public or private sale of equity or debt securities. The Company has no present arrangements for future borrowings, other than possible borrowing availability under the Credit Facility, or other sales of securities and its cash flow from operations is not expected to be adequate to provide all the funds needed for drilling purposes. There can be no assurance that these sources will provide funds in sufficient amounts to allow the Company to successfully implement its present business strategy of additional property acquisition or the development of its oil and gas reserves. There can be no assurance that the Company will be able to identify and acquire additional producing oil and gas properties or that any properties that are acquired will prove to be profitable to the Company. The process of integrating acquired properties into the Company's operations may result in unforeseen difficulties and may require a disproportionate amount of management's attention and the Company's resources. In connection with acquisitions, the Company could become subject to significant contingent liabilities arising from the activities of the acquired properties to the extent the Company assumes, or an acquired entity becomes liable for, unknown or contingent liability or in the event that such liabilities are imposed on the Company under theories of successor liability. At December 31, 1996, the Company had total current assets of $3,349,246 including cash of $206,648 and total current liabilities of $9,755,135 including current portions of long-term debt of $5,927,660. As a result of amending the Credit Facility in February 1997, the Company's debt service requirements under this Credit Facility for April through December, 1997 will be $14,275,000. While management expects the acquisitions in late 1996 and in early 1997 to increase cash flows from oil and gas production, such cash flows are not expected to be adequate to meet debt service requirements and to pay other current obligations. Accordingly, the Company will be required to either modify the terms of the restated Credit Facility or obtain other financing. Under the terms of the Credit Facility, the Company is prohibited from paying dividends on its Common Stock. In addition, so long as 3,145 shares of 7 1/2% Cumulative Preferred Stock are outstanding, the Company is restricted from paying any dividends on its Common Stock. -7- Terms of the Credit Facility: The Company's Credit Facility enables the ---------------------------- Company to borrow up to a maximum aggregate of $75,000,000, subject to meeting certain conditions. As of February 17, 1997, the aggregate available to be borrowed under the Credit Facility is comprised of the $32,000,000 borrowing base, the $10,000,000 Special Advance Facility, and a $2,000,000 Special Drilling Facility. The Credit Facility currently provides for amortization payments at the rate of $240,000 on March 1, 1997 and increasing to $475,000 per month commencing April 1, 1997, related to the $32,000,000 borrowing base with all outstanding principal and interest due and payable on January 30, 1999. The $10,000,000 Special Advance Facility must be repaid by September 1, 1997. Interest is payable, at the option of the Company, either at the rate of 1% over the lending bank's base rate or up to 3.75% (based on the principal balance outstanding) over the rate for borrowed dollars by the lending bank in the London Interbank market. The indebtedness is collateralized by first liens on all of the Company's oil and gas properties. The Credit Facility includes various affirmative and negative covenants, including, among others, the requirements that the Company (i), maintain a ratio of current assets to current liabilities, as defined, of no less than 1.0 to 1.0, (ii) maintain a debt service coverage ratio of net cash flow per quarter to required quarterly reduction of indebtedness of not less than 1.10 to 1.0, (iii) maintain minimum tangible net worth at the end of each fiscal quarter of $10,250,000, plus certain percentages of net income and proceeds received from the sale of securities, and (iv) maintain selling, general and administrative expenses per quarter of not in excess of 25% of consolidated net revenues for the quarter ended March 31, 1997 and 20% of consolidated net revenues for all subsequent quarters. The Company is obligated under the terms of its Credit Facility to enter into commodity hedges covering not less than 75% of the Company's proved developed production of oil and natural gas for a period of not less than twelve months with minimum floor prices to be mutually agreed upon by the Company and Bank One, Texas, N.A., for natural gas and oil, with counterparties acceptable to the bank. These commodity hedges are required to be in place no later than March 4, 1997. Material breaches of these or other covenants which are not cured or waived could result in a default under the Credit Facility resulting in this indebtedness becoming immediately due and payable and empowering the lender to foreclose against the collateral for the loan. During the year ended December 31, 1996 the Company requested and obtained waivers of the provisions, under the January 1996 Loan Agreement requiring a 1:1 ratio of current assets to current liabilities for the year ended December 31, 1996, and for the quarter ended SeptemberE30, 1996, the restriction on general and administrative expenses for the quarter ended March 31, 1996, and a covenant violated as a result of the termination of a former officer of the Company. In order to provide the funds necessary to complete the Norse, Huffman and Horizon acquisitions, on February 18, 1997 two investors loaned to the Company the aggregate sum of $4,500,000 represented by the Company's promissory notes. Of the aggregate amount, $2,500,000 bears interest at 5% per annum and matures on April 18, 1997, with the remaining $2,000,000 bearing interest at 12% per annum and maturing on October 31, 1997. In the event -8- the principal and accrued interest is not paid when due, such amount is automatically converted into a number of shares of the Company's Common Stock determined by dividing such amount by a sum equal to 75% of the closing bid price for the Company's Common Stock on the five (5) days prior to the maturity date, with respect to the $2,500,000 obligation, and on the maturity date with respect to the $2,000,000 obligation. As additional consideration for making the loan, the investors also purchased at a price of $.01 per share a total of 250,000 shares of the Company's common stock. The fair market value of the Company's common stock was $2.63 per share on the date such shares were issued. The Company paid a fee of $250,000 for the $2,500,000 Note. Net cash provided by operations increased to $2,595,745 for the year ended 1996 as compared to net cash provided of $112,629 in 1995, primarily due to the cash flows generated from the 1996 Acquisitions. The 1996 operating cash flows of $2,595,745 include a $5,050,000 full cost ceiling write-down and a $1,432,973 loss on early extinquishment of debt, partially offset by a deferred income tax benefit of $2,992,547, and net changes in operating assets and liabilities. The Company used $32,790,854 of net cash in investing activities for the year ended 1996 compared to net cash used of $11,380,529 for the same period in 1995. This was primarily due to the acquisition of Buttonwood, net of cash acquired, for $17,592,973, the acquisition of Comstock for $6,430,195, net of adjustments, the Various Working Interests acquisition for $3,270,000, the Athena acquisition for $4,200,000, oil and gas enhancements in the amount of $1,177,327 and other producing property acquisitions of $3,554,657. Additionally, net cash of $3,434,298 was provided from the sale of property and equipment. Net cash provided by financing activities for the year ended 1996 was $30,244,198 compared to $10,600,481 provided in 1995. The 1996 amount of $30,244,198 includes proceeds from the issuance of common stock of $13,141,368 and proceeds from the issuance of preferred stock of $3,997,430. The 1996 amount also includes proceeds from long-term debt of $26,528,096, less repayments of $12,817,815 on short and long-term debt. The net amount was used to finance the 1996 Acquisitions. INFLATION The price the Company receives for its oil and gas has been impacted primarily by the world oil market and the domestic market for natural gas, respectively, rather than by any measure of general inflation. Because of the relatively low rates of inflation experienced in the United States in recent years, the Company's production costs and general and administrative expenses have not been impacted significantly by inflation. -9- CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 With the exception of historical matters, the matters discussed in this commentary and elsewhere in this Report are "forward-looking statements" as defined under the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties. Forward-looking statements include, but are not limited to, statements under the following headings: (i) under "Year Ended December 31, 1996 Compared with Year Ended December 31, 1995" relating to the Company's dependence for profits and revenues on prevailing spot market prices for oil and gas, (ii) under "Inflation" as to the impact of inflation on the Company, (iii) under "Liquidity and Capital Resources" as to the Company's capital requirements, business strategy, ability to attain and maintain profitability and cash flow, dependence upon the acquisition of and ability to acquire additional oil and gas properties or entering into joint oil and gas well development arrangements, access to debt and equity capital and availability of joint venture development arrangements, estimates as to its needs for additional capital and the times at which such additional capital will be required, expectations as to the sources of this capital and funds, ability to successfully implement its business strategy, ability to identify and integrate successfully any additional producing oil and gas properties it acquires and whether such properties can be operated profitably, ability to maintain compliance with covenants of its various loan documents and other agreements pursuant to which securities have been issued, ability to borrow funds or maintain levels of borrowing availability under credit arrangements, statements about Proved Reserves or borrowing availability based on Proved Reserves and future net cash flows and the present value thereof and Supplementary Oil and Gas Information in Note 10 to Notes to Consolidated Financial Statements. The Company wishes to caution readers that the following important factors, and those described elsewhere in this commentary and Report, or in other Securities and Exchange Commission filings, among others, in some cases have affected, and in the future could affect, the Company's actual results and could cause the Company's actual consolidated results during 1997 and beyond, to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company: . The Company has a short operating history in the oil and gas industry, having entered that business in November 1994 after being engaged in an entirely different business prior thereto. The Company achieved losses through mid-1996 during the time it has been engaged in oil and gas operations and also during all other periods prior thereto since its organization in 1985. In order for the Company to attain and maintain profitability and generate cash flow, it will be dependent upon acquiring or developing additional oil and gas properties. There can be no assurance that it will be able to do so. -10- . Without raising additional capital, the Company will be unable to acquire additional producing oil and gas properties and its ability to develop its existing oil and gas properties will be limited to the extent of its available cash flow. Accordingly, in order for the Company to achieve its business objective and achieve continuing profitable operations, it will be necessary to generate additional cash flow from operations, raise additional capital or enter into joint oil and gas well development arrangements. . Management intends to fund future acquisitions and develop its oil and gas reserves using cash flow from operations as well as public and private sales of debt and equity securities and joint oil and gas well development arrangements, among other possible sources. The Company's cash flow from operations is not expected to be adequate to provide the funds needed for these purposes. There can be no assurance that these other sources will provide funds in sufficient amounts to allow the Company to successfully implement its present business strategy of additional property acquisition or the development of its oil and gas reserves. The Company has no definitive present arrangements to raise additional capital from the sale of its securities or joint development arrangements. No assurance can be given as to the availability or terms of any such additional financing or joint development arrangements or that such terms as are available may not be dilutive to the interests of the Company's stockholders. . The profitability and revenues of the Company are dependent, to a significant extent, upon prevailing spot market prices for oil and gas. In the past, oil and gas prices and markets have been volatile. Prices are subject to wide fluctuations in response to changes in supply of and demand for oil and gas, market uncertainty and a variety of additional factors that are beyond the control of the Company. Such factors include supply and demand, political conditions, weather conditions, government regulations, the price and availability of alternative fuels and overall economic conditions. Gas prices have fluctuated significantly over the past twelve months. . The Company is engaged in seeking to identify and acquire additional oil and gas producing properties. There can be no assurance that the Company will be able to identify and acquire additional producing oil and gas properties or that any properties that are acquired will prove to be profitable for the Company. The process of integrating acquired properties into the Company's operations may result in unforeseen difficulties and may require a disproportionate amount of management's attention and the Company's resources. In connection with acquisitions, the Company could become subject to significant contingent liabilities arising from the activities of the acquired properties to the extent the Company assumes, or an acquired entity becomes liable for, unknown or contingent liabilities or in the event that such liabilities are imposed on the Company under theories of successor liability. -11- . The outstanding principal under the Company's Credit Facility must be amortized at the rate of $240,000 on March 1, 1997 and increasing to $475,000 per month, commencing April 1, 1997, with the entire outstanding balance due January 30, 1999. The Credit Facility includes a $10,000,000 Advance Facility which is due on September 1, 1997. The Credit Facility is secured by first mortgages on all of the Company's oil and gas properties. The loan agreement relating to the Credit Facility contains various affirmative and negative covenants including, among others, the requirements that the Company maintain certain ratios of current assets to current liabilities, debt service coverage ratio, minimum tangible net worth, restrictions on selling, general and administrative expenses and the payment of dividends. Material breaches of these or other covenants which are not cured or waived could result in a default under the loan agreement resulting in this indebtedness becoming immediately due and payable and empowering the lender to foreclose against the collateral for the loan. Under such circumstances, the Company's stockholders could lose their entire investment. There can be no assurance that the Company will remain in compliance with all of its covenants and agreements in the Credit Facility. The Company's borrowings under the Credit Facility as well as its projected borrowing are, to a large extent, a function of the value of the Company's oil and gas reserves, which fluctuate from time to time, which are the primary component used in determining the amount of borrowing available to the Company. Changes in the Company's cash needs or borrowing availability could negatively impact the Company's reserve development plans or its ability to meet its obligations as they come due. Negative revisions in oil and gas reserves could require reductions in the principal amounts or otherwise reduce funds available to be borrowed under the Credit Facility. . 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 in this Report represent estimates only. Oil and gas reserve engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact way, and estimates by other engineers might differ from those included in this Report. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. This Report contains estimates of the Company's proved oil and gas reserves -12- and the projected future net cash flows therefrom, which have been prepared by an independent petroleum engineering firm. Actual future production, oil and gas prices, revenue, capital expenditures, taxes and operating expenses may vary substantially from those assumed in making estimates, and the Company's reserves may be subject to material upward or downward revision and the rate of production from oil and gas properties declines as reserves are depleted. In addition, the Company's ability to develop its reserves will be dependent upon the timely availability of financing for this purpose without which the Company's ability to produce the projected amounts of oil and gas will be adversely affected thereby adversely affecting the projected future net cash flows. . With respect to wells not operated by the Company in which it has a working interest, the independent operators are, in some cases, privately-held companies who may have limited financial resources. If a third party operator experiences financial difficulty and fails to pay for materials and services in a timely manner, the wells operated by such third party operators could be subject to material and workmen's liens. In such event, the Company would incur costs in discharging such liens. . The Company is dependent upon the services of its President, Michael Paulk, and Vice-President, John Rainwater. The loss of their services could have a material adverse effect upon the Company. ITEM 7 - FINANCIAL STATEMENTS: - ----------------------------- The response to this Item is included in a separate section of this report. See page F-1. -13- SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. GOTHIC ENERGY CORPORATION BY: /s/ Michael K. Paulk ------------------------------- MICHAEL K. PAULK, 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 the Company and in the capacities and on the dates indicated. SIGNATURE TITLE DATE - --------- ----- ---- /s/ Michael K. Paulk President (Principal June 3, 1997 - ------------------------------- Executive Officer Michael K. Paulk and Director) /s/ John J. Fleming Director June 3, 1997 - ------------------------------- John J. Fleming /s/ John Rainwater Vice President and June 3, 1997 - ------------------------------- Director John Rainwater /s/ Morton A. Cohen Director June 3, 1997 - ------------------------------- Morton A. Cohen /s/ Brian E. Bayley Director June 3, 1997 - ------------------------------- Brian E. Bayley -14- INDEX TO FINANCIAL STATEMENTS Report of Independent Accountants................................... F-2 Consolidated Balance Sheet, December 31, 1996....................... F-3 Consolidated Statements of Operations, Years ended December 31, 1996 and 1995............................ F-4 Consolidated Statements of Changes in Stockholders Equity, Years ended December 31, 1996 and 1995............................ F-5 Consolidated Statements of Cash Flows, Years ended December 31, 1996 and 1995............................ F-6 Notes to Consolidated Financial Statements.......................... F-7 F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders Gothic Energy Corporation and Subsidiaries We have audited the accompanying consolidated balance sheet of Gothic Energy Corporation and subsidiaries as of December 31, 1996 and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for the years ended December 31, 1996 and 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Gothic Energy Corporation and subsidiaries as of December 31, 1996, and the consolidated results of their operations and their cash flows for the years ended December 31, 1996 and 1995, in conformity with generally accepted accounting principles. Coopers & Lybrand L.L.P. Tulsa, Oklahoma February 24, 1997 F-2 GOTHIC ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET DECEMBER 31, 1996
ASSETS - ------ CURRENT ASSETS: Cash and cash equivalents $ 206,648 Oil and gas receivable 2,802,140 Receivable from officers and employees 51,932 Assets held for sale 209,740 Other 78,786 ------------ TOTAL CURRENT ASSETS 3,349,246 PROPERTY AND EQUIPMENT: Oil and gas properties on full cost method 39,857,665 Equipment, furniture and fixtures 328,492 Accumulated depreciation, depletion and amortization (3,636,414) ------------ PROPERTY AND EQUIPMENT, NET 36,549,743 OTHER ASSETS, NET 1,566,894 ------------ TOTAL ASSETS $ 41,465,883 ============ LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------ CURRENT LIABILITIES: Accounts payable trade $ 1,336,854 Revenues payable 1,978,221 Accrued liabilities 512,400 Current portion long-term debt 5,927,660 ------------ TOTAL CURRENT LIABILITIES 9,755,135 LONG-TERM DEBT 15,854,000 GAS IMBALANCE LIABILITY 1,025,266 COMMITMENTS AND CONTINGENCIES (NOTES 7 AND 8) STOCKHOLDERS' EQUITY: Preferred stock, par value $.05, authorized 500,000 shares; issued and outstanding 5,540 shares 277 Common stock, par value $.01, authorized 100,000,000 shares; issued and outstanding 12,381,857 shares 123,819 Additional paid in capital 33,321,990 Accumulated deficit (18,614,604) ------------ TOTAL STOCKHOLDERS' EQUITY 14,831,482 ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 41,465,883 ============
See accompanying notes to consolidated financial statements F-3 GOTHIC ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
1996 1995 ----------- ----------- REVENUES: Oil and gas sales $10,385,382 $ 1,893,717 Well operations 1,061,804 62,937 Interest and other income 68,284 81,296 ----------- ----------- TOTAL REVENUES 11,515,470 2,037,950 COSTS AND EXPENSES: Lease operating expenses 4,806,741 1,202,535 Depreciation, depletion and 2,856,000 882,450 amortization Selling, general and administrative 1,781,739 1,009,539 expense Provision for impairment of oil and 5,050,000 2,247,083 gas properties Provision for impairment of investment - 802,287 Loss on termination of option - 1,850,000 ----------- ----------- Operating loss (2,979,010) (5,955,944) Interest expense 1,528,598 1,627,402 ----------- ----------- LOSS BEFORE INCOME TAXES AND (4,507,608) (7,583,346) EXTRAORDINARY ITEM INCOME TAX BENEFIT 2,992,547 - ----------- ----------- LOSS BEFORE EXTRAORDINARY ITEM (1,515,061) (7,583,346) LOSS ON EARLY EXTINGUISHMENT OF DEBT 1,432,973 - (NOTE 3) ----------- ----------- NET LOSS (2,948,034) (7,583,346) PREFERRED DIVIDENDS ($68.75 PER 380,875 - PREFERRED SHARE) PREFERRED DIVIDEND - AMORTIZATION OF PREFERRED DISCOUNT 791,429 _ ----------- ----------- NET LOSS AVAILABLE FOR COMMON SHARES $(4,120,338) $(7,583,346) =========== =========== LOSS PER COMMON SHARE BEFORE EXTRAORDINARY $(.23) $(1.73) ITEM /(A)/ =========== =========== LOSS PER COMMON SHARE $(.35) $(1.73) =========== =========== WEIGHTED AVERAGE COMMON SHARES 11,663,117 4,375,417 OUTSTANDING =========== ===========
/(a)/ Loss per common share before extraordinary item is computed after giving effect to the preferred dividends, both actual and imputed. See accompanying notes to consolidated financial statements F-4
GOTHIC ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 COMMON PREFERRED ADDITIONAL TOTAL SHARES SHARES COMMON PREFERRED PAID-IN ACCUMULATED SUBSCRIPTION STOCKHOLDERS' OUTSTANDING OUTSTANDING STOCK STOCK CAPITAL DEFICIT RECEIVABLE EQUITY ----------- ----------- -------- --------- ----------- ------------ ------------ ------------ BALANCE, DECEMBER 31, 1994 3,045,777 - $ 30,458 $ - $10,034,078 $ (6,910,920) $ (270,000) $ 2,883,616 Issuance of common stock on conversion of debt 98,000 - 980 - 195,020 - - 196,000 Issuance of common stock in Private Placement 123,880 - 1,239 - 188,313 - 270,000 459,552 Issuance of common stock with 280,000 - 2,800 - 870,325 - - 873,125 Quest financing Issuance of common stock with 954,128 - 9,541 - - - - 9,541 Stratum financing Issuance of common stock in connection with Johnson Ranch 1,000,000 10,000 - 2,677,500 - - 2,687,500 acquisition Net loss - - - - - (7,583,346) - (7,583,346) ----------- ----------- -------- --------- ----------- ------------ ------------ ----------- BALANCE, AT DECEMBER 31, 5,501,785 - $ 55,018 - $13,965,236 $(14,494,266) $ - $ (474,012) 1995 Issuance of common stock in public offering 7,635,000 - 76,350 - 12,890,032 - - 12,966,382 Return of stock with Stratum (954,128) - (9,541) - - - - (9,541) repayment Issuance of preferred stock - 5,540 - 277 5,287,153 - - 5,287,430 Preferred fee 28,667 - 287 - (287) - - - Issuance of common stock with 40,000 - 400 - 62,100 - - 62,500 Quest financing Issuance of common stock on conversion of debt 14,000 - 140 - 27,860 - - 28,000 Issuance of common stock in connection with property acquisition 116,533 - 1,165 - 298,467 - - 299,632 Preferred stock dividends - - - - - (380,875) - (380,875) Preferred dividend amortization of discount - - - 791,429 (791,429) - Net loss - - - - - (2,948,034) - (2,948,034) ----------- ----------- -------- --------- ----------- ------------ ------------ ----------- BALANCE, AT DECEMBER 31, 1996 12,381,857 5,540 $123,819 $ 277 $33,321,990 $(18,614,604) - $14,831,482 =========== =========== ======== ========= =========== ============ ============ ===========
See accompanying notes to consolidated financial statements GOTHIC ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
1996 1995 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (2,948,034) $( 7,583,346) ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Depreciation, depletion and 2,856,000 882,450 amortization Amortization of discount and loan 69,314 1,033,125 costs Provision for impairment of oil and 5,050,000 2,247,083 gas properties Provision for impairment of investment - 802,287 Loss on termination of option - 1,850,000 Deferred income tax benefit (2,992,547) - Loss on early extinguishment of debt 1,432,973 - CHANGES IN ASSETS AND LIABILITIES: Increase in accounts receivable (1,552,481) (82,272) Decrease (increase) in other current 12,971 (65,432) assets Increase in accounts and revenues 894,098 812,716 payable Increase(decrease) in accrued (565,562) 216,018 liabilities Decrease in other assets 339,013 - ------------ ------------ NET CASH PROVIDED BY OPERATING $ 2,595,745 $ 112,629 ACTIVITIES NET CASH USED BY INVESTING ACTIVITIES: Proceeds from sale of investment 200,000 - Proceeds from collection of note 123,000 - receivable Proceeds from sale of property 3,111,298 627,459 Purchase of property and equipment (17,454,852) (11,605,326) Property development (1,177,327) (402,662) Acquisition of business, net of cash (17,592,973) - acquired ------------ ------------ NET CASH USED BY INVESTING ACTIVITIES $(32,790,854) $(11,380,529) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from short-term debt - 3,000,000 Payment of short-term debt (1,560,000) (150,000) Proceeds from long-term debt 26,528,096 7,275,998 Payment of long-term debt (11,257,815) (785,632) Proceeds from sale of common stock, 13,141,368 1,777,552 net Proceeds from sale of preferred 3,997,430 - stock, net Payment of Dividends (173,125) - Other (431,756) (517,437) ------------ ------------ NET CASH PROVIDED BY FINANCING $ 30,244,198 $ 10,600,481 ACTIVITIES NET CHANGE IN CASH AND CASH EQUIVALENTS 49,089 (667,419) CASH AND CASH EQUIVALENTS, BEGINNING OF 157,559 824,978 PERIOD ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $ 206,648 $ 157,559 ============ ============ SUPPLEMENTAL DISCLOSURE OF INTEREST PAID $ 1,386,817 $ 456,309 ============ ============
See accompanying notes to consolidated financial statements 6 GOTHIC ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. GENERAL AND ACCOUNTING POLICIES ORGANIZATION AND NATURE OF OPERATIONS - The consolidated financial statements include the accounts of Gothic Energy Corporation, (the "Company"), and its subsidiaries, Gothic Energy of Texas, Inc. ("Gothic Texas"), since its inception in 1995 and Buttonwood Energy Corporation and its subsidiaries, Buttonwood Petroleum, Inc. and Dakota Services, Inc. ("Buttonwood") since their acquisition on January 30, 1996. Since November 1994, the Company has been primarily engaged in the business of acquiring, developing and exploiting oil and gas reserves in Oklahoma, Texas, Arkansas and Kansas. Substantially all of the Company's oil and gas reserves are being sold regionally in the "spot market" or under short-term contracts, not extending beyond twelve months. USE OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In addition, accrued and deferred lease operating expenses, gas imbalance liabilities, oil and gas reserves (see note 10) and the valuation of stock based compensation (see note 5) also include significant estimates which could materially differ from the amounts ultimately realized. CASH EQUIVALENTS - Cash and Cash Equivalents include cash on hand, amounts held in banks and highly liquid investments with a maturity of three months or less at date of purchase. FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK - Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of trade receivables with a variety of national and international oil and natural gas companies. The Company does not generally require collateral related to receivables. Such credit risk is considered by management to be limited due to the large number of customers comprising the Company's customer base. In addition, at December 31, 1996, the Company had a concentration of cash of $713,000, with one bank. OIL AND GAS PROPERTIES - The Company accounts for its oil and gas exploration and development activities using the full cost method of accounting prescribed by the Securities and Exchange Commission ("SEC"). Accordingly, all productive and non-productive costs incurred in connection with the acquisition, exploration and development of oil and gas reserves are capitalized and depleted using the units-of-production method based on proved oil and gas reserves. The Company capitalizes costs including: salaries and related fringe benefits of employees directly engaged in the acquisition, exploration and development of oil and gas properties, as well as other directly identifiable general and administrative costs F-7 NOTE 1. GENERAL AND ACCOUNTING POLICIES (CONTINUED) associated with such activities. Such costs do not include any costs related to production, general corporate overhead, or similar activities. The Company's oil and gas reserves are estimated annually by petroleum engineers. The Company's calculation of depreciation, depletion and amortization ("DD&A") includes estimated future expenditures to be incurred in developing proved reserves and estimated dismantlement and abandonment costs, net of salvage values. The average composite rate used for DD&A on oil and gas properties was $.64 and $.80 per Mcfe in 1996 and 1995, respectively. DD&A on oil and gas properties amounted to $2,820,000 and $747,000 in 1996 and 1995, respectively. In the event the unamortized cost of oil and gas properties being amortized exceeds the full cost ceiling as defined by the SEC, the excess is charged to expense in the period during which such excess occurs. The full cost ceiling is based principally on the estimated future discounted net cash flows from the Company's oil and gas properties. The Company recorded a $5,050,000 provision for impairment of oil and gas properties at March 31, 1996. As a result of the $5,050,000 impairment provision and an aggregate of $2,850,000 of Buttonwood deposits written off, the Company recorded a tax benefit of $2,992,547 which offset the deferred tax liability related to the acquired Buttonwood oil and gas properties. A similar provision of $2,247,083 was recorded during the year ended December 31, 1995. As discussed in Note 10, estimates of oil and gas reserves are imprecise. Changes in the estimates or declines in oil and natural gas prices could cause the Company in the near-term to reduce the carrying value of its oil and natural gas properties further. Sales and abandonments of properties are accounted for as adjustments of capitalized costs with no gain or loss recognized unless a significant amount of reserves is involved. Since all of the Company's oil and gas properties are located in the United States, a single cost center is used. With respect to wells operated by the Company, but in which it has a working interest, the independent operators are, in some cases, privately- held companies who may have limited financial resources. If a third party operator experiences financial difficulty and fails to pay for material and services in a timely manner, the wells operated by the third party operator could be subject to material and workmen's liens. The Company has no reason to believe that its current operators are experiencing significant financial difficulties. EQUIPMENT, FURNITURE AND FIXTURES - Equipment, furniture and fixtures are stated at cost and are depreciated on the straight-line method over their estimated useful lives which range from three to seven years. DEBT ISSUANCE COSTS - The unamortized portion of debt issuance costs included in other assets, which includes the estimated fair value of warrants, stock or other interests given to obtain financing, is amortized and included in interest expense using the straight-line F-8 NOTE 1. GENERAL AND ACCOUNTING POLICIES (CONTINUED) method over the term of the related debt. Amortization of debt issuance costs for the years ended December 31, 1996 and 1995 amounted to $69,314 and $1,033,125, respectively. NATURAL GAS BALANCING - The Company uses the sales method for recording natural gas sales. The Company's oil and condensate production is sold, title passed, and revenue recognized at or near its wells under short-term purchase contracts at prevailing prices in accordance with arrangements which are customary in the oil industry. Sales of gas applicable to the Company's interest in producing oil and gas leases are recorded as revenues when the gas is metered and title transferred pursuant to the gas sales contracts covering its interest in gas reserves. During such times as the Company's sales of gas exceed its pro rata ownership in a well, such sales are recorded as revenues unless total sales from the well have exceeded the Company's share of estimated total gas reserves underlying the property at which time such excess is recorded as a gas balancing liability. At December 31, 1996, total sales exceeded the Company's share of estimated total gas reserves on eleven wells by $381,755 (128,468 Mcf), based on the year end "spot market" price of natural gas. The gas balancing liability has been classified in the balance sheet as non-current, as the Company does not expect to settle the liability during the next twelve months. The Company has recorded deferred charges for estimated lease operating expenses incurred in connection with its underproduced gas imbalance position. At December 31, 1996, cumulative total gas sales volumes for underproduced wells were less than the Company's pro-rata share of total gas production from these wells by 1,214,208 Mcf, resulting in prepaid lease operating expenses of $1,250,634, which are included in other assets in the accompanying balance sheet. In addition, the Company has recorded accrued charges for estimated lease operating expenses incurred in connection with its overproduced gas imbalance position. At December 31, 1996, cumulative total gas sales volumes for overproduced wells exceeded the Company's pro-rata share of total gas production from these wells by 624,768 Mcf, resulting in accrued lease operating expenses of $643,511, which are included in the gas balancing liability in the accompanying balance sheet. INCOME TAXES - The Company applies the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). Under SFAS No. 109, deferred tax liabilities or assets arise from the temporary differences between the tax basis of assets and liabilities, and their basis for financial reporting, and are subject to tests of realizability in the case of deferred tax assets. LOSS PER COMMON SHARE - Loss per common share is computed on the basis of the weighted average shares of common stock outstanding, including the effect of dilutive common stock equivalents. Primary and fully diluted earnings per share are the same for all periods presented. F-9 NOTE 1. GENERAL AND ACCOUNTING POLICIES (CONTINUED) STOCK BASED COMPENSATION - The Company applies Accounting Principles Board Opinion No. 25 in accounting for its stock option plans. Under this standard, no compensation expense is recognized for grants of options which include an exercise price equal to or greater than the market price of the stock on the date of grant. Accordingly, based on the Company's grants in 1996 and 1995, no compensation expense has been recognized. HEDGING ACTIVITIES - During 1996, the Company entered into an agreement with a gas purchaser to hedge a portion of its monthly gas production. Under the agreement, the difference between the current value of the Company's gas, based upon the spot market price, and a fixed price was received or paid by the Company. The Company hedged 5,000 Mcf per day for the period of July 1, 1996 through December 31, 1996 at a price of $2.06 per Mcf. The Company recorded payments received or made under this agreement in its oil and gas sales. The Company has a new hedging agreement in place with the same gas purchaser to hedge 5,000 Mcf per day for the period January 1, 1997 through March 31, 1997 at a price of $2.65 per Mcf. NOTE 2. OIL AND GAS PROPERTY ACQUISITIONS AND DISPOSITIONS ACQUISITIONS SUBSEQUENT TO YEAR-END 1996 NORSE ACQUISITION - On February 18, 1997, the Company acquired from Norse Exploration, Inc., and Norse Pipeline, Inc. (collectively, "Norse"), various working interests in 11 oil and gas producing properties and, through the acquisition of the outstanding capital stock of Norse Pipeline, Inc., its 40.09% general partnership interest in the Sycamore Gas System (the "Sycamore System"), an Oklahoma gathering system, processing plant and storage facility. The oil and gas wells and the gathering system are located in the Springer Field in Carter County, Oklahoma. The total purchase price was $10,750,000, plus two-year warrants to purchase 200,000 shares of the Company's Common Stock at a per share exercise price of $2.50 of which the Company paid a deposit of $1,075,000 toward the purchase price in December 1996. The estimated fair value of such warrants at the date of acquisition was approximately $254,000. HUFFMAN ACQUISITION - The Company also on February 18, 1997, acquired from H. Huffman & Company ("Huffman"), an Oklahoma limited partnership, various working interests in 13 oil and gas producing properties and an additional 10.97% interest in the Sycamore System. The oil and gas wells are located in the same producing area as the properties acquired from Norse. The total purchase price for the assets acquired was $3,950,000 of which the Company paid a deposit of $287,500 toward the purchase price in December 1996. HORIZON ACQUISITION - The Company also acquired, on February 18, 1997, from Horizon Gas Partners, L.P. and HSRTW, Inc. (collectively, "Horizon"), various working and royalty interests in approximately 100 oil and gas producing properties. The producing properties F-10 NOTE 2. OIL AND GAS PROPERTY ACQUISITIONS AND DISPOSITIONS (CONTINUED) are located in Major and Blaine counties of Oklahoma. The purchase price was $10,000,000. ACQUISITIONS DURING YEAR-END 1996 ATHENA ACQUISITION - On December 27, 1996, the Company completed an acquisition from Athena Energy, Inc. of various working interest in 85 producing oil and gas properties (the "Athena Acquisition"). The Company operates approximately 30 of the wells. The purchase price for the properties acquired was approximately $4,200,000. Substantially all the properties acquired are located in western Oklahoma and the Texas Panhandle. Subsequent to year end, substantially all of the non-operated well interests acquired from Athena were sold for net proceeds of approximately $210,000. VARIOUS WORKING INTEREST ACQUISITIONS - On August 5, 1996, the Company completed the acquisition, from various sellers, of working interests in approximately 120 wells in the Anadarko Basin of Western Oklahoma, and the Arkoma Basin of Eastern Oklahoma and Arkansas (the "Working Interest Acquisitions"). The Company operates 70 of the wells in which the interests were acquired. The aggregate purchase price for these wells was $3,270,000. STRATUM ACQUISITION - On May 20, 1996, the Company acquired from Stratum Group Energy Capital, L.P. and Stratum Corp. (the "Stratum Acquisition"), the overriding royalty interest of 7% of the net revenues derived from the properties acquired in the Johnson Ranch financing provided by Stratum to the Company in May 1995 for the Johnson Ranch Acquisition. The purchase price was $800,000. COMSTOCK ACQUISITION - On May 16, 1996, the Company completed the acquisition, from Comstock Oil and Gas, Inc. and Comstock Offshore Energy, Inc. (the "Comstock Acquisition"), of various working interest in 145 producing oil and gas properties. The Company operates 70 of the wells. The purchase price for the properties acquired was $6,430,195. Substantially all of the properties acquired are located in the Anadarko Basin of western Oklahoma and the Arkoma Basin of eastern Oklahoma and Arkansas. BUTTONWOOD ACQUISITION - On January 30, 1996 the Company completed the acquisition of Buttonwood Energy Corporation ("Buttonwood"). Concurrently with entering into an option agreement with Buttonwood on September 27, 1995 for $1,000,000, the parties terminated without being exercised a similar option purchased by the Company in March 1995 for $1,850,000. The Company recorded a loss on termination of these options in 1995, with the $1,000,000 recorded as an impairment of oil and gas properties. The aggregate purchase price of $18,008,712 including acquisition costs of $389,212, was allocated to the assets acquired and liabilities assumed as follows: F-11 NOTE 2. OIL AND GAS PROPERTY ACQUISITIONS AND DISPOSITIONS (CONTINUED)
Current assets $ 1,632,327 Property and equipment 20,784,016 Other assets 1,435,500 Current liabilities (1,660,628) Gas imbalance liability (1,189,956) Deferred income taxes (2,992,547) ----------- Aggregate purchase price 18,008,712 Less: Cash acquired (415,739) ----------- Net cash paid $17,592,973 ===========
The transaction was financed with proceeds from a public offering of the Company's common stock, the sale of preferred stock, a bridge financing and the establishment of a credit facility with Bank One, Texas. The public offering and the preferred financing (Note 4), generated net proceeds of $17,216,000. The remaining purchase price was paid out of the proceeds from the Bank One, Texas Credit Facility (Note 3). ACQUISITIONS DURING YEAR-END 1995 JOHNSON RANCH ACQUISITION - On June 2, 1995 the Company completed the acquisition of working interests in approximately 69 oil and gas wells in Loving County Texas, through its wholly owned subsidiary, Gothic Texas, from Johnson Ranch Partners ("Johnson Ranch"). The purchase price was $7,250,000, plus 1,000,000 shares of the Company's common stock valued at $2.69 per share, the closing market price on the date the acquisition was completed. The transaction was financed with proceeds of a loan from Stratum Group, L.L.C. ("Stratum"), to Gothic Texas in the maximum aggregate amount of $8,131,500, of which only $6,756,500 was drawn and used to finance the acquisition. As consideration for making the loan, Gothic Texas conveyed to Stratum an overriding royalty interest of 7% of Gothic's net interest in each of the properties acquired. As additional consideration for making the loan, Stratum was issued five-year common stock purchase warrants to purchase an aggregate of 1,000,000 shares of the Company's Common Stock, exercisable, at $3.25 per share. The shares issuable upon exercise of the warrants have certain demand and "piggyback" registration rights. Stratum also received a security interest in and the right to sell additional shares of the Company's Common Stock exercisable in the event of a default under the loan agreement. An aggregate of 954,128 shares were issued to Stratum, pursuant to this arrangement. On January 30, 1996, through its new credit facility, the Company paid Stratum all outstanding amounts due them and received back all common stock held by Stratum as collateral for the loan. F-12 NOTE 2. OIL AND GAS PROPERTY ACQUISITIONS AND DISPOSITIONS (CONTINUED) EGOLF ACQUISITION - On January 19, 1995, the Company completed the acquisition of working interests in approximately 208 oil and gas wells located primarily in western Oklahoma, for a total purchase price of $1,584,000 plus one-year common stock purchase warrants to purchase 100,000 shares of the Company's common stock at an exercise price of $2.50 per share. These warrants expired without being exercised. All of the above noted acquisitions were accounted for under the purchase method and, accordingly, results of operations of the acquired properties are included in the Company's results of operations since the respective dates of the acquisitions. The The following reflects the unaudited proforma results of operations assuming the 1995 and 1996 acquisitions had all been consummated on January 1, 1995.
1996 1995 ---- ---- Revenues 14,266 12,592 Operating loss (1,906) (4,443) Net loss (2,800) (5,337) Loss per common share (.24) (.46)
PROPERTY DISPOSITION - Management of the Company reviews the properties acquired and from time to time disposes of wells that are deemed to be unprofitable, fail to meet management's operating requirements or, under certain circumstances, are operated by other persons. From time to time, the Company disposes of wells operated by the Company where the well does not meet operating requirements. During the year ended December 31, 1996, the Company disposed of various interests in an aggregate of 514 properties for a total sales price of $3,111,298. Of such amount, $2,402,096 was applied to reduce outstanding indebtedness and $709,202 was used for working capital purposes. NOTE 3. LONG-TERM DEBT AND NOTES PAYABLE LONG-TERM DEBT Long-term debt at December 31, 1996 consists of the following:
Bank One Credit Facility $21,744,000 Others 37,660 Less: Current Portion (5,927,660) ----------- Total Long-Term Debt $15,854,000 ===========
On January 19, 1996, the Company entered into a Loan Agreement with Bank One, Texas, N.A. (the "Credit Facility"), which reflecting subsequent amendments, enabled the Company to borrow, from time to time and, subject to meeting certain borrowing base F-13 NOTE 3. LONG-TERM DEBT AND NOTES PAYABLE (CONTINUED) requirements and other conditions, a maximum aggregate of $25,000,000, consisting of a $20,000,000 revolving loan and a $5,000,000 acquisition note. On January 30, 1996, $11,000,000 of the Credit Facility was used to finance a portion of the purchase price for the Buttonwood Acquisition and repay outstanding indebtedness. Additional proceeds of $7,230,195 were used on May 16, 1996 to finance the Comstock Acquisition and the Stratum Acquisition, and on July 31, 1996, proceeds of $2,792,200 were used to finance the acquisition of well interests from various sellers. In December 1996, additional proceeds of $5,505,701 were used to finance the $4,214,406 purchase price for the Athena Acquisition, and $1,291,295 of the down payments for the Norse and Huffman Acquisitions. The Company has repaid principal in the amount of $4,784,096 under the Credit Facility since January 30, 1996. The terms of the Credit Facility provided for amortization payments at the rate of $240,000 per month under the revolving loan commencing September 1, 1996, with all outstanding principal and interest due and payable on January 30, 1999. Of the $5,000,000 acquisition note, $3,010,000 was outstanding at year end and was due on March 31, 1997. Interest was payable, at the option of the Company, either at the rate of 1% over the lending bank's rate or up to 3.75% (based on the principal balance outstanding) over the rate for borrowed dollars by the lending bank in the London Interbank market. The indebtedness was collateralized by first liens on all of the Company's oil and gas properties. The Credit Facility included various affirmative and negative covenants, including, among others, the requirements that the Company (i),Emaintain a ratio of current assets to current liabilities, as defined, of no less than 1.0 to 1.0, (ii) maintain a debt service coverage ratio of net cash flow per quarter to required quarterly reduction of indebtedness of not less than 1.10 to 1.0, (iii) maintain minimum tangible net worth at the end of each fiscal quarter of $10,250,000, plus certain percentages of net income and proceeds received from the sale of securities, and (iv) maintain selling, general and administrative expenses per quarter not in excess of 25% of consolidated net revenues. Material breaches of these or other covenants which were not cured or waived could have resulted in a default under the Credit Facility resulting in the indebtedness becoming immediately due and payable and empowering the lender to foreclose against the collateral for the loan. During the year ended December 31, 1996, the Company requested and obtained a waiver of the provision requiring a 1:1 ratio of current assets to current liabilities for the year ended December 31, 1996 and for the quarter ended September 30, 1996, the restriction on general and administrative expenses for the quarter ended March 31, 1996, and a covenant violated as a result of the termination of a former officer of the Company. On February 17, 1997, the Company and Bank One, Texas, N.A., entered into a Restated Loan Agreement (the "Credit Facility") which currently enables the Company to borrow, from time to time and, subject to meeting certain borrowing base requirements and other conditions, a maximum aggregate of $75,000,000. As of February 17, 1997, the aggregate available to be borrowed under the Credit Facility is comprised of a $32,000,000 borrowing availability (the "borrowing base") based on the Company's oil and gas reserve reports, a $10,000,000 special advance facility (the "Special Advance Facility") and a $2,000,000 special drilling facility (the "Special Drilling Facility"). F-14 NOTE 3. LONG-TERM DEBT AND NOTES PAYABLE (CONTINUED) On February 18, 1997, the Company drew down the borrowing base and the Special Advance Facility for a total of $41,668,000. These funds were used to repay all existing Bank One debt outstanding in the amount of $21,264,000, to partially finance the February 18, 1997 Huffman, Norse and Horizon acquisitions in the amount of $19,404,000 and to pay a $1,000,000 loan fee to Bank One. The terms of the Credit Facility currently provide for amortization payments at the rate of $240,000 on March 1, 1997 and increasing to $475,000 per month commencing April 1, 1997, with all outstanding principal and interest due and payable on January 30, 1999. The Special Advance Facility of $10,000,000 is due on September 1, 1997. Interest is payable, at the option of the Company, either at the rate of 1% over the lending bank's base rate (9.25% at December 31, 1996) or up to 3.75% (based on the principal balance outstanding) over the rate for borrowed dollars by the lending bank in the London Interbank market. The indebtedness is collateralized by first liens on all of the Company's oil and gas properties. The Credit Facility includes various affirmative and negative covenants, including, among others, the requirements that the Company (i),Emaintain a ratio of current assets to current liabilities, as defined, of no less than 1.0 to 1.0, (ii) maintain a debt service coverage ratio of net cash flow per quarter to required quarterly reduction of indebtedness of not less than 1.10 to 1.0, (iii) maintain minimum tangible net worth at the end of each fiscal quarter of $10,250,000, plus certain percentages of net income and proceeds received from the sale of securities, (iv) maintain selling, general and administrative expenses per quarter not in excess of 25% of consolidated net revenues for the quarter ended March 31, 1997 and 20% of consolidated net revenues for all subsequent quarters and (v) and to arrange for hedges covering not less than 75% of the Company's proved developed production of oil and natural gas for a period of not less than twelve months with minimum floor prices to be mutually agreed upon by the Company and Bank One. Material breaches of these or other covenants which are not cured or waived could result in a default under the Credit Facility resulting in the indebtedness becoming immediately due and payable and empowering the lender to foreclose against the collateral for the loan. In the event certain promissory notes owing to the bank by two officers of the Company in the aggregate amount of $316,000 are not paid when due on December 31, 1997, the Company has agreed that such amounts will be drawn against the Company's Credit Facility and the officers will be obligated to the Company for such sums. Future maturities of long-term debt, as of December 31, 1996, based on the terms of the original Bank One loan agreement, or the Bridge Financing described below are as follows:
1997 $ 5,927,660 1998 2,880,000 1999 12,974,000 ----------- $21,781,660 ===========
F-15 NOTE 3. LONG-TERM DEBT AND NOTES PAYABLE (CONTINUED) As noted above, on February 17, 1997, the Company and Bank One amended the Credit Facility to provide for additional borrowings and, accordingly, the monthly payments were increased from $240,000 per month to $475,000 per month under the revolving loan. Additionally, the $10,000,000 Special Advance Facility is due on September 1, 1997. On June 2, 1995, Gothic Texas entered into an agreement with Stratum Group, LLC ("Stratum") in which Stratum agreed to loan Gothic Texas a maximum aggregate of $8,131,500, of which only $6,756,500 was drawn and was used to complete the Johnson Ranch Acquisition. At December 31, 1995, the amount outstanding was $6,622,815. On January 30, 1996, the Company, with proceeds from its new credit facility, paid Stratum in full and terminated its loan agreement with them. The transaction resulted in a loss on extinquishment of debt of $1,432,973 and is shown as an extraordinary item in the statement of operations. Based on the borrowing rates currently available to the Company for debt with similar terms and maturities, long-term debt at December 31, 1996 approximates its fair value. NOTES PAYABLE In order to provide the funds necessary to complete the Norse, Huffman, and Horizon acquisitions, on February 18, 1997 two accredited investors, as defined by the Securities Act, loaned to the Company the aggregate sum of $4,500,000 represented by the Company's promissory notes ("Bridge Financing"). Of the aggregate amount, $2,500,000 bears interest at 5% per annum and matures on April 18, 1997, with the remaining $2,000,000 bearing interest at 12% per annum and maturing on October 31, 1997. In the event the principal and accrued interest is not paid when due, such amount is automatically converted into a number of shares of the Company's Common Stock determined by dividing such amount by a sum equal to 75% of the closing bid price for the Company's Common Stock on the five (5) days prior to the maturity date, with respect to the $2,500,000 obligation, and on the maturity date with respect to the $2,000,000 obligation. As additional consideration for making the loan, the investors also purchased at a price of $.01 per share a total of 250,000 shares of the Company's common stock. The fair market value of the Company's common stock was $2.63 per share on the date such shares were issued. Also, the Company paid a $250,000 fee for the $2,500,000 Note. F-16 NOTE 4. STOCKHOLDERS' EQUITY COMMON STOCK AND PREFERRED STOCK OFFERING - On January 30, 1996, the Company completed a public offering of 2,545,000 Units at a price of $6.00 per Unit. Each Unit consisted of three shares of the Company's common stock and three five year redeemable common stock purchase warrants, each redeemable for one share of common stock at $2.40 per share. The offering netted the Company approximately $12,970,000, all of which was applied to the purchase of Buttonwood Energy Corporation. In connection with the offering, the Underwriter was granted an option to acquire 230,000 Underwriter Units exercisable at a price of $9.90 per Unit. Also on January 30, 1996, the Company completed a preferred stock financing of 5,540 shares of the Company's 7 1/2% Cumulative Convertible Preferred Stock. Additionally, 28,667 shares of common stock were issued as a placement fee on the preferred stock offering. The financing included 1,290 shares issued to Quest Capital Corporation in exchange for $1,290,000 principal amount of the Quest Note, and the sale for cash of 4,250 shares, for an aggregate cash price of $4,250,000 (net of fees of $252,570). The 5,540 shares of 7 1/2% Cumulative Convertible Preferred Stock are convertible commencing December 31, 1996, into shares of the Company's Common Stock at a conversion price per share of Common Stock equal to the lessor of (iE) $2.00 or (ii) a price equal to the average of the closing prices of the Company's Common stock during the 30 business days prior to the day the shares are converted less a discount of 12%. On the basis of the above mentioned conversion price, an aggregate of 2,770,000 shares of Common Stock are issuable on conversion. The Company has the right to redeem the shares of Preferred Stock at their liquidation value of $1,000 per share, plus any accrued and unpaid dividends at any time after January 30, 1998, upon giving 30 days prior written notice. Due to the fact that the preferred stock is convertible into the Company's common stock at a discount from market, the Company has computed an imputed dividend of $791,429, which is based on the common stock market value of $2.00 per share at the date of issuance and a 12 1/2% discount. The discount was accreted as an imputed dividend through DecemberE31, 1996 and, accordingly, affects income (loss) available for common shares. In June 1996, the Company issued 116,533 shares of its common stock to two separate parties as consideration for their interest in oil and gas properties located on the Johnson Ranch. The fair value assigned to these oil and gas properties was $299,600, based on the trading price of the Company's stock on the date of the acquisition. In June 1995, the Company issued 1,000,000 shares of its common stock to Merrill Lynch Capital Corporation as partial consideration for the Johnson Ranch Acquisition (Note 2). The stock was trading at a value of $2.69 per share on the date of issuance. Also in June 1995, the Company issued 650,000 shares of common stock to the Stratum Group as collateral for financing provided by Stratum to complete the Johnson Ranch Acquisition (Note 2). Through September 1995, an additional 304,128 shares of common stock were issued to Stratum as collateral pursuant to the financing agreement. On F-17 January 30, 1996 the Company repaid Stratum and the 954,128 shares of common stock held by Stratum as collateral were returned to the Company. In March 1995 the Company entered into an agreement with Quest Capital Corporation ("Quest"), at which time Quest loaned the Company $1,850,000. Pursuant to the agreement the Company issued 100,000 shares of common stock to Quest in March NOTE 4. STOCKHOLDERS' EQUITY (CONTINUED) 1995. Additionally, the Company was obligated to issue an additional 25,000 shares of common stock for each of the four months of July through October and 40,000 shares of common stock each month from November forward, or until the debt was repaid. The Company issued 180,000 additional shares of common stock to Quest, bringing the total shares issued to Quest at December 31, 1995, to 280,000. An additional 40,000 shares of common stock were issued in January 1996, prior to the time the loan was repaid. During the period January 1995 through June 1995, Noteholders converted a total of $656,800 in principal and interest into 325,600 shares of the Company's common stock while retaining 52,500 of $1.00 common stock warrants. The following tables reflect the Company's outstanding warrants and options at December 31, 1996, 1995 and 1994.
EXERCISE NUMBER PRICE ($) EXPIRATION OUTSTANDING EXPIRED/ OUTSTANDING EXERCISABLE PER SHARE DATE 12/31/94 GRANTED EXERCISED CANCELED 12/31/95 12/31/95 --------- ---------- ----------- ---------- ------------ --------- ------------ ----------- WARRANTS 1991 Public Offering 5.50 06/30/96 800,000 - - - 800,000 800,000 1991 Underwriter 6.00 11/08/96 160,000 - - - 160,000 160,000 Private Placement 3.00 02/28/95 48,013 - - 48,013 - - Quest 1.00 04/17/97 - 300,000 - - 300,000 300,000 Egolf 2.50 01/19/96 - 100,000 - - 100,000 100,000 Stratum 3.25 06/02/2000 - 1,000,000 - - 1,000,000 1,000,000 Bridge 2.40 01/30/2001 - 250,000 - - 250,000 - Note Extenstion 1.00 08/31/97 72,500 - - 20,000 52,500 52,500 ----------- ---------- ------------ --------- ------------ --------- Total Warrants 1,080,513 1,650,000 - 68,013 2,662,500 2,412,500 OPTIONS (NOTE 5) Employees 1.50 11/01/99 - 125,000 - - 125,000 - 3.38 02/28/95 1,109 - - 1,109 - - Officers & Directors 1.50 11/01/99 - 250,000 - - 250,000 - 2.50 10/04/99 500,000 - - - 500,000 250,000 Former Director/Officer 1.50 07/15/97 20,000 - - - 20,000 20,000 2.00 09/15/2004 30,000 - - - 30,000 30,000 2.65 08/14/95 10,000 - - 10,000 - - ----------- ---------- ------------ --------- ------------ --------- Total Options 561,109 375,000 - 11,109 925,000 300,000 Total 1,641,622 2,025,000 - 79,122 3,587,500 2,712,500
F-18 NOTE 4. STOCKHOLDERS' EQUITY (CONTINUED)
EXERCISE NUMBER PRICE ($) EXPIRATION OUTSTANDING EXPIRED/ OUTSTANDING EXERCISABLE PER SHARE DATE 12/31/94 GRANTED EXERCISED CANCELED 12/31/95 12/31/95 --------- ---------- ----------- ---------- ------------ --------- ------------ ----------- WARRANTS 1991 Public Offering 5.50 06/30/96 800,000 - - 800,000 - - 1991 Underwriter 6.00 11/08/96 160,000 - - 160,000 - - 1996 Public Offering(1) 2.40 01/30/2001 - 7,635,000 - - 7,635,000 7,635,000 1996 Underwriter 2.40 01/30/2001 - 690,000 - - 690,000 690,000 Quest 1.00 04/17/97 300,000 - - - 300,000 300,000 Egolf 2.50 01/19/96 100,000 - - 100,000 - - Stratum 3.25 06/02/2000 1,000,000 - - - 1,000,000 1,000,000 Bridge 2.40 01/30/2001 250,000 - - - 250,000 250,000 Note Extension 1.00 08/31/97 52,500 - - - 52,500 52,500 Underwriter 2.25 08/19/2001 - 200,000 - - 200,000 200,000 Consultant 2.38 03/14/2001 - 29,531 - - 29,531 29,531 --------- ---------- ----------- ---------- ------------ --------- ------------ ----------- Total Warrants 2,662,500 8,554,531 - 1,060,000 10,157,031 10,157,031 OPTIONS (NOTE 5) 1996 Underwriter Share 3.30 01/30/2001 - 690,000 - - 690,000 690,000 Employee 1.50 11/01/99 125,000 - - - 125,000 62,500 1.75 02/01/2001 - 45,000 - - 45,000 - 2.50 12/18/2001 - 135,000 - - 135,000 - Officers & Directors 1.50 11/01/99 250,000 - - 150,000 100,000 50,000 2.50 10/04/99 500,000 - - - 500,000 500,000 2.56 07/16/2001 - 600,000 - - 600,000 - Former Director/Officer 1.50 07/15/97 20,000 - - - 20,000 20,000 2.00 09/15/2004 30,000 - - - 30,000 30,000 --------- ---------- ----------- ---------- ------------ --------- ------------ ----------- Total Options 925,000 1,470,000 - 150,000 1,745,000 1,352,500 Total 3,587,500 10,024,531 - 1,210,000 12,402,031 11,509,531
(1) Warrants are redeemable at the option of the Company at a per warrant price of $.01 per warrant at any time after the Warrants become exercisable, upon not less than 15 business days prior written notice, if the last sale price of the Common Stock has been at least 200% of the then exercise price of the Warrants for the 20 consecutive trading days prior to date of notice. Warrant holders are entitled to exercise their warrants up to the date of redemption. F-19 NOTE 5. STOCK OPTIONS INCENTIVE STOCK OPTION PLAN - The Company has an incentive stock option and non-statutory option plan (the "Plan"), which provides for the issuance of options to purchase up to 2,500,000 shares of Common Stock to key employees and Directors. The incentive stock options granted under the Plan are generally exercisable for a period of ten years from the date of the grant, except that the term of an incentive stock option granted under the Plan to a stockholder owning more than 10% of the outstanding common stock must not exceed five years and the exercise price of an incentive stock option granted to such a stockholder must not be less than 110% of the fair market value of the common stock on the date of grant. The exercise price of a non-qualified option granted under the Plan may not be less than 40% of the fair market value of the common stock at the time the option is granted. No non-qualified options have been issued under the Plan. As of December 31, 1996 and 1995, options to purchase 1,005,000 and 376,109 (1,109 shares expired during 1995) shares of common stock had been granted under the plan, respectively. Options to employees to purchase an aggregate of 305,000 common shares are exercisable, with 125,000 shares exercisable at $1.50 per share through November 1, 1999, 45,000 shares exercisable at $1.75 per share, through February 1, 2001, and 135,000 shares exercisable at $2.50 per share, through December 18, 2001. Options to officers and directors to purchase an aggregate of 700,000 common shares are outstanding, with 100,000 shares exercisable at $1.50 per share, through November 1, 1999 and 600,000 shares exercisable at $2.56 per share, through July 16, 2001. Half of the options are exercisable after the completion of one year of future service as an employee or director with the remaining options being exercisable upon the completion of the second year of future service. OTHER OPTIONS - On October 4, 1994 the Company granted 250,000 options to each of two officers of the Company to purchase common stock of the Company at $2.50 per share. Half of the options are exercisable after the completion of one year of future service as an employee or director with the remaining options being exercisable upon the completion of the second year of future service. On September 15, 1994, the Company granted 10,000 options to each of two directors and a former consultant. The options are currently exercisable at $2.00 per share until September 15, 2004, at which time the options expire. On July 15, 1992, the Company granted an option to a director/officer to purchase 20,000 shares of common stock with an exercise price of $2.50 per share, exercisable through July 15, 1997. On September 15, 1994, the exercise price of these options was decreased to $1.50 per share. OMNIBUS INCENTIVE PLAN - On August 13, 1996 at the Annual Shareholders' Meeting, the shareholders approved the 1996 Omnibus Incentive Plan and the 1996 Non-Employees Stock Option Plan. The 1996 Omnibus Incentive Plan provides for compensatory awards representing or corresponding up to an aggregate of 1,000,000 shares of Common Stock of the Company to officers, directors and certain other key employees. Awards may be granted F-20 NOTE 5. STOCK OPTIONS (CONTINUED) for no consideration and consist of stock options, stock awards, stock appreciation rights, dividend equivalents, other stock-based awards (such as phantom stock) and performance awards consisting of any combination of the foregoing. Generally, options will be granted at an exercise price equal to the lower of (EiE)100% of fair market value of the shares of Common Stock on the date of grant or (ii) 85% of the fair market value of the shares of Common Stock on the date of exercise. Each option will be exercisable for the period or periods specified in the option agreement, which will generally not exceed 10 years from the date of grant. No options have been issued under the Omnibus Incentive Plan. NON-EMPLOYEE STOCK OPTION PLAN - The 1996 Non-Employee Stock Option Plan provides a means by which non-employee Directors of the Company and consultants to the Company can be given an opportunity to purchase stock in the Company. The Plan provides that a total of 1,000,000 shares of the Company's Common Stock may be issued pursuant to options granted under the Non-Employee Plan, subject to certain adjustments. The exercise price for each option granted under the Non-Employee Plan will be not less than the fair market value of the Common Stock underlying the option on the date of grant. Each option granted under the Non-Employee Plan is exercisable 10 years after the date of grant. Options granted to Directors will terminate to the extent such options have not been previously exercised thirty (30) days after the date the Director is no longer a Director of the Company. No options have been issued under the Non-Employee Plan. The Company applies Accounting Principles Board Opinion No. 25 in accounting for its Incentive Stock Option Plan and other stock options issued. Accordingly, no compensation cost has been recognized in 1996 and 1995. Had compensation been determined on the basis of fair value pursuant to Statement of Financial Accounting Standards No. 123, net loss and loss per share would have been increased as follows:
1996 1995 ---- ---- Net loss available for common shares: As reported $(3,328,909) $(7,583,346) ============ ============ Proforma $(3,772,571) $(7,646,628) ============ ============ Loss per Share: As reported $ (.29) $ (1.73) ============ ============ Proforma $ (.32) $ (1.75) ============ ============
The fair value of each option granted is estimated using the Black Scholes model. The Company's volatility of stock was 0.90 based on previous stock performance. Dividend yield was estimated to remain at zero with a risk free interest rate of 6.0 percent in both 1996 and 1995. Expected life was 3 years based on prior experience, the vesting periods involved and the make up of participating employees within each grant. Fair value of options granted during 1996 and 1995 under the Stock Option Plan were $1,175,000 and $202,500, respectively. F-21 NOTE 6. INCOME TAXES Deferred tax assets and liabilities are comprised of the following at December 31, 1996:
Deferred tax assets: Gas balancing liability $ 390,000 Net operating loss carryforwards 4,889,000 Depletion carryforwards 257,000 ----------- Gross deferred tax assets 5,536,000 Deferred tax liabilities: Prepaid lease operating expenses (475,000) Book over tax basis of oil and gas properties (4,761,000) ----------- Gross deferred tax liabilities (5,236,000) Net deferred tax assets 300,000 Valuation allowance (300,000) ----------- $ 0 ===========
As a result of a change in control of the Company in 1994, approximately $4,901,000 of net operating loss carryforwards generated prior to the change in control are unavailable for future use. Net operating losses generated subsequent to the change in control of approximately $6,970,000 are available for future use against taxable income. These net operating loss carryforwards expire in the year 2010. In addition, the acquisition of Buttonwood Energy Corporation in January, 1996 made available approximately $5,900,000 of net operating loss carryforwards and $675,000 of depletion carryforwards generated prior to the acquisition. However, the loss carryforwards and depletion carryforwards are limited annually under Internal Revenue Code Section 382 due to a change in ownership. The net operating loss carryforwards expire in the year 2010 and the depletion carryforwards can be carried forward indefinitely. Due to the uncertainty of the Company's ability to utilize the net operating loss carryforwards and depletion carryforwards and the limitation under Section 382, a 100% valuation allowance has been recorded. NOTE 7. COMMITMENTS The Company has entered into five-year employment agreements with its President and Vice-President. Under the agreements, as amended in November 1996, each receives a base salary of $121,000 per year plus additional amounts as may be determined from time to time by the Company's Board of Directors. In addition, such persons are to receive a cash bonus as may be determined by the Company's Board of Directors. The Company has the right to terminate the employment agreements at any time upon 45 days notice. Unless the agreement has been terminated for cause, as defined, the Company is obligated to pay each of the officers the sum of $200,000, together with any sums unpaid under the terms of the F-22 NOTE 7. COMMITMENTS (CONTINUED) employment agreement, and continue their medical insurance in effect for a period of one year after such termination. In the event of a change of control in the Company, as defined, each of the officers has the right to terminate their employment agreements with the Company within 60 days thereafter and the Company is obligated to pay the same sums and other benefits described above as if such agreements had been terminated by the Company without cause. In the event certain promissory notes owing to the bank by two officers of the Company in the aggregate amount of $316,000 are not paid when due on December 31, 1997, the Company has agreed that such amounts will be drawn against the Company's Credit Facility and the officers will be obligated to the Company for such sums. The Company leases its corporate offices and certain office equipment and automobiles under non-cancelable operating leases. Rental expense under non-cancelable operating leases was $110,347 and $95,846 for the years ended December 31, 1996 and 1995, respectively. Remaining minimum annual rentals under non-cancelable lease agreements subsequent to December 31, 1996 are as follows:
1997 $131,013 1998 120,022 1999 114,476 2000 9,000 2001 8,250
NOTE 8. CONTINGENCIES A former officer and employee of the Company, on May 6, 1996, commenced an arbitration proceeding under the Rules of the American Arbitration Association against the Company seeking to recover damages for an alleged breach of contract and intentional interference with the contract. The damages sought are approximately $384,000. The Company believes that it has adequate basis to prove that the termination for cause was appropriate, and accordingly, no amount has been accrued in the financial statements. NOTE 9. MAJOR CUSTOMERS During the year ended December 31, 1996, the Company was a party to contracts whereby its sold approximately 48% of its gas production to Aurora Natural Gas, LLC, 11% of its gas production to GPM Gas Corporation and 82% of its oil production to Sun Refining and Marketing. During the year ended December 31, 1995, the Company was a party to contracts whereby it sold approximately 53% of its gas production to GPM Gas Corporation and 24% to Enron Capital and Trade Resources, and 95% of its oil production to Stratum Group Energy Capital, L.P. F-23 NOTE 10. SUPPLEMENTARY OIL AND GAS INFORMATION FINANCIAL DATA The following supplemental historical and reserve information is presented in accordance with Financial Accounting Standards Board Statement No. 69, "Disclosures About Oil and Gas Producing Activities". CAPITALIZED COSTS - The aggregate amounts of capitalized costs relating to oil and gas producing activities, net of valuation allowances, and the aggregate amounts of the related accumulated depreciation, depletion, and amortization at December 31, 1996 were as follows:
1996 ---------- Proved properties $ 39,858,000 Less: Accumulated depreciation, depletion, and amortization (3,567,000) ---------- Net oil and gas properties $ 36,291,000 ==========
COSTS INCURRED - Costs, capitalized and expensed, incurred in oil and gas property acquisition, exploration and development activities for the year ended December 31, 1996 were as follows:
1996 ---------- Property acquisition $ 35,347,425 Development costs 1,177,327 ---------- Total costs incurred $ 36,524,752 ==========
OIL AND GAS RESERVES DATA (UNAUDITED) ESTIMATED QUANTITIES - Oil and natural gas reserves cannot be measured exactly. Estimates of oil and natural gas reserves require extensive judgments of reservoir engineering data and are generally less precise than other estimates made in connection with financial disclosures. Proved reserves are those quantities which, upon analysis of geological and engineering data, appear with reasonable certainty to be recoverable in the future from known oil and natural gas reservoirs under existing economic and operating conditions. Proved developed reserves are those reserves which can be expected to be recovered through existing wells with existing equipment and operating methods. Proved undeveloped reserves are those reserves which are expected to be recovered from new wells on undrilled acreage or from existing wells where a relatively major expenditure is required. Estimates of oil and natural gas reserves require extensive judgments of reservoir engineering data as explained above. Assigning monetary values to such estimates does F-24 NOTE 10. SUPPLEMENTARY OIL AND GAS INFORMATION (CONTINUED) reduce the subjectivity and changing nature of such reserve estimates. Indeed, the uncertainties inherent in the disclosure are compounded by applying additional estimates of the rates and timing of production and the costs that will be incurred in developing and producing the reserves. The information set forth herein is therefore subjective and, since judgments are involved, may not be comparable to estimates submitted by other oil and natural gas producers. In addition, since prices and costs do not remain static and no price or cost escalations or de-escalations have been considered, the results are not necessarily indicative of the estimated fair market value of estimated proved reserves nor of estimated future cash flows. Accordingly, these estimates are expected to change as future information becomes available. All of the Company's reserves are located onshore in the states of Oklahoma, Texas, Arkansas and Kansas. The following unaudited table sets forth proved oil and gas reserves at December 31, 1996:
1996 -------------------------- Bbls Mcf ----------- ----------- Proved Reserves: Beginning of year 711,000 18,698,000 Revisions of previous estimates 222,000 10,276,000 Purchases of reserves in place 639,000 42,633,000 Production (164,000) (3,404,000) Sales of reserves in place (250,000) (3,669,000) --------- ---------- End of year 1,158,000 64,534,000 ========= ========== Proved Developed: Beginning of year 642,000 5,093,000 End of year 1,135,000 47,485,000
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS - Future net cash inflows are based on the future production of proved reserves of crude oil and natural gas as estimated by petroleum engineers by applying current prices of oil and gas to estimated future production of proved reserves. Prices used in determining future cash inflows for oil and natural gas as of December 31, 1996, were $24.20 per barrel and $2.65 per mcf, respectively. Future net cash flows are then calculated by reducing such estimated cash inflows by the estimated future expenditures (based on current costs) to be incurred in developing and producing the proved reserves and by the estimated future income taxes. Subsequent to December 31, 1996, the "spot market" price of natural gas decreased to below $2.00 per mcf which would have a significant impact on the SMOG values. Estimated future income taxes are computed by applying the appropriate year-end tax rate to the future pretax net cash flows relating to the Company's estimated proved oil and gas reserves. The estimated future income taxes give effect to permanent differences and tax credits and allowances. The standardized measure of discounted future net cash flows is based on criteria established by Financial Accounting Standards Statement No. 69, "Accounting for Oil and F-25 NOTE 10. SUPPLEMENTARY OIL AND GAS INFORMATION (CONTINUED) Gas Producing Activities" and is not intended to be a "best estimate" of the fair value of the Company's oil and gas properties. For this to be the case, forecasts of future economic conditions, varying price and cost estimates, varying discount rates and consideration of other than proved reserves (i.e., probable reserves), would have to be incorporated into the valuations. Included in the estimated standardized measure of future cash flows are certain capital projects. The Company estimates the capital required to develop its undeveloped oil and gas reserves over the next three years to be approximately $9.65 million, including $6.10 million during the year ended December 31, 1997. Bank One established a special drilling advance fund of $2 million which the Company can draw upon during 1997 to fund its drilling costs. The Company does not have any present arrangements to raise additional funds and there can be no assurance that it will be able to do so on satisfactory terms. If such capital is not employed, the estimated future cash flows will be impacted. The following table sets forth the Company's unaudited estimated standardized measure of discounted future net cash flows, (in thousands). Proved reserves for the year ended December 31, 1996 were estimated by an independent petroleum engineering firm and for the year ended December 31, 1995 were estimated by petroleum engineers employed by the Company.
December 31, December 31, 1996 1995 ------------ ------------ Cash Flows Relating to Proved Reserves: Future cash inflows $ 199,166 $ 43,824 Future production costs (73,976) (16,646) Future development costs ( 9,645) (11,030) Future income tax expense (30,919) (68) ------- ------- 84,626 16,080 Ten percent annual discount factor (35,543) (7,901) ------- ------- Standardized Measure of Discounted Future Net Cash Flows $ 49,083 $ 8,179 ======= =======
The following table sets forth changes in the standardized measure of discounted future net cash flows (in thousands):
December 31, December 31, 1996 1995 ------------ ------------ Standardized measure of discounted future cash flows-beginning of period $ 8,179 $ - Sales of oil and gas produced, net of operating expenses (5,579) (691) Purchases of reserves-in-place 30,930 16,007 Sales of reserves-in-place (3,598) (496) Revisions of previous quantity estimates and changes in sales prices and production costs 18,333 (7,381) Accretion of discount 818 740 ------ ------ Standardized measure of discounted future cash flows-end of period $ 49,083 $ 8,179 ====== ======
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