U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-QSB
(Mark One)
[ ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended March 31, 1999
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from _______ to _______
Commission file number 001-12679
ENERGY SEARCH, INCORPORATED
(Exact Name of Small Business Issuer as Specified in its Charter)
TENNESSEE 62-1423071
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
280 FORT SANDERS WEST BLVD., SUITE 200
KNOXVILLE, TENNESSEE 37922
(Address of Principal Executive Offices)
(800) 551-5810
(Issuer's Telephone Number, Including Area Code)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or
for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past
90 days. Yes [X] No [ ]
The number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: 4,019,308 (May 14,
1999)
Transitional Small Business Disclosure Format (check one): Yes [ ]
No [X]
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ENERGY SEARCH, INCORPORATED
PAGE
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS:
BALANCE SHEETS 1
STATEMENTS OF OPERATIONS 3
STATEMENTS OF CASH FLOWS 4
NOTES TO FINANCIAL STATEMENTS 5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATION 5
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 13
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 14
SIGNATURES 16
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ENERGY SEARCH, INCORPORATED
BALANCE SHEETS
MARCH 31, DECEMBER 31,
1999 1998<F*>
----------- ------------
(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 250,663 $ 595,749
Accounts receivable 873,836 980,881
Other current assets 103,760 90,226
----------- -----------
Total current assets 1,228,259 1,666,856
OIL AND GAS PROPERTIES
Proven properties 13,702,986 13,165,858
Unproven properties 211,095 209,616
Wells and related equipment 11,471,970 11,357,198
Less accumulated depreciation, depletion and
amortization (4,797,740) (4,467,912)
----------- -----------
Net oil and gas properties 20,588,311 20,264,760
OTHER ASSETS
Other property and equipment, net 273,680 287,746
Investments in related partnerships 1,733,847 1,713,267
Deferred tax asset 982,000 886,000
Other 214,447 204,780
----------- -----------
Total other assets 3,203,974 3,091,793
TOTAL ASSETS $25,020,544 $25,023,409
=========== ===========
<FN>
<F*>Condensed from audited financial statements
</FN>
ENERGY SEARCH, INCORPORATED
BALANCE SHEETS (CONTINUED)
MARCH 31, DECEMBER 31,
1999 1998<F*>
----------- ------------
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt $ 549,098 $ 546,407
Accounts payable and accrued liabilities 614,311 632,677
----------- -----------
Total current liabilities 1,163,409 1,179,084
LONG-TERM DEBT, less current portion 7,956,494 7,703,369
SHAREHOLDERS' EQUITY
Preferred stock (no par value, 5,000,000 shares
authorized; 175,547 and 175,547 shares of
9% redeemable convertible issued at outstanding
as of March 31, 1999 and December 31, 1998,
respectively) 831,071 847,707
Common stock (no par value, 25,000,000 shares
authorized; 4,019,308 and 4,017,308 shares issued
and outstanding as of March 31, 1999 and
December 31, 1998, respectively) 17,206,862 17,206,862
Accumulated deficit (2,137,292) (1,913,613)
----------- -----------
Total shareholders' equity 15,900,641 16,140,956
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $25,020,544 $25,023,409
=========== ===========
<FN>
<F*>Condensed from audited financial statements
</FN>
See notes to Financial Statements
-2-
ENERGY SEARCH INCORPORATED
STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31, 1999 MARCH 31, 1998
-------------- --------------
REVENUE
Oil & gas sales $ 627,684 $ 647,074
Management fees 23,000 47,566
Net turnkey revenue -- (93,840)
Other revenue 127,560 212,266
---------- ---------
Total revenue 778,244 813,066
OPERATING EXPENSES
Production costs 96,566 156,663
Exploration costs 15,645 53,079
Depreciation, depletion and amortization 388,039 221,960
Interest 160,186 20,433
General and administrative 415,118 519,218
---------- ---------
Total operating expenses 1,075,554 971,353
NET LOSS FROM OPERATIONS (297,310) (158,287)
OTHER INCOME (EXPENSE)
Program subsidies (27,716) (42,546)
Equity in income of related partnerships 5,347 30,821
---------- ---------
Total other income (expense) (22,369) (11,725)
NET (LOSS) BEFORE INCOME TAXES (319,679) (170,012)
INCOME TAX BENEFIT 96,000 50,300
---------- ---------
NET (LOSS) $ (223,679) $(119,712)
BASIC NET (LOSS) PER COMMON SHARE (.06) (0.03)
DILUTED NET (LOSS) PER COMMON SHARE (.06) (0.03)
See notes to Financial Statements
-3-
ENERGY SEARCH, INCORPORATED
STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31, 1999 MARCH 31, 1998
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(223,679) $ (119,712)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation, depletion and amortization expense 388,039 221,960
Equity in income of related partnerships (5,347) (30,821)
Increase in deferred taxes (96,000) (50,300)
(Increase) decrease in assets:
Accounts receivable and due from partnerships 58,299 278,559
Other current assets (13,534) 19,925
Other assets (30,605) (22,139)
Increase (decrease) in liabilities:
Accounts payable and accrued liabilities (18,366) 469,718
--------- ----------
Net cash provided by operating activities 58,807 767,190
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of proven properties (537,128) (1,714,651)
Purchase of wells and other related equipment (114,772) (525,752)
Purchase of other property and equipment (5,708) (29,886)
Distributions from affiliated partnerships 16,014 22,031
Contributions to affiliated partnerships -- (30,536)
Purchase of oil and gas leases (1,479) (8,160)
--------- ----------
Net cash used in investing activities (643,073) (2,286,954)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on stock issuance costs common stock -- (11,250)
Payments on stock issuance costs preferred stock (16,636) --
Proceeds from issuance of long-term debt 270,000 --
Payments on long-term debt (14,184) (6,813)
--------- ----------
Net cash provided by financing activities 239,180 (18,063)
NET INCREASE IN CASH AND CASH EQUIVALENTS (345,086) (1,537,827)
CASH AND CASH EQUIVALENTS - Beginning of period 595,749 2,252,316
-4-
CASH AND CASH EQUIVALENTS - End of period $ 250,663 $ 714,489
========= ==========
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ENERGY SEARCH, INCORPORATED
- ---------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 1999
BASIS OF PRESENTATION
The condensed Balance Sheets as of March 31, 1999 and December 31,
1998, the Statements of Operations for the three-month periods ended March
31, 1999 and 1998 and the Statements of Cash Flows for the three-month
periods ended March 31, 1999 and March 31, 1998 have been prepared by the
Company.
In the opinion of management all adjustments (which include
reclassifications and normal recurring adjustments) necessary to present
fairly the financial position, results of operations and cash flows at
March 31, 1999 and for all periods presented have been made. Preparing
financial statements requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, revenues and
expenses. Actual results may differ from these estimates. Interim results
are not necessarily indicative of results for a full year.
Certain information and footnote disclosures normally included in the
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. It is suggested that
these condensed financial statements be read in conjunction with the
Company's audited financial statements for the year ended December 31, 1998
and notes thereto included in the Form 10-KSB/A filed with the Securities
and Exchange Commission on April 15, 1999.
EARNINGS PER SHARE
Earnings (loss) per share of common and common equivalent stock are
based on the weighted average common shares outstanding and are
retroactively adjusted for stock splits.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
FORWARD-LOOKING STATEMENTS
This discussion and analysis of financial condition and results of
operations, and other sections of this Form 10-QSB, contain forward-looking
statements that are based on management's beliefs, assumptions, current
expectations, estimates and projections about the oil and gas industry, the
economy, and about the Company itself. Words such as "anticipates,"
"believes," "estimates," "expects," "forecasts," "intends," "is likely,"
"plans," "predicts," "projects," variations of such words and similar
-6-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(CONTINUED)
expressions are intended to identify such forward-looking statements.
These statements are not guarantees of future performance and involve
certain risks, uncertainties and assumptions that are difficult to predict
with regard to timing, extent, likelihood and degree of occurrence.
Therefore, actual results and outcomes may materially differ from what may
be expressed or forecasted in such forward-looking statements.
Furthermore, the Company undertakes no obligation to update, amend or
clarify forward-looking statements, whether as a result of new information,
future events or otherwise.
Important factors that could cause actual results to differ materially
from the forward-looking statements include, but are not limited to:
changes in production volumes, worldwide demand and commodity prices for
petroleum natural resources; the timing and extent of the Company's success
in discovering, acquiring, developing and producing natural gas and oil
reserves; risks incident to the drilling and operation of natural gas and
oil wells; future production and development costs; the effect of existing
and future laws, governmental regulations and the political and economic
climate of the United States; the effect of hedging activities; conditions
in the capital markets; and the effects of the Year 2000 issues on the
Company's business.
OVERVIEW
The Company is an independent oil and gas company organized as a
Tennessee corporation in 1990 and engaged in and focused exclusively on the
exploration, development, production and acquisition of natural gas
properties and to a limited extent oil in the Appalachian Basin. The
Company's emphasis is on natural gas production with approximately 90% of
its production in 1998 from natural gas. Daily net production averaged
approximately 2.99 MMcfed in 1998, and currently exceeds 3.0 MMcfed.
The Company's future growth is expected to be driven by development,
exploitation and controlled exploration drilling on its existing properties
and the continuation of an opportunistic acquisition strategy in the
Appalachian Basin region. The Company has over 150 developmental well
sites to drill on its existing leasehold acreage. All of these sites are
located in fields with established production histories.
-7-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(CONTINUED)
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31,
1998
FINANCIAL CONDITION
Total assets decreased $2,865 or .01% from December 31, 1998 to March
31, 1999 primarily due to a decrease of $438,597 in current assets and
after an offsetting net increase in oil and gas properties of $323,551 and
other assets of $112,181.
Current assets for the three-month period ended March 31, 1999
decreased $438,597 to $1,228,259 or a 26.3% decrease compared to current
assets for the year ended December 31, 1998. The decrease in current
assets is due primarily to a decrease in cash of $345,086 to $250,663 or
57.9% for the three-month period ended March 31, 1999. This decrease is
due to the Company's continued expenditures of cash for drilling and
development of wells in its Beaver Lease and Churchtown lease areas as well
as enhancement efforts and development of wells in its Simmons Field and
Viking Field. See "--Cash Flow from Operations, Investing and Financing
Activities" for further discussion.
Oil and gas properties for the three-month period ended March 31, 1999
increased $323,551 to $20,588,311 or1.6% from the amount reported at
December 31, 1998. The increase is primarily a result of continued
successful drilling activity for the Company's own account and the purchase
by the Company of oil and gas lease interests in proven properties.
The Company increased capital expenditures for drilling and well-
related equipment from December 31, 1998 to March 31, 1999 in the amount of
$114,772. The increase is primarily a result of Company drilling in the
first quarter of 1999.
Proven properties increased $537,128 to $13,702,986 or 4.1% from the
amount reported at December 31, 1998. The increase is primarily due to the
purchase by the Company of oil and gas lease interests in proven
properties and the capitalization of intangible drilling costs
(approximately $296,467) associated with the Company drilled wells.
The Company has concluded that certain of the wells it initially
drilled on the Beaver Lease are in need of substantial remediation to
achieve desired rates of production. The remediation project is in the
process of being designed and is expected to commence in the later part of
1999 if capital funds become available. The cost of the remediation
project is not yet known.
-8-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(CONTINUED)
Total liabilities increased $237,450 or 2.7% from December 31, 1998 to
March 31, 1999 due primarily to an increase in long-term debt of $253,125.
See "--Liquidity & Capital Resources" for further discussion. This
increase in long-term debt was used primarily to fund the drilling,
development and enhancement efforts on Company wells described above.
Current liabilities decreased $15,675 to $1,163,409 or 1.3% from December
31, 1998 to March 31, 1999 primarily due to a decrease in accounts payable
and accrued expenses of $18,366 to $614,311 at March 31, 1999, a decrease
of 2.9%.
RESULTS OF OPERATIONS
For the three-month period ended March 31, 1999, the Company had a net
loss after tax of $223,679, compared to net loss after tax of $119,712 for
the three-month period ended March 31, 1998.
For the three-month period ended March 31, 1999, total net revenues
decreased $34,822 or 4.3% from $813,066 to $778,244 for the same period in
1998 due primarily to a decrease in oil and gas revenue, management fees
and other revenue.
Oil and gas revenue decreased $19,390 to $627,684 for the three-month
period ended March 31, 1999, a decrease of 3.0% over that reported as of
March 31, 1998. Net paid production increased 19% from approximately 2.6
MMcfed in the first quarter of 1998 to approximately 3.1 MMcfed in the
first quarter of 1999. Despite the increase in net paid production, oil
and gas revenue decreased due to the decrease in the price of the natural
gas commodity. The average gas price was $2.23 and $2.74 for the three-
month periods ended March 31, 1999 and 1998, respectively.
Management fees for the three-month period ended March 31, 1999
decreased $24,566 to $23,000, a decrease of 51.6% over that reported as of
March 31, 1998. This decrease is a result of the purchase of the working
interests owned by five Affiliated Drilling Partnerships in the third
quarter of 1998 thus eliminating any payment obligation by the Affiliated
Drilling Partnerships to the Company hereafter. Management fees are
derived from services provided to Affiliated Drilling Partnerships, and the
Company expects management fees to continue to decrease.
Other revenue decreased $84,706 for the three-month period ended March
31, 1999, a decrease of 39.9% over that reported for the same period in
1998. This decrease is due primarily to a decrease in the gas
transportation revenue earned by the Company. In 1998, the Company charged
-9-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(CONTINUED)
certain wells a transportation fee for gas flowing through the Company's
pipeline system. Effective in the third quarter of 1998, the Company
eliminated the transportation fee. For the three-month period ended March
31, 1999, the Company recognized no gas transportation revenue compared to
gas transportation revenue of approximately $56,905 for the three-month
period ended March 31, 1998.
The decrease in other revenue is also due to a decrease in the gross
operating commission revenue earned by Equity Financial Corporation ("EFC")
of approximately $16,562 to $120,895, a decrease of 12% over that reported
for the same period in 1998. The decrease is primarily a result of EFC
having reduced its number of actual workers to only one. EFC has been a
profitable segment of the Company's operation. For the three-month period
ended March 31, 1999, EFC had a net loss of approximately $9,749. The
Company expects EFC to be marginally profitable in 1999. If EFC is not
profitable at year-end 1999, management will evaluate the continued
viability of EFC. Interest income decreased approximately $9,893 due to the
decrease in the Company's cash balances.
For the three-month period ended March 31, 1999, the Company
recognized no turnkey revenue compared to a net turnkey expense of $93,840
for the three-month period ended March 31, 1998. Net turnkey revenue is
drilling profit recognized upon the drilling to total depth of wells in
Affiliated Drilling Partnerships. The Company did not sponsor an Affiliated
Drilling Partnership in the first quarter of 1999 or 1998. The turnkey
expense recognized in the first quarter of 1998 was a result of additional
expenses incurred on the 1997 year-end drilling programs.
Management anticipates continued growth in oil and gas revenues;
however, management does not expect the growth to continue at the same high
levels reflected in 1998. The continued growth of the Company's oil and gas
revenues and reserves will be dependent on future drilling success, capital
raising efforts and the pricing of the Company's primary commodity product,
natural gas.
Total operating expenses increased $104,201 or 10.7% for the three-
month period ended March 31, 1999 over the three-month period ended March
31, 1998. This increase is due primarily to an increase in depreciation,
depletion and amortization expense associated with the larger number of
Company wells and increased production of net wells now owned by the
Company of $166,079 or 74.8% and an increase in interest expense of
$139,753 or 684% due to the increase in the Company's long-term debt.
Production expenses and exploration expenses decreased $60,097 and $37,434
-10-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(CONTINUED)
for the three-month period ended March 31, 1999 over that reported for the
same period in 1998. Production expenses decreased in the first quarter
of 1999 primarily due to a change in personnel which resulted in a decrease
in the wages allocated to production expenses. Subject to a change in the
Company's current personnel, this trend should continue. In the first
quarter of 1998, the Company was involved in a project implementing new
technology for exploration and development of the Company's reserves and
well database. The project was substantially completed in the first quarter
of 1998.
General and administrative ("G&A") expenses decreased $104,100 to
$415,118 or 20.0% for the three-month period ended March 31, 1999. This
net decrease is primarily a result of the change in business plan of the
Company to drill primarily for the account of the Company. Certain costs
directly related to drilling of Company wells have been included in the
cost of oil and gas properties. To a lessor extent, G&A expenses decreased
due to a decrease in EFC's G&A included into the G&A costs of the Company
of approximately $126,257, a $30,648 decrease in expenses over that
reported for the same period in 1998.
Other income and expense changed from a net expense of $11,725 for the
three-month period ended March 31, 1998 to a net expense of $22,369 for the
three-month period ended March 31, 1999. The change is primarily a result
of a decrease in the income of related partnerships of $25,474 and an
offsetting decrease in program reimbursement of $14,830. These costs
fluctuate based on production of partnership wells for which the Company is
the managing general partner and will continue at a similar amount during
the remainder of 1999.
CASH FLOW FROM OPERATIONS, INVESTING AND FINANCING ACTIVITIES
The Company provided $58,807 of net cash flow from operating
activities for the three-month period ended March 31, 1999 and provided
$767,190 of net cash flow from operating activities for the same period in
1998. Cash was absorbed by a loss of $223,679 and a loss of $119,712 for
the three-month periods ended March 31, 1999 and 1998, respectively. Cash
was provided by a decrease in accounts receivable and amounts due from
partnerships of $58,299 and $278,559 for the three-month periods ended
March 31, 1999 and March 31, 1998, respectively. The decrease in accounts
receivable for the three-month period ended March 31, 1999 was a result of
a decrease in the oil and gas revenue receivable of $107,045 and an
offsetting increase in the amounts due from partnerships of $48,746. The
decrease in accounts receivable for the three-month period ended March 31,
1998 was a result of the collection of the year-end Affiliated Drilling
-11-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(CONTINUED)
Partnership receivable. Cash was used by an increase in other assets of
$30,605 and a decrease in accounts payable and accrued expenses of $18,366
for the three-month period ended March 31, 1999. The increase in other
assets was primarily a result of an increase in net bank loan costs of
$40,879 and an offsetting decrease in prepaid stock costs of $6,250. Cash
was provided for the three-month period ended March 31, 1998 by an increase
in accounts payable and accrued expenses of $469,718. Cash was provided by
depreciation, depletion and amortization ("DDA") of $388,039 and $221,960
for the three-month periods ended March 31, 1999 and 1998, respectively.
The increase in DDA is a direct result of increased drilling and natural
gas operations.
Cash flows used for investing activities decreased from $2,286,954 for
the three-month period ended March 31, 1998 to $643,073 for the three-month
period ended March 31, 1999. The primary investment activities for the
three-month period ended March 31, 1999 were purchases of proven properties
of $537,128, purchases of wells and related equipment of $114,772 and
purchases of other property and equipment of $5,708. The primary
investment activities for the three-month period ended March 31, 1998 were
purchases of proven properties of $1,714,651, purchases of wells and
related equipment of $525,752, purchases of other property and equipment of
$29,886 and contributions to Affiliated Drilling Partnerships of $30,536.
The cash flow from investing activities were distributions from Affiliated
Drilling Partnerships of $16,014 and $22,031 for the three-month periods
ending March 31, 1999 and 1998, respectively.
Cash flows from financing activities increased $257,243 from the
amount reported at March 31, 1998 to a level of $239,180 for the three-
month period ended March 31, 1999. The significant source of financing
activities in the first quarter of 1999 was proceeds from incurring long-
term debt in the amount of $270,000. The majority of the funds were used
for the Company's continued expenditures for drilling and development of
wells in its Churchtown and Beckley lease areas. The primary cause of the
decrease in cash flows from financing activities was the payment of stock
issuance costs of $16,636 and $11,250 for the three-month periods ending
March 31, 1999 and 1998, respectively. The other significant uses of cash
flows from financing activities were the payments on long-term debt of
$14,184 and $6,813 for the three-month periods ending March 31, 1999 and 1998,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
The primary source of funds in 1999 has been from cash flow from
operations and borrowing against the Company's Bank One credit facility in
-12-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(CONTINUED)
the amount of approximately $270,000. The proceeds from these sources have
been spent on Company operations and developmental drilling activities in
the southeastern Ohio and Southern West Virginia areas.
There can be no assurance that the Company will realize any funds by
the sponsoring of an Affiliated Drilling Partnership in 1999.
The Company intends to fund its budgeted capital expenditures in 1999
primarily from cash flow from operations and borrowings. The Company has
in place a Bank One credit facility with a credit limit which has been
expanded by $1,000,000 to a total of $8,800,000 and upon which $8,019,776
was drawn down as of March 31, 1999. The Bank One credit facility is
collateralized by a first lien on the Company's oil and natural gas
properties. Interest is payable at prime plus 1.50% per annum. The Bank
One credit facility includes a principal reduction of $75,000 per month
commencing on September 1, 1999. The Company also has a note payable to
SunTrust Bank with an outstanding principal balance of approximately $486,000
as of March 31, 1999, collateralized by certain equipment, payable in monthly
installments of principal and interest at 7.75% per annum, with unpaid
principal balance due March 5, 2003. The Company is subject to various
loan covenants in connection with its credit facilities including
requirements on its tangible net worth, debt to tangible net worth, limits
on partnership subsidies, restrictions on payment of dividends and general
and administrative expenses. The Company was in compliance with these
covenants at March 31, 1999.
The Company has experienced and expects to continue to experience
substantial working capital requirements due primarily to the Company's
active exploration and development programs. The Company plans to
commence development of its coalbed methane leases in 1999. The Company
believes that cash flow from operations and borrowings under existing or
contemplated additional credit facilities should allow the Company to
implement its present business strategy in 1999. If sufficient capital
resources are not available to the Company, its drilling of new wells and
property development activities would be substantially curtailed.
EFFECTS OF COMMODITY PRICING AND INFLATION
The Company's revenues, profitability, future growth and ability to
borrow funds or obtain additional capital, and the carrying value of its
properties, substantially are dependent on prevailing prices of natural gas
and oil. The Company cannot predict future natural gas and oil price
movements with certainty. Declines in prices received for natural gas and
-13-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(CONTINUED)
oil may have an adverse effect on the Company's financial condition,
liquidity, ability to finance capital expenditures and results of
operations. Lower prices also may impact the amount of reserves that can
be produced economically by the Company. If the price of natural gas and
oil increases (decreases), there could be a corresponding increase
(decrease) in the operating cost that the Company is required to bear for
operations, as well as an increase (decrease) in revenues. Recent rates of
inflation have had a minimal effect on the Company.
ENVIRONMENTAL AND OTHER REGULATORY MATTERS
The Company's business is subject to certain federal, state and local
laws and regulations relating to the exploration for, and the development,
production and transportation of, natural gas and oil, as well as
environmental and safety matters. Many of these laws and regulations have
become more stringent in recent years. Although the Company believes it is
in substantial compliance with all applicable laws and regulations, the
requirements imposed by laws and regulations may change. The Company is
unable to predict the ultimate cost of compliance with these requirements.
Inability to meet environmental requirements could materially adversely
affect the Company's business, financial condition and results of
operations. Compliance with governmental laws and regulations applicable
to the Company has not had a material adverse effect on the earnings or
competitive position of the Company to date. Future regulations may add to
the cost of, or limit, drilling activity.
YEAR 2000 READINESS DISCLOSURE
This Year 2000 Readiness Disclosure is based upon and partially
repeats information provided by the Company's outside consultants and
others regarding the Year 2000 readiness of the Company and its customers,
suppliers, financial institutions and other parties. Although the Company
believes this information to be accurate, it has not independently verified
such information.
STATE OF READINESS. The Company is acutely aware of and has assessed
and will continue to assess the impact of the Year 2000 issue on the
Company's reporting systems and operations. The Year 2000 issue exists
because many computer systems and applications abbreviate dates by
eliminating the first two digits of the year, assuming that these two
digits would always be "19." Unless corrected, this shortcut may cause
problems with some computer systems and equipment with embedded computer
chips.
-14-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(CONTINUED)
The Company has developed a plan to identify those systems that could
be effected by the Year 2000 problem. Management has identified and
assessed the Year 2000 problem with respect to both information technology
(I.T.) and non-information technology (Non-I.T.) system issues. Management
has concluded that it has minimal Non-I.T. system issues which affect day
to day operations. The primary I.T. Systems for the Company are its
accounting software system and its geological/engineering software
products.
The Company's current accounting system is not presently Year 2000
ready. The Company has, along with outside consultants, evaluated its
current system in comparison with four alternative systems and has
concluded that a change in systems is required to assure readiness for the
Year 2000. The new accounting (I.T.) software chosen is Sherware, Inc.
which has been purchased at a cost of $2,740. Installation and data
conversion to the new system began in April 1999 and is expected to be
fully operational by June 1999 at an all inclusive cost of approximately
$5,000 to $7,000. This cost includes cost of software purchase,
installation, conversion of data from the old to the new system and
training of staff in the operation of the new system.
The Company uses two primary non-accounting software products, a
specialized engineering software, the Aries System, for the evaluation of
production and reserves and the GeoGraphix System geologic software for
reservoir evaluation and modeling. The Company is advised by the
manufacturers that both of these systems are currently Year 2000 compliant.
Lastly, the Company has evaluated Year 2000 issues relating to third
parties with whom the Company does business. These relate primarily to
financial institutions, vendors of products and vendors to whom the Company
sells goods in its normal business operations.
Vendors generally include suppliers of well equipment and services.
Management does not expect the ability of these vendors to supply goods and
services to be adversely affected by the Year 2000 event. The vendor's
billing and invoice systems may experience change and/or delays during the
transition, however. Gas marketers to whom the Company sells its end
product likewise have advised the Company that they are aware of the Year
2000 issue and are or will timely be Year 2000 compliant. Management does
not expect an adverse impact on the Company's day to day operations as a
result of third parties' unreadiness. There is no assurance that the
systems of other companies on which the Company's systems rely will be
converted in a timely manner. Unreadiness by these third parties could
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(CONTINUED)
expose the Company to the potential for loss and impairment of business
processes and activities. The Company is assessing these risks and is
creating contingency plans intended to address perceived risks. If such
modifications and conversions are not made, or are not completed in a
timely manner, the Year 2000 issue could have an adverse impact on the
operations of the Company.
COST TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES. As of May 12, 1999,e
Company has spent approximately $10,000 on identifying and assessing
the Year 2000 issue in connection with the Company's computer programs and
applications, which includes extensive internal personnel hours in
researching the Year 2000 issue and evaluating readiness. Financial
expenditure on outside consultants to date has been minimal. As discussed
above, the decision to change the Company I.T. accounting software system
will be at a total estimated cost of approximately $5,000 to $7,000.
Total anticipated costs of Year 2000 compliance activities is not expected
to exceed $25,000. This amount will be paid from the operating capital
budget and would represent less than one percent of the Company's expected
total G&A expenses for the year.
Based on currently available information, management does not
anticipate that the costs to address the Year 2000 issue will have a
material adverse effect on the Company's financial condition, results of
operations or liquidity. However, the extent to which the computer
operations and other systems of the Company's important third parties are
adversely affected could, in turn, affect the Company's ability to
communicate with third parties and could have a material adverse effect on
the operations of the Company.
RISKS OF THE COMPANY'S YEAR 2000 ISSUES. The Company does not
reasonably expect any material lost revenue as a result of the Year 2000
issue. The most likely worst case scenario would be a delay in financial
analytical abilities of the Company in the event of a delay in implementing
the new I.T. financial software system. Similar delays in third party
vendor invoicing and/or gas marketing reporting and/or payment could be
temporarily experienced. Management does not expect the Year 2000 to have
a materially adverse effect on the Company's results of operation,
liquidity or financial condition.
THE COMPANY'S CONTINGENCY PLAN. The Company is implementing its new
internal accounting system and expects it and all other internal systems to
be fully Year 2000 compliant and tested by June 1999. At that time, the
Company will evaluate further the need and extent to which a "contingency
plan" should be developed with respect to Year 2000 readiness.
-16-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(CONTINUED)
If the Company's plans as outlined above are not successful, there
could be a disruption of the Company's ability to render distributions and
complete monthly accounting functions as well as a possible slowdown of
certain computer-dependent processes.
The costs of becoming Year 2000 compliant as outlined above and the
date that the Company expects to complete the Year 2000 modifications are
based on management's best estimates. There can be no guarantee that these
estimates will be achieved and actual results could differ from those
anticipated. Specific factors that might cause differences include, but
are not limited to, the ability of other companies on which the Company's
systems rely to modify or convert their systems to be Year 2000 compliant,
the ability to locate and correct all relevant computer codes and the
ability of vendors with whom the Company deals to timely become Year 2000
compliant.
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Effective in January of 1999, 90,000 executive officer common stock
purchase warrants became vested equally to Messrs. Torrey, Cooper and Remine.
These warrants have an exercise price of $4.50 per share and are exercisable
at any time. These warrants were issued pursuant to Section 4(2) of the
Securities Act of 1933 and Rule 701 promulgated thereunder.
In January of 1999, outside directors Douglas A. Yoakley and Kim A. Walbe
were issued 1,000 shares of Company common stock each pursuant to the
Company's Stock Option and Restricted Stock Plan of 1998. The issuance of
these shares was exempt from registration under Section 4(2) of the Securities
Act of 1933 and Rule 701 promulgated thereunder.
In December of 1998, effective in January of 1999, the Board of Directors
and the Compensation Committee authorized the reduction of the exercise price
of certain common stock purchase warrants issued to non-employee directors
and employees. These warrants were considered to be cancelled and reissued
under the Company's Stock Option and Restricted Stock Plan of 1998. There
are 19,000 shares of Common Stock issuable pursuant to these reissued options.
The exercise price has been reduced from an initial range of $5.25 to $6.50
per share, to a new exercise price of $4.50 per share. The options currently
are exercisable and have various expiration dates. The reduction of exercise
price and resulting reissuance of warrants was exempt from registration under
-17-
Section 4(2) of the Securities Act of 1933 and Rule 701 promulgated
thereunder.
Also in December of 1998, effective in January of 1999, the Board of
Directors and the Compensation Committee authorized the reduction of the
exercise price of 180,000 vested executive officer common stock purchase
warrants issued in equal amounts to Messrs. Torrey, Cooper and Remine. The
exercise price was reduced from $8.00 per share to $4.50 per share. It is the
Company's intent to bring these warrants under the Stock Option and
Restricted Stock Plan of 1998 if the proposed amendment to the Plan is
adopted by the shareholders at the Company's June 17, 1999 annual meeting of
shareholders. The reduction of exercise price and resulting reissuance of
warrants was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933 and Rule 701 promulgated thereunder.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS. The following document is filed as an exhibit to
this report on Form 10-QSB:
EXHIBIT NO. DOCUMENT
3.1 Fourth Amended and Restated Charter of the Registrant<F1>
3.2 Bylaws of the Registrant<F2>
4.1 Specimen of Common Stock Certificate<F3>
4.2 Specimen of Redeemable Series A Common Stock Purchase
Warrant Certificate<F3>
4.3 Specimen of Underwriters' Warrant Certificate<F3>
4.4 Charter (See Exhibit 3.1)
4.5 Bylaws (See Exhibit 3.2)
9.1 Shareholder Voting Agreement and Irrevocable Proxy<F3>
10.1 Energy Search Natural Gas 1995-A L.P. Limited Partnership
Agreement, dated March 31, 1995<F3>
10.2 Energy Search Natural Gas 1995-A L.P. Joint Drilling and
Operating Agreement, dated March 31, 1995<F3>
10.3 Energy Search Natural Gas 1996 L.P.-Limited Partnership
Agreement, dated June 10, 1996<F3>
10.4 Energy Search Natural Gas 1996 L.P.-Joint Drilling and
Operating Agreement, dated June 10, 1996<F3>
10.5 ESI Pipeline Operating Partnership-Limited Partnership
Agreement, dated January 7, 1993<F3>
10.6 Energy Search Natural Gas Pipeline Income Partnership-
Limited Partnership Agreement, dated January 7, 1993<F3>
10.7 Gas Servicing Agreement between the Registrant and ESI
Pipeline Operating L.P., dated January 5, 1993<F3>
10.8 Selling Agreement-Class B Convertible Preferred Shares
between Registrant and Equity Financial Corporation, dated
March 4, 1996<F3>
-18-
10.9 Selling Agreement-Class A and Class B Preferred Shares
between Registrant and Equity Financial Corporation, dated
March 4, 1996<F3>
10.10 Selling Agreement-Variable Rate Subordinated Debentures
between Registrant and Equity Financial Corporation, dated
September 19, 1994<F3>
10.11 Aircraft Lease between Charles P. Torrey, Jr. and the
Registrant dated February 1, 1995<F3>
10.12 Beaver Coal Company Lease between Beaver Coal Company
Limited and the Registrant, dated September 15, 1996<F3>
10.13 Employment Agreements with officers and key employees of the
Registrant
(a) John M. Johnston<F3><F*>
(b) Robert L. Remine<F3><F*>
(c) Charles P. Torrey, Jr.<F3><F*>
(d) Richard S. Cooper<F3><F*>
(e) Michael W. Mooney<F4><F*>
10.14 Promissory Notes of Executive Officers in Favor of
Registrant
(a) Charles P. Torrey, Jr.<F3>
(b) Robert L. Remine<F3>
(c) Richard S. Cooper<F3>
10.15 Stock Option Plan<F3><F*>
10.16 Outside Directors' Stock Option Plan<F3><F*>
10.17 Form of Lock-Up Agreement<F3>
10.18 Stock Option and Restricted Stock Plan of 1998<F1><F*>
10.19 Form of Indemnification Agreement <F1><F*>
10.20 1998 Stock Option and Restricted Stock Plan for Outside
Advisors and Consultants<F5>
27.1 Financial Data Schedule
- -------------------------------
<F*> Management contract or compensatory plan or arrangement.
-19-
<F1> Previously filed with the Company's Definitive Proxy Statement filed
on April 28, 1998 with the Securities and Exchange Commission, and
here incorporated by reference.
<F2> Previously filed with the Company's Form 10-QSB for the quarter ended
June 30, 1998.
<F3> Previously filed with the Company's Registration Statement on Form SB-
2 (Registration No. 333-12755) filed with the Securities and Exchange
Commission, and here incorporated by reference.
<F4> Previously filed with the Company's Form 10-KSB Annual Report for the
fiscal year ended December 31, 1997, and here incorporated by
reference.
<F5> Previously filed with the Company's Form 10-QSB Quarterly Report for
the quarter ended September 30, 1998, and here incorporated by
reference.
(b) REPORTS ON FORM 8-K. The Company did not file a Form 8-K report
during the three-month period ended March 31, 1999.
-20-
SIGNATURES
In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ENERGY SEARCH, INCORPORATED
Date: May 14, 1999 By /S/ RICHARD S. COOPER
Richard S. Cooper, President
Date: May 14, 1999 By /S/ ROBERT L. REMINE
Robert L. Remine, Chief Financial Officer
-21-
EXHIBIT INDEX
EXHIBIT NO. DOCUMENT
3.1 Fourth Amended and Restated Charter of the Registrant<F1>
3.2 Bylaws of the Registrant<F2>
4.1 Specimen of Common Stock Certificate<F3>
4.2 Specimen of Redeemable Series A Common Stock Purchase
Warrant Certificate<F3>
4.3 Specimen of Underwriters' Warrant Certificate<F3>
4.4 Charter (See Exhibit 3.1)
4.5 Bylaws (See Exhibit 3.2)
9.1 Shareholder Voting Agreement and Irrevocable Proxy<F3>
10.1 Energy Search Natural Gas 1995-A L.P. Limited Partnership
Agreement, dated March 31, 1995<F3>
10.2 Energy Search Natural Gas 1995-A L.P. Joint Drilling and
Operating Agreement, dated March 31, 1995<F3>
10.3 Energy Search Natural Gas 1996 L.P.-Limited Partnership
Agreement, dated June 10, 1996<F3>
10.4 Energy Search Natural Gas 1996 L.P.-Joint Drilling and
Operating Agreement, dated June 10, 1996<F3>
10.5 ESI Pipeline Operating Partnership-Limited Partnership
Agreement, dated January 7, 1993<F3>
10.6 Energy Search Natural Gas Pipeline Income Partnership-
Limited Partnership Agreement, dated January 7, 1993<F3>
10.7 Gas Servicing Agreement between the Registrant and ESI
Pipeline Operating L.P., dated January 5, 1993<F3>
10.8 Selling Agreement-Class B Convertible Preferred Shares
between Registrant and Equity Financial Corporation, dated
March 4, 1996<F3>
10.9 Selling Agreement-Class A and Class B Preferred Shares
between Registrant and Equity Financial Corporation, dated
March 4, 1996<F3>
10.10 Selling Agreement-Variable Rate Subordinated Debentures
between Registrant and Equity Financial Corporation, dated
September 19, 1994<F3>
10.11 Aircraft Lease between Charles P. Torrey, Jr. and the
Registrant dated February 1, 1995<F3>
10.12 Beaver Coal Company Lease between Beaver Coal Company
Limited and the Registrant, dated September 15, 1996<F3>
10.13 Employment Agreements with officers and key employees of the
Registrant
(a) John M. Johnston<F3><F*>
(b) Robert L. Remine<F3><F*>
(c) Charles P. Torrey, Jr.<F3><F*>
(d) Richard S. Cooper<F3><F*>
(e) Michael W. Mooney<F4><F*>
-i-
10.14 Promissory Notes of Executive Officers in Favor of
Registrant
(a) Charles P. Torrey, Jr.<F3>
(b) Robert L. Remine<F3>
(c) Richard S. Cooper<F3>
10.15 Stock Option Plan<F3><F*>
10.16 Outside Directors' Stock Option Plan<F3><F*>
10.17 Form of Lock-Up Agreement<F3>
10.18 Stock Option and Restricted Stock Plan of 1998<F1><F*>
10.19 Form of Indemnification Agreement <F1><F*>
10.20 1998 Stock Option and Restricted Stock Plan for Outside
Advisors and Consultants<F5>
27.1 Financial Data Schedule
- -------------------------------
<F*> Management contract or compensatory plan or arrangement.
<F1> Previously filed with the Company's Definitive Proxy Statement filed
on April 28, 1998 with the Securities and Exchange Commission, and
here incorporated by reference.
<F2> Previously filed with the Company's Form 10-QSB for the quarter ended
June 30, 1998.
<F3> Previously filed with the Company's Registration Statement on Form SB-
2 (Registration No. 333-12755) filed with the Securities and Exchange
Commission, and here incorporated by reference.
<F4> Previously filed with the Company's Form 10-KSB Annual Report for the
fiscal year ended December 31, 1997, and here incorporated by
reference.
<F5> Previously filed with the Company's Form 10-QSB Quarterly Report for
the quarter ended September 30, 1998, and here incorporated by
reference.
-ii-