UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q/A
| x | Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended September 30, 2005.
or
| ¨ | Transition report pursuant to section 13 or 15(d) of the Securities Exchange act of 1934 |
For the transition period from to
000-50072
Commission File No.
Energytec, Inc.
(Exact name of registrant as specified in its charter)
| Nevada | 75-2835634 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
14785 Preston Road, Suite 550, Dallas, Texas 75254
(Address of principal executive offices and Zip Code)
(972) 789-5136
(Registrant’s telephone number, including area code)
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, (3) is not a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (check one):
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as described in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 67,686,591 shares of common stock as of November 10, 2005.
2
AND SUBSIDIARY
Condensed Consolidated Balance Sheets
September 30, 2005 (Unaudited) and December 31, 2004
ASSETS
| Restated September 30, 2005 | December 31, 2004 | |||||
| (Unaudited) | (Audited) | |||||
CURRENT ASSETS | ||||||
Cash and cash equivalents | $ | 1,829,641 | $ | 6,567,930 | ||
Accounts receivable, revenue | 887,543 | 469,178 | ||||
Accounts receivable, joint interests | 307,500 | 307,500 | ||||
Accounts receivable, programs | 2,739,560 | 834,600 | ||||
Accounts receivable, other | 1,273,539 | 549,560 | ||||
Accounts receivable, related party | 83,170 | 79,795 | ||||
Prepaid income taxes | 748,854 | — | ||||
Other current assets | 12,500 | 12,500 | ||||
TOTAL CURRENT ASSETS | 7,882,307 | 8,821,063 | ||||
PROPERTY AND EQUIPMENT | ||||||
Oil and gas properties, successful efforts | 21,760,178 | 14,682,694 | ||||
Gas pipeline | 1,576,629 | 1,559,107 | ||||
Oil and gas supplies | 431,653 | 342,846 | ||||
Well service and related equipment | 5,473,604 | 2,753,608 | ||||
| 29,242,064 | 19,338,255 | |||||
Less accumulated depreciation, depletion and amortization | 1,561,821 | 1,031,073 | ||||
NET PROPERTY AND EQUIPMENT | 27,680,243 | 18,307,182 | ||||
OTHER ASSETS | ||||||
Long-term receivables, advance payments | 4,985,660 | 1,481,795 | ||||
TOTAL OTHER ASSETS | 4,985,660 | 1,481,795 | ||||
| $ | 40,548,210 | $ | 28,610,040 | |||
The accompanying notes are an integral part of these consolidated financial statements.
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ENERGYTEC, INC.
AND SUBSIDIARY
Condensed Consolidated Balance Sheets(Continued)
September 30, 2005 (Unaudited) and December 31, 2004
LIABILITIES AND SHAREHOLDERS’ EQUITY
| Restated September 30, 2005 | December 31, 2004 | |||||||
| (Unaudited) | (Audited) | |||||||
CURRENT LIABILITIES | ||||||||
Accounts payable and accrued expenses | $ | 2,070,745 | $ | 1,147,911 | ||||
Accounts payable, revenue | 1,554,693 | 1,104,314 | ||||||
Income taxes payable | — | 1,669,977 | ||||||
Turnkey costs payable | 5,900,937 | 1,451,806 | ||||||
Debenture bonds | 125,000 | 175,000 | ||||||
Notes payable, current maturities | 759,855 | 826,094 | ||||||
TOTAL CURRENT LIABILITIES | 10,411,230 | 6,375,102 | ||||||
LONG-TERM LIABILITIES | ||||||||
Notes payable, net of current maturities | 659,894 | 977,702 | ||||||
Asset retirement obligation | 670,564 | 624,303 | ||||||
Deferred federal income taxes | 2,136,732 | 1,356,879 | ||||||
TOTAL LONG-TERM LIABILITIES | 3,467,190 | 2,958,884 | ||||||
TOTAL LIABILITIES | 13,878,420 | 9,333,986 | ||||||
SHAREHOLDERS’ EQUITY | ||||||||
Preferred stock (10,000,000 shares authorized, none issued and outstanding, $.001 par) | — | — | ||||||
Common stock (90,000,000 shares authorized, 62,040,868 issued and 62,040,115, outstanding and 59,534,281 issued and 59,348,981 outstanding, respectively, $.001 par) | 62,042 | 59,535 | ||||||
Additional paid-in capital | 26,475,781 | 20,594,763 | ||||||
Treasury stock, at cost | (147 | ) | (36,351 | ) | ||||
Retained earnings (deficit) | 132,114 | (1,341,893 | ) | |||||
TOTAL SHAREHOLDERS’ EQUITY | 26,669,790 | 19,276,054 | ||||||
| $ | 40,548,210 | $ | 28,610,040 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
4
AND SUBSIDIARY
Unaudited Condensed Consolidated Statements of Operations
For the Three and Nine Months Ended September 30, 2005 and 2004 (Unaudited)
| Three Months Ended | Nine Months Ended | ||||||||||||
| Restated 2005 | 2004 | Restated 2005 | 2004 | ||||||||||
REVENUES | |||||||||||||
Oil and gas revenue | $ | 388,122 | $ | 431,637 | $ | 1,080,701 | $ | 982,144 | |||||
Drilling revenue | 514,229 | — | 514,229 | — | |||||||||
Well service revenue | 895,149 | 350,644 | 2,373,803 | 953,848 | |||||||||
Gas sales | 505,310 | 45,233 | 1,203,416 | 137,561 | |||||||||
Gain on sale of working interests | 1,387,946 | 2,713,847 | 4,289,391 | 7,225,370 | |||||||||
Gain on sale of drilling program | 205,269 | — | 1,929,416 | — | |||||||||
TOTAL REVENUES | 3,896,025 | 3,541,361 | 11,390,956 | 9,298,923 | |||||||||
EXPENSES | |||||||||||||
Oil and gas expenses | |||||||||||||
Lease operating | 263,682 | 320,420 | 949,509 | 666,409 | |||||||||
Well service expenses | 1,177,462 | 281,404 | 2,713,242 | 756,965 | |||||||||
Drilling expenses | 366,629 | — | 366,629 | — | |||||||||
Gas purchases | 460,653 | — | 1,076,025 | — | |||||||||
Depreciation, depletion and amortization | 198,117 | 103,041 | 572,654 | 309,123 | |||||||||
Environmental remediation | 978,138 | — | 978,138 | — | |||||||||
Interest expense | 112,869 | 60,300 | 225,905 | 169,199 | |||||||||
General and administrative expenses | 637,759 | 309,223 | 2,114,524 | 732,010 | |||||||||
TOTAL EXPENSES | 4,195,309 | 1,074,388 | 8,996,626 | 2,633,706 | |||||||||
OTHER INCOME | |||||||||||||
Interest income | 1,277 | — | 4,078 | — | |||||||||
TOTAL OTHER INCOME | 1,277 | — | 4,078 | — | |||||||||
NET (LOSS) INCOME BEFORE (BENEFIT) PROVISION FOR INCOME TAXES | (298,007 | ) | 2,466,973 | 2,398,408 | 6,665,217 | ||||||||
(BENEFIT) PROVISION FOR INCOME TAXES | (43,888 | ) | 863,441 | 924,401 | 2,332,826 | ||||||||
NET (LOSS) INCOME | $ | (254,119 | ) | $ | 1,603,532 | $ | 1,474,007 | $ | 4,332,391 | ||||
EARNINGS PER SHARE | |||||||||||||
Basic | $ | — | $ | 0.03 | $ | 0.03 | $ | 0.08 | |||||
Diluted | $ | — | $ | 0.03 | $ | 0.03 | $ | 0.08 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
5
AND SUBSIDIARY
Condensed Consolidated Statement of Changes in Shareholders’ Equity
For the Year Ended December 31, 2004, and Nine Months Ended September 30, 2005 (Unaudited)
| Number of Shares | Preferred Stock $.001 Par Value | Common Stock $.001 Par Value | Additional Paid-In Capital | Treasury Stock | Retained (Deficit) | Total | ||||||||||||||||||||
BALANCE, December 31, 2003 (Audited) | 48,524,017 | — | 48,524 | 5,247,333 | (33,155 | ) | 770,066 | 6,032,768 | ||||||||||||||||||
Capital stock issued for cash | 4,945,706 | — | 4,946 | 6,919,042 | — | — | 6,923,988 | |||||||||||||||||||
Capital stock issued for assets | 215,000 | — | 215 | 166,785 | — | — | 167,000 | |||||||||||||||||||
Capital stock issued for stock dividend | 3,252,626 | — | 3,253 | 7,412,734 | — | (7,415,987 | ) | — | ||||||||||||||||||
Capital stock issued for services | 225,000 | — | 225 | 172,775 | — | — | 173,000 | |||||||||||||||||||
Capital stock issued upon conversion of notes and debentures | 471,932 | — | 472 | 272,994 | — | — | 273,466 | |||||||||||||||||||
Capital stock issued upon exercise of options | 1,900,000 | — | 1,900 | 403,100 | — | — | 405,000 | |||||||||||||||||||
Treasury stock purchased for cash | — | (3,196 | ) | (3,196 | ) | |||||||||||||||||||||
Net income | — | — | — | — | — | 5,304,028 | 5,304,028 | |||||||||||||||||||
BALANCE, December 31, 2004 (Audited) | 59,534,281 | — | 59,535 | 20,594,763 | (36,351 | ) | (1,341,893 | ) | 19,276,054 | |||||||||||||||||
Treasury stock retired | (185,300 | ) | (185 | ) | (36,019 | ) | 36,204 | — | ||||||||||||||||||
Capital stock issued for cash | 2,498,775 | 2,499 | 5,496,641 | 5,499,140 | ||||||||||||||||||||||
Capital stock issued for services | 25,000 | 25 | 39,975 | 40,000 | ||||||||||||||||||||||
Capital stock issued upon conversion of debenture | 25,000 | 25 | 49,975 | 50,000 | ||||||||||||||||||||||
Capital stock issued under stock compensation plan | 143,112 | 143 | 330,446 | 330,589 | ||||||||||||||||||||||
Net income (Restated) | — | — | — | — | — | 1,474,007 | 1,474,007 | |||||||||||||||||||
BALANCE, September 30, 2005 | 62,040,868 | $ | — | $ | 62,042 | $ | 26,475,781 | $ | (147 | ) | $ | 132,114 | $ | 26,669,790 | ||||||||||||
The accompanying notes are an integral part of these consolidated financial statements
6
AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2005 (Unaudited) and for the Year Ended December 31, 2004
| Restated September 30, 2005 | December 31, 2004 | |||||||
| (Unaudited) | (Audited) | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
Net income | $ | 1,474,007 | $ | 5,304,028 | ||||
Adjustments to reconcile net income to net cash used in operating activities | ||||||||
Capital stock issued for services | 40,000 | — | ||||||
Capital stock issued under stock compensation plan | 330,589 | — | ||||||
Unrealized loss on investment | — | 1,500 | ||||||
Gain on sale of working interests | (4,289,391 | ) | (10,510,501 | ) | ||||
Gain on sale of drilling program | (1,929,416 | ) | — | |||||
Depreciation, depletion and amortization | 530,748 | 418,374 | ||||||
Impairment of long-lived assets | — | 120,905 | ||||||
Changes in assets and liabilities | ||||||||
Accounts receivable, revenue | (418,365 | ) | (229,082 | ) | ||||
Accounts receivable, joint interests | — | 73,051 | ||||||
Accounts, receivable programs | (1,904,960 | ) | (834,600 | ) | ||||
Accounts receivable, other | (723,979 | ) | (484,560 | ) | ||||
Accrued interest, related party | (3,375 | ) | (4,795 | ) | ||||
Prepaid income taxes | (748,854 | ) | — | |||||
Other current assets | — | (6,738 | ) | |||||
Accounts payable and accrued expenses | 922,834 | 499,457 | ||||||
Accounts payable, revenue | 450,379 | 1,104,314 | ||||||
Royalties payable | — | (1,008,695 | ) | |||||
Turnkey costs payable | 2,391,032 | 1,061,987 | ||||||
Federal income taxes payable | (1,669,977 | ) | 1,112,085 | |||||
Deferred federal income taxes | 779,853 | 934,281 | ||||||
Net cash flows used in operating activities | (4,768,875 | ) | (2,448,989 | ) | ||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
Purchases of property and equipment | (14,115,242 | ) | (12,853,233 | ) | ||||
Proceeds from sale working interests | 12,534,600 | 16,134,708 | ||||||
Loan advanced to a related party | — | (75,000 | ) | |||||
Advance revenue payments | (3,503,865 | ) | (1,481,795 | ) | ||||
Net cash flows (used in) provided by investing activities | (5,084,507 | ) | 1,724,680 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
7
ENERGYTEC, INC.
AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows(Continued)
For the Nine Months Ended September 30, 2005 (Unaudited) and for the Year Ended December 31, 2004
| Restated September 30, 2005 | December 31, 2004 | |||||||
| (Unaudited) | (Audited) | |||||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
Payments on notes payable | (384,047 | ) | (1,257,536 | ) | ||||
Payments on short-term notes payable | — | (22,650 | ) | |||||
Proceeds provided from borrowings on notes payable | — | 50,000 | ||||||
Proceeds provided from sale of common stock | 5,499,140 | 7,328,988 | ||||||
Proceeds provided from sale of stock subscriptions | — | — | ||||||
Payments for purchase of treasury stock | — | (3,196 | ) | |||||
Net cash flows provided by financing activities | 5,115,093 | 6,095,606 | ||||||
NET (DECREASE) INCREASE IN CASH | (4,738,289 | ) | 5,371,297 | |||||
CASH, beginning | 6,567,930 | 1,196,633 | ||||||
CASH, ending | $ | 1,829,641 | $ | 6,567,930 | ||||
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS | ||||||||
Cash paid for interest | $ | 225,905 | $ | 247,595 | ||||
Cash paid for income taxes | $ | 2,360,586 | $ | 1,028,151 | ||||
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES | ||||||||
Capital stock issued for acquisition of assets | $ | — | $ | 167,000 | ||||
Capital stock issued for settlement of notes payable | $ | — | $ | 223,466 | ||||
Capital stock issued for stock dividend | $ | — | $ | 7,415,987 | ||||
Capital stock issued for conversion of debenture | $ | 50,000 | $ | 50,000 | ||||
Capital stock issued for services | $ | 40,000 | $ | 173,000 | ||||
Capital stock issued under stock compensation plan | $ | 330,589 | $ | — | ||||
Assets acquired through notes payable | $ | — | $ | 162,343 | ||||
The accompanying notes are an integral part of these consolidated financial statements
8
AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Unaudited)
1. BASIS OF PRESENTATION
These consolidated financial statements are unaudited but, in the opinion of management, reflect all adjustments necessary for a fair presentation of the results for the periods reported. All such adjustments are of a normal recurring nature unless disclosed otherwise. These financial statements, including selected notes, have been prepared in accordance with the applicable rules of the Securities and Exchange Commission and do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. Certain reclassifications of prior year data have been made to conform to 2005 classifications. These interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Form 10 registration statement filed with the Securities and Exchange Commission May 2, 2005, as amended September 19, 2005. The Company’s exploration and production activities are accounted for under the “successful efforts” method.
2. THIRD QUARTER RESTATEMENT
During the fourth quarter of 2005, the Company made several significant adjustments that impacted amounts previously reported in the Company’s fiscal quarter ended September 30, 2005. These adjustments related to the recognition of the gain on sale of drilling program and the gain on sale of working interests. Specifically, the terms of the drilling program were renegotiated during the fourth quarter of 2005, resulting in a deferral of the gain. Additionally, certain commissions paid in January 2006, as discussed in Note 2, were related to the sale of working interests during the quarter ended September 30, 2005. These adjustments would have reduced pretax income by approximately $2,058,099 resulting in a loss for the quarter ended September 30, 2005, of $254,121 and net income for the three quarters ended September 30, 2005, of $1,474,004. The basic and diluted earnings per share for the quarter and the three quarters ended September 30, 2005, would have been $0.00 and $0.03, respectively. Because these events had not occurred and were not anticipated, these adjustments were not considered in the preparation of the unaudited consolidated financial statements contained in our Form 10-Q filed by the Company on November 14, 2005.
3. EARNINGS PER SHARE
Basic earnings per share amounts are computed by dividing net income available to common stockholders by the weighted average number of common stock shares outstanding during the periods. Diluted earnings per share amounts take into consideration all potentially dilutive common shares such as options and convertible securities.
For basic earnings per share purposes, for the nine months ended September 30, 2005 and 2004, weighted average common stock shares outstanding totaled 62,005,090 and 50,535,949, respectively. For diluted earnings per share purposes, for the nine months ended September 30, 2004, weighted average common stock shares outstanding totaled 62,031,812 and 50,565,116, respectively, and included shares relating to the assumed conversion of notes and debentures and the assumed exercise of stock options. Net income for diluted earnings per share purposes includes the add back of the interest savings from the assumed conversion of notes and debentures, net of the related tax effects. For the nine months ended September 30, 2005, potentially dilutive securities are excluded from the computation as their effect is anti-dilutive.
4. STOCK BASED COMPENSATION AND RESTRICTED STOCK GRANTS
In December 2004, the FSAB issued SFAS No. 123R, “Share-Based Payments”, revising SFAS No. 123,Accounting for Stock-Based Compensation, and superseding Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees”. SFAS No. 123R establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, including obtaining employee services in share-based payment transactions. SFAS No. 123R applies to all awards granted after the required effective date and to awards modified, purchased or canceled after that date. Adoption was effective June 15, 2005. There have been no such awards granted, modified, purchased, or canceled since March 15, 2005, as discussed below. Management does not believe the adoption of this accounting pronouncement will have a material impact on the Company’s financial position or operating results.
On March 15, 2005, the Company granted certain employees the rights to restricted common stock shares totaling 644,000 shares, vesting equally in January of each of the years 2006, 2007 and 2008. Pursuant to SFAS No. 123R, these nonvested, restricted shares will be recognized as compensation expense over the periods in which the services are provided and in which the shares vest at their fair value, which is the same amount for which similarly restricted shares would be issued to third parties. The stock was valued at $2.31 per share which approximated the per share price of restricted common stock sold in a private placement during the same time period. As of January 1, 2006, 214,667 shares vested. Compensation expense of $84,221 and $168,441 was recognized for the three months and nine months ended September 30, 2005. Additional compensation of $162,148 was capitalized and is included in “Well service and related equipment” in the accompanying consolidated financial statements.
5. ASSET RETIREMENT OBLIGATION
Effective January 1, 2003, the Company adopted SFAS No. 143, “Accounting for Asset Retirement Obligations”. Pursuant to this accounting standard, the Company recognized additional liabilities at September 30, 2005 and December 31, 2004, of approximately $15,789 and $327,016, respectively, for asset retirement obligations related to the future costs of plugging and abandoning its oil and gas properties, the removal of equipment and facilities from lease acreage and returning such land to its original condition. These costs reflect the legal obligations associated with the normal operation of oil and gas properties and were capitalized by increasing the carrying amounts of the related long-lived assets by the fair value of these obligations, discounted to their present value. The cumulative effect from the initial adoption of this accounting standard at January 1, 2003 was not significant and net income for the year ended December 31, 2002, would not have been materially different if this standard had been adopted effective January 1, 2002.
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ENERGYTEC, INC.
AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Unaudited)
The changes in the carrying amount of the Company’s asset retirement obligations for the nine months ended September 30, 2005, and the year ended December 31, 2004, are as follows.
| 2005 | 2004 | |||||
Balance at beginning of period | $ | 654,775 | $ | 297,287 | ||
Accretion expense | 15,789 | 29,729 | ||||
Payments | — | — | ||||
Liabilities incurred | — | 297,287 | ||||
Balance at end of period | $ | 670,564 | $ | 624,303 | ||
5. BORROWINGS
The Company’s borrowings consist of various notes payable with similar terms and maturities, convertible notes payable, and debenture notes. None of these borrowings contain any significant debt covenants or restrictions on Company assets or dividend payments.
The notes payable are with various financial institutions, bear interest at rates ranging from 7.5% to 12.0%, are payable in monthly installments of principal and interest, are collateralized by accounts receivable and by various oil and gas properties or other equipment, and mature through September 2005.
In June 2003, the Company issued debenture notes to various individuals. The notes bear interest at 8.0%, are unsecured and mature in 2008. Interest is payable monthly in arrears on or before the 15th of each month. Additional interest equal to .5% or 1% of the principal amount is payable to the holder if the average mcf price of gas does not fall within given ranges for each six month measurement period. The debentures are convertible at the holders’ option into the Company’s common stock shares at a conversion price of $2.00 per share. In September 2004, $50,000 of these debentures was converted into 25,000 shares of common stock. In June 2005, $50,000 of these debentures was converted into 25,000 shares of common stock.
Future maturities required under the terms of the above debt are as follows:
Year Ended | Amount | ||
2006 | $ | 759,855 | |
2007 | 423,744 | ||
2008 | 236,150 | ||
| $1,419,749 | |||
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ENERGYTEC, INC.
AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Unaudited)
6. INCOME TAXES
The Company accounts for income taxes pursuant to SFAS No. 109, “Accounting for Income Taxes”, which requires the establishment of deferred tax assets and liabilities for the recognition of future deductions or taxable amounts and operating loss and tax credit carry forwards. Deferred federal income tax expense or benefit is recognized as a result of the change in the deferred tax asset or liability during the year using the currently enacted tax laws and rates that apply to the period in which they are expected to affect taxable income. Valuation allowances are established, if necessary, to reduce deferred tax assets to the amounts that will more likely than not be realized.
The Company’s provision for income taxes reflects the federal income taxes calculated at the statutory rates and state taxes calculated at the statutory rates net of any federal income tax benefit. The Company’s statutory rate and effective tax rate are approximately 35%. A reconciliation of income tax expense at the statutory federal and state income tax rates to income tax expense at the Company’s effective tax rate for the three months and nine months ended September 30, 2005 and 2004, is as follows:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||
| 2005 | 2004 | 2005 | 2004 | ||||||||||
Income tax, statutory rates | $ | (136,834 | ) | $ | 863,441 | $ | 793,567 | $ | 2,332,826 | ||||
State taxes, net | 92,946 | — | 130,834 | — | |||||||||
Nondeductible and other | — | — | — | — | |||||||||
Provision for income taxes | $ | (43,888 | ) | $ | 863,441 | $ | 924,401 | $ | 2,332,826 | ||||
The following temporary differences gave rise to the deferred tax asset and liability at:
| September 30, 2005 | December 31, 2004 | |||||
Deferred tax asset: | ||||||
Balance, January 1 | $ | 210,385 | $ | 210,385 | ||
Valuation allowance | — | — | ||||
Net deferred tax asset | 210,385 | 210,385 | ||||
Deferred tax liability: | ||||||
Balance, January 1 | 1,567,264 | 623,983 | ||||
Effect of excess of financial statement depletion over tax depletion | — | 6,928 | ||||
Effect of intangible drilling costs expensed for tax purposes which were capitalized for financial statement purposes | 779,853 | 927,353 | ||||
Gross deferred tax liability | 2,347,117 | 1,567,264 | ||||
Net deferred tax liability | $ | 2,136,732 | $ | 1,356,879 | ||
11
ENERGYTEC, INC.
AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Unaudited)
7. ENVIRONMENTAL ISSUES
The Company is engaged in oil and gas exploration and production and may become subject to certain liabilities as they relate to environmental clean up of well sites or other environmental restoration procedures as they relate to the drilling of oil and gas wells and the operation thereof. In the Company’s acquisition of existing or previously drilled wells, the Company may not be aware of what environmental safeguards were taken at the time such wells were drilled or during such time the wells were operated. Should it be determined that a liability exists with respect to any environmental clean up or restoration, the liability to cure such a violation could fall upon the Company.
In November 2004, an oil spill of eight barrels occurred on land where several of the Company’s wells are located. Following the occurrence of the spill and for several days thereafter, there was significant rainfall, the result of which had the effect of dispersing the spilled oil over a fourteen acre area. In addition, the fourteen acres was part of a larger area committed to a Federal wetlands mitigation project. The remediation and restoration of the land is governed by the Texas Railroad Commission and other attendant regulatory authorities. During November and December 2004, the Company incurred approximately $520,000 of costs related to the clean up. Through March 31, 2005, an additional $1,925,618 of such costs were incurred and paid. On November 11, 2005, the Company received a letter from the Texas Railroad Commission indicating that the spill file had been closed. However, the Company still has remediation and restoration issues currently being resolved with various natural resource regulatory authorities.
In connection with this spill, the Company filed a claim with both its primary and secondary insurance carrier. Under these policies, the Company has combined coverage of $2,000,000 subject to deductibles of $5,000. Accordingly, the Company recognized an insurance recovery receivable related to the clean up costs incurred. However, during the claims process, the insurance carrier denied the claim based upon a pollution exclusion clause in both policies. Due to weather and other contributing factors beyond the Company’s control, management does not believe the exclusion clause should apply in this instance. The Company is considering options for further action to recover costs through insurance coverage. However, based upon uncertainty of collection as of September 30, 2005, $263,762 related to betterments and future preventative measures has been capitalized in accordance with EITF 90-8 and is reflected in oil and gas properties. An additional $978,138 of the receivable has been reserved and is reflected as environmental remediation in the accompanying statements of income. The Company believes it is in full compliance with all requirements related to the spill and has satisfactorily complied with all environmental concerns.
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| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Overview
Energytec, Inc. was formed for the purpose of engaging in oil and gas producing activities through the acquisition of oil and gas properties. We own working interests in 62,466 acres of oil and gas leases in Texas and Wyoming. We also own a gas pipeline of approximately 63 miles in Texas. Energytec is pursuing an ongoing reworking and drilling program to increase production from its properties. Energytec also owns a well service business operated through its subsidiary, Comanche Well Service Corporation.
Results of Operations
Revenue
For the three months ended September 30, 2005, oil and gas revenue has decreased 10% from the same period for 2004, with a 10% increase for the nine months ended September 30, 2005, as compared to the same period for 2004. The average oil price over the first nine months of 2005 was approximately $18.56 per barrel higher than the comparable period in 2004. During the nine months ended September 30, 2005, Energytec recompleted 6 wells on the J.E. Worsham, A.J. Deason, B. Davis, and George Thompson leases in Hopkins and Rusk counties. The addition of these wells increased production by 1,159 additional net barrels over the same quarter in 2004. However, production declined by 385 net barrels from the nine months ended September 30, 2004, in the Redwater area, due to a decrease in ownership in certain wells. Additionally, production declined by 1,566 net barrels from the nine months ended September 30, 2004, in the Trix-Liz field due to severance of wells pending compliance pursuant to Texas Railroad Commission (RRC) requirements. All severances were reconnected by the end of the third quarter of 2005, except for one lease (Garbade lease). Energytec is continuing to work with the RRC to bring all wells into compliance with RRC requirements and prevent future severances. The following table shows the gross and net oil and gas production for each month in the three-month period ended September 30, 2005:
| Oil (Bbl) | Gas (Mcf) | |||||||
Month in 2005 | Gross | Net | Gross | Net | ||||
July | 10,570 | 1,871 | 23,543 | 2,859 | ||||
August | 9,815 | 2,137 | 27,279 | 4,982 | ||||
September | 10,985 | 2,060 | 24,086 | 4,817 | ||||
During the current quarter Energytec drilled the first well in the Sulphur Bluff field under the drilling program that was finalized in July. Comanche Well Service, the Company’s wholly owned subsidiary, recognized drilling revenue of $514,229, which included revenue from per diem drilling of $147,600 and billed direct costs totaling $366,629. Under this program, two additional wells will be drilled in the Sulphur Bluff field and one development well and two exploration wells will be drilled in the Redwater area. The three wells in the Sulphur Bluff field will be drilled below the base of the Paluxy Sand, but may also be dually completed to reach gas reserves below the Paluxy Sand. Energytec retained a 35 percent net-profits overriding royalty interest in all the wells.
Well service revenue continues to increase because we are utilizing more of our equipment and have added well service units, which have been put into service on additional properties. The revenue has increased by 149%, from $953,848 for the nine months ended September 30, 2004, to $2,373,803 for the same period in 2005. Well service expenses have also risen due to the addition of employees and the expense of maintaining the equipment. The expense increased by 258%, from $756,965 for the nine months ended September 30, 2004, to $2,713,242 for the same period in 2005. During the first six months of 2004, employees were also involved in the construction of a shop. These expenses were capitalized resulting in lower well service expenses during that period of time. For the current year, we have a loss of $339,439 from well services provided. This is primarily due to the addition of employees who were utilized to complete construction and necessary repairs on additional well service units and a drilling rig which Energytec began using in the third quarter of 2005. Revenues were not generated from the additional well service units until the second quarter of 2005. No revenues were recognized from the drilling rig until the end of the third quarter of 2005. For the three months ended September 30, 2005, we incurred a loss from well services provided of $282,313. The loss resulted from additional labor costs for maintaining the new units
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and rigs, increased fuel cost of approximately $102,000 for the third quarter of 2005, and training necessary to put the drilling rig into operation. The Company is currently reviewing its hourly rate for well service provided to determine if a fuel surcharge should be added or if the rate should be adjusted.
For the three months and nine months ending September 30, 2004, the gas sales and purchases were netted. In 2005, the gross sales were presented as revenues with the purchases reflected as expenses. The net gas sales for the three months and nine months ended September 30, 2005, were $44,657 and $127,391, respectively, which is less than a 10 percent fluctuation from the prior year.
Oil and gas expenses
Lease operating expenses have increased from $283,100 for the nine months ended September 30, 2004, to $949,509 for the same period in the current year. This is an increase of 42%. For the three months ended September 30, 2005, the lifting costs per barrel averaged $6.90 for a total of $100,093. Lease operating expenses also include $140,175 of costs associated with non-producing wells and $23,414 associated with the pipeline. Lease operating expenses as compared to oil and gas revenues appear to be high due to the expenses on these non-producing wells, creating a high ratio of expense to revenue. As we continue to recomplete additional wells and bring them onto production, the costs as a percentage of the revenue should continue to decline. Additionally, as we plug wells in accordance with RRC requirements, the costs of maintaining non-producing wells will decline.
General and administrative
General and administrative expenses increased 106% from $309,223 for the three months ended September 30, 2004, to $637,759 for the same period in 2005. Likewise, the general and administrative expenses increased by 189% from $732,010 for the nine months ended September 30, 2004, to $2,114,524 for the same period in 2005. During the time period from the first half of 2004 through the third quarter of 2005, Energytec added employees and additional office space in both the corporate offices and in the Talco field office. We also incurred additional consulting expenses related to the drilling program that began in the third quarter of 2005.
Other income (expense)
During the three months ended September 30, 2005, Energytec recognized a gain on sale of working interests of $1,387,946 which is $1,325,901 lower than the same period for the prior year.
During 2005, the Company entered into an agreement to drill seven wells in two of its fields for $8,000,000 under a turnkey agreement through completion of the wells. Commissions of $800,000 were paid to two individuals in connection with the agreement. (Note 2) The sales proceeds of $8,000,000 less the commissions of $800,000 were recorded as a liability pending the completion of the wells. The liability included $3,500,000 for the sale of well sites owned by the Company and the estimated cost of drilling and completion of the wells totaling $3,700,000. The drilling budget of $3,700,000 includes approximately $1,000,000 to cover potential overruns associated with increasing costs of materials and labor precipitated by rising oil prices. The Company has elected to reserve recognition of this amount until such time as all wells are completed.
Comanche Well Service provides the drilling services and bills for these services based upon average market day rates plus expenses. As wells are drilled, the liability is reduced by direct drilling costs plus a standard daily drilling rate of $3,000 per day. The gain on the sale of the well sites is recognized as wells are completed. Through September 30, 2005, the Company had recognized a gain of $1,929,416 and drilling revenues of $514,229. The consolidated financial statements reflect a remaining liability after recognition of the gain and drilling revenues of $4,756,355, which is reflected in turnkey costs payable in the accompanying balance sheet at September 30, 2005. There are no further signed agreements for future drilling contracts.
Liquidity and Capital Resources
Capital expenditures in the third quarter of 2005 totaled approximately $3,000,000. Capital expenditures through the first nine months of 2005 totaled approximately $14,000,000. The total capital budget for 2005 is expected to be approximately $15 million, which will be funded through cash reserves and the assignment of working interests or short term borrowings.
On November 3, 2005, Energytec acquired approximately 2,500 acres in Bowie County along with substantial supporting data for the Company’s Redwater Project. The cost of the acquisition was $240,000.
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During June 2005, one debenture was converted resulting in the issuance of 25,000 shares of common stock.
During October 2005, Energytec sold shares of its common stock to 21 private investors at an aggregate offering price of $2,149,503, which was before the seven percent stock dividend effected in October 2005. After giving effect to the stock dividend, these persons purchased approximately 766,656 shares of common stock at an effective purchase price of $2.80 per share. The private placement is continuing with respect to 4,238,499 additional shares at an offering price of $2.75 per share, or a total of $11,779,622. There is no assurance any of these additional shares will be sold. Each person purchasing the shares in the private placement has the right to put the shares back to Energytec on November 15, 2006 at a price of $3.75 per share. Assuming all of the shares are sold in the private offering, the resulting put obligation would be a material direct financial obligation of Energytec because, if all of the put options are exercised, the total payment by Energytec would be approximately $18.9 million. The Company plans to utilize approximately $6,000,000 of the capital raised in the private placement for property acquisitions with the remainder being used for working capital and other potential acquisitions. Subsequent to December 31, 2005, $427,911 of commissions were paid to individuals in connection with this private placement.
Capital Commitments The following table discloses aggregate information about our contractual obligations including notes payable and lease obligations, and the periods in which payments are due as of September 30, 2005:
Contractual Obligations | Total | Less Than 1 Year | 1-3 Years | 4-5 Years | After 5 Years | ||||||||||
Notes payable | $ | 1,544,749 | $ | 884,855 | $ | 659,804 | $ | — | $ | — | |||||
Interest on above notes | 128,580 | 75,788 | 52,792 | — | — | ||||||||||
Operating lease obligations | 38,538 | 38,538 | — | — | — | ||||||||||
Purchase commitments under service provider contracts | — | — | — | — | — | ||||||||||
Total contractual obligations | $ | 1,711,867 | $ | 999,181 | $ | 712,686 | $ | — | $ | — | |||||
Critical accounting policies and estimates
Critical Accounting Policies and Estimates
Energytec prepares its financial statements in accordance with accounting principles generally accepted in the United States of America, or GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. In response to SEC Release No. 33-8040, “Cautionary Advice Regarding Disclosure About Critical Accounting Policies,” described below are certain of these policies that are likely to be of particular importance to the portrayal of Energytec’s financial position and results of operations and require the application of significant judgment by management. Energytec will analyze estimates, including those related to oil and gas revenues, reserves and properties, as well as goodwill and contingencies, and base its estimates on historical experience and various other assumptions that management believes to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. You should expect the following critical accounting policies will affect management’s more significant judgments and estimates used in the preparation of Energytec’s financial statements.
Revenue Recognition
The Company recognizes revenue from the sales of crude oil and natural gas when title passes to the customer. Crude oil and natural gas is sold to approximately six purchasers located in Texas. The Company receives revenues directly from the purchaser. Revenues from the production of properties in which the Company has an interest with other producers are recognized on the basis of the Company’s net working or royalty interest. Revenues owned by working interest partners are recorded as accounts payable, revenues. Lease operating expenses and capital expenditures to be borne by the working interest partners are netted against their portion of revenues.
Revenues from the workover and rehabilitation of oil and gas properties through the Company’s CWS subsidiary are recognized when the services have been performed.
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The Company also recognizes income from the transportation of natural gas through its pipeline. Revenue is recognized when title passes to the customer and is based upon the volume of natural gas passing through the pipeline. Gas sales in the accompanying consolidated financial statements represent the revenue received from the customer based upon the volume of gas at a spot rate determined pursuant to a purchase contract with the customer. Gas purchases represent the gas purchased at the spot rate as defined by the purchase contract less a fee of $0.55 per mcf.
The Company recognized drilling revenue under a drilling program agreement at a standard daily drilling rate of $3,000 per day plus costs as drilling progresses.
Oil and Gas Properties
Energytec uses the successful efforts method of accounting for oil and gas producing activities. Costs to acquire mineral interests in oil and gas properties, to drill and equip exploratory wells that find proved reserves, and costs to drill and equip development wells are capitalized. Costs to drill exploratory wells that do not find proved reserves, geological and geophysical costs, and costs of carrying and retaining unproved properties are expensed.
Unproved oil and gas properties that are individually significant are periodically assessed for impairment of value and a loss is recognized at the time of impairment by providing an impairment allowance. Other unproved properties are amortized based on the Energytec’s experience of successful drilling and average holding period. Capitalized costs of producing oil and gas properties, after considering estimated residual salvage values, are depreciated and depleted by the unit of production method. Support equipment and other property and equipment are depreciated over their estimated useful lives.
On the sale or retirement of a complete or partial unit of a proved property, the cost and related accumulated depreciation, depletion, and amortization are eliminated from the property accounts, and the resultant gain or loss is recognized.
On the sale of an entire interest in an unproved property for cash or cash equivalent, gain or loss on the sale is recognized, taking into consideration the amount of any recorded impairment if the property had been assessed individually. If a partial interest in an unproved property is sold, the amount received is treated as a reduction of the cost of the interest retained.
Oil and Gas Reserves
The process of estimating quantities of oil and gas reserves is complex, requiring significant decisions in the evaluation of all available geological, geophysical, engineering and economic data. The data for a given field may also change substantially over time as a result of numerous factors including, but not limited to, additional development activity, evolving production history and continual reassessment of the viability of production under varying economic conditions. As a result, material revisions to existing reserve estimates may occur from time to time. Although every reasonable effort is made to ensure that reserve estimates reported represent the most accurate assessments possible, the subjective decisions and variances in available data for various fields make these estimates generally less precise than other estimates included in the financial statement disclosures.
Energytec will use the unit-of-production method to amortize our oil and gas properties. Changes in proved developed reserve quantities will cause corresponding changes in depletion expense in periods subsequent to the quantity revision.
Impairment of Long-Lived Assets
Energytec will account for its long-lived assets, including oil and gas properties, under the provisions of SFAS No. 144. This provision requires the recognition of an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and measure an impairment loss as the difference between the carrying amount and the fair value of the asset. The Company recorded impairment of $120,905 for the year ended December 31, 2004.
Accounting for Asset Retirement Obligations
Energytec will account for the asset retirement obligations under the provisions of FASB No. 143, which requires the fair value of the liability for an asset retirement obligation be recognized in the period in which it is incurred. When the liability is initially recorded, the offset is capitalized by increasing the carrying amount of the long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. To settle the liability, the obligation is paid, and to the extent there is a difference between the liability and the amount of cash paid, a gain or loss upon settlement is recognized.
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Federal Income Taxes
Energytec will account for federal income taxes under the provisions of SFAS No. 109, which requires the recognition of deferred tax assets and liabilities for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax basis. In addition, the recognition of future tax benefits, such as net operating loss carry forwards, are required to the extent that realization of such benefits are more likely than not.
Accounting for Stock-Based Compensation
SFAS No. 123, “Accounting for Stock-Based Compensation,” encourages entities to recognized compensation costs for stock-based employee compensation plans using the fair value method of accounting, as defined therein. In December 2004, the FASB issued SFAS 123R, “Share-Based Payments,” revising SFAS No. 123, “Accounting for Stock Based Compensation,” and superseding “Accounting for Stock Issued to Employees.” SFAS 123R establishes standards for the accounting of transactions in which an entity exchanges it equity instruments for goods or services, including obtaining employee services in share-based payment transactions. SFAS 123R applies to all awards granted after the effective date and to awards modified, purchased or canceled after that date. Adoption is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. Energytec adopted SFAS 123R in the first quarter of 2005.
Goodwill
Energytec will account for any goodwill it may recognize in the future in accordance with Statement of Financial Accounting Standard (SFAS) No. 142,Goodwill and Other Intangible Assets. SFAS No. 142 requires an annual impairment assessment. A more frequent assessment is required if certain events occur that reasonably indicate an impairment may have occurred. The volatility of oil and gas prices may cause more frequent assessments. The impairment assessment requires Energytec to make estimates regarding the fair value of the reporting unit. The estimated fair value is based on numerous factors, including future net cash flows of Energytec’s estimates of proved reserves as well as the success of future exploration for and development of unproved reserves. These factors are each individually weighted to estimate the total fair value of the reporting unit. If the estimated fair value of the reporting unit exceeds its carrying amount, goodwill of the unit is considered not impaired. If the carrying amount exceeds the estimated fair value, then a measurement of the loss must be performed, with any deficiency recorded as an impairment.
Contingencies
A provision for contingencies is charged to expense when the loss is probable and the cost can be reasonably estimated. Determining when expenses should be recorded for these contingencies and the appropriate amounts for accrual is a complex estimation process that includes subjective judgment. In many cases, this judgment is based on interpretation of laws and regulations, which can be interpreted differently by regulators and/or courts of law. Energytec will closely monitor known and potential legal, environmental, and other contingencies and periodically determine when it should record losses for these items based on information available to it.
Recent Accounting Pronouncements
During the year ended December 31, 2005, and through June 2006, there were several new accounting pronouncements issued by the Financial Accounting Standards Board (FSAB) the most recent of which was SFAS No. 156, “Accounting for Servicing of Financial Assets- an Amendment of FASB Statement No. 140”. Each of these pronouncements, as applicable, has been or will be adopted by the Company. Management does not believe the adoption of any of these accounting pronouncements has had or will have a material impact on the Company’s financial position or operating results
During 2004, the EITF discussed Issue No. 04-9, “Accounting for Suspended Well Costs.” SFAS No. 19 “Financial Accounting and Reporting by Oil and Gas Producing Companies,” requires costs of drilling exploratory wells to be capitalized pending determination of whether the well has found proved reserves. If the well has found proved reserves, the capitalized costs are included in wells, equipment and facilities. If, however, the well has not found proved reserves, the capitalized costs of drilling the well are expensed, net of any salvage value, within one year except under certain specific circumstances. The application of this guidance has caused confusion within the industry. The EITF removed this issue from their September 2004 meeting and requested that the FASB consider an amendment to SFAS No. 19 to address this issue. The FASB issued on February 5, 2005 an FSP that would amend SFAS No. 19 to permit the continued capitalization of
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exploratory wells costs beyond one year if the well had found sufficient quantity of reserves to justify its completion as a producing well and that the company is making sufficient progress assessing the reserves and the economic and operating viability of the project. The FSP was effective April 4, 2005.
Energytec will continue to carry as an asset the cost of drilling exploratory wells that find sufficient quantities of reserves to justify their completion as producing wells if the required capital expenditure is made and drilling of additional exploratory wells is under way or planning for the near future. Once these activities have demonstrated that the reserves are economically producible, the project will be reviewed to ensure proper capital is allocated to the project so the proper development of the reserves is accomplished. Exploratory wells not meeting these criteria will be expensesd and Energytec does not believe that this issue will have a material impact on its financial statements.
Forward-Looking Statements
This report contains forward-looking statements within the meaning of the federal securities laws that relate to future events or Energytec’s future financial performance. All statements in this report that are not historical facts, including, but not limited to, statements about oil and gas exploration and development activities, oil and gas reserves, oil and gas prices, competition with other oil and gas companies, government regulation of the oil and gas industry and related matters, and plans and objectives for future operations, are hereby identified as “forward-looking statements.” The words “may,” “should,” “will,” “expect,” “could,” “anticipate,” “believe,” “estimate,” “plan,” “intend” and similar expressions have been used to identify certain of the forward-looking statements. Forward-looking statements are based on current expectations, estimates, and projections, and they are subject to a number of risks, uncertainties, and assumptions that could cause actual results to differ materially from those described in the forward-looking statements. Such forward-looking statements should, therefore, be considered in light of various important factors, including those set forth in our Form 10 registration statement filed with the Securities and Exchange Commission May 2, 2005, as amended September 19, 2005.
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange, interest rates, and commodity prices.
The Company is not currently involved in any hedge contracts or foreign contracts and therefore has no exposure to such risks.
Our major market risk exposure is in the pricing applicable to our oil production and natural gas sales. Realizing pricing is primarily driven by the prevailing domestic price for crude oil. Historically, prices received for oil and gas sales have been volatile and unpredictable. We expect pricing volatility to continue. Oil prices ranged from a low of $35.75 per barrel to a high of $64.40 per barrel during the first nine months of 2005. Gas prices during 2005 ranged from a low of $4.54 per mcf to a high of $6.90 per mcf. A significant decline in the prices of oil or natural gas could have a material adverse effect on our financial condition and results of operations.
Increase in revenues is dependent upon acquisition of additional properties and re-completions on existing wells. Energytec’s ability to close on acquisitions are subject to due diligence which includes the verification of clear titles on acquired leases and the ability to close in a timely manner. Title issues or other matters that delay closing could have a material adverse effect on the acquisition of properties, resulting in expenses incurred without the realization of any additional revenues. Energytec is subject to regulatory action from the Texas Railroad Commission and other agencies, including, but not limited to the Environmental Protection Agency and Texas Parks and Wildlife. Any non-compliance with these agencies could materially impact Energytec’s ability to secure the necessary permits to re-complete additional wells or to produce and sell oil and gas.
| ITEM 4. | CONTROLS AND PROCEDURES |
Subsequent to December 31, 2005, material weaknesses in Energytec’s internal controls and procedures became apparent. The Company carried out an evaluation, under the supervision and with the participation of the Company’s Disclosure Committee and management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2005, and for prior periods. Based upon this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were not effective because of the material weaknesses described below. As a result, reports filed by the Company with the Securities and Exchange Commission prior to December 31, 200,5 contained information that was inaccurate or did not include all relevant disclosure. Furthermore, certifications signed and filed by
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Frank W Cole as the former Chief Executive Officer and Chief Financial Officer of Energytec with the Securities and Exchange Commission under the Sarbanes-Oxley Act of 2002 were false.
Because the Company is currently a non-accelerated filer, the internal control over financial reporting as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) has not been subjected to audit by an independent registered accounting firm. However, management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed under the supervision of the Company’s principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. In light of the material weaknesses described below, the Company performed additional analysis and other post-closing procedures to ensure its consolidated financial statements are prepared in accordance with generally accepted accounting principles. Accordingly, management believes that the consolidated financial statements included in this report fairly present in all material respects our financial position, results of operations and cash flows for the periods presented.
The Company did not maintain an effective control environment as related to its disclosure controls and procedures and as defined in the Internal Control-Integrated Framework published by the Committee of Sponsoring Organizations of the Treadway Commission. Specifically, the following control deficiencies were identified:
| • | Only two persons, Frank W Cole and his assistant, had responsibility for and authority to approve invoices and related entries in the accounting records and to issue checks for the payment of Company expenses and obligations throughout 2005, |
| • | As Mr. Cole was both the Chief Executive Officer and Chief Financial Officer, there was no effective check on his conduct or activities, |
| • | Mr. Cole falsified or directed his assistant to falsify Company records, and because of his position and control of the operations, records, bank accounts, and communication of information within the Company, his misdeeds could not be readily identified or addressed, |
| • | As the Chief Executive Officer and Chief Financial Officer Mr. Cole controlled communication of disclosure and financial issues to the Board of Directors, its committees, and management, and |
| • | The Company did not establish effective polices and procedures to address the risk of override in the financial reporting process by Mr. Cole. |
As a result of the foregoing, the Company undertook an investigation of the financial transactions and underlying records, identifying the following:
| • | The expenditure of amounts totaling approximately $345,000 related to the payment of fictitious invoices, personal use of employee time and materials by the district manager of the Talco field office, |
| • | Payment of $7,002,395 of commissions to individuals in violation of Federal and state securities laws and/or rules of the National Association of Securities Dealers, Inc., |
| • | The overstatement of Energytec’s reserves for 2003 by 1,294,441 barrels of oil and for 2004 by 1,178,930 barrels of oil, |
| • | The payment of approximately $86,000 to various vendors during the first quarter of 2006 to plug wells, near Wichita Falls, Texas, which were not owned by Energytec, and |
| • | The sale of 83.62% of the working interest in properties which collateralized a bank loan in the amount of approximately $1,900,000. |
The extent of loss due to the personal use of Company assets and employees which is currently estimated to be approximately $345,000, was incurred over a period of approximately 26 months, affecting 2004, 2005, and the first quarter of 2006. The audited financial statements include disclosure related to the recognition of these amounts, but the financial statements have not been restated because the impact to each period did not significantly impact the overall financial
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statements. The commissions associated with the sale of working interests were properly accounted for as a cost reducing the gain on the sale of the working interests as disclosed in the audited consolidated financial statements and the accompanying notes. Commissions related to the sale of common stock through the private placements were either recorded as expenses or as acquisition costs for those proceeds that were specifically utilized for the acquisition of oil and gas properties. Disclosure of these amounts has been provided in the notes to the audited consolidated financial statements included in this report.
The reserves for the years ended December 31, 2004 and 2003 were incorrectly reported in Energytec’s 2004 and 2003 SAS 69 disclosures and reserve information presented in Energytec’s Form 10 filed with the Securities and Exchange Commission in May 2005 and subsequent amendments. Energytec has updated the reserve reports and has restated the SAS 69 disclosures for the years ended December 31, 2004 and 2003, to remove reserves associated with the wells that were without the proper permitting and spacing required by the RRC; to assign reserves that are supported by actual production in the Talco/Trix-Liz Field and Sulphur Bluff Field; and to assign the correct ownership percentages to Energytec’s oil and gas wells.
Pursuant to the revision of reserves, Energytec evaluated the impairment valuation for the years ended December 31, 2004 and 2003. No charge to impairment was necessary because the reduction in the proved developed and undeveloped reserves did not reduce the estimated value of the reserves below the book value at current market conditions. Additionally, Energytec can secure the necessary permits associated with the 23 dually completed wells and resolve the spacing requirements, bringing these wells into compliance with the rules of the RRC as previously discussed elsewhere in this report, resulting in the ability to assign reserves to the affected reservoirs.
Subsequent to March 18, 2006, the incumbent management with the oversight of the Audit Committee has been aggressively addressing all of the above material weaknesses in our internal control over financial reporting and disclosure controls and procedures. Management has implemented disclosure controls to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934, is processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and reported to the appropriate level of management. Specifically, these disclosure controls include regularly scheduled management meetings which include operational supervisors and employees, open discussion of current and planned operations, regularly scheduled meetings with the Finance Committee of the Board of Directors who oversee the operating budget and expenditures, capital expenditures budget and the Company’s acquisition and divestiture plans. Additionally, the Company has established a Disclosure Committee which is made up of the Interim CEO, Interim CFO, Controller, Vice President of Drilling and Production, and Purchasing Manager. This committee meets regularly and thoroughly reviews all reports filed or submitted by the Company under the Securities Exchange Act of 1934. Additionally, management with the oversight of the Audit Committee is continuing to evaluate its internal control over financial reporting and other key processes based on the criteria in the Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in anticipation of an audit of management’s assessment as of December 31, 2006, in compliance with the provisions of the Sarbanes-Oxley Act of 2002.
Except as otherwise discussed herein, there have been no changes in the Company’s internal control over financial reporting during the most recently completed fiscal quarter, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II
| ITEM 5. | OTHER INFORMATION |
As noted in “ITEM 4. CONTROLS AND PROCEDURES”, subsequent to December 31, 2005, material weaknesses in Energytec’s internal control were discovered. On July 21, 2006, Energytec filed its Form 10-K for the year ended December 31, 2005, with the Securities Exchange Commission. In “ITEM 1. BUSINESS, Recent Developments” of the 2005 Form 10-K additional information concerning the events and circumstances that led to the discovery of the deficiencies and subsequent actions is provided.
On November 3, 2005, Energytec acquired approximately 2,500 acres in Bowie County along with substantial supporting data for the Company’s Redwater Project. The cost of the acquisition was $240,000.
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| ITEM 6. | EXHIBITS |
| Exhibit No. | Title of Document | |
| 31.1 | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 31.2 | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 32.1 | Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| �� | Energytec, Inc. | |||||||
| Date: September 6, 2006 | By: | /s/ Don Lambert | ||||||
Don Lambert President and Chief Executive Officer | ||||||||
| Date: September 6, 2006 | By: | /s/ Dorothea Krempein | ||||||
Dorothea Krempein Chief Financial Officer | ||||||||
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