UNITED STATES
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
| o | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| | For the fiscal year ended December 31, 2008 |
| o | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| | For the transition period from to . |
Commission File No. 0-054306
American Energy Production, Inc.
(Exact name of registrant as specified in its charter)
| | |
| (State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
6073 Hwy 281 South, Mineral Wells, TX | | |
| (Address of principal executive offices) | | (Zip Code) |
Registrant’s telephone number, including area code (940) 445-0698
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | | Name of each exchange on which registered |
| | |
| Securities registered pursuant to section 12(g) of the Act: |
Common Stock, $0.0001 par value |
| (Title of Class) |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yeso No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx Noo
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer o
Non-accelerated filer o Smaller reporting company x
(Do not check if a smaller reporting company)
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o Nox
As of the last business day of the Company’s most recently completed second fiscal quarter, the aggregate market value of voting and non-voting common equity held by non-affiliates* was $_________.
As of April 15, 2009, the registrant had 20,363,389 common shares outstanding.
* Without asserting that any of the issuer’s directors or executive officers, or the entities that own shares of common stock are affiliates, the shares of which they are beneficial owners have been deemed to be owned by affiliates solely for this calculation.
| TABLE OF CONTENTS |
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| PART I | | |
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PART II | | |
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| | 31 |
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PART III | | |
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PART IV | | |
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FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, and Section 27A of the Securities Act of 1933. Any statements contained in this report that are not statements of historical fact may be forward-looking statements. When we use the words “intends,” “estimates,” “predicts,” “potential,” “continues,” “anticipates,” “plans,” “expects,” “believes,” “should,” “could,” “may,” “will” or the negative of these terms or other comparable terminology, we are identifying forward-looking statements. Forward-looking statements involve risks and uncertainties, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by forward-looking statements. These factors include our research and development activities, distributor channels, compliance with regulatory impositions; and our capital needs. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.
Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business.
For further information about these and other risks, uncertainties and factors, please review the disclosure included in this report under “Part I, Item 1A, Risk Factors.”
PART I
American Energy Production, Inc. (“American Energy”, “the Company”, “we”, “us”, “our” “its”) is a publicly traded oil and gas company that is engaged primarily in the acquiring, developing, producing, exploring and selling of oil and natural gas. The Company traditionally has acquired oil and gas companies that have the potential for increased oil and natural gas production utilizing new technologies, well workovers and fracture stimulation systems. Additionally, the Company has expanded its scope of business to include the drilling of new wells with its own equipment through its wholly-owned subsidiary companies. The Company website is www.americanenergyproduction.com.
The Company’s wholly-owned subsidiaries are primarily involved in three areas of oil and gas operations.
1. Leasing programs.
2. Production acquisitions
3. Drilling and producing with proven and emerging technologies.
The Company believes that for the foreseeable future, the world will be highly dependent on oil and natural gas. Currently, alternative fuels are far more expensive than fossil fuels and because of the politically unstable conditions of many of the energy producing regions of the world. As a result, the Company believes that oil and natural gas will remain a key yet volatile component of the world energy future and furthermore, with the ever increasing world demand for energy, the domestic production of oil and gas will play an even greater role in America’s future then it already has to date.
History of Company Development
The Company was f/k/a Communicate Now.com, Inc. and was incorporated on January 31, 2000 under the laws of the State of Delaware. On July 15, 2002, the Company changed its corporate name to American Energy Production, Inc.
On February 20, 2003, upon the acquisition of certain oil and gas assets, the Company entered into a new development stage. Activities during the development stage include acquisition of assets, obtaining geological reports, developing an implementation plan to extract oil and gas, completing initial sales of oil and seeking capital.
On January 12, 2004, the Company filed a Form N-54A with the Securities and Exchange Commission (“SEC”) to be regulated as a BDC under the Investment Company Act of 1940, as amended (“Act”).
In May 2006, the SEC Staff issued a comment letter to the Company (the “Comment Letter”) raising a number of questions relating to the Company’s BDC operations. In response to the Comment Letter, the Company undertook a review of its compliance with the 1940 Act and subsequently determined that it was not in compliance with several important provisions of the 1940 Act. Accordingly, and after careful consideration of the 1940 Act requirements applicable to BDCs, the Board determined that continuation as a BDC was not in the best interests of the Company and its shareholders
On March 13, 2007, at a Special Meeting of Shareholders, the Shareholders approved and authorized the Board to withdraw the Company’s election to be treated as a BDC under the 1940 Act and the election of three directors to the Board. On April 3, 2007, the Company filed a Form N-54C to withdraw its election to be regulated as a BDC and as of that date, is no longer a BDC under the 1940 Act. The Company is no longer a BDC with unconsolidated majority-owned portfolio companies but rather be an oil and gas operating company with consolidated subsidiaries. The results of operations for April 1, 2007 through April 3, 2007 were not material and therefore, the Company will utilize April 1, 2007 as the inception date for the new development stage
At a meeting held on May 16, 2007, the Board of Directors reviewed the Company’s current business and financial performance, the recent trading range of its Common Stock and inability to obtain additional capital from the investment community with 494,170,082 shares of Common Stock issued and outstanding and 500,000,000 shares of Common Stock authorized. As a result, the Board determined that a reverse stock split was desirable and in the best interest of the Company. On July 5, 2007, the Company filed a Definitive 14A Proxy Statement with the SEC giving notice of a special shareholders meeting to be held on August 17, 2007 for the purpose of approving a one-for-twenty five reverse stock split. On September 14, 2007, the Company announced that all of the required steps had been completed for the one-for-twenty five reverse stock split of its common stock. In connection with the reverse stock split, the Company was assigned a new stock symbol. The Company's shares were previously quoted on the OTC Bulletin Board under the stock symbol AMEP and are now reported on the OTC Bulletin Board under the new stock symbol AENP. The new stock symbol and the reverse stock split were effective at the beginning of trading on September 14, 2007.
On September 30, 2008, the Company announced the issuance of an SEC Order Instituting Cease-and-Desist and Exemption Suspension Proceedings, Making Findings, Imposing a Cease-and-Desist Order, and Permanently Suspending the Regulation E Exemption Pursuant to Section 9(f) of the Investment Company Act of 1940 and Rule 610(c) of Regulation E (Order) against the Company. The Order finds that the Company had, among other things, issued senior securities without the required asset coverage, issued rights to purchase securities without expiration to non-security holders, issued prohibited non-voting stock, issued securities for services, failed to make and keep required records; and failed to establish a majority of disinterested directors on its board. As a result, the Company violated Sections 18(a), 18(d), 18(i), 23(a), 31(a)(1), and 56(a) respectively, of the Investment Company Act and Investment Company Act Rule 31a-1. In addition, the Company failed to obtain a fidelity bond as required under Section 17(g) of the Investment Company Act and Rule 17g-1 thereunder, and failed to implement a compliance program as required under Investment Company Act Rule 38a-1. Finally, the Company failed to comply with Rule 609 of Regulation E because it did not file offering status reports on Form 2-E in connection with a securities offering under Regulation E commenced in January 2004.
Based on the above, the Order permanently suspends the Regulation E exemption and orders the Company to cease and desist from committing or causing any violations and any future violations of Sections 17(g), 18(a), 18(d), 18(i), 23(a), 31(a)(1) and 56(a) of the Investment Company Act and Rules 17g-1, 31a-1, and Rule 38a-1 thereunder. The Company consented to the issuance of the Order without admitting or denying any of the findings.
In determining the Order, the SEC considered remedial acts promptly undertaken by the Company and cooperation afforded the SEC staff and as a result, the Company did not incur any fines or other penalties, and no action was taken against any individuals.
Our Strategy
Management believes that:
| · | Natural gas is an environmentally friendly fuel that will be increasingly valued in the United States; |
| · | There are a number of natural gas and/or oil and development projects that we are pursuing which will require significant capitalization to complete, explore and develop; |
| · | We have the ability to assemble the technical and commercial and resources needed to pursue these potential projects; and |
| · | Our successful development of one or more large potential natural gas or oil projects will create substantial shareholder value. |
The principal elements of our strategy to maximize shareholder value are:
Generate growth through drilling. We expect to generate long-term reserve and production growth predominantly through our drilling activities. We anticipate the substantial majority of our future capital expenditures will be directed toward the drilling of wells, although we expect to continue to acquire additional leasehold interests. Initially, we anticipate reserve growth will be our primary focus with a more balanced reserve and production growth profile as we continue to execute our growth strategy.
Manage costs by maximizing operational control. We seek to exert control over our exploration, exploitation and development activities. As the operator of our projects, we have greater control over the amount and timing of the expenditures associated with those activities. As we manage our growth, we are focused on reducing lease operating expenses, general and administrative costs, and finding and development costs on a per mcfe basis. As of December 31, 2008, we operated 100% of our wells, although we may not be able to be operator of all our future projects.
Pursue complementary leasehold interest and property acquisitions. We intend to attempt to supplement our drilling strategy with complementary leasehold interest and property acquisitions.
Current Natural Gas and Oil Projects
We are in the process of building our portfolio of exploration and exploitation projects targeting both oil and natural gas. We believe that there is potential for commercial development in areas where historical drilling attempts resulted in indications of oil and gas but ultimate development was not pursued, and we intend to continue to focus our activities in areas having this profile. We believe that the application of advanced drilling, completion and stimulation technologies combined with a strong commodity pricing environment could make development of our project areas economically viable.
Through Production Resources, Inc. (“PRI”), our wholly owned subsidiary, we own leases covering approximately 1,600 gross acres of land in Medina County, Texas. The leases have 173 gross and net wells drilled to shallow saturated sand called the Olmos. There is an additional zone similar to the Olmos called the Escondido that has been commercially productive in this area but it has not been tested on these leases. Additional wells can be drilled on these leases to the Olmos formation under the current spacing rules. This is a heavy oil field has had produced for a number of years. Initially the field had enough pressure to flow but over time pumping and advanced recovery methods were necessary. Previously, the field had been ignored for a number of years due to the high operating costs, low oil prices and low daily production.
Additionally, through Bend Arch Petroleum, Inc. (“Bend Arch”), our wholly owned subsidiary, we own leases covering approximately 6,100 gross acres of land primarily in the counties of Palo Pinto, Eastland and Comanche, Texas. The leases have 34 gross wells (31 net wells) drilled to the shallower Bend Conglomerate and the deeper Strawn formation. Most of these wells need to be re-worked and re-stimulated to achieve maximum productive potential.
Natural Gas and Oil Reserves
The following table presents information as of December 31, 2008 with respect to our estimated proved reserves:
| Net Proved Reserve Summary and PV-10 Forecast from December 31, 2008 | |
| | | | | | | | | | | | |
| PDP (b) | | | .303 | | | | 5.927 | | | $ | 36,542,066 | | | $ | 6,884,536 | |
| PDBP (c) | | | .230 | | | | 7.500 | | | | 45,733,971 | | | | 12,201,860 | |
| PUD (d) | | | 7.195 | | | | 27.095 | | | | 396,669,564 | | | | 127,959,348 | |
Total Proved (a) | | | 7.728 | | | | 40.522 | | | $ | 479,330,566 | | | $ | 147,045,744 | |
| (a) | Proved reserves are those quantities of gas that, by analysis of geological and engineering data, can be estimated with reasonable certainty to be commercially recoverable from known reservoirs and under current economic conditions, operating methods and government regulations. |
| (b) | PDP is Proved Producing Reserves and represents reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. |
| (c) | PDBP is Proved Behind Pipe Reserves and represents reserves that are expected to be recovered from existing wells where a relatively major expenditure is required for recompletion. |
| (d) | PUD is Proved Undeveloped Reserves and represents undeveloped reserves that are expected to be recovered from new wells on un-drilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. |
| (e) | PV-10 represents the present value, discounted at 10% per annum, of estimated future net revenue before income tax of our estimated proved reserves. The estimated future net revenues were determined by using reserve quantities of proved reserves and the periods in which they are expected to be developed and produced based on economic conditions prevailing at December 31, 2008. PV-10 is a non-GAAP financial measure because it excludes income tax effects. Management believes that the presentation of the non-GAAP financial measure of PV-10 provides useful information to investors because it is widely used by professional analysts and sophisticated investors in evaluating oil and natural gas companies. PV-10 is not a measure of financial or operating performance under GAAP. PV-10 should not be considered as an alternative to the standardized measure as defined under GAAP. We have included a reconciliation of PV-10 to the most directly comparable GAAP measure — standardized measure of discounted future net cash flow — in the following table: |
| | | December 31, 2008 |
| | | |
| Standardized measure of discounted future net cash flows (d) | | $ | 95,579,734 | |
| Add: Present value of future income tax discounted at 10% | | | 51,466,010 | |
| PV-10 | | $ | 147,045,744 | |
| | | | | |
| (d) | The standardized measure represents the present value of estimated future cash inflows from proved oil and natural gas reserves, less future development, abandonment, production and income tax expenses, discounted at 10% per annum to reflect timing of future cash flows and using the same pricing assumptions as were used to calculate PV-10. Standardized measure differs from PV-10 because standardized measure includes the effect of future income taxes. |
Acreage
The following table sets forth as of December 31, 2008 the gross and net acres of both developed and undeveloped oil and gas leases that we hold. “Gross” acres are the total number of acres in which we own a working interest. “Net” acres refer to gross acres multiplied by our fractional working interest. Acreage numbers do not include our options to acquire additional leaseholds which have not been exercised.
| December 31, 2008 | | | | | | | | | | | | | | | | | | |
| | Developed(a) | | Undeveloped(b) | | Total |
| Play/Trend | Gross | | Net | | Gross | | Net | | Gross | | Net |
| | | | | | | | | | | | |
| Texas | 7,701 | | 7,393 | | - | | - | | 7,701 | | 7,393 |
| (a) | Developed refers to acres that are allocated or assignable to producing wells or wells capable of production. Developed acreage includes acreage having wells shut-in awaiting the addition of infrastructure. |
| (b) | Undeveloped refers to lease acreage on which wells have not been developed or completed to a point that would permit the production of commercial quantities of oil or natural gas regardless of whether such acreage contains proved reserves. |
Production and Price Information
The following tables summarize sales volumes, sales prices, and production cost information for the periods indicated:
| | | Year Ended December 31, | |
| | | 2008 | |
| Production | | | |
| Oil (bbls) | | | 11,501 | |
| Natural gas (mcf) | | | 88,711 | |
| Natural gas equivalent (mcfe) | | | 14,785 | |
| Total equivalent (bbls) | | | 26,286 | |
| | | | | |
| Oil and natural gas sales | | | | |
| Oil sales | | $ | 1,072,005 | |
| Natural gas sales | | | 768,538 | |
Total (A) | | $ | 1,840,543 | |
| Average sales price | | | | |
| Oil ($ per bbl) | | $ | 93.21 | |
| Natural gas ($ per mcf) | | | 8.66 | |
| Natural gas equivalent ($ per mcfe) | | | 51.98 | |
| | | | | |
| Average production cost | | | | |
| Total equivalent ($ bbls) | | $ | 86.18 | |
(A) Excludes $1,516 of oil and gas royalty income included in Total Revenue for consolidated financial statements.
The following table sets forth information at December 31, 2008, relating to the productive wells in which we owned a working interest as of that date. Productive wells consist of producing wells and wells capable of production, including natural gas wells awaiting pipeline connections to commence deliveries and oil wells awaiting connection to production facilities. Gross wells are the total number of productive wells in which we have an interest, and net wells are the sum of our fractional working interests owned in gross wells.
| December 31, 2008 | | | |
| Play/Trend | | Gross Wells | | | Net Wells | |
| | | | | | | |
| Texas | | | 207 | | | | 204 | |
Drilling Activities
The following table sets forth information with respect to wells drilled and completed during the periods indicated. The information should not be considered indicative of future performance, nor should it be assumed that there is necessarily any correlation between the number of productive wells drilled, quantities of reserves found or economic value. Productive wells are those that produce commercial quantities of hydrocarbons, regardless of whether they produce a reasonable rate of return.
| | | | Gross Wells | | | Net Wells | |
| Period | Type of Well | | Productive(b) | | | Dry(c) | | | Total | | | Productive(b) | | �� | Dry(c) | | | Total | |
| Year ended December 31, 2008 | Exploratory(a) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
| | Texas | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Development(a) | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
| | Texas | | | | | | | | | | | | | | | | | | | | | | | | |
| (a) | An exploratory well is a well drilled either in search of a new, as yet undiscovered, oil or natural gas reservoir or to greatly extend the known limits of a previously discovered reservoir. A development well is a well drilled within the presently proved productive area of an oil or natural gas reservoir, as indicated by reasonable interpretation of available data, with the objective of being completed in that reservoir. |
| (b) | A productive well is an exploratory or development well found to be capable of producing either oil or natural gas in sufficient quantities to justify completion as an oil or natural gas well. |
| (c) | A dry well is an exploratory or development well that is not a producing well or a well that has either been plugged or has been converted to another use. |
Markets and Customers
The success of our operations is dependent upon prevailing prices for natural gas and oil. The markets for natural gas and oil have historically been volatile and may continue to be volatile in the future. Natural gas and oil prices are beyond our control. However, rising demand for natural gas to fuel power generation and meet increasing environmental requirements has led some industry observers to indicate that long term demand for natural gas is increasing.
We may use different strategies for gas sales depending on the location of the field and the local markets. In some locations, we may use proprietary CO2 reduction units to process our own gas and sell it to nearby local markets. In other cases, we may connect to nearby high pressure transmission pipelines. We are not currently aware of any restraints with respect to pipeline availability. However, because of the nature of natural gas development, there may be periods of time when pipeline capacity is inadequate to meet our transportation needs. It is often the case that as new development comes on-line, pipelines are near or at capacity before new pipelines are built.
We have no firm delivery contract for the delivery of our natural gas sales.
To the extent that we bring new wells on-line and our production volume increases, of which there is no assurance, we will sell the new production in the spot markets or under new monthly base contracts. We expect that we will usually sell in this fashion, partly through firm gas delivery contracts and partly in the spot markets.
Prices for oil and natural gas fluctuate fairly widely based on supply and demand. Supply and demand are influenced by weather, foreign policy and industry practices. For example, demand for natural gas has increased in recent years due to a trend in the power plant industry to move away from using oil and coal as a fuel source to using natural gas, because natural gas is a cleaner fuel. Nonetheless, in light of historical fluctuations in prices, there can be no assurance at what price we will be able to sell our oil and natural gas. It is possible that prices will be low at the time periods in which the wells are most productive, thereby reducing overall returns.
Competition
The natural gas and oil industry is intensely competitive and speculative in all of its phases. We encounter competition from other natural gas and oil companies in all areas of our operations. In seeking suitable natural gas and oil properties for acquisition, we compete with other companies operating in our areas of interest, including medium and large natural gas and oil companies and other independent operators, which have greater financial resources and have been engaged in the exploration and production business for a much longer time than we have. Many of our competitors also have substantially larger operating staffs than we do. Many of these competitors not only explore for and produce natural gas and oil but also market natural gas and oil and other products on a regional, national or worldwide basis. These competitors may be able to pay more for productive natural gas and oil properties and exploratory prospects, and define, evaluate, bid for and purchase a greater number of properties and prospects than we are able to. In addition, these competitors may have a greater ability to continue exploration activities during periods of low market prices. Our ability to acquire additional properties and to discover reserves in the future will depend on our ability to evaluate and select suitable properties and to finance and consummate transactions in a highly competitive environment.
The prices of our natural gas and oil production will be controlled by market forces. However, competition in the natural gas and oil exploration industry also exists in the form of competition to acquire leases and obtain favorable transportation prices. We are extremely small, with limited financial resources and may have difficulty acquiring additional acreage and/or projects and may have difficulty arranging for the transportation of our production. We also face competition in obtaining natural gas and oil drilling rigs and in sourcing the manpower to run them and provide related services.
Government Regulation of the Oil and Gas Industry
General.
Our business is affected by numerous laws and regulations, including energy, environmental, conservation, tax and other laws and regulations relating to the energy industry. Failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, the imposition of injunctive relief or both. Moreover, changes in any of these laws and regulations could have a material adverse effect on our business. In view of the many uncertainties with respect to current and future laws and regulations, including their applicability to us, we cannot predict the overall effect of such laws and regulations on our future operations.
We believe that operations where we own interests comply in all material respects with applicable laws and regulations and that the existence and enforcement of these laws and regulations have no more restrictive an effect on our operations than on other similar companies in the energy industry.
The following discussion contains summaries of certain laws and regulations and is qualified in its entirety by the foregoing and by reference to the full text of the laws and regulations described.
Federal Regulation of the Sale and Transportation of Oil and Gas.
Various aspects of our oil and gas operations are or will be regulated by agencies of the federal government. The Federal Energy Regulatory Commission, or FERC, regulates the transportation and sale for resale of natural gas in interstate commerce pursuant to the Natural Gas Act of 1938, or NGA, and the Natural Gas Policy Act of 1978, or NGPA. In the past, the federal government has regulated the prices at which oil and gas could be sold. While ”first sales” by producers of natural gas, and all sales of crude oil, condensate and natural gas liquids can currently be made at uncontrolled market prices, Congress could reenact price controls in the future. Deregulation of wellhead sales in the natural gas industry began with the enactment of the NGPA in 1978. In 1989, Congress enacted the Natural Gas Wellhead Decontrol Act.
The Decontrol Act removed all NGA and NGPA price and non-price controls affecting wellhead sales of natural gas effective January 1, 1993, and resulted in a series of Orders being issued by FERC requiring interstate pipelines to provide transportation services separately, or ”unbundled,” from the pipelines’ sales of gas and to provide open access transportation on a nondiscriminatory basis that is equal for all natural gas shippers.
We do not believe that we will be affected by these or any other FERC rules or orders materially differently than other natural gas producers and marketers with which we compete.
The FERC also has issued numerous orders confirming the sale and abandonment of natural gas gathering facilities previously owned by interstate pipelines and acknowledging that if the FERC does not have jurisdiction over services provided on those facilities, then those facilities and services may be subject to regulation by state authorities in accordance with state law. A number of states have either enacted new laws or are considering the adequacy of existing laws affecting gathering rates and/or services. Other state regulation of gathering facilities generally includes various safety, environmental, and in some circumstances, nondiscriminatory take requirements, but does not generally entail rate regulation. Thus, natural gas gathering may receive greater regulatory scrutiny of state agencies in the future. Our anticipated gathering operations could be adversely affected should they be subject in the future to increased state regulation of rates or services, although we do not believe that we would be affected by such regulation any differently than other natural gas producers or gatherers. In addition, the FERC’s approval of transfers of previously-regulated gathering systems to independent or pipeline affiliated gathering companies that are not subject to FERC regulation may affect competition for gathering or natural gas marketing services in areas served by those systems and thus may affect both the costs and the nature of gathering services that will be available to interested producers or shippers in the future.
We conduct certain operations on federal oil and gas leases, which are administered by the Minerals Management Service, or MMS. Federal leases contain relatively standard terms and require compliance with detailed MMS regulations and orders, which are subject to change. Among other restrictions, the MMS has regulations restricting the flaring or venting of natural gas, and has proposed to amend those regulations to prohibit the flaring of liquid hydrocarbons and oil without prior authorization. Under certain circumstances, the MMS may require any of our operations on federal leases to be suspended or terminated. Any such suspension or termination could materially and adversely affect our financial condition, cash flows and operations. The MMS issued a final rule that amended its regulations governing the valuation of crude oil produced from federal leases. This rule, which became effective June 1, 2000, provides that the MMS will collect royalties based on the market value of oil produced from federal leases, and was further modified by amendments to the June 2000 MMS rules, effective July 1, 2004. Also, the MMS promulgated new Federal Gas Valuation rules, effective June 1, 2005 (70FR 11869, March 10, 2005) concerning calculation of transportation costs, including the allowed rate of return in the calculation of actual transportation costs in non-arm’s length arrangements and addresses various other related matters. We cannot predict whether this new gas rule will become effective, nor can we predict whether the MMS will take further action on oil and gas valuation matters. However, we do not believe that any such rules will affect us any differently than other producers and marketers of crude oil with which we will compete.
Additional proposals and proceedings that might affect the oil and gas industry are pending before Congress, the FERC, the MMS, state commissions and the courts. We cannot predict when or whether any such proposals may become effective. In the past, the natural gas industry has been heavily regulated. There is no assurance that the regulatory approach currently pursued by various agencies will continue indefinitely. Notwithstanding the foregoing, we do not anticipate that compliance with existing federal, state and local laws, rules and regulations will have a material or significantly adverse effect upon our capital expenditures, earnings or competitive position. No material portion of our business is subject to re-negotiation of profits or termination of contracts or subcontracts at the election of the federal government.
State Regulation.
Our operations also are subject to regulation at the state and, in some cases, county, municipal and local governmental levels. This regulation includes requiring permits for the drilling of wells, maintaining bonding requirements in order to drill or operate wells and regulating the location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, the plugging and abandonment of wells and the disposal of fluids used and produced in connection with operations. Our operations also are or will be subject to various conservation laws and regulations. These include (1) the size of drilling and spacing units or proration units, (2) the density of wells that may be drilled, and (3) the unitization or pooling of oil and gas properties. In addition, state conservation laws, which frequently establish maximum rates of production from oil and gas wells, generally prohibit the venting or flaring of gas and impose certain requirements regarding the ratability of production. State regulation of gathering facilities generally includes various safety, environmental and, in some circumstances, nondiscriminatory take requirements, but (except as noted above) does not generally entail rate regulation. These regulatory burdens may affect profitability, but we are unable to predict the future cost or impact of complying with such regulations.
Environmental Matters.
Operations on properties in which we have an interest are subject to extensive federal, state and local environmental laws that regulate the discharge or disposal of materials or substances into the environment and otherwise are intended to protect the environment. Numerous governmental agencies issue rules and regulations to implement and enforce such laws, which are often difficult and costly to comply with and which carry substantial administrative, civil and criminal penalties and in some cases injunctive relief for failure to comply. Some laws, rules and regulations relating to the protection of the environment may, in certain circumstances, impose ”strict liability” for environmental contamination. These laws render a person or company liable for environmental and natural resource damages, cleanup costs and, in the case of oil spills in certain states, consequential damages without regard to negligence or fault. Other laws, rules and regulations may require the rate of oil and gas production to be below the economically optimal rate or may even prohibit exploration or production activities in environmentally sensitive areas. In addition, state laws often require some form of remedial action, such as closure of inactive pits and plugging of abandoned wells, to prevent pollution from former or suspended operations. Legislation has been proposed in the past and continues to be evaluated in Congress from time to time that would reclassify certain oil and gas exploration and production wastes as ”hazardous wastes.” This reclassification would make these wastes subject to much more stringent storage, treatment, disposal and clean-up requirements, which could have a significant adverse impact on operating costs. Initiatives to further regulate the disposal of oil and gas wastes are also proposed in certain states from time to time and may include initiatives at the county, municipal and local government levels. These various initiatives could have a similar adverse impact on operating costs. The regulatory burden of environmental laws and regulations increases our cost and risk of doing business and consequently affects our profitability.
The federal Comprehensive Environmental Response, Compensation and Liability Act, or CERCLA, also known as the ”Superfund” law, imposes liability, without regard to fault, on certain classes of persons with respect to the release of a ”hazardous substance” into the environment. These persons include the current or prior owner or operator of the disposal site or sites where the release occurred and companies that transported, disposed or arranged for the transport or disposal of the hazardous substances found at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources, and it is not uncommon for the federal or state government to pursue such claims. It is also not uncommon for neighboring landowners and other third parties to file claims for personal injury or property or natural resource damages allegedly caused by the hazardous substances released into the environment. Under CERCLA, certain oil and gas materials and products are, by definition, excluded from the term ”hazardous substances.” At least two federal courts have held that certain wastes associated with the production of crude oil may be classified as hazardous substances under CERCLA. Similarly, under the federal Resource, Conservation and Recovery Act, or RCRA, which governs the generation, treatment, storage and disposal of ”solid wastes” and ”hazardous wastes,” certain oil and gas materials and wastes are exempt from the definition of ”hazardous wastes.” This exemption continues to be subject to judicial interpretation and increasingly stringent state interpretation. During the normal course of operations on properties in which we have an interest, exempt and non-exempt wastes, including hazardous wastes, that are subject to RCRA and comparable state statutes and implementing regulations are generated or have been generated in the past. The federal Environmental Protection Agency and various state agencies continue to promulgate regulations that limit the disposal and permitting options for certain hazardous and non-hazardous wastes.
Our operations will involve the use of gas fired compressors to transport collected gas. These compressors are subject to federal and state regulations for the control of air emissions. Title V status for a facility results in significant increased testing, monitoring and administrative and compliance costs. To date, other compressor facilities have not triggered Title V requirements due to the design of the facility and the use of state-of-the-art engines and pollution control equipment that serve to reduce air emissions. However, in the future, additional facilities could become subject to Title V requirements as compressor facilities are expanded or if regulatory interpretations of Title V applicability change. Stack testing and emissions monitoring costs will grow as these facilities are expanded and if they trigger Title V. The U.S. Environmental Protection Agency and some other state environmental agencies have increased their focus on control of minor gas emission leaks from pipelines, compressors, tanks, and related oil and gas production and storage equipment in response to ozone non-attainment requirements increasing the costs and complexity of our operations. We believe that the operator of the properties in which we have an interest is in substantial compliance with applicable laws, rules and regulations relating to the control of air emissions at all facilities on those properties.
Although we maintain insurance against some, but not all, of the risks described above, including insuring the costs of clean-up operations, public liability and physical damage, there is no assurance that our insurance will be adequate to cover all such costs, that the insurance will continue to be available in the future or that the insurance will be available at premium levels that justify our purchase. The occurrence of a significant event not fully insured or indemnified against could have a material adverse effect on our financial condition and operations.
Compliance with environmental requirements, including financial assurance requirements and the costs associated with the cleanup of any spill, could have a material adverse effect on our capital expenditures, earnings or competitive position. We do believe, however, that our operators are in substantial compliance with current applicable environmental laws and regulations. Nevertheless, changes in environmental laws have the potential to adversely affect operations. At this time, we have no plans to make any material capital expenditures for environmental control facilities.
As of December 31, 2008, we have 10 full time employee and no part-time employees. We are not a party to any collective bargaining agreements. We believe that our relations with our employees are good.
You should carefully consider each of the following risk factors and all of the other information provided in this Annual Report. The risks described below are those we currently believe may materially affect us. An investment in our Common Stock involves a high degree of risk, and should be considered only by persons who can afford the loss of their entire investment.
Any investment in our common stock involves a high degree of risk. In addition to the other information contained in this report, including risks and uncertainties described elsewhere, you should carefully consider the following risk factors and all of the information contained in this Annual Report in evaluating us or deciding whether to purchase our common stock. The risks and uncertainties described below or elsewhere in this Annual Report are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business and operations. The following list of risk factors should not be considered as all inclusive. If any of the following risks were to occur, our business, financial condition, operating results and cash flows could be materially affected, all of which might cause the trading price of our common stock to decline, and you could lose all or part of any investment you may make in our common stock.
Our actual results may differ materially from those anticipated in our forward-looking statements. We operate in a market environment that is difficult to predict and that involves significant risks and uncertainties, many of which will be beyond our control. Refer also to “SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS” at the beginning of this Annual Report.
Risks related to our industry, business and strategy.
Going Concern Risk
We have previously had and could have future losses, deficits and deficiencies in liquidity, which could impair our ability to continue as a going concern. Our independent registered public accounting firm has indicated that certain factors raise substantial doubt about our ability to continue as a going concern and these factors are discussed in Note 2 to our audited financial statements. Since its inception, the Company has suffered recurring losses from operations and has been dependent on existing stockholders and new investors to provide the cash resources to sustain its operations.
As reflected in the accompanying financial statements, the Company had a net loss of $2,148,551 for the year ended December 31, 2008. Additionally, the Company has a negative working capital balance of $6,693,177, a stockholders’ deficit of $3,055,149 at December 31, 2008 and is subject to certain contingencies as discussed in Notes 1 and 7 to the accompanying consolidated financial statements, which could have a material impact on the Company’s financial condition and operations. The ability of the Company to continue as a going concern is dependent on the Company’s ability to raise capital and generate sufficient revenues and cash flow from its business plan as an oil and gas operating company. The financial statements included in this report do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
Management believes that as a result of the one-for-twenty five reverse stock split recently approved by the shareholders of the Company, the Company will have several options available to obtain financing from third parties in order to carry out the business plan of the Company.
We have substantial current obligations and at December 31, 2008, we had $6,782,260 of current liabilities as compared to only $89,0838 of current assets. Accordingly, the Company does not have sufficient cash resources or current assets to pay these obligations.
Our substantial debt obligations pose risks to our business and stockholders by:
| · | making it more difficult for us to satisfy our obligations; |
| · | requiring us to dedicate a substantial portion of our cash flow to principal and interest payments on our debt obligations, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other corporate requirements; |
| · | impeding us from obtaining additional financing in the future for working capital, capital expenditures and general corporate purposes; and |
| · | making us more vulnerable to a downturn in our business and limit our flexibility to plan for, or react to, changes in our business. |
The time required for us to become profitable is highly uncertain, and we cannot assure you that we will achieve or sustain profitability or generate sufficient cash flow from operations to meet our planned capital expenditures, working capital and debt service requirements. If required, our ability to obtain additional financing from other sources also depends on many factors beyond our control, including the state of the capital markets and the prospects for our business. The necessary additional financing may not be available to us or may be available only on terms that would result in further dilution to the current owners of our common stock. If we fail to make any required payment under the agreements and related documents governing our indebtedness or fail to comply with the financial and operating covenants contained in them, we would be in default.
We have significant financial and operational covenant.
Our wholly owned subsidiary, Bend Arch, has a $2,000,000 amended promissory note (“Note”) accruing interest at 8% with Proco Operating Co., Inc. (“Proco”), a company controlled by the brother of the Company’s Chief Executive Officer with a maturity date of December 31, 2009. The purpose of the Note is to secure payment for oil and gas leases and wells located in Comanche and Eastland counties in the State of Texas sold to Bend Arch by Proco on June 15, 2004. The Note replaced a $2,000,000 convertible debenture dated January 5, 2004.
The terms of the Note include (i) the payment of interest at a rate of eight percent (8%) per annum (ii) principal and interest due and payable on December 31, 2009 (iii) no prepayment penalty (iv) payment made in excess of sixty (60) days after the due date of December 31, 2009 is a default of the Note and Bend Arch will forfeit all ownership of the related leases and wells and relinquish operations on the lease and wells to Proco, and (v) upon a default of the Note, Bend Arch will vacate the leases with no rights of ownership and execute the necessary documents to transfer the leases and wells to Proco or its assigns. Bend Arch also has a covenant that as long as the Note is outstanding and unpaid, no transfer, assignment or sale of the underlying leases and wells securing the payment of the Note will be allowed without the written approval of Proco.
If we are determined to be in default of the covenants provided for in the Note, the impact on our business could be materially detrimental.
Our operations require large amounts of capital and we may be unable to obtain needed capital or financing on satisfactory terms, which could lead to a loss of properties and a decline in our natural gas and oil reserves.
Our current plans require us to make large capital expenditures for the exploration and development of our existing acreage and we also anticipate that we will need substantial additional capital to pursue other potential projects. Historically, we have funded our capital expenditures through the issuance of equity.
There are no commitments from any source to provide any equity or debt financing. Even if we are able to obtain equity or debt financing, of which there is no assurance, issuing equity securities to satisfy our financing requirements could cause substantial dilution to our existing stockholders. Debt financing, if obtained, could lead to:
| · | a substantial portion of our operating cash flow being dedicated to the payment of principal and interest, |
| · | our being more vulnerable to competitive pressures and economic downturns, and |
| · | restrictions on our operations. |
If we are not able to obtain capital through an equity or debt financing or otherwise, our ability to execute our business plans could be greatly limited. Moreover, we will need to increase our sources of revenue, funding or both to sustain operations for the long run. There is no assurance that this will occur.
We may not discover commercially productive oil and gas reserves, which will impact our ability to meet our business goals.
Our ability to locate reserves is dependent upon a number of factors, including our participation in multiple exploration projects and our technological capability to locate oil and gas in commercial quantities. We cannot predict that we will have the opportunity to participate in projects that economically produce commercial quantities of oil and gas in amounts necessary to create a positive cash flow for the Company or that the projects in which we elect to participate will be successful. There can be no assurance that our planned projects will result in significant reserves or that we will have future success in drilling productive wells at economical reserve replacement costs.
Oil and gas prices are volatile and an extended decline in prices can significantly affect our financial results, impede our growth and hurt our business prospects
Our future profitability and rate of growth and the anticipated carrying value of our oil and gas properties could be affected by the then prevailing market prices for oil and gas. We expect the markets for oil and gas to continue to be volatile. If we are successful in continuing to establish production, any substantial or extended decline in the price of oil or gas could:
| · | have a material adverse effect on our results of operations, |
| · | limit our ability to attract capital, |
| · | make the formations we are targeting significantly less economically attractive, |
| · | reduce our cash flow and borrowing capacity, and |
| · | reduce the value and the amount of any future reserves. |
Various factors beyond our control will affect prices of oil and gas, including:
| · | worldwide and domestic supplies of oil and gas, |
| · | the ability of the members of the Organization of Petroleum Exporting Countries to agree to and maintain oil price and production controls, |
| · | political instability or armed conflict in oil or gas producing regions, |
| · | the price and level of foreign imports, |
| · | worldwide economic conditions, |
| · | marketability of production, |
| · | the level of consumer demand, |
| · | the price, availability and acceptance of alternative fuels, |
| · | the availability of processing and pipeline capacity, |
| · | weather conditions, and |
| · | actions of federal, state, local and foreign authorities. |
These external factors and the volatile nature of the energy markets make it difficult to estimate future prices of oil and gas. In addition, sales of oil and gas are seasonal in nature, leading to substantial differences in cash flow at various times throughout the year.
Our exploration and development activities are subject to reservoir and operational risks which may lead to increased costs and decreased production.
The marketability of our oil and gas production, if any, will depend in part upon the availability, proximity and capacity of gas gathering systems, pipelines and processing facilities. Federal and state regulation of oil and gas production and transportation, general economic conditions, changes in supply and changes in demand all could adversely affect our ability to produce and market our oil and natural gas. If market factors were to change dramatically, the financial impact could be substantial because we would incur expenses without receiving revenues from the sale of production. The availability of markets is beyond our control.
Even when oil and gas is found in what is believed to be commercial quantities, reservoir risks, which may be heightened in new discoveries, may lead to increased costs and decreased production. These risks include the inability to sustain deliverability at commercially productive levels as a result of decreased reservoir pressures, large amounts of water, or other factors that might be encountered. As a result of these types of risks, most lenders will not loan funds secured by reserves from newly discovered reservoirs, which would have a negative impact on our future liquidity. Operational risks include hazards such as fires, explosions, craterings, blowouts (such as the blowout experienced at our initial exploratory well), uncontrollable flows of oil, gas or well fluids, pollution, releases of toxic gas and encountering formations with abnormal pressures. In addition, we may be liable for environmental damage caused by previous owners of property we own or lease. As a result, we may face substantial liabilities to third parties or governmental entities, which could reduce or eliminate funds available for exploration, development or acquisitions or cause us to incur substantial losses. The occurrence of any one of these significant events, if it is not fully insured against, could have a material adverse effect on our financial condition and results of operations.
We face risks related to title to the leases we enter into that may result in additional costs and affect our operating results.
It is customary in the oil and gas industry to acquire a leasehold interest in a property based upon a preliminary title investigation. If the title to the leases acquired is defective, we could lose the money already spent on acquisition and development, or incur substantial costs to cure the title defect, including any necessary litigation. If a title defect cannot be cured, we will not have the right to participate in the development of or production from the leased properties. In addition, it is possible that the terms of our oil and gas leases may be interpreted differently depending on the state in which the property is located. For instance, royalty calculations can be substantially different from state to state, depending on each state’s interpretation of lease language concerning the costs of production. We cannot guarantee that there will be no litigation concerning the proper interpretation of the terms of our leases. Adverse decisions in any litigation of this kind could result in material costs or the loss of one or more leases.
To the extent that we undertake exploratory drilling, it is a high risk activity with many uncertainties that could adversely affect our business, financial condition or results of operations.
Exploratory drilling involves numerous risks, including the risk that we will not find any commercially productive oil or gas reservoirs. The cost of drilling, completing and operating wells is often uncertain, and a number of factors can delay or prevent drilling operations, including:
| · | unexpected drilling conditions, |
| · | pressure or irregularities in formations, |
| · | equipment failures or accidents, |
| · | adverse weather conditions, |
| · | compliance with governmental requirements, |
| · | shortages or delays in the availability of drilling rigs and the delivery of equipment, and |
| · | shortages of trained oilfield service personnel. |
Our future drilling activities may not be successful, nor can we be sure that our overall drilling success rate or our drilling success rate for activities within a particular area will not decline. Unsuccessful drilling activities could have a material adverse effect on our results of operations and financial condition. Also, we may not be able to obtain any options or lease rights in potential drilling locations that we identify. Although we have identified a number of potential exploration projects, we cannot be sure that we will ever drill them or that we will produce oil or gas from them or any other potential exploration projects.
Accounting rules may require write-downs, which may result in a charge to earnings.
We follow the successful efforts method of accounting, capitalizing costs of successful exploratory wells and expensing costs of unsuccessful exploratory wells. All developmental costs are capitalized. We are predominately engaged in exploration and production activities.
Depreciation and depletion of producing properties is computed on the units-of-production method based on estimated proved oil and natural gas reserves. Depreciation of non-oil and gas properties is over their estimated useful life of three years, using the straight line method. Repairs and maintenance are expensed, while renewals and betterments are generally capitalized. Expenditures less than $1,000, including contract labor, are expensed to operations in the year incurred.
At least quarterly, or more frequently if conditions indicate that long-term assets may be impaired, the carrying value of property is compared to management’s future estimated pre-tax cash flow from the properties. In accordance with Statement of Financial Accounting Standards No. 144, Accounting for Impairment or Disposal Of Long-Lived Assets, if impairment is necessary, the asset carrying value is written down to fair value. Cash flow pricing estimates are based on existing proved reserve and production information and pricing assumptions that management believes are reasonable. Impairment of individually significant unproved properties is assessed and amortized on an aggregate basis. We had no significant unproved properties at December 31, 2008 and no impairment was necessary at December 31, 2008.
The oil and gas exploration and production industry is highly competitive and many of our competitors have more resources than we do.
We compete in oil and gas exploration with a number of other companies. Many of these competitors have financial and technological resources vastly exceeding those available to us. We cannot be sure that we will be successful in acquiring and developing profitable properties in the face of this competition. In addition, from time to time, there may be competition for, and shortage of, exploration, drilling and production equipment. These shortages could lead to an increase in costs and delays in operations that could have a material adverse effect on our business and our ability to develop our properties. Problems of this nature also could prevent us from producing any oil and gas we discover at the rate we desire to do so.
The oil and gas industry is heavily regulated and costs associated with such regulation could reduce our profitability.
Federal, state and local authorities extensively regulate the oil and gas industry. Legislation and regulations affecting the industry are under constant review for amendment or expansion, raising the possibility of changes that may affect, among other things, the pricing or marketing of oil and gas production. State and local authorities regulate various aspects of oil and gas drilling and production activities, including the drilling of wells (through permit and bonding requirements), the spacing of wells, the unitization or pooling of oil and gas properties, environmental matters, safety standards, the sharing of markets, production limitations, plugging and abandonment, and restoration. The overall regulatory burden on the industry increases the cost of doing business, which, in turn, decreases profitability.
Our oil and gas operations must comply with complex environmental regulations and such compliance is costly.
Our oil and gas operations are subject to complex and constantly changing environmental laws and regulations adopted by federal, state and local governmental authorities. New laws or regulations, or changes to current requirements, could have a material adverse effect on our business. We will continue to be subject to uncertainty associated with new regulatory interpretations and inconsistent interpretations between state and federal agencies. We could face significant liabilities to the government and third parties for discharges of oil, natural gas, produced water or other pollutants into the air, soil or water, and we could have to spend substantial amounts on investigations, litigation and remediation. We cannot be sure that existing environmental laws or regulations, as currently interpreted or enforced, or as they may be interpreted, enforced or altered in the future, will not have a material adverse effect on our results of operations and financial condition.
Technological changes could put us at a competitive disadvantage.
The oil and gas industry is characterized by rapid and significant technological advancements and introductions of new products and services using new technologies. As new technologies develop, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement those new technologies at a substantial cost. If other oil and gas exploration and development companies implement new technologies before we do, those companies may be able to provide enhanced capabilities and superior quality compared with what we are able to provide. We may not be able to respond to these competitive pressures and implement new technologies on a timely basis or at an acceptable cost. If we are unable to utilize the most advanced commercially available technologies, our business could be materially and adversely affected.
Oil and gas sales are seasonal leading to varying cash flow during the year.
Sales of oil and natural gas are seasonal in nature, leading to substantial differences in cash flow at various times throughout the year. The marketability of our oil and gas production, if any, will depend in part upon the availability, proximity and capacity of gas gathering systems, pipelines and processing facilities. Federal and state regulation of oil and gas production and transportation, general economic conditions, changes in supply and changes in demand all could negatively affect our ability to produce and market oil and natural gas. If market factors were to change dramatically, the financial impact could be substantial because we would incur expenses without receiving revenues from sales of production. The availability of markets and the volatility of product prices are beyond our control and represent a significant risk to us.
Our oil and gas business depends on transportation facilities owned by others.
The marketability of our potential oil and gas production depends in part on the availability, proximity and capacity of pipeline systems owned or operated by third parties. Federal and state regulation of oil and gas production and transportation, tax and energy policies, changes in supply and demand and general economic conditions could adversely affect our ability to produce, gather and transport oil and natural gas.
Oil and gas reserve estimates may not be accurate.
There are numerous uncertainties inherent in estimating quantities of proved oil and natural gas reserves and in projecting future rates of production and timing of development expenditures, including many factors beyond our control. Reserve engineering is a subjective process of estimating underground accumulations of oil and natural gas that cannot be measured in any exact way, and the accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. As a result, estimates made by different engineers often vary from one another. In addition, results of drilling, testing and production subsequent to the date of an estimate may justify revisions of such estimates, and such revisions, if significant, would change the schedule of any further production and development drilling. Accordingly, reserve estimates are generally different, and often materially so, from the quantities of oil and natural gas that are ultimately recovered. Furthermore, estimates of quantities of proved reserves and their PV-10 value may be affected by changes in crude oil and gas prices because the Company’s quantity estimates are based on prevailing prices at the time of their determination.
Attempts to grow our business could have an adverse effect
Because of our small size, we desire to grow rapidly in order to achieve certain economies of scale. Although there is no assurance that this rapid growth will occur, to the extent that it does occur, it will place a significant strain on our financial, technical, operational and administrative resources. As we increase our services and enlarge the number of projects we are evaluating or in which we are participating, there will be additional demands on our financial, technical and administrative resources. The failure to continue to upgrade our technical, administrative, operating and financial control systems or the occurrence of unexpected expansion difficulties, including the recruitment and retention of geoscientists and engineers, could have a material adverse effect on our business, financial condition and results of operations.
The failure to complete future property acquisitions successfully could reduce earnings and slow growth.
We may not be able to identify properties for acquisition or may not be able to make acquisitions on terms that we consider economically acceptable. There is intense competition for acquisition opportunities in the oil and gas industry. Competition for acquisitions may increase the cost of, or cause us to refrain from, completing acquisitions. Our strategy of completing acquisitions is dependent upon, among other things, our ability to obtain debt and equity financing and, in some cases, regulatory approvals. Our ability to pursue its growth strategy may be hindered if we are not able to obtain financing or regulatory approvals.
Shortages of supplies, equipment and personnel may adversely affect our operations.
Our ability to conduct operations in a timely and cost effective manner depends on the availability of supplies, equipment and personnel. The oil and gas industry is cyclical and experiences periodic shortages of drilling rigs, supplies and experienced personnel. Shortages can delay operations and materially increase operating and capital costs.
Our ability to market the oil and gas that we produce will be essential to our business.
Several factors beyond our control may adversely affect our ability to market the oil and gas that we discover. These factors include the proximity, capacity and availability of oil and gas pipelines and processing equipment, market fluctuations of prices, taxes, royalties, land tenure, allowable production and environmental protection. The extent of these factors cannot be accurately predicted, but any one or a combination of these factors may result in our inability to sell our oil and gas at prices that would result in an adequate return on our invested capital. We currently distribute the oil that we produce through a single pipeline. If this pipeline were to become unavailable, we would incur additional costs to secure a substitute facility in order to deliver the gas that we produce. In addition, although we currently have access to firm transportation for the majority of our current gas production, there is no assurance that we will be able to procure additional transportation on terms satisfactory to us, or at all, to the extent we increase and expand the area or areas of our production.
We will have limited control over the activities on properties we do not operate.
We currently have one operator over the oil and gas activities on our properties, but in the future other companies may operate some or many of the properties in which we have an interest. We will have limited ability to influence or control the operation or future development of these non-operated properties. Our dependence on the operator and other working interest owners for these projects and our limited ability to influence or control the operation and future development of these properties could materially adversely affect the realization of our targeted returns on capital in these drilling or acquisition activities.
Hedging our production may result in losses.
We currently have no hedging agreements in place. However, we may in the future enter into arrangements to reduce our exposure to fluctuations in the market prices of oil and natural gas. We may enter into oil and gas hedging contracts in order to increase credit availability. Hedging will expose us to risk of financial loss in some circumstances, including if:
| · | production is less than expected, |
| · | the other party to the contract defaults on its obligations, or |
| · | there is a change in the expected differential between the underlying price in the hedging agreement and actual prices received. |
In addition, hedging may limit the benefit we would otherwise receive from increases in the prices of oil and gas. Further, if we do not engage in hedging, we may be more adversely affected by changes in oil and gas prices than our competitors who engage in hedging.
We have limited senior management resources, and we need to attract and retain highly skilled personnel; we may be unable to effectively manage growth with our limited resources.
Our senior management currently consists of Charles Bitters, Chief Executive Officer, Chief Financial Officer and sole Director, Joe Christopher, President of Oil America Group, Inc., our wholly-owned subsidiary and Renny Walker, President of Production Resources, Inc,., our wholly-owned subsidiary. Our limited senior management requires them to handle an increasingly large and more diverse amount of responsibility. Expansion of our business would place a significant additional strain on our limited managerial, operational, and financial resources. In such event, we will be required to expand our operational and financial systems and to expand, train, and manage our work force in order to manage the expansion of our operations. Our failure to fully integrate our new employees into our operations could have a material adverse effect on our business, prospects, financial condition, and results of operations. Our ability to attract and retain highly skilled personnel is critical to our operations and expansion. We face competition for these types of personnel from other oil and gas companies and more established organizations, many of which have significantly larger operations and greater financial, marketing, human, and other resources than we have. We may not be successful in attracting and retaining qualified personnel on a timely basis, on competitive terms, or at all. If we are not successful in attracting and retaining these personnel, our business, prospects, financial condition, and results of operations will be materially adversely affected. Our future success will be dependent on our ability to attract and retain key personnel
We do not have a full time Chief Financial Officer or Controller
We currently do not have a full time Chief Financial Officer or Controller. Rather, we utilize external consultants for recording our accounting information and for preparing our required SEC reporting requirements including this Form 10-K. Charles Bitters, our Chief Executive Officer is not a trained accountant and relies on the external consultants to prepare the required information and disclosures. In addition, compliance with Section 404 of the Sarbanes-Oxley Act of 2002 has and will continue to place additional strain on our limited managerial, operational, and financial resources which we believe will be very significant and could have a material adverse effect on our business, prospects, financial condition and results of operations. Our future success will be dependent on our ability to attract and retain key personnel
We may incur substantial costs in order to comply with the requirements of the Sarbanes-Oxley act of 2002.
The Sarbanes-Oxley Act of 2002 has introduced many new requirements applicable to us regarding corporate governance and financial reporting. Among many other requirements is the requirement under Section 404(a) of the Sarbanes-Oxley Act for management to report on our internal controls over financial reporting and the requirement under Section 404(b) of the Sarbanes-Oxley Act for our registered independent public accountant to attest to this report.
We were required to comply with Section 404(a) effective for this year ended December 31, 2008. Our management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2008 and concluded that the disclosure controls and procedures were not effective, because certain deficiencies involving internal controls constituted a material weakness. The material weakness identified did not result in the restatement of any previously reported financial statements or any other related financial disclosure, nor does management believe that it had any effect on the accuracy of the Company’s financial statements for the current reporting period.
To the best of our ability, we may devote substantial time and incur substantial costs during fiscal 2009 to improve our controls and procedures with the goal of compliance. We cannot, however, be certain that we will remediate the material weaknesses discovered, if any, in complying with Section 404.
Risks related to our common stock.
We have a limited market for our common stock, and our stock price is volatile
Our common stock is not listed on a national securities exchange or quoted on the Nasdaq Global Market or Nasdaq Small Capital Market. Instead, our common stock is currently quoted on the OTC Bulletin Board under the symbol “AENP.OB.” Trading on the OTC Bulletin Board is sporadic and highly volatile. The market price for our common stock has fluctuated in the past and may continue to fluctuate in the future. The market price of our common stock is subject to, and will continue to be subject to, a variety of factors, including without limitation:
| · | the business environment; |
| · | the operating results of companies in the industries we serve; |
| · | future announcements concerning our business or that of our competitors or customers; |
| · | the introduction of new products or changes in product pricing policies by us or our competitors; |
| · | changes in analysts’ earnings statements or performance estimates; |
| · | developments in the financial markets; |
| · | quarterly operating results; |
| · | perceived dilution from stock issuances for acquisitions and other transactions; and |
| · | market conditions of securities traded on the OTC Bulletin Board. |
Furthermore, stock prices for many companies fluctuate for reasons that may be unrelated to their operating results. Those fluctuations and general economic, political and market conditions, such as recessions, international currency fluctuations or terrorist or military actions, as well as public perception of equity values of publicly traded companies, may adversely affect the market price of our common stock.
There is no assurance of an established public trading market for our common stock
Although our common stock trades on the OTC Bulletin Board, a regular trading market for our common stock may not be sustained in the future. The NASD (National Association of Stock Dealers) has enacted recent changes that limit quotations on the OTC Bulletin Board to securities of issuers that are current in their reports filed with the SEC. The OTC Bulletin Board is an inter-dealer, over-the-counter market that provides significantly less liquidity than the NASD’s automated quotation system (the “Nasdaq Stock Market”). Quotes for stocks included on the OTC Bulletin Board are not listed in the financial sections of newspapers as are those for the NASDAQ Stock Market. Therefore, prices for securities traded solely on the OTC Bulletin Board may be difficult to obtain and holders of our common stock may be unable to resell their securities at or near their original offering price, or at any price.
Our common stock is considered a “penny stock” and may be difficult to sell
Our common stock is considered to be a “penny stock” since it meets one or more of the definitions in Rule 3(a)(51-1) promulgated under the Exchange Act. These include but are not limited to the following: (i) the stock trades at a price less than $5 per share; (ii) we are NOT traded on a “recognized” national securities exchange; (iii) we are NOT quoted on the Nasdaq Stock Market; (iv) we are NOT have a market value of listed securities of $50 million; or (v) it does NOT have a minimum bid price of $4 per share. The principal result or effect of being designated a “penny stock” is that securities broker-dealers cannot recommend the stock but must trade in it on an unsolicited basis. Section 15(g) of the Exchange Act, and Rule 15g-2 promulgated thereunder by the SEC, require broker-dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document before effecting any transaction in a penny stock for the investor’s account. Our common stock will not be considered a “penny stock” if our net tangible assets exceed $2,000,000 or our average revenue is at least $6,000,000 for the previous three years.
Potential investors in our common stock are urged to obtain and read such disclosure carefully before purchasing any shares that are deemed to be “penny stock.” Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any investor for transactions in such stocks before selling any penny stock to that investor. This procedure requires the broker-dealer to (i) obtain from the investor information concerning his or her financial situation, investment experience and investment objectives; (ii) reasonably determine, based on that information, that transactions in penny stocks are suitable for the investor and that the investor has sufficient knowledge and experience as to be reasonably capable of evaluating the risks of penny stock transactions; (iii) provide the investor with a written statement setting forth the basis on which the broker-dealer made the determination in clause (ii) above; and (iv) receive a signed and dated copy of such statement from the investor, confirming that it accurately reflects the investor’s financial situation, investment experience and investment objectives. Compliance with these requirements may make it more difficult for holders of our common stock to resell their shares to third parties or to otherwise dispose of them in the market or otherwise.
If we fail to maintain effective internal controls over financial reporting, the price of our common stock may be adversely affected
We have identified certain material weaknesses in our internal controls over financial reporting per the assessment required pursuant to rules adopted by the SEC pursuant to the Sarbanes-Oxley Act of 2002. This may have an adverse impact on investor confidence and the price of our common stock. Failure to establish and maintain appropriate internal controls over financial reporting, or any failure of those controls once established, could have a material adverse effect on our business, financial condition or results of operations or raise concerns for investors. Any actual or perceived weaknesses or conditions in our internal controls over financial reporting that need to be addressed may have a material adverse effect on the price of our common stock.
Loss of Control by Present Management and Shareholders
The Company may consider an acquisition in which the Company would issue as consideration for the business opportunity to be acquired an amount of the Company's authorized but unissued Common Stock that could, upon issuance, constitute as much as 51% of the voting power and equity of the Company. The result of such an acquisition would be that the acquired company's stockholders and management would control the Company, and the Company's management could be replaced by persons unknown at this time. Such a merger could leave investors in the securities of the Company with a greatly reduced percentage of ownership of the Company. Management could sell its control block of stock at a premium price to the acquired company's stockholders, although management has no plans to do so.
Dilutive Effects of Issuing Additional Common Stock
In order to pursue our business plans, we will need to raise additional capital. If we are able to obtain additional funding through the sale of common stock, the financing would dilute the equity ownership of existing stockholders.
The necessary financing could be obtained through one or more transactions that could effectively dilute the ownership interests of our then-current stockholders. Further, there can be no assurances that we will be able to secure such additional financing. The board of directors of the Company has authority to issue such unissued shares without the consent or vote of the shareholders of the Company. We are authorized to issue up to 500,000,000 shares of our common stock and 5,000,000 shares of preferred stock, $0.001 par value per share.
Our Board of Directors can issue preferred stock with terms that are preferential to our common stock.
Our Board of Directors may issue up to 5,000,000 shares of preferred stock without action by our stockholders. Rights or preferences could include, among other things:
| · | the establishment of dividends which must be paid prior to declaring or paying dividends or other distributions to our common stockholders; |
| · | greater or preferential liquidation rights which could negatively affect the rights of common stockholders; and |
| · | the right to convert the preferred stock at a rate or price which would have a dilutive effect on the outstanding shares of common stock. |
See “Description of Securities—Preferred Stock”.
In addition, any preferred stock that is issued may have rights, including as to dividends, liquidation preferences and voting, that are superior to those of holders of Common Stock.
We have not and do not anticipate paying dividends on our Common Stock.
We have not paid any cash dividends to date with respect to our common stock. We do not anticipate paying dividends on our common stock in the foreseeable future since we will use all of our earnings, if any, to finance expansion of our operations. However, we are authorized to issue preferred stock and may in the future pay dividends on our preferred stock that may be issued.
We do not own any real estate or other physical properties materially important to our operation. Our administrative and principal executive offices are located at 6073 Hwy 281 South, Mineral Wells, TX 76067. We currently do not have a lease and we are not paying rent for our office space. It is being provided to the Company by our Chief Executive Officer and sole director free of charge. Usage of this office space and the related value is de minimis. Therefore, no expense has been recorded in the accompanying financial statements. We expect we will have to lease more substantial corporate office space in the near future and that the cost of the space may be material to our operations. We believe that our office facilities are suitable and adequate for our business as it is contemplated to be conducted.
From time to time, we may become subject to proceedings, lawsuits and other claims in the ordinary course of business including proceedings related to environmental and other matters. Such matters are subject to many uncertainties, and outcomes are not predictable with assurance.
During the period covered by this Annual Report, and as of the present date, we were not and are not a party to any material legal proceedings, nor were or are we aware of any threatened litigation of a material nature against us.
| ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Market Information
As of April 15, 2009, the Company had 20,360,389 shares of common stock issued and outstanding. The Company’s common stock, par value $0.0001 per share (the "Common Stock"), is traded on the Over the Counter Bulletin Board ("OTCBB") under the symbol "AENP".
The following table sets forth certain information as to the high and low bid quotations quoted on the OTCBB for our 2008 and 2007 fiscal years. Information with respect to over-the-counter bid quotations represents prices between dealers, does not include retail mark-ups, markdowns or commissions, and may not necessarily represent actual transactions.
| | | High | | | Low | |
| | | | | | | |
| Fiscal Year Ending 2008 | | | | | | |
| First Quarter | | $ | 0.47 | | | $ | 0.27 | |
| Second Quarter | | $ | 0.44 | | | $ | 0.23 | |
| Third Quarter | | $ | 0.25 | | | $ | 0.15 | |
| Fourth Quarter | | $ | 0.21 | | | $ | 0.01 | |
| | | | | | | | | |
| Fiscal Year Ending 2007 | | | | | | | | |
| First Quarter | | $ | 2.25 | | | $ | 1.50 | |
| Second Quarter | | $ | 1.75 | | | $ | 0.75 | |
| Third Quarter | | $ | 1.00 | | | $ | 0.25 | |
| Fourth Quarter | | $ | 0.49 | | | $ | 0.22 | |
On April 15, 2009, the closing bid price for a share our common stock, as reported by the OTCBB was $0.038.
Holders
As of April 15, 2009, there were approximately 415 stockholders of record of our common stock, which does not include shareholders whose shares are held in street or nominee names, and no shares of our preferred stock were issued or outstanding.
Dividends
No cash dividends have been declared or paid on our common stock since our inception. No restrictions limit our ability to pay dividends on our common stock. We do not expect to pay any dividends in the near future.
Securities Authorized For Issuance Under Equity Compensation Plans
In September 2008, the Company’s Board of Directors approved the issuance of up to 10,000,000 shares of common stock under the 2008 Non-Qualified Stock Option Plan (the “Plan”). The Plan is to assist the Company in securing and retaining Key Participants of outstanding ability by making it possible to offer them an increased incentive to join or continue in the service of the Company and to increase their efforts for its welfare through participation in the ownership and growth of the Company. On September 25, 2008, the Company filed a Form S-8 with the SEC for the registration of the underlying shares of stock from the plan. As of April 15, 2009, no grants under the Plan had been issued by the Company.
Recent Sales of Unregistered Securities
None
| | | Years Ended | |
| | | December 31, | |
| | | 2008 | | | 2007 | |
| | | | | | | |
| Revenues | | $ | 1,842,059 | | | $ | 1,581,661 | |
| Total Operating Expenses | | | 3,617,895 | | | | 3,743,656 | |
| Operating Loss | | | (1,775,836 | ) | | | (2,161,995 | ) |
| Total Other Income (Expense) | | | (372,716 | ) | | | (121,982 | ) |
| Net Loss | | $ | (2,148,551 | ) | | $ | (2,283,978 | ) |
| Net Cash Provided by Operating Activities | | $ | 117,874 | | | $ | 122,368 | |
| | | | | | | | | |
| Per Share and Share Data | | | | | | | | |
| Weighted average Shares Outstanding | | | 20,361,880 | | | | 19,770,055 | |
| Shares Outstanding at Year-End | | | 20,360,389 | | | | 19,767,055 | |
| Net Loss Per Share - Basic and Diluted | | $ | (0.11 | ) | | $ | (0.12 | ) |
| Book Value Per Share | | $ | (0.15 | ) | | $ | (0.05 | ) |
| Market Price: | | | | | | | | |
| High | | $ | 0.47 | | | $ | 2.25 | |
| Low | | $ | 0.01 | | | $ | 0.22 | |
| Year-End Close | | $ | 0.03 | | | $ | 0.45 | |
| | | | | | | | | |
| Assets | | | | | | | | |
| Current Assets | | $ | 89,083 | | | $ | 134,740 | |
| Property and equipment, net | | $ | 4,011,903 | | | $ | 4,365,765 | |
| Other Assets | | $ | 135,280 | | | $ | 272,771 | |
| Total Assets | | $ | 4,236,266 | | | $ | 4,773,277 | |
| | | | | | | | | |
| Liabilities | | | | | | | | |
| Total Current Liabilities | | $ | 6,782,260 | | | $ | 5,155,387 | |
| Asset Retirement Obligations | | $ | 509,155 | | | $ | 524,488 | |
| Total Liabilities | | $ | 7,291,415 | | | $ | 5,679,875 | |
| Stockholders' Deficit | | $ | (3,055,149 | ) | | $ | (906,599 | ) |
| Total Liabilities and Stockholders' Deficit | | $ | 4,236,266 | | | $ | 4,773,277 | |
| | | | | | | | | |
| Number of Employees | | | 10 | | | | 11 | |
| | | | | | | | | |
| Oil and Gas Wells | | | | | | | | |
| Gross | | | 207 | | | | 220 | |
| Net | | | 204 | | | | 215 | |
| | | | | | | | | |
| Acreage | | | | | | | | |
| Gross | | | 7,701 | | | | 7,811 | |
| Net | | | 7,393 | | | | 7,394 | |
| | | | | | | | | |
| Reserves | | | | | | | | |
| Proved Oil (MBBL) | | | 7.728 | | | | 6.934 | |
| Proved Natural Gas (BCF) | | | 40.522 | | | | 1.58 | |
| | | | | | | | | |
| Production | | | | | | | | |
| Oil (bbls) | | | 11,501 | | | | 14,144 | |
| Natural Gas (mcf) | | | 88,711 | | | | 81,928 | |
| Total Equivalent (bbls) | | | 26,286 | | | | 27,799 | |
| | | | | | | | | |
| Average Sales Price | | | | | | | | |
| Oil (bbls) | | $ | 93.21 | | | $ | 68.74 | |
| Natural Gas (mcf) | | $ | 8.66 | | | $ | 7.42 | |
| Natural Gas Equivalent (mcfe) | | $ | 51.98 | | | $ | 44.52 | |
| ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion and analysis of our financial condition and results of operations is qualified by reference to, and should be read in conjunction with, our audited consolidated financial statements included in this Annual Report (the “Financial Statements”), and the accompanying notes thereto, and the other financial information appearing elsewhere in this Annual Report. The analysis set forth below is provided pursuant to applicable SEC regulations and is not intended to serve as a basis for projections of future events. Our actual results may differ materially from those anticipated in our forward-looking statements. Please also refer to “SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS” beginning on page 4 of this Annual Report and “RISK FACTORS” beginning on page 8 of this Annual Report.
OVERVIEW
For a description of the historical development of our business, please refer to “Item 1. Description of Business – History of Company Development” beginning on page 6 of this Annual Report.
RECENT DEVELOPMENTS
On March 6, 2009 but effective December 31, 2008, Bent Arch executed a Fourth Modification and Extension Agreement (the “Fourth Extension”) in relation to the Note that was to become due and payable on December 31, 2008. The Third Extension modified the terms of the Note as follows;
| · | The maturity date of the Note was extended to December 31, 2009. |
Critical Accounting Estimates and Policies
The methods, estimates and judgment we use in applying our most critical accounting policies have a significant impact on the results we report in our financial statements. The Securities and Exchange Commission has defined the most critical accounting policies as the ones that are most important to the portrayal of our financial condition and results, and require us to make our most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based upon this definition, our most critical estimates include going concern, BDC conversion, oil and gas properties, property and equipment, the evaluation of whether our assets are impaired, asset retirement obligations, revenue recognition, the valuation allowance for deferred tax assets, and the estimate of reserves of oil and gas that are used to develop projected income whereby an appropriate discount rate has been used. We also have other key accounting estimates and policies, but we believe that these other policies either do not generally require us to make estimates and judgments that are as difficult or as subjective, or it is less likely that they would have a material impact on our reported results of operations for a given period. For additional information, see Note 3 "Nature of Operations and Summary of Significant Accounting Policies" in the notes to our audited financial statements contained in this Annual Report. Although we believe that our estimates and assumptions are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates.
GOING CONCERN
The independent registered public accounting firms’ reports to our financial statements at December 31, 2008 and 2007 and for the years ended December 31, 2008 and 2007, include an explanatory paragraph in addition to their audit opinion stating that our recurring losses from operations, net cash used in operations, stockholders’ deficit and working capital deficiency raise substantial doubt about our ability to continue as a going concern. Our financial statements do not include any adjustments to reflect the possible effects on recoverability and classification of assets or the amounts and classification of liabilities that may result from our inability to continue as a going concern.
BDC CONVERSION
As a result of the Company’s conversion from a BDC company to an oil and gas operating company, the change in accounting is considered a change in accounting principle. As a result, in accordance with Statement of Financial Accounting Standard 154, "Accounting for Changes and Error Corrections," which requires that a change in accounting principle be retrospectively applied to all prior periods presented, the Company’s financial statements are presented on an operating and consolidated basis for all current and prior periods presented on a retrospective basis without regard to the BDC method of accounting. The Company does not believe that withdrawing its election to be regulated as a BDC will have any impact on its federal income tax status, because the Company never elected to be treated as a regulated investment company under Subchapter M of the Internal Revenue Code. Instead, the Company has always been subject to corporate level federal income tax on its income (without regard to any distributions it makes to its shareholders) as a “regular” corporation under Subchapter C of the Internal Revenue Code.
OIL AND GAS PROPERTIES
The Company uses the successful efforts method of accounting for its oil and gas properties. Costs incurred by the Company related to the acquisition of oil and gas properties and the cost of drilling successful wells are capitalized. Costs to maintain wells and related equipment and lease and well operating costs are charged to expense as incurred. Gains and losses arising from sales of properties are included in income. Unproved properties are assessed periodically for possible impairment.
PROPERTY AND EQUIPMENT
The Company’s oil and gas rig is depreciated over its estimated useful life of ten years, using the straight line method. Vehicles and field equipment are depreciated over their estimated useful life of three years and five years, respectively, using the straight line method. Maintenance, repairs and minor replacements are charged to operations in the year incurred.
EVALUATION OF ASSET IMPAIRMENT
We account for the impairment of long-lived assets including proved properties in accordance with Financial Accounting Standards, SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the book value of the asset may not be recoverable. Recoverability of the asset is measured by comparison of its carrying amount to the undiscounted cash flow that the asset or asset group is expected to generate. If such assets or asset groups are considered to be impaired, the loss recognized is the amount by which the carrying amount of the property if any, exceeds its fair market value. Based on our impairment analysis of property and equipment, no impairment charge has been recorded for the years ended December 31, 2008 or 2007.
ASSET RETIREMENT OBLIGATIONS
The Company accounts for asset retirement obligations in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 143, Accounting for Asset Retirement Obligations. The asset retirement obligations represent the estimated present value of the amounts expected to be incurred to plug, abandon, and remediate the producing properties at the end of their productive lives, in accordance with state laws, as well as the estimated costs associated with the reclamation of the property surrounding. The Company determines the asset retirement obligations by calculating the present value of estimated cash flows related to the liability. The asset retirement obligations are recorded as a liability at the estimated present value as of the asset’s inception, with an offsetting increase to producing properties. Periodic accretion of the discount related to the estimated liability is recorded as an expense in the statement of operations.
The estimated liability is determined using significant assumptions, including current estimates of plugging and abandonment costs, annual inflation of these costs, the productive lives of wells, and a risk-adjusted interest rate. Changes in any of these assumptions can result in significant revisions to the estimated asset retirement obligations. Revisions to the asset retirement obligations are recorded with an offsetting change to producing properties, resulting in prospective changes to depletion and depreciation expense and accretion of the discount. Because of the subjectivity of assumptions and the relatively long lives of most of the wells, the costs to ultimately retire the Company’s wells may vary significantly from prior estimates.
REVENUE RECOGNITION
Revenues from sales of crude oil and natural gas products are recorded when deliveries have occurred and legal ownership of the commodity transfers to the customer. Revenues from the production of oil and natural gas properties in which the Company shares an undivided interest with other producers are recognized based on the actual volumes sold by the Company during the period.
VALUATION ALLOWANCE FOR DEFERRED TAX ASSETS
In assessing the recoverability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The valuation allowance at December 31, 2008 was $1,548,597. Net operating loss carry-forwards aggregate approximately $4,424,563 and expire in the years through 2029.
As discussed previously, on April 3, 2007, the Company filed a Form N-54C to withdraw its election to be regulated as a BDC and as of that date, is no longer a BDC under the 1940 Act. The Company is no longer a BDC with unconsolidated majority-owned portfolio companies but rather an oil and gas operating company with consolidated subsidiaries. The results of operations for April 1, 2007 through April 3, 2007 were not material and therefore, the Company has utilized April 1, 2007 as the inception date for the new business as an oil and gas operating company. As a result of this change, and IRS Section 382 rules, the net operating loss carry-forwards from previous years to April 1, 2007 will not be allowable and are not included.
Results of Operations
The following discussion of the results of operations should be read in conjunction with our consolidated financial statements and notes thereto for the periods presented included in this Form 10-K.
| | | Years Ended | |
| | | December 31, | |
| | | 2008 | | | 2007 | |
| Revenues: | | | | | | |
| Oil sales, net | | $ | 1,842,059 | | | $ | 1,581,661 | |
| | | | | | | | | |
| Operating Expenses | | | | | | | | |
| Compensation | | | 255,384 | | | | 213,419 | |
| Consulting | | | - | | | | 3,260 | |
| Depreciation, depletion and accretion | | | 562,334 | | | | 540,677 | |
| Rent | | | 89,161 | | | | 36,527 | |
| General and administrative | | | 225,836 | | | | 389,746 | |
| Production | | | 2,265,456 | | | | 2,300,198 | |
| Professional | | | 126,748 | | | | 173,393 | |
| Taxes | | | 91,896 | | | | 86,436 | |
| Website | | | 1,080 | | | | - | |
| Total Operating Expenses | | | 3,617,895 | | | | 3,743,656 | |
| | | | | | | | | |
| Operating Loss | | | (1,775,836 | ) | | | 2,161,995 | ) |
| | | | | | | | | |
| Other Income (Expense) | | | | | | | | |
| Other income (expense) | | | (195,942 | ) | | | 19,097 | |
| Gain on sale of properties | | | - | | | | 29,309 | |
| Interest expense | | | (170,769 | ) | | | (164,383 | ) |
| Payroll tax expense and penalties | | | (6,004 | ) | | | (6,004 | ) |
Total Other Income (Expense) | | | (372,716 | ) | | | (121,982 | ) |
| | | | | | | | | |
| Net Loss | | $ | (2,148,551 | ) | | $ | (2,283,978 | ) |
Year Ended December 31, 2008 compared to December 31, 2007
Revenues:
Revenues increased $260,399 or 16%, to $1,842,059 for 2008 from $1,581,661 for 2007. The increase was due to increased market pricing from the sale of the Company’s oil and gas production..
Operating Expenses:
Operating expenses decreased $125,761, or 3%, to $3,617,895 for 2008 from $3,743,656 for 2007. The decrease was primarily the result of a $163,910 decrease in general and administrative expense, a $34,742 decrease in production expense and a $46,645 decrease in professional expense, offset by a $52,633 increase in rent expense, a $41,966 increase in compensation expense and a $21,658 increase in depreciation, depletion and accretion expense. The decrease in production expense was primarily from the Company not being able to focus on its oil and gas operations because of insufficient operating cash. The change in general and administrative and professional expense was from an effort made by the Company to reduce expenses.
Other Income (Expense):
Other income (expense) increased $250,733 of expense, or approximately 100% to $372,716 of expense for 2008 from $121,982 of expense for 2007. The change was primarily composed of a $215,039 increase in other expense, of which $195,000 was related to an adjustment of accrued compensation not properly recorded in the prior periods. Additionally, the change was comprised of $29,309 gain on sale of properties in 2007 with no corresponding amount in 2008.
Liquidity and Capital Resources:
Cash and cash equivalents were $88,937 at December 31, 2008 as compared to $133,220 at December 31, 2007, and working capital deficit was $6,693,177 at December 31, 2008 as compared to a working capital deficit of $5,020,647 at December 31, 2007. The increase in the working capital deficit was primarily from a $1,531,027 increase in due to related parties and $161,864 increase in accrued interest payable.
Historical Trends:
Operating Activities
Cash provided by operating activities was $117,874 for the year ended December 31, 2007 compared to cash provided of $122,638 for the year ended December 31, 2007.
Investing Activities
Cash used in investing activities was $253,504 for the year ended December 31, 2008 compared to cash used of $144,178 for the year ended December 31, 2007. The increase in cash used resulted primarily from an increase in the investment in property and equipment.
Financing Activities
Cash provided by financing activities was $91,348 for the year ended December 31, 2008 compared to $48,127 of cash provided for the year ended December 31, 2007. The change was primarily from a reduction in the repayment of notes payable from 2007 to 2008 by $29,221.
Our principal uses of cash to date have been for operating activities and we have funded our operations previously primarily by incurring indebtedness in the form of convertible debentures and issuing common stock. Our existing debt obligations pose a significant liquidity risk to our business and stockholders by requiring us to dedicate a substantial portion of our cash flow to principal and interest payments on our debt obligations, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other corporate requirements. Additionally, these debt obligations may impede us from obtaining additional financing in the future for working capital, capital expenditures and other corporate requirements and may make us more vulnerable to a downturn in our business and limit our flexibility to plan for, or react to, changes in our business.
Debt:
Our debt at December 31, 2008 and 2007 consisted of the following:
Lease Payable
| | | December 31, |
| | | 2008 | | | 2007 |
| $21,238 computer equipment lease, bearing interest at 10% per annum | | $ | 16,131 | | | $ | 16,131 | |
On April 16, 2001, the Company leased computer equipment under a 36-month lease that was accounted for as a capital lease in the amount of $21,238. The lease was secured by the computer equipment and perfected by a financing statement; however, the Company liquidated the equipment in 2006 (with the lessor approval) and paid the resulting $4,000 of proceeds to the lessor. As a result of the computer liquidation other payments, the remaining unpaid balance of principal has been $16,131 since March 31, 2006. The payable is personally guaranteed by a former officer/director and the Chief Executive Officer of the Company. As of December 31, 2008, the Company has recorded a total of $25,029 in accrued interest for this payable in the accompanying Balance Sheet.
In November 2003, a settlement was negotiated with the lessor discussed above to forgive the outstanding principal and accrued interest on the lease payable once the transfer of 4,000 shares (100,000 shares prior to the one-for-twenty five reverse stock split) of the Company’s common stock personally held by the Company’s Chief Executive office occurs. The Chief Executive Officer of the Company transferred these shares on September 15, 2003. However, as of December 31, 2008, the transaction has not been finalized as the lessor has not agreed to the settlement. The Company expects to fully resolve this matter in the future at which time the value of the shares exchanged and any related gain or loss will be determined and recognized.
As of December 31, 2008, the Company has recorded $122,671 of accrued interest for previously issued convertible debentures. Several convertible debenture holders previously elected to convert all or a portion of the convertible debentures into common stock. However, the conversion did not include accrued interest that was specified in the convertible debenture documentation. Although the Company believes that no further common stock will be issued for these conversions, the accrued interest balance for these converted debentures is included in the accrued interest balance as of December 31, 2008.
Notes Payable
| | | December 31, | |
| | | 2008 | | | 2007 | |
| $2,000,000 Promissory Note, dated February 20, 2003, bearing interest at 8% per annum and due on December 31, 2008 | | $ | 2,000,000 | | | $ | 2,000,000 | |
| $25,000 Line of Credit, dated October 28, 2005, bearing simple variable interest at 6% per annum and due on February 28, 2008. | | | 24,062 | | | | 23,714 | |
| $103,000 Note, dated March, 2008, not formalized and not bearing interest | | | 91,000 | | | | - | |
| | | $ | 2,115,062 | | | $ | 2,023,714 | |
On June 15, 2004, Bend Arch Petroleum, Inc. (“Bend Arch”), a wholly-owned subsidiary of the Company executed a $2,000,000 promissory note accruing interest at 8% with Proco Operating Co., Inc., a company controlled by the brother of the Company’s Chief Executive Officer with a maturity date of July 25, 2007. The purpose of the Note is to secure payment for oil and gas leases and wells located in Comanche and Eastland counties in the State of Texas sold to Bend Arch by Proco on June 15, 2004. The Note replaced a $2,000,000 convertible debenture dated January 5, 2004.
The terms of the Note included (i) the payment of interest at a rate of eight percent (8%) per annum (ii) principal and interest due and payable on July 25, 2007 (iii) no prepayment penalty (iv) payment made in excess of sixty (60) days after the due date of July 25, 2007 is a default of the Note and Bend Arch will forfeit all ownership of the related leases and wells and relinquish operations on the lease and wells to Proco, and (v) upon a default of the Note, Bend Arch will vacate the leases with no rights of ownership and execute the necessary documents to transfer the leases and wells to Proco or its assigns.
Effective July 25, 2007, Bent Arch executed a Modification and Extension Agreement (the “First Extension”) in relation to the Note that became due and payable on the same date.
The First Extension modified the terms of the Note as follows:
| · | The maturity date of the Note was extended to September 25, 2007. |
| · | Bend Arch covenants that as long as the Note is outstanding and unpaid, no transfer, assignment or sale of the underlying leases and wells securing the payment of the Note will be allowed without the written approval of Proco. |
Effective September 25, 2007, Bent Arch executed a Second Modification and Extension Agreement (the “Second Extension”) in relation to the Note that became due and payable on the same date. The Second Extension modifies the terms of the Note as follows:
| · | The maturity date of the Note was extended to March 31, 2008. |
As of December 31, 2008, the Company has accrued $798,685 of accrued interest on the Promissory Note and is included as a component of accrued interest payable in the accompanying financial statements.
On March 6, 2009 but effective December 31, 2008, Bent Arch executed a Fourth Modification and Extension Agreement (the “Fourth Extension”) in relation to the Note that was to become due and payable on December 31, 2008. The Fourth Extension modified the terms of the Note as follows;
| · | The maturity date of the Note was extended to December 31, 2009. |
On October 28, 2005, Bend Arch entered into a $25,000 line of credit facility with a financial institution for working capital purposes. The line of credit is secured by a certificate of deposit held by the financial institution and bears simple interest per annum at a variable rate which is six percent (6%) as of December 31, 2008. As of December 31, 2008, the outstanding balance is $24,062 and is included in the Note Payable balance in the accompanying consolidated financial statements.
In March 2008, the Company purchased oilfield property and equipment for a price of $150,000. The terms included a cash payment of $47,000 and a note payable for the balance of $103,000. During the nine months ended September 30, 2008, the Company paid down $12,000 of principal and the balance is $91,000 as of December 31, 2008 and classified as a component of Note Payable in the accompanying consolidated financial statements. As of December 31, 2008, no formal agreement of the terms of the note payable had been finalized and the Company has a verbal agreement to pay the principal back at a rate of $10,000 monthly. It is anticipated that a formal agreement will be negotiated and finalized in the future.
Equity Financing
For the year ended December 31, 2007 and 2006, the Company received $89,000 and $2,335,245 of proceeds, net of offering costs, from the issuance of common stock, respectively.
Contractual Obligations and Commercial Commitments
The following table highlights, as of December 31, 2008, our contractual obligations and commitments by type and period:
| | | | | | | |
| Contractual Obligations | | Total | | | Less than 1 year | |
| | | | | | | |
Debt: | | | | | | |
| Lease Payable | | $ | 16,131 | | | $ | 16,131 | |
| Notes Payable | | | 2,115,062 | | | | 2,115,062 | |
| Accrued Interest Payable | | | 946,385 | | | | 946,385 | |
| Total Debt | | $ | 3,077,578 | | | $ | 3,077,578 | |
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
2009 OUTLOOK
Our ability to have a successful oil and gas company is heavily dependent on securing additional capital to supplement the anticipated timeframe required for the oil and gas revenues and cash flows to be sufficient to cover our operating expenses. As a result, we are searching for an alternative means of securing additional capital, which may include the sale of additional shares of our common stock or the issuance of additional debt securities. Additionally, we require additional funds for working capital and for growth opportunities. However, there is no assurance that additional equity or debt financing will be available on terms acceptable to our management or that the additional financing will be available when we require the funds.
If we are unable to obtain additional capital or successfully implement our business strategy, this will have a significant impact on our ability to continue as a going concern.
| ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
The Consolidated Financial Statements and schedules that constitute Item 8 are attached at the end of this Annual Report on Form 10-K. An index to these Financial Statements and schedules is also included on page F-1 of this Annual Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
There have been no disagreements, or transactions or events similar to those which involved such disagreements or reportable events, with former accountants on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of the former accountant, would have caused it to make reference to the subject matter disagreements in connection with any of its reports.
ITEM 9A. CONTROLS AND PROCEDURES
We maintain “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable assurance of achieving the desired control objectives, and we necessarily are required to apply our judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures.
Our management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2008 and concluded that the disclosure controls and procedures were not effective, because certain deficiencies involving internal controls constituted a material weakness as discussed below. The material weakness identified did not result in the restatement of any previously reported financial statements or any other related financial disclosure, nor does management believe that it had any effect on the accuracy of the Company’s financial statements for the current reporting period.
Management’s Annual Report on Internal Control over Financial Reporting.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Our internal control system was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes, in accordance with generally accepted accounting principles. Because of inherent limitations, a system of internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate due to change in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management, including our principal executive officer and principal accounting officer, conducted an evaluation of the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on its evaluation, our management concluded that there is a material weakness in our internal control over financial reporting. A material weakness is a deficiency, or a combination of control deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
The material weakness(s) identified are:
| 1. | The Company does not have a full time Accounting Controller or Chief Financial Officer and utilizes part time consultants to perform these critical responsibilities. This lack of full time accounting staff results in a lack of segregation of duties and accounting technical expertise necessary for an effective system of internal control. |
Additionally, management determined during its internal control assessment the following weakness(s), while not considered material, are items that should be considered by the Board of Directors for resolution in the near future:
| 1. | The management of oil and gas leases including a schedule of oil and gas lease agreements and related documents to ensure that the Company has rights to Oil and Gas, expiration and renewal dates, contractual payments regarding royalties, taxes, improvements, etc. This ensures correct oil and gas capital accounts, revenues and related expenses are calculated correctly by Accounting. Additionally, the CEO (since there is no CFO) should review all Oil and gas lease agreements. |
| 2. | The Company should take steps to require that oil and gas expenditures are properly classified into the proper categories such as acquisition costs and intangible and tangible drilling costs. Without this, the Company cannot properly determine the proper recording and disclosure of oil and gas expenditures. |
| 3. | The Company should take steps to enhance the security for bank wire transfers. Currently, the Subsidiary President’s and CEO provide instruction to the bookkeepers to initiate a wire transfer. As a security enhancement, the Bank should be required to obtain approval from the CEO or CFO to make the wire transfer. |
| 4. | The Company IT process should be strengthened as there is no disaster recovery plan, no server, and the company accounting records are maintained through a consultant accountant. The Company should consider the purchase and implementation of a server and proper back-ups off site to ensure that accounting information is safeguarded. |
| 5. | The Company should take steps to implement a policies and procedures manual. |
In order to mitigate all of the above weaknesses(s), to the fullest extent possible, all financial reports are reviewed by the Chief Executive Officer as well as the Board of Directors for reasonableness. All unexpected results are investigated. At any time, if it appears that any control can be implemented to continue to mitigate such weaknesses, it is immediately implemented. As soon as our finances allow, we will hire sufficient accounting staff and implement appropriate procedures as described above.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only management’s report in this annual report.
This report shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liabilities of that section, and is not incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2008 that have materially affected, or are reasonable likely to materially affect, our internal control over financial reporting.
Not applicable.
| ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE |
Directors and Executive Officers
The principal occupations of each of our executive officers and directors for at least the past five years are as follows:
| Name | Age | Positions Held With The Company | Director Since |
| Charles Bitters | 63 | Chief Executive Officer, President and Director | 2002 |
| Joe Christopher | 60 | President of Oil America Group, Inc. and Director | 2008 |
| Renny Walker | 56 | President of Production Resources, Inc. | N/A |
There are no family relationships among any of our directors or executive officers. Each executive officer is elected or appointed by, and serves at the discretion of, our board of directors.
Charles Bitters has been Chief Executive Officer and director of the Company since 2002 and President since 2001. Mr. Bitters has over 25 years experience in all phases of the petroleum industry including drilling of oil and gas wells and the stimulation, production and operation of oil and gas wells. From 1997 to 2000, he was the Managing Member of Trinity Group, LLC, an oil and gas lease production company. Mr. Bitters holds a Bachelor of Science degree from Tarleton State University.
Joe Christopher has been President of Oil America Group, Inc., a wholly-owned subsidiary of the Company, since 2005 and was elected as a director of the Company in 2008. Mr. Christopher has a background in banking, securities, construction and manufacturing and is a graduate of the University of Texas at Arlington, Texas with a degree in Business Administration.
Renny Walker has been President of Production Resources, Inc. Oil America Group, Inc., a wholly-owned subsidiary of the Company, since 2005. Mr. Walker has an extensive background in the oil and gas industry including significant experience as a landman and in oil and gas exploration and production.
Effective May 27, 2008, Joe Christopher was elected to serve as a Director and will serve as a Director until the next annual meeting of the Shareholders of the Company.
There are no agreements with respect to the election of Directors. We have not previously compensated our Directors for service on our Board of Directors, any committee thereof, or reimbursed for expenses incurred for attendance at meetings of our Board of Directors and/or any committee of our Board of Directors. Officers are appointed annually by our Board of Directors and each Executive Officer serves at the discretion of our Board of Directors. The Company does not have a standing nominating committee or audit committee as the Board consists of only two members, Mr. Bitters and Mr. Christopher, which makes such committee’s impracticable. Mr. Bitters and Mr. Christopher are the sole directors participating in the consideration of director nominees. The Company knows of no understanding or arrangement between any director, nominee for director, officer or any other person pursuant to which he was or is to be selected as a director or nominee for director or an Officer of the Company.
None of our officers and/or directors signing this annual report have ever filed any bankruptcy petition, been convicted of or been the subject of any criminal proceedings or the subject of any order, judgment or decree involving the violation of any state or federal securities laws.
Section 16(a) Beneficial Ownership Reporting Compliances
Pursuant to Section 16(a) of the 1934 Act, the Company's directors and executive officers, and any persons holding more than 10% of its common stock, are required to report their beneficial ownership and any changes therein to the SEC and the Company. Specific due dates for those reports have been established, and the Company is required to report herein any failure to file such reports by those due dates. Based on the Company's review of Forms 3, 4 and 5 filed by such persons, the Company believes that during the fiscal year ended December 31, 2008, all Section 16(a) filing requirements applicable to such persons were met in a timely manner.
Code of Ethics, Whisteblower and Insider Trading
On February 1, 2008, the Company adopted a Code of Ethics for its Principal Executive Officer and Senior Financial Officer (the “Code of Ethics”). A copy of the Code of Ethics is filed as Exhibit 14 to this Form 10-K. The Code of Ethics is also available free of charge by writing to the Company at 6073 Hwy 281 South, Mineral Wells, TX 76067. The Code of Ethics establishes procedures for personal investment and restricts certain transactions by our personnel. The Code of Ethics generally does not permit investment by our employees in securities that may be purchased or held by us. Any updates to the Code of Ethics will be disclosed by the Company on a Form 8-K.
Additionally, the Company adopted Whistleblower and Insider Trading and Disclosure Policies on February 1, 2008. The Whistleblower policy provides that any employee of the Company may submit a good faith complaint regarding accounting or auditing matters to the management of the Corporation without fear of dismissal or retaliation of any kind. The Company is committed to achieving compliance with all applicable securities laws and regulations, accounting standards, accounting controls and audit practices. The Corporation’s Board of Directors (until an Audit Committee is formally established) will oversee treatment of employee concerns in this area.
The Insider Trading Policy and Disclosure Policy provides guidance and procedures for employees, consultants, officers and directors related to Rule 10b-5 of the federal securities laws which prohibits buying or selling of a company’s stock by any person having knowledge of non-public material information concerning that company. In this context, material information is defined as information that a reasonable investor would want to know in making a decision to buy or sell that stock. The federal securities laws also impose certain duties on companies whose stock is publicly traded to take appropriate measures, in advance, to prevent insider trading violations. Primarily for this reason, the Company has adopted this policy to limit and restrict buying and selling of its stock by persons with access to non-public information in an effort to prevent violations of the antifraud provisions of the securities laws.
Identification of Audit Committee; Audit Committee Financial Expert
As discussed previously, the Company does not have a standing audit committee as the Board consists of only two members, Mr. Bitters and Mr. Christopher, which makes such a committee impracticable.
The Delaware General Corporation Law, our charter and by-laws provide for indemnification of our directors and officers for liabilities and expenses that they may incur in such capacities. In general, directors and officers are indemnified with respect to actions taken in good faith in a manner reasonably believed to be in, or not opposed to, the best interests of the Company, and with respect to any criminal action or proceeding, actions that the indemnitee had no reasonable cause to believe were unlawful.
Our charter and by-laws limit the liability of directors to the maximum extent permitted by Delaware law. Delaware law provides that directors of a corporation will not be personally liable for monetary damages for breach of their fiduciary duties as directors, except liability for:
| · | any breach of their duty of loyalty to the corporation or its stockholders; |
| · | acts of omissions that are not in good faith or that involve intentional misconduct or a knowing violation of law; |
| · | unlawful payments of dividends or unlawful stock repurchases or redemptions; or |
| · | any transaction from which the director derived an improper personal benefit. |
The limitations do not apply to liabilities arising under the federal securities laws and do not affect the availability of equitable remedies, including injunctive relief or rescission.
Our charter and by-laws provide that we will indemnify our directors and officers, and may indemnify other employees and agents, to the maximum extent permitted by law. We believe that indemnification under our by-laws covers at least negligence and gross negligence on the part of indemnified parties. Our by-laws also permit us to secure insurance on behalf of any officer, director, employee or agent for any liability arising out of actions taken in his or her capacity as an officer, director, employee or agent, regardless of whether the by-laws would permit indemnification.
At present, there is no pending litigation or proceeding involving any of our directors, officers or employees in which indemnification is sought, nor are we aware of any threatened litigation that may result in claims for indemnification.
Our charter provides that we must indemnify our directors and officers and that we must advance expenses, including attorneys’ fees, to our directors and officers in connection with legal proceedings, subject to very limited exceptions. In addition, our charter provides that our directors will not be personally liable for monetary damages to us for breaches of their fiduciary duty as directors, except to the extent that the Delaware law statute prohibits the elimination or limitation of liability of directors for breaches of fiduciary duty.
These provisions may discourage stockholders from bringing a lawsuit against our directors for breach of their fiduciary duties. These provisions may also have the effect of reducing the likelihood of derivative litigation against directors and officers, even though such an action, if successful, might otherwise benefit us and our stockholders. Furthermore, you may lose some or all of your investment in our common stock if we pay the costs of settlement or damage awards against our directors and officers under these provisions. We believe these provisions are necessary to attract and retain talented and experienced directors and officers.
ITEM 11. EXECUTIVE COMPENSATION
We provided named executive officers and our other employees with a salary to compensate them for services rendered during the fiscal year. Salary amounts for the named executive officers are determined for each executive based on his or her position and responsibility, and on past individual performance. Salary levels are typically considered annually as part of our performance review process. Merit based increases to salaries of the named executive officers are based on our board of directors’ assessment of the individual’s performance.
The following table shows for the years ended December 31, 2008 and 2007, the compensation awarded or paid by the Company to its Chief Executive Officer and its named executive officers as that term is defined in Item 402(a)(2) of Regulation S-B.
Summary Compensation Table
Name and Principal Position (1) | | Year | | | Salary ($) (4) | | | Bonus ($) | | | Stock Awards ($) | | | Option Awards ($) | | | Non- Equity Incentive Plan Compensation ($) | | | Change in Pension Value and Nonqualified Deferred Compensation Earnings | | | All other Compensation ($) | | | Total ($) | |
| Charles Bitters, Chief Executive Officer | | | 2008 2007 | | | | 120,000 120,000 | | | | - - | | | | - - | | | | - - | | | | - - | | | | - - | | | | - - | | | | 120,000 120,000 | |
| Joe Christopher, President of Oil America Group, Inc. | | | 2008 2007 | | | | 65,000 65,000 | | | | - - | | | | - - | | | | - - | | | | - - | | | | - - | | | | - - | | | | 65,000 65,000 | |
| Renny Walker, President of Production Resources, Inc. | | | 2008 2007 | | | | 70,384 64,970 | | | | - 29,047 | (3) | | | - - | | | | - - | | | | - - | | | | - - | | | | - - | | | | 70,384 94,017 | |
1 Mr. Bitters and Mr. Christopher serve on the Company’s board of directors and do not receive any compensation for their director roles.
2 Mr. Bitters and Mr. Christopher serve on the Company’s board of directors and do not receive any compensation.
3 Mr. Walker’s bonus includes $27,547 of payments from the sale of a lease in 2007.
4 Salary is total base salary earned, rather paid or not. For both 2008 and 2007, Mr. Bitters earned $120,000 of salary and Mr. Christopher earned $65,000 of salary, both of which were accrued and unpaid.
No director received any type of compensation from the Company for serving in such capacity during the years ended December 31, 2008 and 2007.
Option Grants in Last Fiscal Year
No options were granted in the year ended December 31, 2008 to any executive officers.
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option Values
No options were exercised in the year ended December 31, 2008 by any executive officers.
Outstanding Equity Awards at Fiscal Year-End
We do not currently have any outstanding stock appreciation rights or stock options outstanding at December 31, 2008.
Employment Agreements
Effective July 1, 2003, the Company entered into a salary and equipment rental agreement with its Charles Bitters, its Chief Executive Officer. As of January 1, 2005, the $3,500 per month equipment rental agreement with the Chief Executive Officer was terminated. As of December 31, 2007, the Company owed the Chief Executive Officer $306,425 for unpaid amounts under the agreement. During the year ended December 31, 2008, the Company accrued but did not pay $120,000 for compensation, reduced the balance $8,500 for payments made to the Chief Executive Officer, and increased the balance $93,000 for advances made by the Chief Executive Officer on behalf of the Company. As a result, the accrued balance as of December 31, 2008 is $510,925 and is classified as a component of Due To Related Parties in the accompanying financial statements.
Effective January 1, 2005, the Company has an agreement with Joe Christopher, the President of its wholly owned subsidiary Oil America Group, Inc. in the amount of $65,000 annually. Through December 31, 2008, the Company has accrued $260,000 of accrued compensation related to this agreement and this amount is recorded as other current liabilities in the accompanying consolidated financial statements.
In the future we may implement a retirement savings plan and medical insurance plan covering our officers and other employees.
We do not have any other contractual arrangements with our executive officers or directors, nor do we have any compensatory arrangements with our executive officers other than as described above. Except as described above with respect to Mr. Bitters, we have not agreed to make any payments to our named executive officers because of resignation, retirement or any other termination of employment with us or our subsidiaries, or from a change in control of us, or a change in the executive’s responsibilities following a change in control.
Director Compensation
We do not have a formal plan for director compensation. No director received any type of compensation from the Company for serving in such capacity for the year ended December 31, 2008.
| ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
The following table summarizes certain information as of April 15, 2009 with respect to the beneficial ownership of our common stock by (1) our directors and executive officers, (2) stockholders known by us to own 5% or more of the shares of our Common Stock, and (3) all of our executive officers and directors as a group.
Beneficial ownership is determined in accordance with the Rule 13d-3(a) of the Securities Exchange Act of 1934, as amended, and generally includes voting or investment power with respect to securities. Except as indicated by footnote, and subject to community property laws, where applicable, the person named below has voting and investment power with respect to all shares of our common stock shown as beneficially owned by him.
| | Title of Class | Name and Address of Beneficial Owner (a) | Amount and Nature of Beneficial Ownership | Percent of Class |
| | Common Stock | Charles Bitters, CEO and Director 353 South Hackberry Ave New Braunfels, TX 78130 | 113,816 (b) | * |
| | Common Stock | Joe Christopher, President of Oil America Group, Inc. 400 S. Zang Blvd., Suite 812 Dallas, TX 75208 | 111,000 (c) | * |
| | Common Stock | Renny Walker, President of Production Resources, Inc. 705 County Rd. 646 Hondo, TX 78861 | 131,944 | * |
| (a) | Under Rule 13d-3 under the Securities Exchange Act of 1934, a beneficial owner of a security includes any person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise has or shares: (i) voting power, which includes the power to vote, or to direct the voting of shares; and (ii) investment power, which includes the power to dispose or direct the disposition of shares. Certain shares may be deemed to be beneficially owned by more than one person (if, for example, persons share the power to vote or the power to dispose of the shares). In addition, shares are deemed to be beneficially owned by a person if the person has the right to acquire the shares (for example, upon exercise of an option) within 60 days of the date as of which the information is provided. In computing the percentage ownership of any person, the number of shares outstanding is deemed to include the number of shares beneficially owned by such person (and only such person) by reason of these acquisition rights. As a result, the percentage of outstanding shares of any person as shown in this table does not necessarily reflect the person’s actual ownership or voting power with respect to the number of shares of common stock actually outstanding on the date of this Offering. As of April 15, 2009, the Company had 20,360,389 shares of common stock issued and outstanding. |
| (b) | Includes 62 shares in the name of a corporation controlled by Mr. Bitter’s wife. |
| (c) | Includes 80,000 shares held directly by Mr. Christopher, 25,000 held directly by a company controlled by Mr. Christopher and 6,000 shares in the name of Oil America Group, Inc., which Mr. Christopher is the President and has sole voting power. |
Equity Compensation Plan Information
The following table gives information as of December 31, 2008, about our common stock that may be
issued upon the exercise of options, warrants and rights under all of our existing equity compensation
plans:
| Plan Category | | (a) Number of securities to be issued upon exercise of outstanding options, warrants and rights | | | (b) Weighted-average exercise price of outstanding options, warrants and rights | | | ‘ (c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a) | |
| Equity compensation plans approved by security holders (1) | | | -0- | | | | -0- | | | | 10,000,000 | |
| Equity compensation plans not approved by security holders | | | -0- | | | | -0- | | | | -0- | |
| Total | | | -0- | | | | -0- | | | | 10,000,000 | |
(1) Consists of the following equity compensation plans: 2008 Non-Qualified Stock Option Plan.
| ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. |
We currently do not have a lease and we are not paying rent on our space. It is being provided to the Company by the Chief Executive Officer free of charge.
Effective July 1, 2003, the Company entered into a salary and equipment rental agreement with its Chief Executive Officer. As of January 1, 2005, the $3,500 per month equipment rental agreement with the Chief Executive Officer was terminated. As of December 31, 2007, the Company owed the Chief Executive Officer $306,425 for unpaid amounts under the agreement. During the year ended December 31, 2008, the Company accrued but did not pay $120,000 for compensation, reduced the balance $8,500 for payments made to the Chief Executive Officer, and increased the balance $93,000 for advances made by the Chief Executive Officer on behalf of the Company. As a result, the accrued balance as of December 31, 2008 is $510,925 and is classified as a component of Due To Related Parties in the accompanying financial statements.
As of December 31, 2008, the Chief Executive Officer of the Company is owed $894,103 for advances and unpaid equipment rental charges made on behalf of Bend Arch, the Company’s wholly-owned subsidiary. As of December 31, 2007, Bend Arch owed the Chief Executive Officer $704,703 for previous advances and equipment rental charges at $4,500 per month. During the year ended December 31, 2008, the Chief Executive Officer advanced $162,400 of funds to Bend Arch; the Company recorded $54,000 for equipment rental charges and repaid $27,000 to the Chief Executive Officer resulting in the $894,103 balance at December 31, 2008 classified as a component of Due to Related Parties in the accompanying financial statements.
At December 31, 2008, the President of Oil America Group, Inc. is owed $260,000 for unpaid salary per an agreement effective January 1, 2005. The agreement is for annual compensation of $65,000 and none of this amount has been paid since the inception of the agreement.
At December 31, 2007, the operator of the Company’s oil and gas properties was owed $696,631 for services as the operator of the Company’s oil and gas production activities. During the year ended December 31, 2008, the operator balance owed was increased for the net activities performed such that as of December 31, 2008, the net amount due to the operator of the Company’s oil and gas production activities was $1,630,734 and is classified as a component of Due to Related Parties in the accompanying financial statements. The operator is Proco Operating Co., Inc. (“Proco”) and is a related party as Proco is controlled by the brother of the Company’s Chief Executive Officer
Our common stock trades on the Over The Counter Bulletin Board. As such, we are not currently subject to corporate governance standards of listed companies, which require, among other things, that the majority of the board of directors be independent.
We are not currently subject to corporate governance standards defining the independence of our directors, and we have chosen to define an “independent” director in accordance with the NASDAQ Global Market's requirements for independent directors (NASDAQ Marketplace Rule 4200). Under this definition, we have determined that since we have only one director and who is also the Chief Executive Officer and Chief Financial Officer of the Company, we do not currently qualify as has having any independent directors. We do not list the “independent” definition we use on our Internet website.
| ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
Audit Fees: Audit fees consist of fees billed for professional services rendered for the audit of our year-end financial statements and services in connection with statutory and regulatory filings. For the year ended December 31, 2008, fees incurred by the Company from Moore were an aggregate of $19,500 for the quarterly review associated with our Form 10-Q filings and any amendments thereto. For the years ended December 31, 2008 and 2007, fees incurred by the Company from Moore were zero and $20,000 for the annual audit of the Company's financial statements included as part of our Form 10-K filing.
Audit-Related Fees: Audit-related services consist of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements and are not reported under “Audit Fees.” These services include attest services that are not required by statute or regulation and consultations concerning financial accounting and reporting standards. There were no audit-related fees during the years ended December 31, 2008 and 2007.
Tax Services Fees: Tax fees consist of fees billed for professional services for tax compliance. These services include assistance regarding federal, state, and local tax compliance. There were no tax fees during the years ended December 31, 2008 and 2007.
All Other Fees: Other fees would include fees for products and services other than the services reported above. There were no other fees during the years ended December 31, 2008 and 2007.
The Company does not have a standing audit committee, rather the entire Board acts as the Company’s audit committee. Management is responsible for our internal controls and the financial reporting process. The independent registered public accounting firm is responsible for performing an independent audit of our financial statements in accordance with auditing standards generally accepted in the United States and expressing an opinion on the conformity of those audited financial statements in accordance with accounting principles generally accepted in the United States. The Board’s responsibility is to monitor and oversee these processes and is also directly responsible for the appointment, compensation, and oversight of the Company's independent registered public accounting firm.
The Board has established a pre-approval policy that describes the permitted audit, audit-related, tax and other services to be provided by Moore, the Company's independent registered public accounting firm. The policy requires that the Board pre-approve the audit and non-audit services performed by the independent registered public accounting firm in order to assure that the provision of such service does not impair the auditor's independence.
Any requests for audit, audit-related, tax and other services that have not received general pre-approval must be submitted to the Board for specific pre-approval, and cannot commence until such approval has been granted. Normally, pre-approval is provided at regularly scheduled meetings of the Board. However, the Board may delegate pre-approval authority to one or more of its members. The member or members to whom such authority is delegated shall report any pre-approval decisions to the Board at its next scheduled meeting. The Board does not delegate its responsibilities to pre-approve services performed by the independent registered public accounting firm to management.
The Board has reviewed the audited consolidated financial statements and met and held discussions with management regarding the audited consolidated financial statements. Management has represented to the Board that the Company's financial statements were prepared in accordance with accounting principles generally accepted in the United States. The Board has discussed with Moore, the Company's independent registered public accounting firm, matters required to be discussed by Statement of Auditing Standards No. 61 (Communication with Audit Committees). The Board received and reviewed the written disclosures and the letter from the independent registered public accounting firm required by Independence Standard No. 1, Independence Discussions with Audit Committees, as amended by the Independence Standards Board, and has discussed with the auditors the auditors' independence.
Based on the Board’s discussion with management and the independent registered public accounting firm, the Board's review of the audited financial statements, the representations of management and the report of the independent registered public accounting firm to the Board, the Board recommends that the audited consolidated financial statements be included in the Company's Annual Report on Form 10-K for the years ended December 31, 2008 and 2007, for filing with the SEC.
| Exhibit No | | Description of Exhibit |
| 2.1 | | Certificate of Amendment to Articles of Incorporation of American Energy Production, Inc. filed with the Delaware Secretary of State (1) |
| | | |
| 3.1 | | Form S-8 Registration Statement under the Securities Act of 1933 filed January 31, 2003. (1) |
| | | |
| 3.2 | | Form 8-A12G for Registration of Certain Classes of Securities Pursuant to Section 12 (b) or (g) of the Securities Act of 1934 filed October 10, 2003. (1) |
| | | |
| 3.3 | | Definitive Proxy Statement Pursuant to Section 14(a) of the Securities Act of 1934 filed November 19, 2003. (1) |
| | | |
| 3.4 | | Form N-54 Notification of Election as a Business Development Company dated January 12, 2004. (1) |
| | | |
| 3.5 | | Form 1-E Notification under Regulation E dated January 14, 2004. (1) |
| | | |
| 3.6 | | Form 1-E/A Notification under Regulation E dated June 24, 2005. (1) |
| | | |
| 3.7 | | Form 2-E Notification under Regulation E dated June 27, 2006. (1) |
| | | |
| 3.8 | | Form 2-E Notification under Regulation E dated December 11, 2006. (1) |
| | | |
| 3.9 | | Definitive Proxy Statement Pursuant to Section 14(a) of the Securities Act of 1934 filed February 8, 2007. (1) |
| | | |
| 3.10 | | Form N-54C Notification of Withdrawal of Business Development Companies dated April 23, 2007. (1) |
| | | |
| 3.11 | | Definitive Proxy Statement Pursuant to Section 14(a) of the Securities Act of 1934 filed July 5, 2007. (1) |
| | | |
| 3.12 | | Form S-8 Registration Statement under the Securities Act of 1933 filed September 25, 2008. (1) |
| | | |
| 14.1 | | Code of Ethics (1) |
| | | |
| 20.1 | | Oil and Gas property valuation by Blue Ridge Enterprises as of December 31, 2008 * |
| | | |
| | |
| | | |
| | |
| | | |
| | |
| | | | |
* Filed herewith
| | (1) | Incorporated by reference. |
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | AMERICAN ENERGY PRODUCTION, INC. | |
| | | | |
| Date: April 30, 2009 | By: | /s/ Charles Bitters | |
| | | Charles Bitters | |
| | | Chief Executive Officer and Chief Financial Officer | |
| | | | |
In accordance with the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| Signature | Title | Date |
| | | |
/s/ Charles Bitters Charles Bitters | President, Chief Executive Officer and Director (Principal Executive, Financial and Accounting Officer) | April 30, 2009 |
/s/ Joe Christopher Joe Christopher | Director | April 30, 2009 |
American Energy Production, Inc. and Subsidiaries
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
MOORE & ASSOCIATES, CHARTERED
ACCOUNTANTS AND ADVISORS
PCAOB REGISTERED
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
American Energy Production, Inc.
We have audited the accompanying consolidated balance sheets of American Energy Production, Inc. as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in stockholders’ equity (deficit) and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conduct our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of American Energy Production, Inc. as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in stockholders’ equity (deficit) and cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company had a net loss of $2,148,551 and $2,283,978 for the years ended December 31, 2008 and 2007, respectively. Additionally, at December 31, 2008, the Company has minimal cash, a negative working capital balance of $6,693,177, and a stockholders’ deficit of $3,055,149. These factors raise substantial doubt about its ability to continue as a going concern. Management’s plans concerning these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Moore & Associates, Chartered
Moore & Associates, Chartered
Las Vegas, Nevada
May 5, 2009
6490 West Desert Inn Rd, Las Vegas, NV 89146 (702) 253-7499 Fax (702) 253-7501
American Energy Production, Inc. and Subsidiaries
| ASSETS | |
| | | 12/31/2008 | | | 12/31/2007 | |
| | | | | | | |
| Current Assets | | | | | | |
| Cash | | $ | 88,937 | | | $ | 133,220 | |
| Accounts receivable | | | - | | | | 1,205 | |
| Other current assets | | | 146 | | | | 316 | |
| Total Current Assets | | | 89,083 | | | | 134,740 | |
| | | | | | | | | |
| Property and equipment, net | | | 4,011,903 | | | | 4,365,765 | |
| | | | | | | | | |
| Other Assets | | | | | | | | |
| Development programs - related party | | | 134,092 | | | | 104,392 | |
| Other | | | 1,188 | | | | 168,379 | |
| Total Other Assets | | | 135,280 | | | | 272,771 | |
| | | | | | | | | |
| Total Assets | | | 4,236,266 | | | | 4,773,277 | |
| | | | | | | | | |
| LIABILITIES | |
| Current Liabilities | | | | | | | | |
| Accounts payable | | $ | 312,903 | | | $ | 373,403 | |
| Other current liabilities | | | 11,855 | | | | 175,548 | |
| Due to related parties | | | 3,295,763 | | | | 1,707,759 | |
| Notes payable | | | 2,115,062 | | | | 2,023,714 | |
| Accrued interest payable | | | 946,385 | | | | 778,486 | |
| Accrued payroll taxes and penalties | | | 84,161 | | | | 80,346 | |
| Lease payable | | | 16,131 | | | | 16,131 | |
| Total Current Liabilities | | | 6,782,260 | | | | 5,155,387 | |
| | | | | | | | | |
| Asset Retirement Obligations | | | 509,155 | | | | 524,488 | |
| | | | | | | | | |
| Total Liabilities | | $ | 7,291,415 | | | $ | 5,679,875 | |
| | | | | | | | | |
| Commitments and Contingencies (Note 8) | | | | | | | | |
| | |
| STOCKHOLDERS' DEFICIT | |
| | | | | | | | | |
| Convertible preferred stock, Series A, $0.0001 par value, | | | | | | | | |
| 5,000,000 shares authorized, 3,500,000 shares | | $ | 350 | | | $ | 350 | |
| Common stock, $0.0001 par value, | | | | | | | | |
| 500,000,000 shares authorized, 20,360,389 and 19,767,055 shares, respectively | | | 2,037 | | | | 1,977 | |
| Common stock issuable, $0.0001 par value, zero and 596,000 shares respectively | | | - | | | | 60 | |
| Additional paid in capital | | | 24,067,655 | | | | 24,067,655 | |
| Accumulated deficit | | | (26,223,191 | ) | | | (24,074,640 | ) |
| | | | (2,153,149 | ) | | | (4,599 | ) |
| Less: Subscription Receivable | | | (902,000 | ) | | | (902,000 | ) |
| | | | | | | | | |
| Total Stockholders' Deficit | | | (3,055,149 | ) | | | (906,599 | ) |
| | | | | | | | | |
| Total Liabilities and Stockholders' Deficit | | $ | 4,236,266 | | | $ | 4,773,277 | |
See accompanying notes to consolidated financial statements.
American Energy Production, Inc. and Subsidiaries
| | | Years Ended | |
| | | December 31, | |
| | | 2008 | | | 2007 | |
| Revenues: | | | | | | |
| Oil sales, net | | $ | 1,842,059 | | | $ | 1,581,661 | |
| | | | | | | | | |
| Operating Expenses | | | | | | | | |
| Compensation | | | 255,384 | | | | 213,419 | |
| Consulting | | | - | | | | 3,260 | |
| Depreciation, depletion and accretion | | | 562,334 | | | | 540,677 | |
| Rent | | | 89,161 | | | | 36,527 | |
| General and administrative | | | 225,836 | | | | 389,746 | |
| Production | | | 2,265,456 | | | | 2,300,198 | |
| Professional | | | 126,748 | | | | 173,393 | |
| Taxes | | | 91,896 | | | | 86,436 | |
| Website | | | 1,080 | | | | - | |
| Total Operating Expenses | | | 3,617,895 | | | | 3,743,656 | |
| | | | | | | | | |
| Operating Loss | | | (1,775,836 | ) | | | 2,161,995 | ) |
| | | | | | | | | |
| Other Income (Expense) | | | | | | | | |
| Other income (expense) | | | (195,942 | ) | | | 19,097 | |
| Gain on sale of properties | | | - | | | | 29,309 | |
| Interest expense | | | (170,769 | ) | | | (164,383 | ) |
| Payroll tax expense and penalties | | | (6,004 | ) | | | (6,004 | ) |
Total Other Income (Expense) | | | (372,716 | ) | | | (121,982 | ) |
| | | | | | | | | |
| Net Loss | | $ | (2,148,551 | ) | | $ | (2,283,978 | ) |
| | | | | | | | | |
| Net Loss Per Share - Basic and Diluted | | $ | (0.11 | ) | | $ | (0.12 | ) |
| | | | | | | | | |
| Weighted average Shares Outstanding | | | 20,361,880 | | | | 19,770,055 | |
See accompanying notes to consolidated financial statements.
American Energy Production, Inc.
Consolidated Statements of Changes in Stockholders’ Equity (Deficit) Years Ended December 31, 2007 and 2006
| | | Preferred Stock | | | Common Stock | | | Common Stock Issuable | | | | | | | | | | | | | |
| | | Shares | | | Amount | | | Shares | | | Amount | | | Shares | | | Amount | | | Subscription Receivable | | | Additional Paid-In Capital | | | Accumulated Deficit | | | Total Stockholders' Deficit | |
| Balance at December 31, 2006 | | | 3,500,000 | | | $ | 350 | | | | 19,767,055 | | | $ | 1,977 | | | | 3,000 | | | $ | - | | | $ | (902,000 | ) | | $ | 23,978,715 | | | $ | (21,790,662 | ) | | $ | 1,288,379 | |
| Common stock issued for subscription receivable | | | - | | | | - | | | | - | | | | - | | | | 593,000 | | | | 60 | | | | - | | | | 88,940 | | | | | | | | 89,000 | |
| Net loss, year ended December 31, 2007 | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | (2,283,978 | ) | | | (2,283,978 | ) |
| Balance at December 31, 2007 | | | 3,500,000 | | | $ | 350 | | | | 19,767,055 | | | $ | 1,977 | | | | 596,000 | | | $ | 60 | | | $ | (902,000 | ) | | $ | 24,067,655 | | | $ | (24,074,640 | ) | | $ | (906,599 | ) |
| Common stock issued for sale of stock - $0.15 per share | | | - | | | | - | | | | 593,334 | | | | 60 | | | | (593,000 | ) | | | (60 | ) | | | - | | | | - | | | | - | | | | 0 | |
| Write off of issuable shares from 2003 - 3,000 shares | | | - | | | | - | | | | - | | | | - | | | | (3,000 | ) | | | (0 | ) | | | - | | | | - | | | | - | | | | (0 | ) |
| Net loss, year ended December 31, 2008 | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | (2,148,551 | ) | | | (2,148,551 | ) |
| Balance at December 31, 2008 | | | 3,500,000 | | | $ | 350 | | | | 20,360,389 | | | $ | 2,037 | | | | - | | | $ | (0 | ) | | $ | (902,000 | ) | | $ | 24,067,655 | | | $ | (26,223,191 | ) | | $ | (3,055,149 | ) |
See accompanying notes to consolidated financial statements
American Energy Production, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
| | | Years Ended | |
| | | December 31, | |
| | | 2008 | | | 2007 | |
| Operating Activities: | | | | | | |
| Net loss | | $ | (2,148,551 | ) | | $ | (2,283,978 | ) |
| | | | | | | | | |
| Adjustments to reconcile net loss to cash provided by operating activities: | | | | | | | | |
| Depreciation expense | | | 479,212 | | | | 443,062 | |
| Depletion expense | | | 61,218 | | | | 74,337 | |
| Accretion expense | | | 21,904 | | | | 23,278 | |
| | | | | | | | | |
| Changes in operating assets and liabilities: | | | | | | | | |
| Accounts receivable | | | 1,205 | | | | 122 | |
| Other current assets | | | 170 | | | | 3,880 | |
| Other assets | | | 167,191 | | | | 16,321 | |
| Accounts payable | | | (60,500 | ) | | | 46,212 | |
| Other current liabilities | | | (163,693 | ) | | | 10,245 | |
| Due from related party | | | - | | | | 88,229 | |
| Due to related party | | | 1,588,004 | | | | 1,531,027 | |
| Accrued interest payable | | | 167,191 | | | | 161,864 | |
| Accrued payroll taxes payable | | | 3,815 | | | | 7,770 | |
| Net Cash Provided By Operating Activities | | | 117,874 | | | | 122,368 | |
| | | | | | | | | |
| Investing Activities: | | | | | | | | |
| Investment in property and equipment | | | (223,805 | ) | | | (118,412 | ) |
| Payments for development programs - related party | | | (29,699 | ) | | | (25,767 | ) |
Net Cash Used In Investing Activities | | $ | (253,504 | ) | | $ | (144,178 | ) |
| | | | | | | | | |
| Financing Activities: | | | | | | | | |
| Proceeds from note payable | | | 103,000 | | | | - | |
Proceeds from sale of common stock | | | - | | | | 89,000 | |
Proceeds from repayment of subscription receivable | | | - | | | | - | |
| Repayment of note payable | | | (11,652 | ) | | | (40,873 | ) |
Net Cash Provided By (Used In) Financing Activities | | | 91,348 | | | | 48,127 | |
| | | | | | | | | |
| Net Increase in Cash | | | (44,282 | ) | | | 26,317 | |
| Cash at Beginning of Period | | | 133,220 | | | | 106,902 | |
| Cash at End of Period | | | 88,937 | | | | 133,219 | |
| Cash interest paid | | $ | - | | | $ | - | |
| | | | | | | | | |
| Supplemental disclosure of non-cash transactions | | | | | | | | |
| Capitalized asset retirement obligations | | $ | - | | | $ | 3,841 | |
| Retirement of asset retirement obligation from sale of properties | | | - | | | | 20,158 | |
| Retirement of asset retirement obligation from audit of properties | | | 37,237 | | | | - | |
See accompanying notes to consolidated financial statements
1. HISTORY AND NATURE OF BUSINESS
American Energy Production, Inc. (“American Energy”, “the Company”, “we”, “us”, “our” “its”) is a publicly traded oil and gas company that is engaged primarily in the acquiring, developing, producing, exploring and selling of oil and natural gas. The Company traditionally has acquired oil and gas companies that have the potential for increased oil and natural gas production utilizing new technologies, well workovers and fracture stimulation systems. Additionally, the Company has expanded its scope of business to include the drilling of new wells with its own equipment through its wholly-owned subsidiary companies.
The Company’s wholly-owned subsidiaries are primarily involved in three areas of oil and gas operations.
1. Leasing programs.
2. Production acquisitions
3. Drilling and producing with proven and emerging technologies.
The Company believes that for the foreseeable future, the world will be highly dependent on oil and natural gas. Currently, alternative fuels are far more expensive than fossil fuels and because of the politically unstable conditions of many of the energy producing regions of the world. As a result, the Company believes that oil and natural gas will remain a key yet volatile component of the world energy future and furthermore, with the ever increasing world demand for energy, the domestic production of oil and gas will play an even greater role in America’s future then it already has to date.
The Company was f/k/a Communicate Now.com, Inc. and was incorporated on January 31, 2000 under the laws of the State of Delaware. On July 15, 2002, the Company changed its corporate name to American Energy Production, Inc.
On February 20, 2003, upon the acquisition of certain oil and gas assets, the Company entered into a new development stage. Activities during the development stage include acquisition of assets, obtaining geological reports, developing an implementation plan to extract oil and gas, completing initial sales of oil and seeking capital.
On January 12, 2004, the Company filed a Form N-54A with the Securities and Exchange Commission (“SEC”) to be regulated as a Business Development Company (“BDC”) under the Investment Company Act of 1940, as amended (“Act”).
In May 2006, the SEC Staff issued a comment letter to the Company (the “Comment Letter”) raising a number of questions relating to the Company’s BDC operations. In response to the Comment Letter, the Company undertook a review of its compliance with the 1940 Act and subsequently determined that it was not in compliance with several important provisions of the 1940 Act. Accordingly, and after careful consideration of the 1940 Act requirements applicable to BDCs, the Board determined that continuation as a BDC was not in the best interests of the Company and its shareholders (See Note 12 – Subsequent Events).
On March 13, 2007, at a Special Meeting of Shareholders, the Shareholders approved and authorized the Board to withdraw the Company’s election to be treated as a BDC under the 1940 Act and the election of three directors to the Board. On April 3, 2007, the Company filed a Form N-54C to withdraw its election to be regulated as a BDC and as of that date, is no longer a BDC under the 1940 Act. The Company is no longer a BDC with unconsolidated majority-owned portfolio companies but rather be an oil and gas operating company with consolidated subsidiaries. The results of operations for April 1, 2007 through April 3, 2007 were not material and therefore, the Company has utilized April 1, 2007 as the inception date for the new business as an oil and gas operating company (See Note 12 – Subsequent Events).
At a meeting held on May 16, 2007, the Board of Directors reviewed the Company’s current business and financial performance, the recent trading range of its Common Stock and inability to obtain additional capital from the investment community with 494,170,082 shares of Common Stock issued and outstanding and 500,000,000 shares of Common Stock authorized. The Board determined that a reverse stock split was desirable and in the best interest of the Company. On July 5, 2007, the Company filed a Definitive 14A Proxy Statement with the SEC giving notice of a special shareholders meeting to be held on August 17, 2007 for the purpose of approving a one-for-twenty five reverse stock split. On September 14, 2007, the Company announced that all of the required steps had been completed for the one-for-twenty five reverse stock split of its common stock. In connection with the reverse stock split, the Company was assigned a new stock symbol. The Company's shares were previously quoted on the OTC Bulletin Board under the stock symbol AMEP and are now reported on the OTC Bulletin Board under the new stock symbol AENP. The new stock symbol and the reverse stock split were effective at the beginning of trading on September 14, 2007.
On September 30, 2008, the Company announced the issuance of an SEC Order Instituting Cease-and-Desist and Exemption Suspension Proceedings, Making Findings, Imposing a Cease-and-Desist Order, and Permanently Suspending the Regulation E Exemption Pursuant to Section 9(f) of the Investment Company Act of 1940 and Rule 610(c) of Regulation E (Order) against the Company. The Order finds that the Company had, among other things, issued senior securities without the required asset coverage, issued rights to purchase securities without expiration to non-security holders, issued prohibited non-voting stock, issued securities for services, failed to make and keep required records; and failed to establish a majority of disinterested directors on its board. As a result, the Company violated Sections 18(a), 18(d), 18(i), 23(a), 31(a)(1), and 56(a) respectively, of the Investment Company Act and Investment Company Act Rule 31a-1. In addition, the Company failed to obtain a fidelity bond as required under Section 17(g) of the Investment Company Act and Rule 17g-1 thereunder, and failed to implement a compliance program as required under Investment Company Act Rule 38a-1. Finally, the Company failed to comply with Rule 609 of Regulation E because it did not file offering status reports on Form 2-E in connection with a securities offering under Regulation E commenced in January 2004.
Based on the above, the Order permanently suspends the Regulation E exemption and orders the Company to cease and desist from committing or causing any violations and any future violations of Sections 17(g), 18(a), 18(d), 18(i), 23(a), 31(a)(1) and 56(a) of the Investment Company Act and Rules 17g-1, 31a-1, and Rule 38a-1 thereunder. The Company consented to the issuance of the Order without admitting or denying any of the findings.
In determining the Order, the SEC considered remedial acts promptly undertaken by the Company and cooperation afforded the SEC staff and as a result, the Company did not incur any fines or other penalties, and no action was taken against any individuals.
2. GOING CONCERN
As reflected in the accompanying consolidated financial statements, the Company had a net loss of $2,148,551 and $2,283,978 for the years ended December 31, 2008 and 2007, respectively. Additionally, at December 31, 2008, the Company has minimal cash, a negative working capital balance of $6,693,177, a stockholders’ deficit of 3,055,149 and is subject to certain contingencies as discussed in Note 10, which could have a material impact on the Company’s financial condition and operations. The ability of the Company to continue as a going concern is dependent on the Company’s ability to raise capital and generate sufficient revenues and cash flow from its business plan as an oil and gas operating company. The financial statements included in this report do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
We have substantial current obligations and at December 31, 2008, we had $6,782,260 of current liabilities as compared to only $89,083 of current assets. Accordingly, the Company does not have sufficient cash resources or current assets to pay these obligations.
Our substantial debt obligations pose risks to our business and stockholders by:
| · | making it more difficult for us to satisfy our obligations; |
| · | requiring us to dedicate a substantial portion of our cash flow to principal and interest payments on our debt obligations, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other corporate requirements; |
| · | impeding us from obtaining additional financing in the future for working capital, capital expenditures and general corporate purposes; and |
| · | making us more vulnerable to a downturn in our business and limit our flexibility to plan for, or react to, changes in our business. |
The time required for the Company to become profitable is highly uncertain, and Management cannot assure you that the Company will achieve or sustain profitability or generate sufficient cash flow from operations to meet planned capital expenditures, working capital and debt service requirements. If required, the ability to obtain additional financing from other sources also depends on many factors beyond the Company’s control, including the state of the capital markets and the prospects for the Company’s business. The necessary additional financing may not be available to the Company or may be available only on terms that would result in further dilution to the current owners of common stock.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with United States Generally Accepted Accounting Principles (“U.S. GAAP”) for annual financial information and with the instructions to Form 10-K of Regulation S-K.
Principles of Consolidation
The accompanying consolidated financial statements include the general accounts of American Energy and its wholly-owned subsidiaries as of December 31, 2008 and 2007 and all significant intercompany transactions, accounts and balances have been eliminated.
Accounting Estimates
When preparing financial statements in conformity with U.S. GAAP, management must make estimates based on future events that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the date of the financial statements, and revenues and expenses during the reporting period. Actual results could differ from these estimates. Significant estimates in the accompanying financial statements include going concern, BDC conversion, oil and gas properties, property and equipment, the evaluation of whether our assets are impaired, asset retirement obligations, revenue recognition, the valuation allowance for deferred tax assets, and the estimate of reserves of oil and gas that are used to develop projected income whereby an appropriate discount rate has been used. We also have other key accounting estimates and policies, but we believe that these other policies either do not generally require us to make estimates and judgments that are as difficult or as subjective, or it is less likely that they would have a material impact on our reported results of operations for a given period. The actual amounts could differ materially from such estimates.
Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid investments with a maturity date of three months or less when purchased.
Oil and Gas Properties
The Company uses the successful efforts method of accounting for its oil and gas properties. Costs incurred by the Company related to the acquisition of oil and gas properties and the cost of drilling successful wells are capitalized. Costs to maintain wells and related equipment and lease and well operating costs are charged to expense as incurred. Gains and losses arising from sales of properties are included in income. Unproved properties are assessed periodically for possible impairment.
Property and Equipment
The Company’s oil and gas rig is depreciated over its estimated useful life of ten years, using the straight line method. Vehicles are depreciated over their estimated useful life of three years, using the straight line method. Maintenance, repairs and minor replacements are charged to operations in the year incurred.
Asset Retirement Obligations
The Company accounts for asset retirement obligations in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 143, Accounting for Asset Retirement Obligations. The asset retirement obligations represent the estimated present value of the amounts expected to be incurred to plug, abandon, and remediate the producing properties at the end of their productive lives, in accordance with state laws, as well as the estimated costs associated with the reclamation of the property surrounding. The Company determines the asset retirement obligations by calculating the present value of estimated cash flows related to the liability. The asset retirement obligations are recorded as a liability at the estimated present value as of the asset’s inception, with an offsetting increase to producing properties. Periodic accretion of the discount related to the estimated liability is recorded as an expense in the statement of operations.
The estimated liability is determined using significant assumptions, including current estimates of plugging and abandonment costs, annual inflation of these costs, the productive lives of wells, and a risk-adjusted interest rate. Changes in any of these assumptions can result in significant revisions to the estimated asset retirement obligations. Revisions to the asset retirement obligations are recorded with an offsetting change to producing properties, resulting in prospective changes to depletion and depreciation expense and accretion of the discount. Because of the subjectivity of assumptions and the relatively long lives of most of the wells, the costs to ultimately retire the Company’s wells may vary significantly from prior estimates.
Accounting for the Impairment of Long-Lived Assets
We account for the impairment of long-lived assets in accordance SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the book value of the asset may not be recoverable. Recoverability of the asset is measured by comparison of its carrying amount to the undiscounted cash flow that the asset or asset group is expected to generate. If such assets or asset groups are considered to be impaired, the loss recognized is the amount by which the carrying amount of the property, if any, exceeds its fair market value. Based upon the Company’s evaluation, no impairment was determined for the years ended December 31, 2008 and 2007.
Revenue Recognition
Revenues from sales of crude oil and natural gas products are recorded when deliveries have occurred and legal ownership of the commodity transfers to the customer. Revenues from the production of oil and natural gas properties in which the Company shares an undivided interest with other producers are recognized based on the actual volumes sold by the Company during the period.
Fair Value of Financial Instruments
We define the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The carrying value of trade receivable, other receivables, other assets and accounts payable approximates fair value because of the short maturity of those instruments. The estimated fair value of our other obligations is estimated based on the current rates offered to us for similar maturities. Based on prevailing interest rates and the short-term maturity of all of our indebtedness, management believes that the fair value of our obligations approximates book value at December 31, 2008 and 2007.
Stock-Based Compensation
The Company adopted SFAS No. 123R, Share-Based Payment, as of January 1, 2006, using the modified prospective application method. This statement requires the recognition of compensation expense when we obtain employee services in stock-based payment transactions.
Prior to January 1, 2006, the Company recognized compensation cost associated with stock-based awards under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Under APB 25, the difference between the quoted market price as of the date of the grant and the contractual purchase price of shares was charged to operations over the vesting period on a straight-line basis. No compensation cost was recognized for fixed stock options with exercise prices equal to the market price of the stock on the dates of grant.
Upon the adoption of SFAS 123R, the Company began recording compensation cost related to all new stock based compensation grants after our adoption date. The compensation cost to be recorded is based on the fair value at the grant date.
Concentration of Risk
Our financial instruments that are potentially exposed to credit risk consist primarily of cash and accounts receivable for which the carrying amounts approximate fair value. At certain times, our demand deposits held in banks may exceed the federally insured limits. The Company has not experienced any losses related to these deposits.
Income Taxes
Income taxes are accounted for under the asset and liability method of SFAS No. 109, Accounting for Income Taxes (“SFAS 109”). Under SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Impact of Recently Issued Accounting Standards
In April 2009, the Financial Accounting Standards Board (“FASB”) issued FSP No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4”). FSP FAS 157-4 provides guidance on estimating fair value when market activity has decreased and on identifying transactions that are not orderly. Additionally, entities are required to disclose in interim and annual periods the inputs and valuation techniques used to measure fair value. This FSP is effective for interim and annual periods ending after June 15, 2009. The Company does not expect the adoption of FSP FAS 157-4 will have a material impact on its financial condition or results of operation.
In October 2008, the FASB issued FSP No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active,” (“FSP FAS 157-3”), which clarifies application of SFAS 157 in a market that is not active. FSP FAS 157-3 was effective upon issuance, including prior periods for which financial statements have not been issued. The adoption of FSP FAS 157-3 had no impact on the Company’s results of operations, financial condition or cash flows.
In December 2008, the FASB issued FSP No. FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities.” This disclosure-only FSP improves the transparency of transfers of financial assets and an enterprise’s involvement with variable interest entities, including qualifying special-purpose entities. This FSP is effective for the first reporting period (interim or annual) ending after December 15, 2008, with earlier application encouraged. The Company adopted this FSP effective January 1, 2009. The adoption of the FSP had no impact on the Company’s results of operations, financial condition or cash flows.
In December 2008, the FASB issued FSP No. FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (“FSP FAS 132(R)-1”). FSP FAS 132(R)-1 requires additional fair value disclosures about employers’ pension and postretirement benefit plan assets consistent with guidance contained in SFAS 157. Specifically, employers will be required to disclose information about how investment allocation decisions are made, the fair value of each major category of plan assets and information about the inputs and valuation techniques used to develop the fair value measurements of plan assets. This FSP is effective for fiscal years ending after December 15, 2009. The Company does not expect the adoption of FSP FAS 132(R)-1 will have a material impact on its financial condition or results of operation.
In September 2008, the FASB issued exposure drafts that eliminate qualifying special purpose entities from the guidance of SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” and FASB Interpretation 46 (revised December 2003), “Consolidation of Variable Interest Entities − an interpretation of ARB No. 51,” as well as other modifications. While the proposed revised pronouncements have not been finalized and the proposals are subject to further public comment, the Company anticipates the changes will not have a significant impact on the Company’s financial statements. The changes would be effective March 1, 2010, on a prospective basis.
In June 2008, the FASB issued FASB Staff Position EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities, (“FSP EITF 03-6-1”). FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting, and therefore need to be included in the computation of earnings per share under the two-class method as described in FASB Statement of Financial Accounting Standards No. 128, “Earnings per Share.” FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning on or after December 15, 2008 and earlier adoption is prohibited. We are not required to adopt FSP EITF 03-6-1; neither do we believe that FSP EITF 03-6-1 would have material effect on our consolidated financial position and results of operations if adopted.
In May 2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts-and interpretation of FASB Statement No. 60”. SFAS No. 163 clarifies how Statement 60 applies to financial guarantee insurance contracts, including the recognition and measurement of premium revenue and claims liabilities. This statement also requires expanded disclosures about financial guarantee insurance contracts. SFAS No. 163 is effective for fiscal years beginning on or after December 15, 2008, and interim periods within those years. SFAS No. 163 has no effect on the Company’s financial position, statements of operations, or cash flows at this time.
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles”. SFAS No. 162 sets forth the level of authority to a given accounting pronouncement or document by category. Where there might be conflicting guidance between two categories, the more authoritative category will prevail. SFAS No. 162 will become effective 60 days after the SEC approves the PCAOB’s amendments to AU Section 411 of the AICPA Professional Standards. SFAS No. 162 has no effect on the Company’s financial position, statements of operations, or cash flows at this time.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133. This standard requires companies to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This Statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company has not yet adopted the provisions of SFAS No. 161, but does not expect it to have a material impact on its consolidated financial position, results of operations or cash flows.
In December 2007, the SEC issued Staff Accounting Bulletin (SAB) No. 110 regarding the use of a "simplified" method, as discussed in SAB No. 107 (SAB 107), in developing an estimate of expected term of "plain vanilla" share options in accordance with SFAS No. 123 (R), Share-Based Payment. In particular, the staff indicated in SAB 107 that it will accept a company's election to use the simplified method, regardless of whether the company has sufficient information to make more refined estimates of expected term. At the time SAB 107 was issued, the staff believed that more detailed external information about employee exercise behavior (e.g., employee exercise patterns by industry and/or other categories of companies) would, over time, become readily available to companies. Therefore, the staff stated in SAB 107 that it would not expect a company to use the simplified method for share option grants after December 31, 2007. The staff understands that such detailed information about employee exercise behavior may not be widely available by December 31, 2007. Accordingly, the staff will continue to accept, under certain circumstances, the use of the simplified method beyond December 31, 2007. The Company currently uses the simplified method for “plain vanilla” share options and warrants, and will assess the impact of SAB 110 for fiscal year 2009. It is not believed that this will have an impact on the Company’s consolidated financial position, results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51”. This statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. Before this statement was issued, limited guidance existed for reporting noncontrolling interests. As a result, considerable diversity in practice existed. So-called minority interests were reported in the consolidated statement of financial position as liabilities or in the mezzanine section between liabilities and equity. This statement improves comparability by eliminating that diversity. This statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 (that is, January 1, 2009, for entities with calendar year-ends). Earlier adoption is prohibited. The effective date of this statement is the same as that of the related Statement 141 (revised 2007). The Company will adopt this Statement beginning March 1, 2009. It is not believed that this will have an impact on the Company’s consolidated financial position, results of operations or cash flows.
In December 2007, the FASB issued FAS No. 141 (revised 2007), Business Combinations’. This Statement replaces FASB Statement No. 141, Business Combinations, but retains the fundamental requirements in Statement 141. This Statement establishes principles and requirements for how the acquirer: (a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; (b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and (c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. The effective date of this statement is the same as that of the related FASB Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements”. The Company will adopt this statement beginning March 1, 2009. It is not believed that this will have an impact on the Company’s consolidated financial position, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities—Including an Amendment of FASB Statement No. 115. This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. This option is available to all entities. Most of the provisions in FAS 159 are elective; however, an amendment to FAS 115 Accounting for Certain Investments in Debt and Equity Securities applies to all entities with available for sale or trading securities. Some requirements apply differently to entities that do not report net income. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS No. 157 Fair Value Measurements. The Company adopted SFAS No. 159 on March 1, 2008 and it did not have a material impact on the Company’s consolidated statement of operations or financial condition.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. The statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this statement does not require any new fair value measurements. However, for some entities, the application of this statement will change current practice. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including financial statements for an interim period within that fiscal year. The Company adopted this statement March 1, 2008, and it did not have a material impact on the Company’s consolidated statement of operations or financial position.
In 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 Accounting for Income Taxes.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS 109. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company adopted FIN 48 as of January 1, 2007, as required.
The current Company policy classifies any interest recognized on an underpayment of income taxes as interest expense and classifies any statutory penalties recognized on a tax position taken as selling, general and administrative expense. There was no interest or selling, general and administrative expenses accrued or recognized related to income taxes for the years ended December 31, 2008 or 2007. The Company has not taken a tax position that would have a material effect on the consolidated financial statements or the effective tax rate for the year ended December 31, 2008 or during the prior three years applicable under FIN 48. It is determined not to be reasonably possible for the amounts of unrecognized tax benefits to significantly increase or decrease within twelve months of the adoption
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a market-based framework or hierarchy for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is applicable whenever another accounting pronouncement requires or permits assets and liabilities to be measured at fair value. SFAS 157 does not expand or require any new fair value measures; however the application of this statement may change current practice. The requirements of SFAS 157 were first effective for the Company’s fiscal year beginning January 1, 2008. However, in February 2008 the FASB decided that an entity need not apply this standard to nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis until the subsequent year. Accordingly, the Company’s adoption of this standard on January 1, 2008, was limited to financial assets and liabilities. The adoption of SFAS 157 did not have a material effect on the Company’s consolidated results of operations or financial condition.
In February 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115.” The fair value option permits entities to choose to measure eligible financial instruments at fair value at specified election dates. The entity will report unrealized gains and losses on the items on which it has elected the fair value option in earnings. SFAS 159 is effective beginning in fiscal year 2008. The adoption of SFAS 159 did not have a material impact on the Company’s consolidated results of operations or financial condition.
Net Income (Loss) per Common Share
Basic earnings per share are computed only on the weighted average number of common shares outstanding during the respective periods.
BDC Conversion
As a result of the Company’s conversion from a BDC company to an oil and gas operating company, the change in accounting is considered a change in accounting principle. As a result, in accordance with Statement of Financial Accounting Standard 154, Accounting for Changes and Error Corrections, which requires that a change in accounting principle be retrospectively applied to all prior periods presented, the Company’s financial statements are presented on an operating and consolidated basis for all current and prior periods presented on a retrospective basis without regard to the BDC method of accounting. The Company does not believe that withdrawing its election to be regulated as a BDC will have any impact on its federal income tax status, because the Company never elected to be treated as a regulated investment company under Subchapter M of the Internal Revenue Code. Instead, the Company has always been subject to corporate level federal income tax on its income (without regard to any distributions it makes to its shareholders) as a “regular” corporation under Subchapter C of the Internal Revenue Code.
4. PROPERTY AND EQUIPMENT
Property and equipment is comprised of the following:
| | | December 31, | |
| | | 2008 | | | 2007 | |
| Oil and gas properties, successful efforts | | $ | 4,283,365 | | | $ | 4,362,610 | |
| Other property and equipment | | | 1,744,067 | | | | 1,520,261 | |
| Total | | | 6,027,431 | | | | 5,840,863 | |
| Less: Accumulated depreciation and depletion | | | 2,015,528 | | | | 1,475,098 | |
| Property and equipment, net | | $ | 4,011,903 | | | $ | 4,365,765 | |
On December 13, 2007, Production Resources, Inc. (“PRI”), a wholly-owned subsidiary of the Company, sold the J.N. Wilson “A” lease in Medina County, Texas to a third party. The lease included 190 acres of land, $49,250 of oil and gas properties and equipment at historical cost, $16,599 of oil and gas properties recorded as an asset for asset retirement obligations, offset by $20,158 of asset retirement obligation liabilities. The sales price of the lease was $75,000 and $45,618 of the proceeds was utilized to pay off the outstanding balance of a promissory note and accrued interest (See Note 5 – Debt). The remaining $29,832 of cash was paid as a bonus to the President of PRI (See Note 6 – Due to and From Related Parties). As a result of the transaction, the Company recorded a $29,309 gain on the sale of properties.
5. DEBT
Our debt at December 31, 2008 and 2007 consisted of the following:
Lease Payable
| | | December 31, | |
| | | 2008 | | | 2007 | |
| $21,238 computer equipment lease, bearing interest at 10% per annum | | $ | 16,131 | | | $ | 16,131 | |
On April 16, 2001, the Company leased computer equipment under a 36-month lease that was accounted for as a capital lease in the amount of $21,238. The lease was secured by the computer equipment and perfected by a financing statement; however, the Company liquidated the equipment in 2006 (with the lessor approval) and paid the resulting $4,000 of proceeds to the lessor. As a result of the computer liquidation other payments, the remaining unpaid balance of principal has been $16,131 since March 31, 2006. The payable is personally guaranteed by a former officer/director and the Chief Executive Officer of the Company. As of December 31, 2008, the Company has recorded a total of $25,029 in accrued interest for this payable in the accompanying Balance Sheet.
In November 2003, a settlement was negotiated with the lessor discussed above to forgive the outstanding principal and accrued interest on the lease payable once the transfer of 4,000 shares (100,000 shares prior to the one-for-twenty five reverse stock split) of the Company’s common stock personally held by the Company’s Chief Executive office occurs. The Chief Executive Officer of the Company transferred these shares on September 15, 2003. However, as of December 31, 2007, the transaction has not been finalized as the lessor has not agreed to the settlement. The Company expects to fully resolve this matter in the future at which time the value of the shares exchanged and any related gain or loss will be determined and recognized – (see Note 7 – Commitments and Contingencies and Note 8 – Related Party Transactions).
As of December 31, 2008, the Company has recorded $122,671 of accrued interest for previously issued convertible debentures. Several convertible debenture holders previously elected to convert all or a portion of the convertible debentures into common stock. However, the conversion did not include accrued interest that was specified in the convertible debenture documentation. Although the Company believes that no further common stock will be issued for these conversions, the accrued interest balance for these converted debentures is included in the accrued interest balance as of December 31, 2008.
Notes Payable
| | | December 31, | |
| | | 2008 | | | 2007 | |
| $2,000,000 Promissory Note, dated February 20, 2003, bearing interest at 8% per annum and due on December 31, 2008 | | $ | 2,000,000 | | | $ | 2,000,000 | |
| $25,000 Line of Credit, dated October 28, 2005, bearing simple variable interest at 6% per annum and due on February 28, 2008. | | | 24,062 | | | | 23,714 | |
| $103,000 Note, dated March, 2008, not formalized and not bearing interest | | | 91,000 | | | | - | |
| | | $ | 2,115,062 | | | $ | 2,023,714 | |
On June 15, 2004, Bend Arch Petroleum, Inc. (“Bend Arch”), a wholly-owned subsidiary of the Company executed a $2,000,000 promissory note accruing interest at 8% with Proco Operating Co., Inc., a company controlled by the brother of the Company’s Chief Executive Officer (See Note 9 – Related Party Transactions and Note 10 – Operator Agreement) with a maturity date of July 25, 2007. The purpose of the Note is to secure payment for oil and gas leases and wells located in Comanche and Eastland counties in the State of Texas sold to Bend Arch by Proco on June 15, 2004. The Note replaced a $2,000,000 convertible debenture dated January 5, 2004.
The terms of the Note included (i) the payment of interest at a rate of eight percent (8%) per annum (ii) principal and interest due and payable on July 25, 2007 (iii) no prepayment penalty (iv) payment made in excess of sixty (60) days after the due date of July 25, 2007 is a default of the Note and Bend Arch will forfeit all ownership of the related leases and wells and relinquish operations on the lease and wells to Proco, and (v) upon a default of the Note, Bend Arch will vacate the leases with no rights of ownership and execute the necessary documents to transfer the leases and wells to Proco or its assigns.
Effective July 25, 2007, Bent Arch executed a Modification and Extension Agreement (the “First Extension”) in relation to the Note that became due and payable on the same date.
The First Extension modified the terms of the Note as follows:
| · | The maturity date of the Note was extended to September 25, 2007. |
| · | Bend Arch covenants that as long as the Note is outstanding and unpaid, no transfer, assignment or sale of the underlying leases and wells securing the payment of the Note will be allowed without the written approval of Proco. |
Effective September 25, 2007, Bent Arch executed a Second Modification and Extension Agreement (the “Second Extension”) in relation to the Note that became due and payable on the same date. The Second Extension modifies the terms of the Note as follows:
| · | The maturity date of the Note was extended to March 31, 2008. (See Note 10- Subsequent Events) |
As of December 31, 2008, the Company has accrued $798,685 of accrued interest on the Promissory Note and is included as a component of accrued interest payable in the accompanying financial statements.
On October 28, 2005, Bend Arch entered into a $25,000 line of credit facility with a financial institution for working capital purposes. The line of credit is secured by a certificate of deposit held by the financial institution and bears simple interest per annum at a variable rate which is six percent (6%) as of December 31, 2008. As of December 31, 2008, the outstanding balance is $24,062 and is included in the Note Payable balance in the accompanying consolidated financial statements.
In March 2008, the Company purchased oilfield property and equipment for a price of $150,000. The terms included a cash payment of $47,000 and a note payable for the balance of $103,000. During the nine months ended September 30, 2008, the Company paid down $12,000 of principal and the balance is $91,000 as of December 31, 2008 and classified as a component of Note Payable in the accompanying consolidated financial statements. As of December 31, 2008, no formal agreement of the terms of the note payable had been finalized and the Company has a verbal agreement to pay the principal back at a rate of $10,000 monthly. It is anticipated that a formal agreement will be negotiated and finalized in the future.
6. DUE TO AND FROM RELATED PARTIES
| Due to Related Parties: | | December 31, | |
| | | 2008 | | | 2007 | |
| Due to Chief Executive Officer from salary and rental agreement with Company. | | $ | 510,925 | | | $ | 306,425 | |
| Due to Chief Executive Officer from advances and rental agreement with Bend Arch | | | 894,103 | | | | 704,703 | |
| Due to President of Oil America Group, Inc. from salary agreement with Company | | | 260,000 | | | | - | |
| Due to Operator of oil and gas properties | | | 1,630,734 | | | | 696,631 | |
| Total Due To Related Parties | | $ | 3,295,763 | | | $ | 1,707,759 | |
Effective July 1, 2003, the Company entered into a salary and equipment rental agreement with its Chief Executive Officer. As of January 1, 2005, the $3,500 per month equipment rental agreement with the Chief Executive Officer was terminated. As of December 31, 2007, the Company owed the Chief Executive Officer $306,425 for unpaid amounts under the agreement. During the year ended December 31, 2008, the Company accrued but did not pay $120,000 for compensation, reduced the balance $8,500 for payments made to the Chief Executive Officer, and increased the balance $93,000 for advances made by the Chief Executive Officer on behalf of the Company. As a result, the accrued balance as of December 31, 2008 is $510,925 and is classified as a component of Due To Related Parties in the accompanying financial statements.
As of December 31, 2008, the Chief Executive Officer of the Company is owed $894,103 for advances and unpaid equipment rental charges made on behalf of Bend Arch, the Company’s wholly-owned subsidiary. As of December 31, 2007, Bend Arch owed the Chief Executive Officer $704,703 for previous advances and equipment rental charges at $4,500 per month. During the year ended December 31, 2008, the Chief Executive Officer advanced $162,400 of funds to Bend Arch; the Company recorded $54,000 for equipment rental charges and repaid $27,000 to the Chief Executive Officer resulting in the $894,103 balance at December 31, 2008 classified as a component of Due to Related Parties in the accompanying financial statements.
At December 31, 2008, the President of Oil America Group, Inc. is owed $260,000 for unpaid salary per an agreement effective January 1, 2005. The agreement is for annual compensation of $65,000 and none of this amount has been paid since the inception of the agreement.
At December 31, 2007, the operator of the Company’s oil and gas properties was owed $696,631 for services as the operator of the Company’s oil and gas production activities. During the year ended December 31, 2008, the operator balance owed was increased for the net activities performed such that as of December 31, 2008, the net amount due to the operator of the Company’s oil and gas production activities was $1,630,734 and is classified as a component of Due to Related Parties in the accompanying financial statements. The operator is Proco Operating Co., Inc. (“Proco”) and is a related party as Proco is controlled by the brother of the Company’s Chief Executive Officer (See Note 10 – Operating Agreement).
7. ASSET RETIREMENT OBLIGATIONS
The following represents a reconciliation of the asset retirement obligations for the years ended December 31, 2008 and 2007:
| | | December 31, | |
| | | 2007 | | | 2006 | |
| Asset retirement obligations at beginning of period | | $ | 524,487 | | | $ | 517,526 | |
| Revision to estimate and additions | | | (37,237 | ) | | | 3,841 | |
| Other adjustments | | | - | | | | (20,157 | ) |
| Liabilities settled during the period | | | - | | | | - | |
| Accretion of discount | | | 21,905 | | | | 23,277 | |
| Asset retirement obligations at end of period | | $ | 509,155 | | | $ | 524,487 | |
8. STOCKHOLDERS’ EQUITY
Capital Structure
The Company is authorized to issue up to 500,000,000 shares of common stock, $0.0001 par value per share, of which 20,360,389 were issued and outstanding as of December 31, 2008
Effective September 14, 2007, the Company announced that all of the required steps had been completed for a one-for-twenty five reverse stock split of its common stock. In connection with the reverse stock split, the shares outstanding prior to the reverse split were 494,170,082 and after the stock split there are 19,767,055, giving effect to rounding adjustments. In accordance with FAS 128, all share and per share amounts have been retroactively adjusted to the beginning of the period to reflect the amendment to our Articles of Incorporation for the reverse stock split.
The Company is authorized to issue up to 5,000,000 shares of preferred stock, $0.0001 par value per share, of which 3,500,000 were issued and outstanding as of December 31, 2007. All of the preferred stock is held by the Chief Executive Officer of the Company. Under the terms of the designation, these Series A shares are not entitled to dividends. The shares are convertible, at the option of the holder, at any time, into three times as many common shares as Series A, preferred that are held. There are no liquidation rights or preferences to Series A, preferred stock holders as compared to any other class of stock. These shares are non-voting, however, the holders, as a class may elect two directors.
There were no changes in the preferred stock outstanding balance for the year ended December 31, 2008.
Common Stock:
Since December 31, 2005, 3,000 shares (75,000 shares adjusted for the one-for-twenty five reverse stock split) remained issuable to an overseas investor who had subscribed for an amount exceeding the shares that were actually issued under the terms of an offering in fiscal 2003. The investor had paid for the full subscription, and as such, no amounts are due to the Company. However, the Company has attempted to contact the investor several times in order to process the certificate but has been unable to reach the investor. In June 2008, the Company made the decision to write off the 3,000 issuable shares that had a post-reverse split historical balance of thirty cents ($0.30). As a result, the Company no longer classifies the 3,000 shares as issuable and the $0.30 historical cost was offset against other income in the consolidated financial statements.
On December 13, 2007, the Company received $89,000 of proceeds from the sale of 593,000 shares of its $0.0001 par value common stock at $.15 per share. The $.15 per share price was determined based upon a 40% discount to the closing market price of $.25 per share on the sale date of December 13, 2007. The discount reflects there is no active market for the stock because it is thinly traded and that the $.25 per share is a more reflective value of the fair market value on the sales date. At December 31, 2007, the shares were classified as common stock issuable in the consolidated financial statements. In January 2008, the shares were issued by the Company’s transfer agent and as such, are no longer classified as common stock issuable.
Options
In September 2008, the Company’s Board of Directors approved the issuance of up to 10,000,000 shares of common stock under the 2008 Non-Qualified Stock Option Plan (the “Plan”). The Plan is to assist the Company in securing and retaining Key Participants of outstanding ability by making it possible to offer them an increased incentive to join or continue in the service of the Company and to increase their efforts for its welfare through participation in the ownership and growth of the Company. On September 25, 2008, the Company filed a Form S-8 with the SEC for the registration of the underlying shares of stock from the plan. As of December 31, 2008, no grants under the Plan had been issued by the Company.
9. INCOME TAXES
There was no income tax during the years ended December 31, 2008 and 2007 due to the Company’s net loss and valuation allowance position.
The Company’s tax expense differs from the “expected” tax expense (benefit) for the years ended December 31, 2008 and 2007 (computed by applying the Federal Corporate tax rate of 35% for 2008 and 2007 to loss before taxes), as follows:
| | | Years Ended December 31, | |
| | | 2008 | | | 2007 | |
| | | | | | | |
| Computed “expected” tax benefit | | $ | (751,993 | ) | | $ | (799,392 | ) |
| Valuation allowance | | | 751,993 | | | | 799,392 | |
| Net taxable benefit | | $ | - | | | $ | - | |
The tax effects of temporary differences that gave rise to significant portions of deferred tax assets and liabilities at December 31 are as follows:
| | | 2008 | | | 2007 | |
| Deferred tax assets: | | | | | | |
| Net operating loss carryforward | | $ | 1,548,597 | | | $ | 790,689 | |
| Accrued compensation | | | 64,750 | | | | 42,000 | |
| Asset retirement obligations | | | 7,666 | | | | 8,147 | |
| Total deferred tax assets | | | 1,621,013 | | | | 840,836 | |
| Deferred tax liabilities: | | | | | | | | |
| Oil and gas properties | | | (78,332 | ) | | | (41,444 | ) |
| Net deferred tax asset | | | 1,542,682 | | | | 799,392 | |
| Valuation allowance | | | (1,542,682 | ) | | | (799,392 | ) |
| Net deferred taxes | | $ | - | | | $ | - | |
In assessing the recognition of deferred tax assets, management estimates it is more likely than not that the Company will be in a net loss position for the year ended December 31, 2008, the Company’s fiscal year end. As a result, the valuation allowance has been recorded for the entire amount of the net deferred tax asset. Net operating loss carry-forwards aggregate approximately $4,424,563 and expire in years through 2029 (see note below).
As discussed previously, on April 3, 2007, the Company filed a Form N-54C to withdraw its election to be regulated as a BDC and as of that date, is no longer a BDC under the 1940 Act. The Company is no longer a BDC with unconsolidated majority-owned portfolio companies but rather an oil and gas operating company with consolidated subsidiaries. The results of operations for April 1, 2007 through April 3, 2007 were not material and therefore, the Company has utilized April 1, 2007 as the inception date for the new business as an oil and gas operating company. As a result of this change, and IRS Section 382 rules, the net operating loss carry-forwards from previous years to April 1, 2007 will not be allowable and are not included in the above disclosures.
10. COMMITMENTS AND CONTINGENCIES
From time to time we may become subject to proceedings, lawsuits and other claims in the ordinary course of business including proceedings related to environmental and other matters. Such matters are subject to many uncertainties, and outcomes are not predictable with assurance.
Prior to December 31, 2007, the Company and certain of its wholly-owned subsidiaries were delinquent in the filing of franchise tax reports with the State of Texas and the State of Delaware and as a result, the Company and certain of its wholly-owned subsidiaries were not in good standing. The Company and its wholly-owned subsidiaries have filed the required reports and as a result, management anticipates that the Company and all of its wholly-owned subsidiaries will be declared in good standing in the near future. However, the Company may face certain penalties and interest due to the delinquent status of the reports before they were filed.
In November 2003, a settlement was negotiated with a lessor to forgive the outstanding principal and interest on the related note payable resulting from leased computers once the transfer of 4,000 shares (100,000 shares prior to the one-for-twenty five reverse stock split) personally held by the Company’s Chief Executive Officer occurred (see Note 5 – Debt and Note 8 – Related Party Transactions). As of December 31 the transaction has not been finalized as the lessor has not agreed to the settlement. However, the shares were transferred to the lessor in September 2003. The Company expects to fully resolve this matter in the future at which time the value of the shares exchanged and any related gain or loss will be determined and recognized.
The Company has included $84,161 of unpaid federal payroll taxes and employee withholdings and related penalties and interest in its accrued expenses as of December 31, 2008. Although the unpaid federal taxes are from the predecessor company, Communicate Now.com, Inc., such amounts are subject to potential federal tax liens for the Company.
The Company has $312,903 of accounts payable as of December 31, 2008 and the majority of this balance is from the predecessor company, Communicate Now.com, Inc. Since these trade accounts payable have been outstanding for an extended period of time with no communication between the Company and any of the vendors, the Company is commencing the process of eliminating the liabilities from its records. However, there can be no assurance that the Company will be successful in its efforts to eliminate the liabilities.
In December 2005 and January 2006, the Company determined that certain issuances of common stock had not been properly disclosed in reports made by the Company’s transfer agent. The Company discussed these items with the transfer agent and the transactions have been reconciled and recorded properly in the Company records. However, the Company believes that two of these transactions, an unauthorized issuance by the transfer agent of 600,000 shares (15,000,000 shares prior to the one-for-twenty five reverse stock split) and an additional unauthorized issuance of 100,000 shares (2,500,000 shares prior to the one-for-twenty five reverse stock split), should be reimbursed to the Company by either the third party who received the shares or the transfer agent. The Company has recorded the fair market valuation of the two transactions in the amount of $875,000 as a subscription receivable as of December 31, 2008 and is in discussions with both the third party and the transfer agent to resolve the issue. As of the date of these financial statements, no resolution of the matter has been completed.
11. RELATED PARTY TRANSACTIONS
We currently do not have a lease and we are not paying rent on our space. It is being provided to the Company by the Chief Executive Officer free of charge.
On November 1, 2003, the Company entered into an operating agreement for its oil and gas production activities with Proco, a company controlled by the brother of the Company’s Chief Executive Officer (See Note 5 – Due to Related Parties). The term of the operating agreement is equal to the term of the oil and gas leases held by the Company. In general, the operator incurs costs which are billed to the Company and the operator markets and sells oil and collects payments from customers. Such payments are then remitted to the Company. The operator has a first and preferred lien on the leasehold interests of the Company against any sums due to the Operator by the Company.
See Note 6 – Due to Related Parties for additional related party transactions.
12. SUBSEQUENT EVENTS
On March 6, 2009 but effective December 31, 2008, Bent Arch executed a Fourth Modification and Extension Agreement (the “Fourth Extension”) in relation to the Note that was to become due and payable on December 31, 2008 (See Note 5 – Debt). The Fourth Extension modified the terms of the Note as follows;
| · | The maturity date of the Note was extended to December 31, 2009. |
SUPPLEMENTAL OIL AND GAS DATA (UNAUDITED)
The following tables set forth supplementary disclosures for oil and gas producing activities in accordance with SFAS No. 69, Disclosures about Oil and Gas Producing Activities.
Costs Incurred
A summary of costs incurred in oil and gas property acquisition, development, and exploration activities (both capitalized and charged to expense) for the year ended December 31, 2008 as follows:
| Acquisition of proved properties | | $ | - | |
| Acquisition of unproved properties | | $ | - | |
| Development costs | | $ | - | |
| Exploration costs | | $ | - | |
Results of Operations for Producing Activities
The following table presents the results of operations for the Company’s oil and gas producing activities for the year ended December 31, 2008:
| Revenues, net of royalties | | $ | 1,842,059 | |
| Production costs | | | (2,265,456 | ) |
| Depletion, depreciation, and valuation provisions | | | (580,723 | ) |
| Exploration costs | | | -- | |
| | | | (1,004,120 | ) |
| Income tax expense | | | - | |
| Results of operations for producing activities (excluding corporate overhead and interest costs) | | $ | (1,004,120 | ) |
Reserve Quantity Information
The following table presents the Company’s estimate of its proved oil and gas reserves all of which are located in the United States. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of reserves related to new discoveries are more imprecise than those for producing oil and gas properties. Accordingly, the estimates are expected to change as future information becomes available. The estimates have been prepared with the assistance of an independent petroleum reservoir engineering firm. Oil reserves, which include condensate and natural gas liquids, are stated in barrels and gas reserves are stated in thousands of cubic feet.
| | | Oil | | | Gas | |
| | | (MBBL) | | | (BCF) | |
| Proved reserves as of December 31, | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| | | | | | | | | | | | | |
| Beginning of period | | | 6.934 | | | | - | | | | 1.575 | | | | - | |
| Conversion from a BDC company to an oil and gas operating company – April 1, 2007 | | | - | | | | 6.944 | | | | - | | | | 1.635 | |
| Production | | | (0.012 | ) | | | (0.010 | ) | | | (0.089 | ) | | | (0.060 | ) |
| Revisions of previous estimates | | | 0.806 | | | | - | | | | 39.036 | | | | - | |
| End of period | | | 7.728 | | | | 6.934 | | | | 40.522 | | | | 1.575 | |
Standardized Measure of Discounted Future Net Cash Flow and Changes Therein Relating to Proved Oil and Gas Reserves
The following information is based on the Company’s best estimate of the required data for the Standardized Measure of Discounted Future Net Cash Flows as of December 31, 2008 and 2007 in accordance with SFAS No. 69, “Disclosures About Oil and Gas Producing Activities” which requires the use of a 10% discount rate. This information is not the fair market value, nor does it represent the expected present value of future cash flows of the Company’s proved oil and gas reserves.
| | | December 31, | |
| | | 2008 | | | 2007 | |
| Future cash inflows | | $ | 576,028,283 | | | $ | 512,426,856 | |
Future production costs (1) | | | (83,582,682 | ) | | | (33,096,290 | ) |
| Future development costs | | | (13,500,000 | ) | | | -- | |
Future income tax expenses (2) | | | (167,630,960 | ) | | | (167,765,698 | ) |
| Future net cash flows | | | 311,314,641 | | | | 311,564,868 | |
| 10% annual discount for estimated timing of cash flows | | | (215,734,906 | ) | | | (215,908,308 | ) |
| Standardized measure of discounted future net cash flows at the end of the year | | $ | 95,579,735 | | | $ | 95,656,560 | |
| (1) | Production costs include oil and gas operations expense, production ad valorem taxes, transportation costs and general and administrative expense supporting the Company’s oil and gas operations. |
| (2) | Previously for the December 31, 2007 report, the Company did not calculate future income tax expense and this has been reflected in the current report. |
See the following table for average prices utilized for the disclosed amounts above.
| | | December 31, 2008 | |
| Average crude oil price per Bbl | | $ | 44.60 | |
| Average natural gas price per Mcf | | $ | 5.71 | |
Future production and development costs, which include dismantlement and restoration expense, are computed by estimating the expenditures to be incurred in developing and producing the Company’s proved crude oil and natural gas reserves at the end of the year, based on year-end costs, and assuming continuation of existing economic conditions.
Future income tax expenses are computed by applying the appropriate year-end statutory tax rates to the estimated future pretax net cash flows relating to the Company’s proved crude oil and natural gas reserves, less the tax bases of the properties involved. The future income tax expenses give effect to tax credits and allowances, but do not reflect the impact of general and administrative costs and exploration expenses of ongoing operations relating to the Company’s proved crude oil and natural gas reserves.
Sources of Changes in Discounted Future Net Cash Flows
Principal changes in the aggregate standardized measure of discounted future net cash flows attributable to the Company’s proved crude oil and natural gas reserves, as required by SFAS No. 69, at year end are set forth in the table below.
| | | Year ended December 31, 2008 | | | Year ended December 31, 2007 | |
| Standardized measure of discounted future net cash flows at the beginning of the year | | $ | 95,656,560 | | | $ | - | |
| Extensions, discoveries and improved recovery, less related costs | | | - | | | | - | |
| Conversion from a BDC company to an oil and gas operating company | | | - | | | | 513,176,934 | |
| Revisions of previous quantity estimates | | | 258,843,160 | | | | - | |
| Changes in estimated future development costs | | | (63,986,392) | | | | (33,096,290) | |
| Purchases (sales) of minerals in place | | | - | | | | - | |
| Net changes in prices and production costs | | | (143,217,588) | | | | - | |
| Accretion of discount | | | 173,403 | | | | (215,908,308) | |
| Sales of oil and gas produced, net of production costs | | | (423,397 | ) | | | (750,078) | |
| Development costs incurred during the period | | | -- | | | | -- | |
| Change in timing of estimated future production and other | | | -- | | | | -- | |
| Net change in income taxes | | | (51,466,011) | | | | (167,765,698) | |
| Standardized measure of discounted future net cash flows at the end of the year | | $ | 95,579,735 | | | $ | 95,656,560 | |
