UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________________________________________
Form 10-Q
x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 number 000-30219
Chancellor Group, Inc.
(Name of small business issuer in its charter)
Nevada | 87-0438647 |
(State or other jurisdiction of | (I.R.S. Employer Identification No.) |
incorporation or organization) |
216 South Price Road, Pampa, TX 79065
(Address of principal executive offices)
(806-688-9697)
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a smaller reporting company. (Check One):
Large accelerated filer o | Accelerated filer o | |
Non-accelerated filer o | Smaller reporting company x | |
(Do not check if a smaller reporting company) |
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding the issuer's common stock, $.001 par value, was 64,802,781 as of August 1, 2008.
Table of Contents
PART I | FINANCIAL INFORMATION | ||
Item 1. | Financial Statements | 1 | |
Item 2. | Management's Discussion and Analysis or Plan of Operation | 11 | |
Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 16 | |
Item 4T. | Controls and Procedures | 16 | |
PART II | |||
Item 1. | Legal Proceedings | 17 | |
Item 6. | Exhibits | 17 | |
EXHIBIT INDEX | 18 |
ii
Item 1. Financial Statements
Chancellor Group, Inc.
(A Development Stage Company)
I N D E X
Page No. | |
Balance Sheets as at June 30, 2008 (Unaudited) and December 31, 2007 (Audited) | 2 |
Statements of Operations | |
For the Three and Six Months Ended June 30, 2008 and 2007 (Unaudited) | 3 |
Statements of Cash Flows | |
For the Six Months Ended June 30, 2008 and 2007 (Unaudited) | 4 |
Notes to Financial Statements (Unaudited) | 5-10 |
1
Chancellor Group, Inc.
CONSOLIDATED BALANCE SHEETS
June 30, 2008 | December 31, 2007 | ||||||
(Unaudited) | (Audited) | ||||||
ASSETS | |||||||
Current Assets | |||||||
Cash in Bank | $ | 305,075 | $ | 218,118 | |||
Revenue Receivable | 331,492 | 248,680 | |||||
Prepaid Insurance | 60,447 | 0 | |||||
Total Current Assets | 697,014 | 466,797 | |||||
Fixed Assets | |||||||
Leasehold Costs - Developed | 5,000,678 | 4,938,564 | |||||
Office Building & Equipment | 127,463 | 126,073 | |||||
Fleet - Road | 66,052 | 62,263 | |||||
Heavy Field Equipment & Tools | 430,375 | 405,593 | |||||
Accumulated Depreciation | ( 688,679 | ) | (411,495 | ) | |||
Total Fixed Assets | 4,935,889 | 5,120,999 | |||||
Other Assets | |||||||
Unamortized Debt Expense | 45,842 | 55,500 | |||||
Prepaid Long Term Hedge | 33,300 | 70,848 | |||||
Deposits | 250 | 250 | |||||
Total Other Assets | 79,392 | 126,598 | |||||
Total Assets | $ | 5,712,295 | $ | 5,714,394 | |||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||
Current Liabilities | |||||||
Accounts Payable — Chancellor | $ | 109,828 | $ | 109,828 | |||
Accounts Payable - Gryphon Production | 393,349 | 264,800 | |||||
Accrued Interest Payable | 410,910 | 113,028 | |||||
Miscellaneous Accounts Payable & Suspense | 41,576 | 10,044 | |||||
Stock Subscription Payable | 1,602 | 1,602 | |||||
Total Current Liabilities | 957,265 | 499,302 | |||||
Long Term Liabilities | |||||||
Note Payable — Senior Debt | 1,962,557 | 2,108,332 | |||||
Note Payable - Subordinated Debt | 3,797,345 | 3,797,345 | |||||
Installment Loan - Equipment | 56,750 | 63,576 | |||||
Note Payable - Investors | 5,160 | 5,160 | |||||
Total Long Term Liabilities | 5,821,812 | 5,974,413 | |||||
Stockholders’ Equity | |||||||
Common Stock: $.001 par value, 250,000,000 shares authorized, 64,802,781 shares issued and outstanding at December 31, 2007 and June 30, 2008 | 64,803 | 62,605 | |||||
Paid in Capital | 3,221,735 | 3,223,733 | |||||
Accumulated Deficit | ( 4,353,320 | ) | ( 4,045,659 | ) | |||
Total Stockholders’ Equity | ( 1,066,782 | ) | ( 759,321 | ) | |||
Total Liabilities and Stockholders’ Equity | $ | 5,712,295 | $ | 5,714,394 |
See Notes to Unaudited Consolidated Financial Statements
2
Chancellor Group, Inc.
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2008 AND JUNE 30, 2007
(Unaudited)
For the three months ended June 30, | For the six months ended June 30, | ||||||||||||
2008 | 2007 | 2008 | 2007 | ||||||||||
Sales - Net of Royalties Paid | |||||||||||||
Oil | $ | 930,480 | $ | 268,473 | $ | 1,718,096 | $ | 268,473 | |||||
Natural Gas | 230,240 | 21,912 | 379,950 | 21,912 | |||||||||
Other Income | 600 | 0 | 1,750 | 0 | |||||||||
Gross Revenue | 1,161,320 | 290,385 | 2,099,796 | 290,385 | |||||||||
Severance Taxes | 58,692 | 13,881 | 105,245 | 13,881 | |||||||||
Marketing Fees | 9,023 | 1,474 | 16,755 | 1,474 | |||||||||
Royalties Paid | 0 | 0 | 13 | 0 | |||||||||
Net Revenue | 1,093,605 | 275,030 | 1,977,783 | 275,030 | |||||||||
Operating Expenses | |||||||||||||
Lease Operating Expense | 419,050 | 88,157 | 736,715 | 88,157 | |||||||||
Other Operating Expense | 331,454 | 329,426 | 659,573 | 325,658 | |||||||||
General & Administrative Expense | 93,392 | 112,970 | 126,476 | 104,743 | |||||||||
Depreciation, Depletion & Amortization | 138,897 | 136,813 | 277,184 | 136,813 | |||||||||
Total Operating Expense | 982,793 | 667,366 | 1,799,948 | 655,371 | |||||||||
Income (loss) From Operations | 110,812 | ( 392,336 | ) | 177,835 | ( 380,341 | ) | |||||||
Other Income (Expenses) | |||||||||||||
Organization Costs | ( 49,299 | ) | ( 49,299 | ) | |||||||||
Hedge Costs Amortization | ( 11,100 | ) | ( 11,100 | ) | ( 22,200 | ) | ( 11,100 | ) | |||||
Total Other Income (Expense) | ( 11,100 | ) | ( 60,399 | ) | ( 22,200 | ) | ( 60,399 | ) | |||||
Financing Charges | |||||||||||||
Interest | 283,388 | 39,313 | 433,290 | 39,292 | |||||||||
Bank Fees Amortization | 15,419 | 14,170 | 30,006 | 14,170 | |||||||||
Total Financing Charges | 298,807 | 53,483 | 463,296 | 56,462 | |||||||||
Income (Loss) before provision for | |||||||||||||
Income Taxes | ( 109,095 | ) | ( 506,218 | ) | ( 307,661 | ) | ( 494,202 | ) | |||||
Provision for Income Taxes | 0 | 0 | 0 | 0 | |||||||||
Net Income (Loss) | $ | ( 199,095 | ) | $ | ( 506,218 | ) | $ | ( 307,661 | ) | $ | ( 494,202 | ) | |
Net Income (Loss) per Share (Basic and Fully Diluted) | $ | ( * | ) | $ | ( * | ) | $ | ( * | ) | $ | ( * | ) | |
Weighted Average Number of Common Shares Outstanding | 64,802,781 | 60,828,906 | 64,802,781 | 63,253,906 |
* Less than $.01 per Share
See Notes to Unaudited Consolidated Financial Statements
3
Chancellor Group, Inc.
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2008 AND JUNE 30, 2007
(Unaudited)
June 30, 2008 | June 30, 2007 | ||||||
Cash Flows From Operating Activities: | |||||||
Net Income (loss) | $ | ( 307,661 | ) | $ | ( 506,218 | ) | |
Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities: | |||||||
Depreciation & Amortization | 277,184 | 136,813 | |||||
(Increase) Decrease in Operating Assets | ( 96,054 | ) | ( 176,887 | ) | |||
Increase (Decrease) in Operating Liabilities | 457,963 | 44,907 | |||||
Net Cash Provided by (used for) Operating Activities | 331,432 | ( 501,385 | ) | ||||
Cash Flows From Investing Activities Capital Expenditures | ( 92,074 | ) | ( 5,489,303 | ) | |||
Net Cash Provided by (used for) Investing Activities | ( 92,074 | ) | ( 5,489,303 | ) | |||
Cash Flows From Financing Activities | |||||||
Notes Payable | ( 152,601 | ) | 6,072,000 | ||||
Paid in Capital | 37,500 | ||||||
Sales of Common Stock | 200 | 0 | |||||
Net Cash Provided by (used for) Financing Activities | ( 152,401 | ) | 6,109,500 | ||||
Net Increase (Decrease) in Cash | 86,957 | 118,812 | |||||
Cash at the Beginning of the Period | 218,118 | 829 | |||||
Cash at the End of the Period | $ | 305,075 | $ | 119,641 |
See Notes to Unaudited Consolidated Financial Statements
4
Chancellor Group, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
NOTE 1. ORGANIZATION, OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Chancellor Group, Inc. (the "Company") was incorporated in the state of Utah on May 2, 1986, and then, on December 31, dissolved as a Utah corporation and reincorporated as a Nevada corporation. The Company's primary business purpose is to engage in the exploration and production of oil and gas. In 1996 the Company's corporate name was changed from Nighthawk Capital, Inc. to Chancellor Group, Inc.
On April 16, 2007, the Company closed the acquisition of assets from Caldwell Production Company, Inc., consisting of 48 mineral leases with 631 wells, of which approximately 100 were believed to be producing wells and 531 inactive well bores equipped with necessary production equipment, and related operating facilities and equipment including an office warehouse facility, ten pickup trucks, two pulling rigs, a backhoe, a winch truck and a water truck. The purchase price for such oil field equipment was $291,500. The purchase price for the mineral leases and an existing office building, including an attached warehouse/shop building valued at $81,630, was $5,000,000. The oil and natural gas leases purchased are on approximately 14,000 acres in Gray and Carson Counties, Texas, with a well spacing of 10 acres, and are in the Panhandle Field, discovered in 1920. After closing the acquisition, the Company has opened corporate offices for our production and oil field service subsidiaries at the purchased facilities in Pampa, Texas.
The plan is to operate our properties and to restore 10-20 wells per month to production. A typical well restoration is estimated to cost $2,500 to $5,000.
Productive capacity at December 31, 2007, was estimated to be 96 bopd and 233 mcfd gas. As of June 30, 2008, 218 wells are producing - an increase of 15 wells since the end of the year. Productive capacity at June 30, 2008 is estimated to be 116 bopd and 236 mcfd gas. The oil is light sweet crude and the natural gas has very high heat content, 1600 to 2600 btu/scf.
As set forth in Note 4 below, on October 30, 2007, we filed for reorganization under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court, District of Northern District of Texas.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Chancellor Group, Inc., and those of its wholly owned subsidiaries: Gryphon Production Company, LLC, and Gryphon Field Services, LLC. These entities are collectively hereinafter referred to as "the Company". Any inter-company accounts and transactions have been eliminated.
Oil and Gas Properties
The Company follows the successful efforts method of accounting for its oil and gas activities. Under this accounting method, costs associated with the acquisition, drilling and equipping of successful exploratory and development wells are capitalized. Geological and geophysical costs, delay rentals and drilling costs of unsuccessful exploratory wells are charged to expense as incurred. The carrying value of mineral leases is depleted over the minimum estimated productive life of the leases, or ten years. Undeveloped properties are periodically assessed for possible impairment due to un-recoverability of costs invested. Cash received for partial conveyances of property interests is treated as a recovery of cost and no gain or loss is recognized.
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Income Tax
Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less as cash equivalents.
Accounting Year
The Company employs a calendar accounting year. The Company recognizes income and expenses based on the accrual method of accounting.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Net Income (loss) per share
The net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of shares of common outstanding. Warrants, stock options, and common stock issuable upon the conversion of the Company's preferred stock (if any), are not included in the computation if the effect would be anti-dilutive and would increase the earnings or decrease loss per share.
Property and Equipment
Property and equipment are recorded at cost and depreciated under the straight line method over the estimated useful life of the equipment. This life is estimated to be five years. The useful life of the office building and warehouse is estimated to be 20 years.
Depletion
The carrying value of the mineral leases is depleted over the minimum estimated productive life of the leases, or ten years.
Accounts Receivable
The Company reviews accounts receivable periodically for collectibles and establishes an allowance for doubtful accounts and records bad debt expense when deemed necessary.
Products and Services, Geographic Areas and Major Customers
The Company plans to develop its domestic oil and gas properties, located in Gray and Carson counties, Texas, and possibly to acquire additional producing oil and gas properties. The Company’s major customers are Valero Marketing, DCP Midstream, and Eagle Rock Energy.
Revenue Recognition
The Company recognizes revenue when a product is sold to a customer, either for cash or as evidenced by an obligation on the part of the customer to pay.
6
Financial Instruments
The carrying value of the Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, and long term debt, as reported in the accompanying balance sheet, approximates fair value.
Employee Stock-Based Compensation
The Company uses the intrinsic value method of accounting for employee stock-based compensation.
Recent Accounting Pronouncements
In March 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 155, "Accounting for Certain Hybrid Financial Instruments." SFAS 155 resolves certain accounting issues related to various hybrid financial instruments. The Company has adopted the provisions of SFAS No. 155 which are effective for fiscal years beginning after September 15, 2006. The adoption did not have a material effect on the results of operations of the Company.
In March 2006, the FASB issued SFAS No. 156 "Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". This statement requires all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable, and permits for subsequent measurement using either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of Statement No. 140. The Company has adopted the provisions of SFAS No. 156, which are effective in general for an entity's fiscal year beginning after September 15, 2006. The adoption did not have a material effect on the results of operations of the Company.
In December 2006, the FASB issued SFAS No. 157 "Fair Value Measurements", to improve consistency and comparability in fair value measurements, and to expand related disclosures. The Company has adopted the provisions of SFAS No. 157, which are effective for financial statements for fiscal years beginning after November 15, 2007. The adoption did not have a material effect on the results of operations of the Company.
In September 2006 the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans”. SFAS No. 158 requires the Company to recognize the funded status of its post retirement plans on the balance sheet and recognize as a component of accumulated other comprehensive income the gains and losses, prior service costs or credits that occur during the financial year but are not recognized as components of the Company’s pension costs This Statement is effective as of the beginning of its first fiscal year that begins after December 15, 2008. The Company does not expect application of SFAS No. 156 to have a material affect on its financial statements.
In February 2007 the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115”. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The amendment to SFAS No. 115 applies to all entities with investments in available-for-sale or trading securities. The statement is effective for fiscal years beginning after November 15, 2007. The Company does not expect application of SFAS No. 159 to have a material affect on its financial statements.
7
NOTE 2. INCOME TAXES
Deferred income taxes arise from the temporary differences between financial statement and income tax recognition of net operating losses. These loss carryovers are limited under the Internal Revenue Code should a significant change in ownership occur. The Company accounts for income taxes pursuant to SFAS 109.
At December 31, 2007, the Company had approximately $4.3 million in unused federal net operating loss carry-forwards, which begin to expire principally in the year 2011. A deferred tax asset of approximately $1,462,000 resulting from the loss carry-forward has been offset by a 100% valuation allowance. The increase in the valuation allowance from year end 2006 to the end of 2007 was approximately $334,900. The net operating loss carry-forwards may be limited under the Change of Control provisions of the Internal Revenue Code section 382.
At June 30, 2008, the Company had approximately $4.6 million in unused federal net operating loss carry-forwards, which begin to expire in the year 2011. A deferred tax asset of approximately $1,564,000 resulting from the loss carry-forward has been offset by a 100% valuation allowance. The increase in the valuation allowance from year end 2007 to the end of June 30, 2008 was approximately $102,000. The net operating loss carry-forwards may be limited under the Change of Control provisions of the Internal Revenue Code section 382.
NOTE 3. STOCKHOLDERS' EQUITY
Common Stock
The Company has 250,000,000 authorized shares of common stock, par value $.001, with 64,802,781 shares issued and outstanding as of June 30, 2008 which was unchanged from the year end.
Preferred Stock
Preferred Series B Stock - The Company has provided for the issuance of 250,000 shares, par value $1,000 per share, of convertible Preferred Series B stock ("Series B"). Each Series B share is convertible at into 166.667 shares of the Company's common stock upon election by the shareholder, with dates and terms set by the Board. No shares of Series B preferred stock are outstanding.
Stock Options
Non-employee Stock Options
The Company accounts for non-employee stock options under SFAS 123 (as amended by SFAS 148), whereby options costs are recorded based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. During the years ended December 31, 2006 and 2007, no options were issued, exercised or cancelled. There were no stock options issued in the first quarter of 2008.
The Company currently has stock options outstanding in the following amounts: 2,000,000 options exercisable for one share of common stock at an exercise price of $0.025 per share, currently exercisable, expiring December 31, 2009, and 4,000,000 options exercisable for one share of common stock at an exercise price of $0.02 per share, currently exercisable, expiring December 31, 2009.
In addition, at the closing of the purchase of the Caldwell Assets, pursuant to an Agreement to Issue Warrants, dated April 13, 2007, with CapWest Resources, Inc. (“CapWest”), we also issued CapWest a warrant (“CapWest Warrants”) to purchase 2,000,000 shares of our common stock, at a purchase price of $0.001 per share, which warrant is exercisable at any time up to April 13, 2012. CapWest has a put option during the period beginning on the first to occur of the following dates (a) the second anniversary of our Loan Agreement with CapWest; or (b) the date when the Company shall have paid CapWest’s loan in full to put the CapWest Warrants to the Company for repurchase at an exercise price of $1,000,000. These amounts are unchanged between December 31, 2007 and June 30, 2008.
Employee Stock Options
The Company accounts for non-employee stock options under SFAS 123 (as amended by SFAS 148). The Company issued no employee stock options and had none outstanding at the end of 2005, 2006 or as of the close of the year ending December 31, 2007. There were no stock options issued in the first and second quarters of 2008.
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NOTE 4. GOING CONCERN UNCERTAINTY
These financial statements are presented assuming the Company will continue as a going concern. The Company has had recurring losses from operations, negative working capital, and stockholders' equity deficiency. This raises substantial doubt about its ability to continue as a going concern. Management's plan in regard to these matters includes restoring sufficient production capacity from the recently acquired properties so as to achieve positive cash flow, as well as raising working capital to assure the Company's viability, through private or public equity offerings and/or debt financing; and acquiring and developing profitable oil and gas properties. There can be no assurance that either operating or capital market transactions will be successful.
The Company filed a bankruptcy petition on October 30, 2007 under Chapter 11 of the United States Bankruptcy Code, and our operating subsidiaries, Gryphon Production Company, LLC and Gryphon Field Services, LLC, filed bankruptcy petitions under Chapter 11 of the Code on October 29 and October 30, 2007, respectively. At this time, the Company is managing its operations and those of its two subsidiaries as a debtor in possession. Our intention making in the Chapter 11 filings was to continue operations of the Company through the Chapter 11 bankruptcy process and to emerge from the Chapter 11 reorganization as an operating company, with our financial structure reorganized, and where all of our creditors would receive the full amounts owed. However, there is no assurance that we will be able successfully to reorganize our company in this bankruptcy proceeding.
NOTE 5. CONTINGENT LIABILITY
On August 4, 2007, the Company received a letter from David L. Kagel, a former attorney for the Company, indicating his intention to initiate an arbitration proceeding or to file a lawsuit for recovery of $50,489 (including interest) for services rendered over several years under prior management. The Company believes the claim is without merit and that it has a number of counterclaims against Mr. Kagel. No further action has occurred regarding this issue.
NOTE 6. DEBT
To finance the acquisition of the assets purchased from Caldwell Production Company, Inc., on April 13, 2007, we closed on a Loan Agreement with Western National Bank (“WNB”), Midland, Texas, for a senior loan facility (the “WNB Loan Agreement”). At the closing of the purchase of the Caldwell Assets, we drew down $2.3 million under the WNB Loan Agreement The interest rate under the WNB Loan Agreement is a variable rate equal to the prime rate as defined in this Agreement plus 2%, but in no event to be less than 9.25%.
April 13, 2007, we also entered into a Loan Agreement with CapWest Resources, Inc., Midland, Texas, for an advancing line of credit/term loan facility, under which we drew down at closing $2,700,000 for the balance of the purchase price of the leases, $291,500 for the equipment, $111,000 for bank fees, legal expenses and associated costs, and $130,000 for initial working capital. The interest rate under the CapWest Loan Agreement is a variable rate equal to the prime rate as defined in this Agreement plus 4%. Under the CapWest loan agreement, CapWest has a 2% overriding royalty interest in the Leases.
After the payout of CapWest’s loan, or in the event that the Company is sold, this overriding royalty interest will convert to a 15% net revenue interest in the Leases. This interest may be purchased by us under a formula specified in this Agreement. The CapWest Loan Agreement has now been fully drawn to the initially agreed amount of $3,700,000.
On August 2, 2007, we agreed in principle, subject to definitive documentation, with CapWest to amend the CapWest Loan Agreement in order to increase the loan by $250,000. The terms of the agreement in principle were: a) The Company must pay accrued interest thru July 30, by August 20, 2007. The Company has paid $42,000 in August, and must pay an additional $85,000 by that date; b) CapWest agreed to require monthly interest only thereafter, until December 31, 2007; c) The Company agreed to attempt to raise $250,000 in common equity by October 31, 2007; d) The Company agreed to reduce administrative salaries by $25,000 per month; e) The net revenue interest after payout provided in the CapWest loan was increased from 15% to 20%.
9
On October 30, 2008 the Company filed a bankruptcy petition under Chapter 11 of the United States Bankruptcy Code, and our operating subsidiaries, Gryphon Production Company, LLC and Gryphon Field Services, LLC, filed bankruptcy petitions under Chapter 11 of the Code on October 29 and October 30, 2007, respectively. The current loan balances due to WNB are $1,962,557 and $56,750. WNB has elected under the subordination terms of the loan agreements to take interest and principal payments against its debt. Consequently, the loans to WNB are current as to interest and principal. The interest to CapWest is accruing and is only reduced by the amount that is not applied to the WNB debt according to its regular amortization. The Company has the right to offset those interest and principal payments but has not elected to do so in that neither cash flow or net income is effected. The current loan balance due to CapWest is $3,797,345 and the applicable accrued interest is $410,910.
Note 7. ACCUMULATED COMPENSATED ABSENCES
It is the Company’s policy to permit employees to accumulate a limited amount of earned by unused vacation, which will be paid to employees upon separation from the Company’s service. The cost of vacation and sick leave is recognized when payments are made to employees. These amounts are immaterial and not accrued.
Note 8. SUBSEQUENT EVENT
On July 22, 2008 the Company signed an agreement to sell a substantial portion of the oil and gas leases that it currently operates. The agreement was signed in anticipation of being dismissed from the bankruptcy proceedings. The closing for the sale is expected to be in late August and effective back June 1, 2008. The sales price is for $13.25 million which, at closing, will allow the Company to retire all its debts and retain approximately $2.5 million in cash for working capital.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
Throughout this report, we make statements that may be deemed "forward-looking" statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts, that address activities, events, outcomes and other matters that Chancellor plans, expects, intends, assumes, believes, budgets, predicts, forecasts, projects, estimates or anticipates (and other similar expressions) will, should or may occur in the future are forward-looking statements. These forward-looking statements are based on management's current belief, based on currently available information, as to the outcome and timing of future events. When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this report.
We caution you that these forward-looking statements are subject to all of the risks and uncertainties, many of which are beyond our control, incident to the exploration for and development, production and sale of oil and gas. These risks include, but are not limited to, commodity price volatility, inflation, lack of availability of goods and services, environmental risks, operating risks, regulatory changes, the uncertainty inherent in estimating proved oil and natural gas reserves and in projecting future rates of production and timing of development expenditures and other risks described herein.
BACKGROUND
We are in the business of acquisition, exploration, and development of natural gas and oil properties, and have completed an initial acquisition of oil and gas leases and related facilities and equipment as described below under “Plan of Operation.” As set forth in detail below, on October 30, 2007, we filed for reorganization under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court, District of Northern District of Texas.
Our common stock is quoted on the Over-The-Counter market and trades under the symbol CHAG.PK. As of August 1, 2008, there were 64,802,781 shares of our common stock issued and outstanding.
Six Months Ended June 30, 2008
We had no production operations in the first quarter of calendar year 2007. Our oil production operations began April 16th, 2007 with an effective date of April 1st, 2007. During the period ending December 31, 2007 we produced 23,120 barrels of oil and produced 55,831 mcf gas. We had 84 wells actually producing oil and gas on April 16, 2007 and restored an additional 119 wells by December 31, 2007. In the six month period ended June 30, 2008, we produced 20,575 barrels of oil and produced 47,318 mcf gas, while generating revenues of $2,092,046. During this period, we restored an additional 15 wells, so that at June 30, we had 218 wells actually producing.
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PLAN OF OPERATION
On April 16, 2007, we closed the acquisition of assets from Caldwell Production Company, Inc., consisting of 48 mineral leases with 631 wells, of which approximately 100 were thought to be producing wells and 531 inactive well bores equipped with necessary production equipment, and related operating facilities and equipment including an office warehouse facility, ten pickup trucks, two pulling rigs, a backhoe, a winch truck and a water truck. The purchase price for the mineral leases and an existing office building including an attached warehouse/shop building valued at $81,630, was $5,000,000, and for the equipment $291,500. The oil and natural gas leases purchased are on approximately 14,000 acres in Gray and Carson Counties, Texas, with a well spacing of 10 acres, and are in the Panhandle Field, discovered in 1920. After closing the acquisition, we has opened corporate offices for our production and oil field service subsidiaries at the purchased facilities in Pampa, Texas. After the initial acquisition, the Gryphon Production Company subsidiary we have acquired additional trucks, including an electrical repair “bucket” truck, which is needed to restore electric power to several previously non-producing wells. The cost of this additional equipment was $34,000 and associated tools and equipment was $6,422. We have also acquired a replacement backhoe machine for $67,000. Subsequently, additional field equipment and tools were purchased for $31,184. We were also required to invest $38,949 in the rehabilitation and restoration of the office building.
We commenced operations on April 16, 2007 with what were 84 actually producing wells. As of June 30, 2008, 218 wells are producing. Productive capacity on June 30, 2008 was estimated to be 116 bopd and 236 mcfd. The oil is light sweet crude and the natural gas has very high heat content, 1600 to 2600 btu/scf.
The following table is for the three months ended:
June 30, 2008 | June 30, 2007 | ||||||
Oil and Gas Sales | |||||||
Oil Sales(Bbl) | 7,773 | 9,727 | |||||
Natural Gas Sales (Mcf) | 22,919 | 13,070 | |||||
Average Sales Price: | |||||||
Oil, per Bbl: | $ | 119.70 | $ | 62.76 | |||
Gas, per MMCF: | $ | 10.05 | $ | 8.15 |
Our current production levels for the first six months of 2008 have increased over the the last six months of 2007. The second quarter production has increased by approximately 14 bopd and 59 mcfd gas. We produced 10,077 and 10,498 barrels of oil in the first and second quarters of 2008, respectively. There is no assurance that management will be able to continue to increase production, or to maintain current production levels.
Generally, in managing our business we must deal with many factors inherent in our industry. First and foremost is wide fluctuation of oil and gas prices. Oil and gas markets are cyclical and volatile, with future price movements difficult to predict. While our revenues are a function of both production and prices, wide swings in prices often have the greatest impact on our results of operations.
Our operations entail significant complexities. Advanced technologies requiring highly trained personnel are utilized in restoration of wells and production. The oil and gas industry is highly competitive. We compete with major and diversified energy companies, independent oil and gas companies, and individual operators. In addition, the industry as a whole competes with other businesses that supply energy to industrial, commercial, and residential end users. Our ability to recruit and retain experienced personnel is vital to the success of our endeavors.
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On October 30, 2007, as discussed in more detail under “Liquidity and Capital Resources” below, due to notices of default received from Western National Bank and CapWest Resources, Inc., we filed a bankruptcy petition under Chapter 11 of the United States Bankruptcy Code, and our operating subsidiaries, Gryphon Production Company, LLC and Gryphon Field Services, LLC, filed bankruptcy petitions under Chapter 11 of the Code on October 29 and October 30, 2007, respectively. At this time, the Company is managing its operations and those of its two subsidiaries as a debtor in possession. Our intention making in the Chapter 11 filings was to continue operations of the Company through the Chapter 11 bankruptcy process and to emerge from the Chapter 11 reorganization as an operating company, with our financial structure reorganized, and where all of our creditors would receive the full amounts owed. However, there is no assurance that we will be able successfully to reorganize our company in this bankruptcy proceeding.
We have filed a Plan of Reorganization on March 1, 2008, and an amendment thereto on April 21, 2008. CapWest Resources, Inc. filed a plan of reorganization on April 2, 2008, and we have filed on May 2, 2008, an objection to that plan. On June 20, 2008, we announced that we were in discussions with a mid-size Texas oil and gas company for the purchase by this company of a part of our oil and gas producing properties, thus permitting payment of the Company's and its subsidiaries’ obligations to their secured and unsecured creditors and, subject to Court approval, an early exit from the Chapter 11 bankruptcy proceeding.
The transaction being discussed would leave the Company debt-free, and with some working capital. The Company, and its wholly-owned subsidiaries, Gryphon Production Company LLC and Gryphon Field Services LLC, would retain approximately 116 wells, of which 48 are actively producing, out of a total of approximately 625 wells. The Company and Gryphon Production Company would continue as licensed Texas Railroad Commission operators. Also retained would be all operating equipment, including two rigs, and our 15.9 acre property, with its shop, yard and office complex. On June 21, 2008, we and our two operating subsidiaries filed a motion with the Bankruptcy Court for dismissal of the bankruptcy case, which is scheduled to be decided by the Court in mid-August 2008.
Liquidity & Capital Resources
As of June 30, 2008 the Company had $305,075 of cash on hand. We have an accumulated deficit of $4,353,320 and have a stockholders' deficiency of $1,066,782 at June 30, 2008.
Loan Agreements with Western National Bank and CapWest Resources, Inc.
To finance the acquisition of the assets purchased from Caldwell Production Company, Inc., on April 13, 2007, we closed on a Loan Agreement with Western National Bank (“WNB”), Midland, Texas, for a senior loan facility (the “WNB Loan Agreement”). At the closing of the purchase of the Caldwell Assets, we drew down $2.3 million under the WNB Loan Agreement The interest rate under the WNB Loan Agreement is a variable rate equal to the prime rate as defined in this Agreement plus 2%, but in no event to be less than 9.25%.
On April 13, 2007, we also entered into a Loan Agreement with CapWest Resources, Inc., Midland, Texas (“CapWest”), for an advancing line of credit/term loan facility, under which we drew down at closing $2,700,000 for the balance of the purchase price of the leases, $291,500 for the equipment, $111,000 for bank fees, legal expenses and associated costs, and $130,000 for initial working capital. The interest rate under the CapWest Loan Agreement is a variable rate equal to the prime rate as defined in this Agreement plus 4%. Under the CapWest loan agreement, CapWest has a 2% overriding royalty interest in the Leases. After the payout of CapWest’s loan, or in the event that the Company is sold, this overriding royalty interest will convert to a 15% net revenue interest in the Leases. This interest may be purchased by us under a formula specified in this Agreement.
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On April 26, 2007 we drew $75,000 for additional working capital and start-up expenses. On May 6, 2007 we drew $88,800 to purchase a hedge floor for a portion of our oil production, as required by the loan agreements. On May 7, 2007 we drew $203,000 to fund lease operating expenses and well restorations. On June 14, 2007 we drew $98,000 for the same purposes. The CapWest Loan Agreement has now been fully drawn to the initially agreed amount of $3,700,000.
Effective July 12, 2007, we executed an agreement ("Modification'), amending the WNB Term Note issued pursuant to the WNB Loan Agreement. The Modification changes the monthly payment date from the 15th to the 25th of each month and extended the maturity date of the loan to April 25, 2010.
Pursuant to the terms of the CapWest Loan Agreement, we have previously executed an assignment of overriding royalty interest under which we conveyed to CapWest a 2% overriding royalty interest ("ORRI") in our leases, proportionately reduced to our net revenue interest. In addition to the aforementioned 2% ORRI, after payout of Cap West's loan (as defined in the CapWest Loan Agreement), CapWest will "back-in" for 15% of our gross oil and gas proceeds, conveyed in a Bill of Sale and Assignment of Contractual Rights dated April 13, 2007. We may repurchase this interest based upon a formula specified in the Cap West Loan Agreement. As of August 2, 2007, we entered into a new Bill of Sale and Assignment of Contractual Rights with CapWest that provides for an additional 5% interest for Cap West in the gross oil and gas proceeds from our leases after payout of Cap West's loan, effectively resulting in an increase of the back-in from 15% to 20% of our gross oil and gas proceeds.
We received a notice of defaults dated September 7, 2007 from counsel for WNB and CapWest stating that we were in default of two financial covenants relating to our consolidated debt service coverage ratio under the WNB and CapWest loan documents. We subsequently received letters from WNB and CapWest, both dated September 12, 2007, waiving the previously stated events of default until October 15, 2007. Following the resignation of Bradley W. Fischer as our Chief Executive Officer effective October 16, 2007, we received notices dated that date from WNB and CapWest as to the existence of an event of default regarding our consolidated debt service coverage ratio, which had been waived by both financial institutions through October 15, 2007, and an event of default relating to the departure of Mr. Fischer as our Chief Executive Officer. As to the noticed default regarding our consolidated debt service coverage ratio, the October 16 notices from the lenders provided us until November 15, 2007 to take appropriate curative action. With regard to the management change, both lenders expressed a willingness to meet with Thomas Grantham, Mr. Fischer’s successor as our President and did, in fact, meet with Mr. Grantham. On October 22, 2007, we received an oral communication from a representative of one the lenders to the effect that the lenders would not waive this event of default and that they would not extend the November 15, 2007 compliance deadline for the debt service coverage ratio covenants. In continuing negotiations, on October 25, 2007, the lenders further advised that the banks would not foreclose on the Company’s assets if the Company agreed to pay the lenders in full by December 15, 2007, execute a release of the banks from liability, and deliver into escrow a deed in trust on all our properties and assets that would be released from escrow and delivered to the banks on December 15, 2007 if all loans were not paid in full.
Bankruptcy Filing under Chapter 11 of the Bankruptcy Code
Due to the potential for an immediate event of default under the WNB and CapWest loan agreements, unless we signed additional documents with the banks with the required payoff of their loans by December 15, 2007, on October 30, 2007, we filed a bankruptcy petition under Chapter 11 of the United States Bankruptcy Code (the “Code”) with the United States Bankruptcy Court, Northern District of Texas. Our operating subsidiaries, Gryphon Production Company, LLC and Gryphon Field Services, LLC filed bankruptcy petitions under Chapter 11 of the Code on October 29 and October 30, 2007, respectively, with the same Court. At this time, the Company is managing its operations and those of its two subsidiaries as a debtor in possession.
Our intention making in the Chapter 11 filings is to continue operations of the Company through the Chapter 11 bankruptcy process and to emerge from the Chapter 11 reorganization as an operating company, with our financial structure reorganized, and where all of our creditors would receive the full amounts owed. In the context of our reorganization under Chapter 11 of the Code, we may be required to raise equity capital to fully rework wells that are currently not in production in the next 12 months and to finance our planned business operations. There are no assurances that we will be able to raise additional equity capital. In the event we are unable to obtain additional capital or funding we may be unable to reorganize successfully under Chapter 11 of the Code.
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Reorganization Plans
We filed a Plan of Reorganization dated June 1, 2008 (the “Plan”), providing for repayment of the WNB and CapWest loans over 42- to 60-month periods, the terms of the repayment being dependent on whether the particular lender accepts the Plan. Under the Plan as filed, the holders of common stock of the Company would retain all of their ownership interest. The Company’s oil and gas leases would be assumed under the Plan, and certain executory contracts would be assumed and certain others rejected.
On April 2, 2008, CapWest Resources, Inc. filed its own plan of reorganization and disclosure statement to which we filed an objection on May 2, 2008.
On April 21, 2008, we filed an amended Plan, in which we set forth a preliminary financing commitment we had received that would enable us to pay off our lenders and emerge from the Chapter 11 reorganization proceeding.
On May 2, 2008, we filed our objections to CapWest Resouces, Inc.’s plan of reorganization and disclosure statement. In this filing we included professional evaluations of the value of our oil and gas reserves that show the value of our reserves substantially to exceed the sum of our obligations to Western National Bank and CapWest Resources, Inc.
On June 20, 2008, we announced that we were in discussions with a mid-size Texas oil and gas company for the purchase by this company of a part of our oil and gas producing properties, thus permitting payment of the Company's and its subsidiaries’ obligations to their secured and unsecured creditors and, subject to Court approval, an early exit from the Chapter 11 bankruptcy proceeding.
The transaction being discussed would leave the Company debt-free, and with some working capital. The Company, and its wholly-owned subsidiaries, Gryphon Production Company LLC and Gryphon Field Services LLC, would retain approximately 130 wells, of which 35 are actively producing, out of a total of approximately 625 wells. The Company and Gryphon Production Company would continue as licensed Texas Railroad Commission operators. Also retained would be all operating equipment, including two rigs, and our 15.9 acre property, with its shop, yard and office complex. On June 21, 2008, we and our two operating subsidiaries filed a motion with the Bankruptcy Court for dismissal of the bankruptcy case, which is scheduled to be decided by the Court in mid-August 2008.
CRITICAL ACCOUNTING POLICIES
The Securities and Exchange Commission recently issued "Financial Reporting Release No. 60 Cautionary Advice Regarding Disclosure About Critical Accounting Policies" ("FRR 60"), suggesting companies provide additional disclosures, discussion and commentary on those accounting policies considered most critical to its business and financial reporting requirements. FRR 60 considers an accounting policy to be critical if it is important to the Company's financial condition and results of operations, and requires significant judgment and estimates on the part of management in the application of the policy. For a summary of the Company's significant accounting policies, including the critical accounting policies discussed below, please refer to the accompanying notes to the financial statements.
The Company assesses potential impairment of its long-lived assets, which include its property and equipment and its identifiable intangibles such as deferred charges under the guidance of SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets". The Company must continually determine if a permanent impairment of its long-lived assets has occurred and write down the assets to their fair values and charge current operations for the measured impairment.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rate Risk - Interest rate risk refers to fluctuations in the value of a security resulting from changes in the general level of interest rates. Investments that are classified as cash and cash equivalents have original maturities of three months or less. Our interest income is sensitive to changes in the general level of U.S. interest rates. We do not have significant short-term investments, and due to the short-term nature of our investments, we believe that there is not a material risk exposure.
We are exposed to interest rate risk with borrowing under our loans with Western National Bank (“WNB”) and CapWest Resources (“CapWest”). The interest rate under the WNB Loan Agreement is a variable rate equal to the prime rate as defined in this Agreement plus 2%, but in no event to be less than 9.25%. The interest rate under the CapWest Loan Agreement is a variable rate equal to the prime rate as defined in this Agreement plus 4%. Increases or decreases in the prime rate will cause our interest obligations under these Agreements to increase or decrease correspondingly, subject to the floor in the WNB Agreement.
Credit Risk - Our accounts receivables are subject, in the normal course of business, to collection risks. We regularly assess these risks and have established policies and business practices to protect against the adverse effects of collection risks. As a result we do not anticipate any material losses in this area.
Commodity Price Risk - We are exposed to market risks related to price volatility of crude oil and natural gas. The prices of crude oil and natural gas affect our revenues, since sales of crude oil and natural gas comprise all of the components of our revenues. A decline in crude oil and natural gas prices will likely reduce our revenues, unless we implement offsetting production increases. We do not use derivative commodity instruments for trading purposes.
ITEM 4T. CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and its Chief Financial Officer are primarily responsible for the accuracy of the financial information that is presented in this Quarterly Report. These officers have as of the close of the period covered by this Quarterly Report, evaluated the Company's disclosure controls and procedures (as defined in Rules 13a-4c and 15d-14c promulgated under the Securities Exchange Act of 1934) and determined that such controls and procedures were effective in ensuring that material information relating to the Company was made known to them during the period covered by this Quarterly Report. In their evaluation, no changes were made to the Company's internal controls in this period that have materially affected, or are reasonably likely materially to affect, the Company’s internal control over financial reporting.
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PART II—OTHER INFORMATION
ITEM 1. Legal Proceedings.
On October 30, 2007, we filed a bankruptcy petition under Chapter 11 of the United States Bankruptcy Code (the “Code”) with the United States Bankruptcy Court, Northern District of Texas. Our operating subsidiaries, Gryphon Production Company, LLC and Gryphon Field Services, LLC filed bankruptcy petitions under Chapter 11 of the Code on October 29 and October 30, 2007, respectively, with the same Court. At this time, the Company is managing its operations and those of its two subsidiaries as a debtor in possession. On March 1, 2008, we filed a Plan of Reorganization with the Court, and on April 21, 2008 filed an amendment to that plan. On April 2, 2008, CapWest Resources, Inc. filed its own plan of reorganization and disclosure statement to which we filed a formal objection on May 2, 2008. On June 20, 2008, we announced that we were in discussions with a mid-size Texas oil and gas company for the purchase by this company of a part of our oil and gas producing properties, thus permitting payment of the Company's and its subsidiaries’ obligations to their secured and unsecured creditors and, subject to Court approval, an early exit from the Chapter 11 bankruptcy proceeding.
The transaction being discussed would leave the Company debt-free, and with some working capital. The Company, and its wholly-owned subsidiaries, Gryphon Production Company LLC and Gryphon Field Services LLC, would retain approximately 130 wells, of which 35 are actively producing, out of a total of approximately 625 wells. The Company and Gryphon Production Company would continue as licensed Texas Railroad Commission operators. Also retained would be all operating equipment, including two rigs, and our 15.9 acre property, with its shop, yard and office complex. On June 21, 2008, we and our two operating subsidiaries filed a motion with the Bankruptcy Court for dismissal of the bankruptcy case. At the August 7, 2008 docket call for our motion to dismiss the bankruptcy case, which is scheduled to be decided by the Court in mid-August 2008.
ITEM 6. Exhibits.
31 | Certification of Principal Executive Officer and Chief Financial Officer Pursuant to Section 302 of The Sarbanes Oxley Act of 2002. |
32 | Certification of Principal Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Chancellor Group, Inc. | ||
(Registrant) | ||
By: | /s/ Thomas Grantham | |
President and | ||
Chief Financial Officer |
Dated: August 14, 2008
EXHIBIT INDEX
Description | ||
31 | Certification of Principal Executive Officer and Chief Financial Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 2002. | |
32 | Certification of Principal Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Oxley Act of 2002. |
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