GALAXY ENERGY CORPORATION
UP TO 28,738,157 SHARES OF COMMON STOCK
Unless the context otherwise requires, the terms "we", "our" and "us"
refers to Galaxy Energy Corporation.
This prospectus relates to the resale by selling stockholders of up to
28,738,157 shares of common stock. We will not receive any proceeds from sale of
any of the shares offered by the selling stockholders. We will pay the expenses
of registering these shares.
Our common stock is traded on the OTC Bulletin Board under the symbol
"GAXI.OB." On October 18, 2004, the closing bid price for our common stock was
$1.55 per share.
INVESTING IN THESE SECURITIES INVOLVES A HIGH DEGREE OF RISK. A
DETAILED EXPLANATION OF THESE RISKS IS INCLUDED IN THE SECTION ENTITLED "RISK
FACTORS" OF THIS PROSPECTUS, BEGINNING ON PAGE 5.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal OFFENSE.
The information in this prospectus is not complete and may be changed.
We may not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
October 19, 2004
TABLE OF CONTENTS
PAGE
PROSPECTUS SUMMARY.............................................................3
RISK FACTORS...................................................................5
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS.............................10
USE OF PROCEEDS...............................................................11
MARKET FOR COMMON EQUITY......................................................11
DIVIDEND POLICY...............................................................11
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.....................12
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.....................................................19
GLOSSARY......................................................................20
BUSINESS AND PROPERTIES.......................................................21
MANAGEMENT....................................................................30
EXECUTIVE COMPENSATION........................................................34
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................36
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................37
DESCRIPTION OF SECURITIES.....................................................39
SELLING STOCKHOLDERS..........................................................43
PLAN OF DISTRIBUTION..........................................................45
LEGAL MATTERS.................................................................46
EXPERTS.......................................................................46
ADDITIONAL INFORMATION........................................................46
REPORTS TO STOCKHOLDERS.......................................................47
INDEX TO FINANCIAL STATEMENTS.................................................47
2
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this
prospectus. You should carefully read this entire prospectus and the financial
statements contained in this prospectus before purchasing our securities.
GALAXY ENERGY CORPORATION
We are in the business of oil and gas exploration and production and
are currently acquiring and developing coal bed methane ("CBM") and other
unconventional and conventional natural gas properties in Wyoming, Montana,
Texas, Europe and other areas that offer attractive exploitation opportunities
for natural gas. To date, we have engaged in only limited drilling activities
and have mostly undeveloped acreage.
We conduct exploration activities to locate natural gas and crude
petroleum through two wholly-owned subsidiaries, Dolphin Energy Corporation and
Pannonian International, Ltd. Should we commence production of these products,
we anticipate that generally they will be sold at the wellhead to purchasers in
the immediate area where the products are produced. We expect that the principal
markets for oil and gas will be refineries and transmission companies that have
facilities near our producing properties.
Our principal executive offices are located at 1331 - 17th Street,
Suite 730, Denver, Colorado 80202. Our telephone number is (303) 293-2300. Our
website is located at WWW.GALAXYENERGY.COM. Information contained in our website
is not part of this prospectus.
THE OFFERING
Securities offered............Up to 28,738,157 shares of common stock that may
be acquired by selling stockholders.
Use of proceeds...............We will not receive any of the proceeds from the
selling stockholders of shares of our common
stock.
Securities outstanding........58,817,509 shares of common stock as of September
21, 2004.
Plan of distribution..........The offering is made by the selling stockholders
named in this prospectus, to the extent they sell
shares. Sales may be made in the open market or
in private negotiated transactions, at fixed or
negotiated prices. See "Plan of Distribution."
Risk factors..................An investment is subject to risk. See "Risk
Factors."
3
SUMMARY SELECTED FINANCIAL INFORMATION
The balance sheet and income statement data shown below were derived
from our audited and unaudited consolidated financial statements. Our results of
operations for any interim period do not necessarily indicate our results of
operations for the full year. You should read this summary financial data in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," "Business," and our financial statements.
BALANCE SHEET DATA:
AUGUST 31, NOVEMBER 30, NOVEMBER 30,
2004 2003 2002
Cash.......................................................... $ 15,526,740 $ 2,239,520 $ 41,320
Working capital (deficit) .................................... $ 10,205,311 $ 1,756,776 $ (1,012,916)
Oil and gas properties........................................ $ 28,468,559 $ 2,799,720 $ 873,797
Total assets.................................................. $ 45,596,085 $ 5,655,433 $ 954,339
Total liabilities............................................. $ 16,430,882 $ 3,020,874 $ 1,104,236
Stockholders' equity (deficit)................................ $ 29,165,203 $ 2,634,559 $ (149,897)
INCOME STATEMENT DATA:
JUNE 18, 2002 JUNE 18, 2002
NINE MONTHS NINE MONTHS (INCEPTION) (INCEPTION)
ENDED ENDED YEAR ENDED THROUGH THROUGH
AUGUST 31, AUGUST 31, NOVEMBER 30, NOVEMBER 30, AUGUST 31,
2004 2003 2003 2002 T 2004
Revenue................... $ 8,565 $ -- $ -- $ -- $ 8,565
Net (loss) ............... $ (5,851,733) $ (1,525,189) $ (2,579,595) $ (1,140,066) $ (9,571,395)
Basic and diluted (loss)
per share $ (0.11) $ (0.05) $ (0.08) $ (0.04) $ (0.25)
4
RISK FACTORS
Before deciding to invest in us or to maintain or increase your
investment, you should carefully consider the risk factors described below,
together with all other information in this prospectus and in our other filings
with the SEC, before making an investment decision. If any of the following
risks actually occurs, our business, financial conditions or operating results
could be materially adversely affected. In such case, the trading price of our
common stock could decline, and you may lose all or part of your investment.
WE HAVE A LIMITED OPERATING HISTORY AND HAVE GENERATED ONLY VERY LIMITED
REVENUES. WE HAVE INCURRED SIGNIFICANT LOSSES AND WILL CONTINUE TO INCUR LOSSES
FOR THE FORESEEABLE FUTURE.
We are an exploration stage oil and gas company and have earned very
limited production revenue. We have not yet found any proved resources on any of
our properties. Our principal activities have been raising capital through the
sale of our securities and identifying and evaluating potential oil and gas
properties.
From inception to August 31, 2004, we have an accumulated deficit of
$9,571,395. We do not expect our operations to generate sufficient cash flows to
provide working capital for our ongoing overhead, the funding of our lease
acquisitions, and the exploration and development of our properties. Without
adequate financing, we may not be able to successfully develop any prospects
that we have or acquire and we may not achieve profitability from operations in
the near future or at all.
WE HAVE RELIED UPON SALE OF DEBT AND EQUITY SECURITIES TO MEET OUR COMMITMENTS
AND FUND OUR DRILLING ACTIVITIES.
As of August 31, 2004, we have projected we will need approximately
$17,349,000 for expenditures on our oil and gas properties. This amount includes
an estimate of $16,829,000 for Wyoming properties to complete existing wells, to
construct necessary production facilities and infrastructure required to
commence gas production and sales, to exercise an option to acquire additional
interests in acreage, and to drill and complete additional development wells.
In August 2004, we entered into an agreement for a private placement of
$20,000,000 of senior secured convertible notes. Net proceeds to us from the
initial $15,000,000 tranche were approximately $13,863,000. We believe that this
amount, plus the proceeds from the placement of the additional $5,000,000 of
convertible notes scheduled to close in October 2004, together with existing
working capital, will be sufficient to complete the above-described projects.
Our ability to complete these projects and to meet all contractual obligations,
including the repayment of the convertible notes and accrued interest thereon,
is dependent upon the results of the work program and the cash flow anticipated
to be generated from the wells drilled and completed as part of that program.
We have relied primarily on the sale of our debt and equity securities
to fund working capital, to acquire oil and natural gas leases, to drill and
complete wells, and to build facilities and infrastructure required to produce
and sell natural gas. Any future financing through the sale of our common stock
will likely result in substantial dilution to our stockholders.
THE LACK OF PRODUCTION AND ESTABLISHED RESERVES FOR OUR PROPERTIES IMPAIRS OUR
ABILITY TO RAISE CAPITAL.
As of August 31, 2004, we have established very short-term test
production of natural gas from a limited number of wells, and have no properties
for which reserves have been established, making it more difficult to raise the
amount of capital needed to fully exploit the production potential of our
properties. Therefore, we may have to raise capital on terms less favorable than
we would desire. This may result in increased dilution to existing stockholders.
THE VOLATILITY OF NATURAL GAS AND OIL PRICES COULD HAVE A MATERIAL ADVERSE
EFFECT ON OUR BUSINESS.
While we are not yet producing or selling oil and gas, the prices of
natural gas and oil affects our business to the extent that such prices
influence a decision to invest in our company. If the prices of natural gas and
oil are low, investors may decide to invest in other industries.
5
TERMS OF SUBSEQUENT FINANCINGS MAY ADVERSELY IMPACT YOUR INVESTMENT.
We may have to engage in common equity, debt, or preferred stock
financing in the future. Your rights and the value of your investment in the
common stock could be reduced. Interest on these debt securities could increase
costs and negatively impacts operating results. Preferred stock could be issued
in series from time to time with such designations, rights, preferences, and
limitations as needed to raise capital. The terms of preferred stock could be
more advantageous to those investors than to the holders of common stock. In
addition, if we need to raise more equity capital from sale of common stock,
institutional or other investors may negotiate terms at least as, and possibly
more, favorable than the terms of your investment. Shares of common stock which
we sell could be sold into the market, which could adversely affect market
price.
THE DEVELOPMENT OF OIL AND GAS PROPERTIES INVOLVES SUBSTANTIAL RISKS THAT MAY
RESULT IN A TOTAL LOSS OF INVESTMENT.
The business of exploring for and producing oil and gas involves a
substantial risk of investment loss that even a combination of experience,
knowledge, and careful evaluation may not be able to overcome. Drilling oil and
gas wells involves the risk that the wells will be unproductive or that,
although productive, the wells do not produce oil and/or gas in economic
quantities. There is no way to predict in advance of drilling and testing
whether any prospect encountering oil or gas will yield oil or gas in sufficient
quantities to cover drilling or completion costs or to be economically viable.
The seismic data, other technologies, and the study of producing fields in the
area do not enable us to know conclusively prior to drilling that oil and gas
will be present, or if present, if it is in commercial quantities. We cannot
assure anyone that the analogies that we draw from available data from other
wells, more fully explored prospects, or producing fields will be applicable to
our drilling prospects.
Other hazards, such as unusual or unexpected geological formations,
pressures, fires, blowouts, loss of circulation of drilling fluids or other
conditions may substantially delay or prevent completion of any well. Adverse
weather conditions can also hinder drilling operations.
DELAYS IN OBTAINING PERMITS FOR METHANE WELLS COULD IMPAIR OUR BUSINESS.
Drilling coalbed methane wells requires obtaining permits from various
governmental agencies. The ease of obtaining the necessary permits depends on
the type of mineral ownership and the state in which the property is located.
Intermittent delays in the permitting process can reasonably be expected
throughout the development of any play. We may shift our exploration and
development strategy as needed to accommodate the permitting process. As with
all governmental permit processes, permits may not be issued in a timely fashion
or in a form consistent with our plan of operations.
IF WE ARE NOT THE OPERATOR OF OUR WELLS, WE WILL HAVE LITTLE OR NO CONTROL OVER
THE PROJECT.
If we are not the operator of the wells in which we have an interest,
we will have limited or no control over the project. More specifically, we will
have limited or no control over the following:
o the timing of the drilling and recompleting of wells;
o the timing and amounts of production; and
o the development and operating costs.
In addition, if we should produce natural gas, we may experience possible
negative gas balance conditions because the operator may sell to a purchaser
other than ours, which may cause a delay in the sale of gas to our interests.
WE MAY INCUR LOSSES AS A RESULT OF TITLE DEFICIENCIES IN THE PROPERTIES IN WHICH
WE INVEST.
It is our practice in acquiring oil and gas leases or undivided
interests in oil and gas leases not to undergo the expense of retaining lawyers
to examine the title to the mineral interest to be placed under lease or already
placed under lease. Rather, we will rely upon the judgment of oil and gas lease
brokers or landsmen who perform the field work in examining records in the
appropriate governmental office before attempting to place under lease a
specific mineral interest. This practice is widely followed in the oil and gas
industry. Prior to the drilling of an oil and gas well, however, it is the
normal practice in the oil and gas industry for the person or company acting as
the
6
operator of the well to obtain a preliminary title review of the spacing
unit within which the proposed oil and gas well is to be drilled to ensure there
are no obvious deficiencies in title to the well; however, neither we nor the
person or company acting as operator of the well will obtain counsel to examine
title to such spacing unit until the well is about to go into production. It
frequently happens, as a result of such examinations, that certain curative work
must be done to correct deficiencies in the marketability of the title, and such
curative work entails expense. The work might include obtaining affidavits of
heirship or causing an estate to be administered. It does happen, from time to
time, that the examination made by the title lawyers reveals that the oil and
gas lease or leases are worthless, having been purchased in error from a person
who is not the owner of the mineral interest desired. In such instances, the
amount paid for such oil and gas lease or leases is generally lost.
WE ARE SUBJECT TO ENVIRONMENTAL REGULATIONS THAT CAN ADVERSELY AFFECT THE TIMING
AND COST OF OUR OPERATIONS.
In general, our exploration activities are subject to certain federal,
state and local laws and regulations relating to environmental quality and
pollution control. Such laws and regulations increase the costs of these
activities and may prevent or delay the commencement or continuance of a given
operation. Since we have not yet commenced any drilling activities, compliance
with these laws and regulations has not had a material effect on our operations
or financial condition to date. Specifically, we are subject to legislation
regarding emissions into the environment, water discharges, and storage and
disposition of hazardous wastes. In addition, legislation has been enacted which
requires well and facility sites to be abandoned and reclaimed to the
satisfaction of state authorities. As of this date, we are unable to predict the
ultimate cost of compliance.
WE ARE SUBJECT TO GOVERNMENTAL REGULATIONS THAT MAY ADVERSELY AFFECT THE COST OF
OUR OPERATIONS.
Oil and gas exploration, development and production are subject to
various types of regulation by local, state and federal agencies. Legislation
affecting the oil and gas industry is under constant review for amendment and
expansion. Also, numerous departments and agencies, both federal and state, are
authorized by statute to issue and have issued rules and regulations binding on
the oil and gas industry and its individual members, some of which carry
substantial penalties for failure to comply. The regulatory burden on the oil
and gas industry increases our cost of doing business and, consequently, affects
our profitability. The possibility exists that laws and regulations enacted in
the future will adversely affect the oil and gas industry. Such new legislation
or regulations could drive up the cost of doing business to the point where our
operations would no longer be profitable.
Most states in which we own and operate properties have statutes, rules
and regulations governing conservation matters including the unitization or
pooling of oil and gas properties, establishment of maximum rates of production
from oil and gas wells and the spacing of such wells.
OUR COMPETITORS MAY HAVE GREATER RESOURCES THAT COULD ENABLE THEM TO PAY A
HIGHER PRICE FOR PROPERTIES.
The oil and gas industry is intensely competitive and we compete with
other companies which have greater resources. Many of such companies not only
explore for and produce crude oil and natural gas but also carry on refining
operations and market petroleum and other products on a worldwide basis. Such
companies may be able to pay more for productive oil and natural gas properties
and exploratory prospects, and to define, evaluate, bid for and purchase a
greater number of properties and prospects than our financial or human resources
permit. Our ability to acquire additional properties and to discover reserves in
the future will be dependent upon our ability to evaluate and select suitable
properties, to obtain funding and to consummate transactions in a highly
competitive environment. There is also competition between the oil and gas
industry and other industries with respect to the supply of energy and fuel to
industrial, commercial and individual customers. At this stage of our
development, we cannot predict if we will be able to effectively compete against
such companies.
OUR OFFICERS AND DIRECTORS ARE ENGAGED IN OTHER BUSINESSES WHICH MAY RESULT IN
CONFLICTS OF INTEREST.
Certain of our directors also serve as directors of other companies or
have significant shareholdings in other companies and, to the extent that such
other companies may participate in ventures in which we may participate, our
directors may have a conflict of interest in negotiating and concluding terms
relating to the extent of such participation. In the event that such a conflict
of interest arises at a meeting of the board of directors, a director who has
such a conflict is required to disclose the nature and extent of his interest to
the board of directors and abstain
7
from voting for or against the approval of such participation or such terms.
Should a director fail to follow this procedure, this could prevent our board of
directors from acting in the best interests of the company and the shareholders.
MARC A. BRUNER AND HIS AFFILIATES CONTROL A SIGNIFICANT PERCENTAGE OF OUR
OUTSTANDING COMMON STOCK WHICH WILL ENABLE THEM TO CONTROL MANY SIGNIFICANT
CORPORATE ACTIONS AND MAY PREVENT A CHANGE IN CONTROL THAT WOULD OTHERWISE BE
BENEFICIAL TO OUR STOCKHOLDERS.
Marc A. Bruner beneficially owns approximately 21.4% of our stock as of
September 21, 2004. This control by Mr. Bruner could have a substantial impact
on matters requiring the vote of the stockholders, including the election of our
directors and most of our corporate actions. This control could delay, defer or
prevent others from initiating a potential merger, takeover or other change in
our control, even if these actions would benefit our stockholders and us. This
control could adversely affect the voting and other rights of our other
stockholders and could depress the market price of our common stock.
OUR FUTURE OPERATING RESULTS MAY FLUCTUATE AND CAUSE THE PRICE OF OUR COMMON
STOCK TO DECLINE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES FOR INVESTORS.
Our limited operating history and the lack of production or reserve
reports on our properties make it difficult to predict accurately our future
operations. We expect that our operating results will fluctuate significantly
from quarter to quarter, due to a variety of factors, many of which are beyond
our control. If our operating results fall below the expectations of investors
or securities analysts, the price of our common stock could decline
significantly. The factors that could cause our operating results to fluctuate
include, but are not limited to:
o worldwide or regional demand for energy;
o domestic and foreign supply of natural gas and oil;
o weather conditions;
o domestic and foreign governmental regulations;
o political conditions in natural gas or oil producing regions;
o price and availability of alternative fuels;
o availability and cost of drilling equipment;
o our ability to establish and maintain key relationships with
lessors, drilling partners and drilling funds;
o the amount and timing of operating costs and capital
expenditures relating to maintaining our business, operations,
and infrastructure; and
o general economic conditions and economic conditions specific to
the energy sector.
These and other external factors have caused and may continue to cause
the market price and demand for our common stock to fluctuate substantially,
which may limit or prevent investors from readily selling their shares of common
stock and may otherwise negatively affect the liquidity of our common stock.
In the past, securities class action litigation has often been brought
against companies following periods of volatility in the market price of their
securities. If securities class action litigation is brought against us it could
result in substantial costs and a diversion of our management's attention and
resources, which could hurt our business.
OUR COMMON STOCK IS SUBJECT TO PENNY STOCK REGULATION THAT MAY AFFECT THE
LIQUIDITY FOR OUR COMMON STOCK.
Our common stock is subject to regulations of the Securities and
Exchange Commission relating to the market for penny stocks. These regulations
generally require that a disclosure schedule explaining the penny stock market
and the risks associated therewith be delivered to purchasers of penny stocks
and impose various sales practice requirements on broker-dealers who sell penny
stocks to persons other than established customers and accredited investors. The
regulations applicable to penny stocks may severely affect the market liquidity
for our common stock and could limit your ability to sell your securities in the
secondary market.
8
OUR ISSUANCE OF THE CONVERTIBLE NOTES AND WARRANTS COULD SUBSTANTIALLY DILUTE
THE INTERESTS OF SHAREHOLDERS.
The $15.0 million in convertible notes we issued in August 2004 are
convertible by the holders into shares of our common stock at any time prior to
their maturity in September 2006 at a conversion price of $1.87, subject to
adjustments for stock splits, stock dividends, stock combinations, and other
similar transactions. We may issue an additional $5.0 million in convertible
notes on essentially the same terms as those issued in August 2004. The
conversion price of the convertible notes could be lowered, perhaps
substantially, in a variety of circumstances, including:
o our issuance of common stock below the convertible notes'
conversion price, either directly or in connection with the
issuance of most securities that are convertible into, or
exercisable for, shares of our common stock;
o our failure to comply with specific registration and listing
obligations applicable to the common stock into which the
convertible notes are convertible; and
o our breaching other obligations to the holders of the
convertible notes.
In addition, we issued to the holders of convertible notes in August
2004 three-year warrants entitling the warrant holders to purchase an aggregate
of 5,194,806 shares of our common stock at an exercise price of $1.54 per share.
Both the number of warrants and the exercise price are subject to adjustments
that could make them further dilutive to our shareholders. In addition, the
warrants provide for the issuance of replacement warrants under certain
circumstances. The replacement warrants would have substantially the same terms
as the initial warrants, but at a new warrant exercise price at a 15% premium to
the then current price. Neither the convertible notes nor the warrants establish
a "floor" that would limit reductions in the conversion price of the convertible
notes or the exercise price of the warrants that may occur under certain
circumstances. Correspondingly, there is no "ceiling" on the number of shares
that may be issuable under certain circumstances under the anti-dilution
adjustment in the convertible notes and warrants. We also issued to the
"finders" of the August 2004 financing transaction five-year warrants to
purchase 300,000 shares of our common stock at an exercise price of $1.54 per
share. Accordingly, our issuance of the convertible notes and warrants could
substantially dilute the interests of our shareholders.
OUR FAILURE TO SATISFY OUR REGISTRATION, LISTING, AND OTHER OBLIGATIONS WITH
RESPECT TO THE COMMON STOCK UNDERLYING THE CONVERTIBLE NOTES AND THE WARRANTS
COULD RESULT IN ADVERSE CONSEQUENCES, INCLUDING ACCELERATION OF THE CONVERTIBLE
NOTES.
We are required to maintain the effectiveness of the registration
statement, of which this document forms a part, covering the resale of the
common stock underlying the convertible notes and warrants, until the earlier of
the date the underlying common stock may be resold pursuant to Rule 144(k) under
the Securities Act of 1933 or the date on which the sale of all the underlying
common stock is completed, subject to certain exceptions. We will be subject to
various penalties for failing to meet our registration obligations and the
related listing obligations for the underlying common stock, which include cash
penalties and the forced redemption of the convertible notes at the greater of:
o 125% of the principal amount, plus accrued interest; or
o the number of shares of our common stock issuable upon
conversion, multiplied by the weighted average price of our
common stock on the trading day immediately preceding our
registration or listing default.
WE ARE OBLIGATED TO MAKE SIGNIFICANT PERIODIC PAYMENTS OF PRINCIPAL AND INTEREST
UNDER OUR CONVERTIBLE NOTES.
We have a material amount of indebtedness outstanding under the
convertible notes. We are required to make a payment of interest on January 14,
2005 and monthly principal payments of $833,333 and accrued interest beginning
March 1, 2005. If we at any time default on our payment obligations the
creditors will have all rights available under the instrument, including
acceleration, termination, and enforcement of security interests. Such security
interests cover all of our assets and those of our subsidiaries.
9
FUTURE EQUITY TRANSACTIONS, INCLUDING EXERCISE OF OPTIONS OR WARRANTS, COULD
RESULT IN DILUTION.
From time to time, we sell restricted stock, warrants, and convertible
debt to investors in private placements. Because the stock is restricted, the
stock is sold at a greater discount to market prices compared to a public stock
offering, and the exercise price of the warrants sometimes is at or even lower
than market prices. These transactions cause dilution to existing stockholders.
Also, from time to time, options are issued to officers, directors, or
employees, with exercise prices equal to market. Exercise of in-the-money
options and warrants will result in dilution to existing stockholders. The
amount of dilution will depend on the spread between the market and exercise
price, and the number of shares involved.
TRADING IN OUR COMMON STOCK ON THE OTC BULLETIN BOARD MAY BE LIMITED THEREBY
MAKING IT MORE DIFFICULT FOR INVESTORS TO RESELL THEIR SHARES OF OUR COMMON
STOCK.
Our common stock trades on the OTC Bulletin Board. The OTC Bulletin
Board is not an exchange and, because trading of securities on the OTC Bulletin
Board is often more sporadic than the trading of securities listed on an
exchange or NASDAQ, you may have difficulty reselling any of the shares that you
purchase from the selling shareholders.
THE ISSUANCE OF SHARES UPON EXERCISE OF OUTSTANDING WARRANTS MAY CAUSE IMMEDIATE
AND SUBSTANTIAL DILUTION TO OUR EXISTING STOCKHOLDERS.
The issuance of shares upon exercise of warrants may result in
substantial dilution to the interests of other stockholders since the selling
stockholders may sell the full amount issuable on exercise. In addition, such
shares would increase the number of shares in the "public float" and could
depress the market price for our common stock.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus includes "forward-looking statements." All statements
other than statements of historical facts included or incorporated by reference
in this report, including, without limitation, statements regarding our future
financial position, business strategy, budgets, projected costs and plans and
objectives of management for future operations, are forward-looking statements.
In addition, forward-looking statements generally can be identified by the use
of forward-looking terminology such as "may," "will," "expect," "intend,"
"project," "estimate," "anticipate," "believe," or "continue" or the negative
thereof or variations thereon or similar terminology. Although we believe that
the expectations reflected in such forward-looking statements are reasonable, we
cannot give any assurance that such expectations will prove to have been
correct. Important factors that could cause actual results to differ materially
from our expectations ("Cautionary Statements") include, but are not limited to,
our assumptions about energy markets, production levels, reserve levels,
operating results, competitive conditions, technology, the availability of
capital resources, capital expenditure obligations, the supply and demand for
oil and natural gas, the price of oil and natural gas, currency exchange rates,
the weather, inflation, the availability of goods and services, drilling risks,
future processing volumes and pipeline throughput, general economic conditions
(either internationally or nationally or in the jurisdictions in which we are
doing business), legislative or regulatory changes (including changes in
environmental regulation, environmental risks and liability under federal, state
and foreign environmental laws and regulations), the securities or capital
markets and other factors disclosed under "Management's Discussion and Analysis
or Plan of Operation," "Business and Properties" and elsewhere in this
prospectus. All subsequent written and oral forward-looking statements
attributable to us, or persons acting on our behalf, are expressly qualified in
their entirety by the cautionary statements. We assume no duty to update or
revise our forward-looking statements based on changes in internal estimates or
expectations or otherwise.
10
USE OF PROCEEDS
We will not receive any of the proceeds from the selling stockholders
of shares of our common stock. However, we may receive the sale price of any
common stock we sell to the selling stockholders upon exercise of the warrants.
We expect to use the proceeds received from the exercise of warrants, if any,
for general working capital purposes. The warrants contain a provision for
cashless exercise. If that provision is utilized, we will not receive any
proceeds.
MARKET FOR COMMON EQUITY
Our common stock has been trading on the over-the-counter bulletin
board ("OTCBB") under the symbol "GAXI" since December 10, 2001. The trading
symbol often appears as "GAXI.OB" in quotation requests on the Internet. The
following table sets forth the range of high and low bid quotations for each
fiscal quarter for the last two fiscal years. These quotations reflect
inter-dealer prices without retail mark-up, mark-down, or commissions and may
not necessarily represent actual transactions.
FISCAL QUARTER ENDING HIGH BID LOW BID
February 28, 2002....................... $ -- $ --
May 31, 2002............................ $ 1.00 $ 0.56
August 31, 2002......................... $ 1.25 $ 0.55
November 30, 2002....................... $ 1.51 $ 0.78
February 28, 2003....................... $ 1.47 $ 1.03
May 31, 2003............................ $ 1.25 $ 0.87
August 31, 2003......................... $ 0.90 $ 0.63
November 30, 2003....................... $ 2.57 $ 0.60
February 29, 2004....................... $ 3.78 $ 1.95
May 31, 2004............................ $ 3.60 $ 1.00
August 31, 2004......................... $ 1.66 $ 1.19
On October 18, 2004, the closing price for the common stock was $1.55.
As of September 21, 2004, there were 147 record holders of our common
stock. Since our inception, no cash dividends have been declared on our common
stock.
DIVIDEND POLICY
We do not anticipate paying dividends on our common stock at any time
in the foreseeable future. Our board of directors plans to retain earnings for
the development and expansion of our business. Our directors also plan to
regularly review our dividend policy. Any future determination as to the payment
of dividends will be at the discretion of our directors and will depend on a
number of factors, including future earnings, capital requirements, financial
condition and other factors as the board may deem relevant. We are not
restricted by any contractual agreement from paying dividends.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
OVERVIEW
Management believes the completion of its fiscal quarter ended February
29, 2004 marked the completion of its first phase of its business plan. The
goals of the first phase were to obtain promising oil and gas properties and
adequate funding to pay for those properties and commence drilling operations.
To accomplish those goals, we needed to build our corporate infrastructure and
make the investing public aware of our presence. We believed that by so doing,
we could raise the capital we needed from the sale of our securities and use
shares of our common stock to pay for property acquisitions. We also negotiated
an agreement with a drilling fund as an alternate source of funding. While this
agreement expired in January 2004, we believe that we may enter into a new
agreement with the drilling fund on substantially the same terms as the original
agreement.
Our goal for the second phase of our business plan, which commenced
March 1, 2004, is to determine the potential of our properties. By so doing, we
can develop a plan to secure additional funding for what we hope will be
development drilling projects.
We have budgeted funds to complete 140 wells on our Powder River Basin
leases by the end of 2004. Our goal is to have 140 wells on production by the
end of 2004, and an additional 40 wells coming on production in early 2005.
Accordingly, in the short-term, management will focus on achieving these goals
within the parameters of the budget. This means maintaining close supervision
over drilling operations, which commenced in February 2004. To accomplish this,
management must make sure that proper reporting procedures and controls have
been implemented. For the long-term, management will use the drilling results to
determine the best courses of action to take with respect to future
acquisitions, growth, and capitalization of the company. Management will
evaluate the effectiveness of the criteria and factors it has used in making
acquisition and growth decisions. Management's determinations will be subject
generally to federal and state policies regarding the development of energy
resources, which can change from time to time.
STATUS OF OIL AND GAS PROPERTIES
POWDER RIVER BASIN - WYOMING. Effective September 30, 2002, we entered
into a lease acquisition and drilling agreement with Pioneer Oil, a Montana
limited liability company ("Pioneer"), which entitled us to earn a 100% working
interest and a 78% net revenue interest in leases covering 15,657 acres in the
Powder River Basin, near Leiter, Wyoming. To acquire the leases covering this
acreage, we were required to pay and did pay $100,000 by January 31, 2003. We
were required to pay $1,650,000 by October 1, 2003, deposit the estimated costs
to drill and complete 30 pilot wells into an escrow account by October 1, 2003,
and drill at least 25 pilot wells by March 1, 2004. The agreement also provided
for the acquisition of a 100% interest in five natural gas wells, for $500,000,
by October 1, 2003. Pioneer extended the obligations due October 1, 2003 to
October 31, 2003, to allow for negotiation of a new agreement.
Instead of negotiating a new agreement, on December 22, 2003, we
purchased Pioneer's position for $1,000,000 cash and 2,000,000 shares of our
common stock, valued at $1.40 per share. By purchasing Pioneer's position, we
are now the lessee under the leases and the owner of the five natural gas wells.
These wells were drilled in late 2001, have been equipped with downhole
production pumps, and one coal zone is partially dewatered. We expect to
commence production from these five completed wells and several additional wells
during 2004. We do not have any estimates as to reserves attributed to these
wells. The leases had required the drilling of 60 wells by March 9, 2004.
However, we reached an agreement to extend this date to October 10, 2004. We
deposited $150,000 into an escrow account, which was to be returned to us if we
met this drilling requirement by October 10, 2004 or forfeited if the drilling
requirement was not met by the deadline.
On October 1, 2004, we completed further negotiations whereby, for the
payment of $150,000 previously held in escrow, the lessors agreed that the
drilling commitment had been met and we acquired an additional 360 acres of oil
and gas leases in the area adjacent to these current lease holdings. We are now
obligated to drill a total of 125 wells on the leased acreage by December 31,
2005 under the terms of the amended lease.
12
During the nine months ended August 31, 2004, we purchased five
existing natural gas wells and transferred 16 existing permits from Pioneer to
Dolphin, drilled 30 new wells and set seven-inch production casing in those
wells, and commenced location surveying, permit procedures, and obtained surface
use agreement approval for an additional portion of these leases.
Effective October 1, 2002, we entered into a Coal Bed Methane
Participation Agreement with Horizon Exploitation, Inc., a Colorado corporation
("Horizon"), to provide funding for the development of our Pioneer leasehold
interests and establish an area of mutual interests in the Powder River Basin
located in Wyoming and Montana for future projects on the same terms as
described below.
Under the terms of the agreement, Horizon was given the right to
participate, subject to funding, in the development of up to 120 wells and the
purchase of the five existing wells from Pioneer. Horizon's commitment to
participate in the development was subject to an initial funding by Horizon of
$100,000, a $500,000 payment for the purchase of the five existing wells, and
the placement of $1,650,000, plus the estimated amount to drill and complete 30
pilot wells, into escrow as a partial payment for a 30-well pilot project on or
before September 15, 2003. The estimated AFE cost per well was $150,000. These
dates were extended to January 15, 2004. Since this agreement has now expired,
we are negotiating a new agreement.
We had an option to acquire additional leases in Sheridan County,
Wyoming, by paying $396,000 by January 15, 2004. We did not exercise the option
and expensed the total paid for the option.
In January 2004, we acquired an operating interest in 61 non-producing
CBM wells and approximately 12,000 gross acres in the Powder River Basin in
Wyoming (the "Continental acreage") from DAR, LLC, in consideration for
3,000,000 restricted shares of our common stock, valued at $1.80 per share,
$163,655, and $2,600,000 in future payments. The amount of $1,000,000 is due
January 14, 2005 and $1,600,000 is due June 24, 2005. We have entered into an
agreement with Continental Industries, LC, an affiliate of DAR, LLC, as contract
operator on our Wyoming Powder River Basin leases.
In March 2004, we acquired the remaining 35% working interest in the
Buffalo Run project for $592,464. In April 2004, we acquired the remaining 50%
working interest in the Dutch Creek project for $300,000 and 360,000 restricted
shares of our common stock, valued at $2.63 per share.
As a result of these acquisitions we have approximately a 100% working
interest in the Buffalo Run project, which has 19 wells drilled and completed
and another 25 wells in various stages of completion, and a 100% working
interest in the Dutch Creek project, which has 13 wells drilled and completed
and another four wells in various stages of completion.
Also in April 2004, we acquired various working interests in
approximately 27,000 net acres adjacent to, and in the vicinity of, the Leiter
and Continental acreage. The acquisition price for these new interests was
$739,550.
In June 2004, we entered into a letter of intent to acquire
approximately 4,400 net acres of oil and gas leases in Campbell and Converse
Counties. Under the terms of the agreement, we committed to pay 100% of the cost
to drill 12 wells on the acreage, to earn a 50% interest in those wells along
with a 50% working interest in nine existing wells, seven of which have been
completed. We paid the seller $100,000 and have the right to acquire for an
additional $1,900,000 payable no later than November 1, 2004, a 90% working
interest in the entire leasehold acreage including all wells on the property.
During the period ended August 31, 2004, we drilled 16 wells on the
acreage thereby completing our drilling commitment. Subsequent to August 31,
2004 we drilled an additional 8 wells on the acreage. On September 30, 2004, we
exercised our option to acquire the additional working interest in the wells and
a 90% working interest in the leasehold acreage in the prospects. After closing
adjustments, we paid approximately $1,886,000 for these interests.
13
POWDER RIVER BASIN - MONTANA. On August 5, 2003, we entered into a
Lease Option and Acquisition Agreement with Quaneco, L.L.C. ("Quaneco").
Quaneco is a privately-held oil and gas company operating primarily in the Rocky
Mountain region.
Under the terms of the agreement, we had an option to acquire up to 50%
of Quaneco's 50% working interest in certain oil and gas leases covering
approximately 214,000 gross acres in the Powder River Basin area of Montana. If
the option were fully exercised, we would acquire the working interests in
approximately 53,500 net acres. The primary geologic target associated in the
acreage is natural gas from shallow coal beds located at depths of 200 feet to
2,500 feet. The purchase price of the option was $6,625,000 payable in six
installments of varying amounts. The first three installments, totaling
$2,787,500, were paid. In addition, Quaneco credited us with payment of $600,000
under the agreement through its purchase of $600,000 in convertible debentures
(discussed below), thereby entitling us to a 12.5% working interest.
On September 1, 2004, we determined not to increase our working
interest position beyond our existing 12.5% (approximately 26,750 net acres and
2 gross wells (0.5 net wells)), so that we can focus our efforts on our coal bed
methane development program in the Powder River Basin of Wyoming. Accordingly,
we are not paying the balance of the option purchase price in the amount of
$3,237,500, the installments of which were due September 1, 2004 and December 1,
2004. There were no penalties to us associated with this decision.
JIU VALLEY - ROMANIA. Effective June 2, 2003, we completed the
acquisition of Pannonian International, Ltd., a Colorado corporation, solely for
1,951,241 shares of our common stock, thereby acquiring Pannonian's concession
agreement covering 21,538 gross acres in the Jiu Valley Coal Basin in Romania.
NEUES BERGLAND - GERMANY. Effective December 12, 2003, Pannonian
International and two non-affiliated private oil and gas companies were granted
an exploration permit covering 149,435 acres.
RESULTS OF OPERATIONS
NINE MONTHS ENDED AUGUST 31, 2004 COMPARED TO NINE MONTHS ENDED AUGUST
31, 2003. During the nine months ended August 31, 2004, the Company recorded its
first natural gas revenues from initial production from five wells acquired in
June 2004. The Company recorded natural gas revenues of $23,780 and production
expenses and taxes of $15,215 (net revenue of $8,565) on net sales volumes of
6,476 MCF. The Company has not recorded depreciation, depletion and amortization
on this production, as it has not recorded any proved reserves as of August 31,
2004 and in management's opinion any such amount would not be material to the
results for the period then ended.
The Company recorded interest income earned on cash deposits with
commercial banks in the amount of $30,886. The cash deposits resulted from the
companies financing and fund raising activities during the year.
For the nine months ended August 31, 2004 and 2003, the Company
incurred general and administrative expenses of $2,598,051 and $1,525,189,
respectively. Significant expenses in 2004 included, salaries and benefits of
$373,489; consulting expenses of $424,932; travel and entertainment expenses
primarily related to financing activities of $346,725; legal expenses of
$428,913; investor relations expenses of $384,139; directors fees of $156,895,
audit fees and accounting expenses of $129,392 and office lease, insurance and
other expenses of $257,765. Corresponding expense for 2003 were salaries and
benefits $193,298; consulting of $308,526; travel and entertainment expenses
primarily related to financing activities of $245,005; legal of $319,355;
investor relations of $290,699; audit and accounting of $45,724 and office
expenses of $93,276. The 2004 increases reflect significantly higher level of
operational activity and a greater number of employees to manage such activity,
the relocation of the Company's headquarters to Denver, Colorado, the completion
of four registration statements for the Company's equity securities and the
requisite legal, accounting and consulting fees to accomplish this level of
activity.
The Company recorded $168,188 of depreciation and amortization expense
in 2004 compared to $-0 in 2003. The 2004 expense is comprised of amortization
of deferred financing costs on the convertible debentures and convertible notes
of $126,879, and depreciation of furniture and equipment, accretion of asset
retirement liability and depreciation of ARO asset of $41,309 in the aggregate,
none of which were applicable for the period ended in 2003.
14
The Company recorded interest and financing costs of $3,124,945 in 2004
compared to $-0- in 2003. The 2004 expense is comprised of interest on 7%
convertible debentures, the convertible notes and other notes payable of
$302,113, liquidated damages related to the Securities Purchase Agreements for
the convertible debentures and the December 2003 private placement of common
stock in the amounts of $404,000 and $35,050 respectively, the amortization of
the discount on the convertible debentures and convertible notes of $712,156 and
the recognition of the Beneficial Conversion Feature discount on the convertible
debentures in the amount of $1,671,627. The liquidated damages were assessed in
accordance with the terms of the respective Securities Purchase Agreements and
reflect the fact the Company was unable meet the deadline for registration of
the common stock to become effective as required by such agreements. See Note 4
and Note 5 to the financial statements for a complete discussion of the discount
and the beneficial conversion feature on the convertible debentures and
convertible notes.
The loss recorded by the Company for the nine-month period ended August
31, 2004, of $5,851,733, increased the accumulated deficit as of that date to
$9,571,395.
YEAR ENDED NOVEMBER 30, 2003 COMPARED TO PERIOD FROM INCEPTION (JUNE
18, 2002) TO NOVEMBER 30, 2002. For the year ended November 30, 2003, we
incurred operating expenses of $2,579,595, primarily for legal expenses
($381,166), investor relations ($374,275), interest expense ($368,649), travel
and entertainment ($321,463), management fees to Resource Venture Management
($320,000), and payroll salaries and taxes ($258,686). These expenses were
incurred in the effort to acquire the oil and gas properties described above and
secure the funding necessary to carry out the acquisitions. Included in investor
relations expenses were amounts incurred with public relations firms for website
development and hosting, writing and disseminating press releases and company
profile pieces, and responding to investor and shareholder inquiries. In
addition, we expensed $65,769 as a result of our decision not to exercise an
option to acquire additional leases in Wyoming and Pannonian's decision to
abandon a property in Australia.
For the period from inception to November 30, 2002, we incurred
operating expenses of $1,140,066, primarily for contract services - Resource
Venture Management ($692,500), consulting fees and payroll ($125,265), legal
fees ($103,314), and travel and entertainment ($102,479).
LIQUIDITY AND CAPITAL RESOURCES
AS OF AUGUST 31, 2004. At August 31, 2004, the Company had working
capital of $10,205,311, as compared to $1,756,776 at November 30, 2003. The
increase in working capital was due primarily to the proceeds from two private
placements of equity securities and a private placement of debt securities,
during the nine-month period
Since inception, the Company has funded its activities through the sale
of convertible debentures, convertible notes, common stock, and the exercise of
warrants, raising net proceeds of $37,932,300 through August 31, 2004, of which
$30,479,800 was raised during the nine-month period then ended. For the nine
months ended August 31, 2004, we used cash of $3,308,322 for our operating
activities and $11,524,830 for our investing activities, which consisted
primarily of drilling and lease acquisition expenditures on our oil and gas
properties.
We completed a private placement of 2,503,571 shares of our common
stock and warrants to purchase 500,715 common shares on December 18, 2003,
resulting in gross proceeds of $3,505,000. The warrants are exercisable for a
four-year period at an original price of $2.71 per share. In accordance with the
terms of the warrants, the exercise price has been reset and these warrants are
currently exercisable at $1.54 per share. We granted registration rights to the
purchasers in this private placement.
We completed a second private placement of 6,637,671 shares of our
common stock and warrants to purchase 1,327,535 common shares on January 15,
2004, resulting in gross proceeds of $11,947,800. The warrants are exercisable
for a five-year period at an original price of $4.05 per share. In accordance
with the terms of the warrants, the exercise price has been reset and these
warrants are currently exercisable at $1.54 per share. We granted registration
rights to the purchasers in this private placement as well.
15
On August 19, 2004, we entered into a securities purchase agreement
with several accredited investors pursuant to which we agreed to sell, and the
investors agreed to purchase in the aggregate, up to $20,000,000 principal
amount of senior secured convertible notes and three-year warrants to purchase
5,194,806 shares of common stock at $1.54 per share. The first tranche of the
financing for $15,000,000 was completed on August 19, 2004. The second tranche
for $5,000,000 is subject to various conditions, including shareholder approval.
The notes are secured by a security interest in all of the assets of our
subsidiaries and us. The notes may be converted by the holders into shares of
common stock at a price of $1.87 per share. Net proceeds from the initial
$15,000,000 placement were approximately $13,863,000. We will use the net
proceeds from the financing for our coal bed methane development program in the
Powder River Basin of Wyoming, as described below. We agreed to file a
registration statement in order to register the resale of the shares issuable
upon conversion of the notes and the shares issuable upon exercise of the
warrants.
We believe that the net proceeds from the August 2004 offering, plus
the proceeds from the placement of the additional $5,000,000 of convertible
notes scheduled to close in October 2004, together with existing working
capital, will be sufficient to complete our planned oil and gas projects. Our
ability to complete these projects and to meet all contractual obligations,
including the repayment of the convertible notes and accrued interest thereon,
is dependent upon the results of the work program and the cash flow anticipated
to be generated from the wells drilled and completed as part of that program.
AS OF NOVEMBER 30, 2003. At November 30, 2003, we had working capital
of $1,756,776, as compared to a deficiency of $1,012,916 at November 30, 2002.
The increase in working capital was due to the receipt in offering proceeds from
the debenture offering described below.
From December 1, 2002 through November 30, 2003, we raised net proceeds
of $6,151,278 through the sale of our common stock and convertible debentures.
These proceeds were used for ongoing operations and to pay accrued trade
payables.
We also negotiated with some of our creditors to convert their debt
into equity. During the fiscal year ended November 30, 2003, Resource Venture
Management, a related party, agreed to convert its $233,204 of debt outstanding
at November 30, 2002, plus management fees for three months in the amount of
$90,000 incurred during fiscal 2003, to 323,204 restricted shares of our common
stock. Another party converted $10,000 of accounts payable to 10,000 shares of
common stock.
To address the cash requirements for the Quaneco agreement and our
working capital needs, we engaged in a private offering of secured convertible
debentures and warrants in September 2003. The offering was completed in early
October 2003, resulting in gross proceeds of $5,640,000, $600,000 of which was a
credit against our property payment obligations. The debenture paid interest at
7% per annum, matured two years from the date of issuance, was secured by all of
our assets (subject to an agreement to subordinate in favor of a senior bank
lender), and was convertible into shares of our common stock based on a price of
$0.59 per share. Investors received five-year warrants to purchase up to
2,867,797 shares at $0.71 per share and 2,867,797 shares at $0.83 per share. We
were obligated to file and have filed a registration statement covering the
shares underlying the debentures and warrants. We had agreed with the debenture
holders to have this registration statement effective by April 6, 2004. Since we
were unable to do so by that date, we paid a penalty of $404,000 to the holders
of the debentures. During the nine months August 31, 2004, all of the debentures
were converted into 9,559,322 shares of common stock. We anticipate that since
that registration statement has become effective, some of the warrants may be
exercised because the exercise prices of the warrants are significantly lower
than the current market price of our common stock.
Since inception, we have funded our activities through the sale of our
debt and equity securities, raising net proceeds of $850,500 through the period
ended November 30, 2002, and net proceeds of $6,151,278 for the year ended
November 30, 2003. For the year ended November 30, 2003, we used cash of
$2,128,993 for our operating activities and $1,824,085 for our investing
activities, which consisted primarily of additions to our oil and gas
properties.
16
PLAN OF OPERATION
As of August 31, 2004, our obligations and commitments to make future
payments are as follows:
Through Through
CONTRACTUAL OBLIGATIONS1<F1>: NOVEMBER 30, 2004 NOVEMBER 30, 2005
Principal and interest payments to DAR, LLC.......... $ 0 $ 2,796,000
Principal and interest payments to holders of secured
convertible notes2<F2>............................ 0 9,898,285
Geological software license.......................... 1,667 6,669
Miami office lease................................... 11,459 26,738
Denver office lease.................................. 12,077 50,540
Total $ 25,203 $ 12,778,232
- -----------------
<FN>
1<F1> Does not include obligations under promissory notes to related parties.
2<F2> Under certain conditions, as described elsewhere in this prospectus, we
have the option to pay the principal and interest with shares of our
common stock instead of cash. Assumes closing on the $5,000,000 of
convertible notes on November 5, 2004 and a constant interest rate of
11.75% per annum.
</FN>
In addition to the above obligations, we intend to utilize our existing
working capital plus the net proceeds of the secured convertible note offerings
for the following capital expenditures on our oil and gas projects:
1) $8,760,000 for Wyoming operations to complete existing wells, to
construct necessary production facilities and infrastructure required
to commence gas production and sales, and to drill and complete
additional development wells;
2) Up to $520,000 for Montana operational expenditures to complete a core
hole program currently underway, and to participate in a 16-well pilot
program, including related project permitting costs;
3) $583,000 to complete the drilling, equipping, and hook up of 12 wells
on the acreage acquired in June 2004.
The above amounts do not include the $1,886,000 paid on September 30,
2004 to exercise the option to acquire the additional interest on the 4,400 net
acres in Campbell and Converse counties, as discussed above. We expect to expend
up to $5,600,000 to drill, equip, and connect up to 61 wells on the prospects.
Our ability to complete all the drilling activities described above and
to meet out commitments and obligations is dependent upon the issuance of an
additional $5 million of secured convertible notes and upon the success of the
drilling program and the amount of cash flow generated from the sale of oil and
gas from the wells drilled. We continue to pursue funding and industry
participation alternatives to ensure our ability to continue to acquire
additional acreage and complete additional drilling activity.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosures of
contingent assets and liabilities. On an ongoing basis, we evaluate our
estimates, including those related to impairment of long-lived assets. We base
our estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions; however, we believe
that our estimates, including those for the above-described items, are
reasonable.
17
OIL AND GAS PROPERTIES
We follow the full cost method of accounting for oil and gas
operations. Under this method, all costs related to the exploration for and
development of oil and gas reserves are capitalized on a country-by-country
basis. Costs include lease acquisition costs, geological and geophysical
expenses, overhead directly related to exploration and development activities
and costs of drilling both productive and non-productive wells. Proceeds from
the sale of properties are applied against capitalized costs, without any gain
or loss being recognized, unless such a sale would significantly alter the rate
of depletion and depreciation.
Depletion of exploration and development costs and depreciation of
production equipment is provided using the unit-of-production method based upon
estimated proven oil and gas reserves. The costs of significant unevaluated
properties are excluded from costs subject to depletion. For depletion and
depreciation purposes, relative volumes of oil and gas production and reserves
are converted at the equivalent conversion based upon relative energy content.
In applying the full cost method, we perform a ceiling test whereby the
carrying value of oil and gas properties and production equipment, net of
recorded future income taxes and the accumulated provision for site restoration
and abandonment costs, is compared annually to an estimate of future net cash
flow from the production of proven reserves. Costs related to undeveloped oil
and gas properties are excluded from the ceiling tests. Discounted net cash
flow, utilizing a 10% discount rate, is estimated using year end prices, less
estimated future general and administrative expenses, financing costs and income
taxes. Should this comparison indicate an excess carrying value, the excess is
charged against earnings. At August 31, 2004 and November 30, 2003 and 2002,
there were no reserves. Costs of oil and gas properties are considered
unevaluated at August 31, 2004 and November 30, 2003 and 2002.
IMPAIRMENT OF LONG-LIVED ASSETS
Our long-lived assets include property and equipment. We assess
impairment of long-lived assets whenever changes or events indicate that the
carrying value may not be recoverable. In performing our assessment we must make
assumptions regarding estimated future cash flows and other factors to determine
the fair value of the respective assets. If these estimates change in the future
we may be required to record impairment charges against these respective assets.
STOCK BASED COMPENSATION
Options that we may grant to employees under our stock option plan are
accounted for by using the intrinsic method under APB Opinion 25, Accounting for
Stock Issued to Employees (APB 25). In October 1995, the Financial Accounting
Standards Board (FASB) issued Statement No.123, Accounting for Stock-Based
Compensation (SFAS123), which defines a fair value based method of accounting
for stock options. The accounting standards prescribed by SFAS 123 are optional
and we have continued to account for stock options under the intrinsic value
method specified in APB 25.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB approved Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure - an amendment of FASB Statement No. 123" (SFAS No. 148). SFAS No.
148 amends Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (SFAS No. 123) to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. SFAS No. 148 is effective for financial statements for fiscal years
ending after December 15, 2002. We will continue to account for stock based
compensation using the methods detailed in the stock-based compensation
accounting policy.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities" to amend and clarify
financial accounting and reporting for derivative instruments,
18
including certain derivative instruments embedded in other contracts and for
hedging activities. The changes in this statement require that contracts with
comparable characteristics be accounted for similarly to achieve more consistent
reporting of contracts as either derivative or hybrid instruments. SFAS No. 149
is effective for contracts entered into or modified after June 30, 2003 and will
be applied prospectively. We do not believe that adoption of this Statement will
have a material impact on the financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity" to
classify certain financial instruments as liabilities in statements of financial
position. The financial instruments are mandatorily redeemable shares, which the
issuing company is obligated to buy back in exchange for cash or other assets,
put options and forward purchase contracts, instruments that do or may require
the issuer to buy back some of its shares in exchange for cash or other assets,
and obligations that can be settled with shares, the monetary value of which is
fixed, tied solely or predominantly to a variable such as a market index, or
varies inversely with the value of the issuer's shares. Most of the guidance in
Statement 150 is effective for all financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. We do not believe that
adoption of this Statement will have a material impact on the financial
statements.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
On November 15, 2002, our directors approved the election of Wheeler
Wasoff, P.C. to audit the financial statements for the fiscal year ended
November 30, 2002. Also on November 15, 2002, we dismissed the former
accountants, Andersen Andersen & Strong, L.C. Our board of directors recommended
Wheeler Wasoff, P.C. because that firm was the existing certifying accountant
for Dolphin Energy Corporation, which was the accounting survivor of the reverse
acquisition described above. During the two most recent fiscal years and the
subsequent interim period, neither we nor anyone on our behalf consulted Wheeler
Wasoff, P.C. regarding the application of accounting principles to a specific
completed or contemplated transaction, or the type of audit opinion that might
be rendered on our financial statements. We did not receive, and Wheeler Wasoff,
P.C. did not provide, any written or oral advice that was an important factor in
reaching a decision as to an accounting, auditing or financial reporting issue
prior to its engagement by us.
Andersen Andersen & Strong, L.C. had audited our financial statements
for the fiscal year ended November 30, 2001. The report of Andersen Andersen &
Strong, L.C. did not contain an adverse opinion or disclaimer of opinion and was
not modified as to uncertainty, audit scope, or accounting principles, except as
follows:
The audit report of Andersen Andersen & Strong, L.C. on our financial
statements as of and for the fiscal year ended November 30, 2001 contained a
separate paragraph stating: "The accompanying financial statements have been
prepared assuming that the Company will continue as a going concern. The Company
is in the exploration stage and will need additional working capital for its
planned activity, which raises substantial doubt about its ability to continue
as a going concern. Management's plans in regard to these matters are described
in Note 5. These financial statements do not include any adjustments that might
result from the outcome of this uncertainty."
During the two most recent fiscal years and the subsequent interim
period through November 15, 2002, there were no disagreements with Andersen
Andersen & Strong, L.C. on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure which, if not
resolved to the satisfaction of Andersen Andersen & Strong, L.C., would have
caused it to make reference to the subject matter of the disagreement in
connection with its report.
19
GLOSSARY
The following is a description of the meanings of some of the natural
gas and oil industry terms used in this prospectus.
AFE (AUTHORIZATION FOR EXPENDITURE). An estimate of the costs of
drilling and completing a proposed well, which the operator provides to each
working interest owner before the well is commenced.
CASING. Steel pipe that screws together and is lowered into the hole
after drilling is complete. It is used to seal off fluids and keeps the hole
from caving in.
COMPLETION. The installation of permanent equipment for the production
of natural gas or oil, or in the case of a dry hole, the reporting of
abandonment to the appropriate agency.
DEVELOPMENT WELL. A well drilled in to a proved natural gas or oil
reservoir to the depth of a stratigraphic horizon known to be productive.
DOWNHOLE. Refers to equipment or operations that take place down inside
a borehole.
DRY HOLE. A well found to be incapable of producing hydrocarbons in
sufficient quantities such that proceeds from the sale of such production exceed
production expenses and taxes.
EXPLORATORY WELL. A well drilled to find and produce natural gas or oil
reserves not classified as proved, to find a new reservoir in a field previously
found to be productive of natural gas or oil in another reservoir or to extend a
known reservoir.
FARM-IN OR FARM-OUT. An agreement under which the owner of a working
interest in a natural gas and oil lease assigns the working interest or a
portion of the working interest to another party who desires to drill on the
leased acreage. Generally, the assignee is required to drill one or more wells
in order to earn its interest in the acreage. The assignor usually retains a
royalty or reversionary interest in the lease. The interest received by an
assignee is a "farm-in" while the interest transferred by the assignor is a
"farm-out."
GROSS ACRES OR GROSS WELLS. The total acres or wells, as the case may
be, in which a working interest is owned.
NET ACRES OR NET WELLS. The sum of the fractional working interest
owned in gross acres or wells, as the case may be.
OPERATOR. The individual or company responsible for the exploration,
development, and production of an oil or gas well or lease.
OVERRIDING ROYALTY. A revenue interest in oil and gas, created out of a
working interest. Like the lessor's royalty, it entitles the owner to a share of
the proceeds from gross production, free of any operating or production costs.
PRODUCTIVE WELL. A well that is found to be capable of producing
hydrocarbons in sufficient quantities such that proceeds from the sale of the
production exceed production expenses and taxes.
PROSPECT. A specific geographic area which, based on supporting
geological, geophysical or other data and also preliminary economic analysis
using reasonably anticipated prices and costs, is deemed to have potential for
the discovery of commercial hydrocarbons.
RESERVOIR. A porous and permeable underground formation containing a
natural accumulation of producible natural gas and/or oil that is confined by
impermeable rock or water barriers and is separate from other reservoirs.
20
SURFACE CASING. Pipe that is set with cement through the shallow water
sands to avoid polluting the water and keep the same from caving in while
drilling a well.
UNDEVELOPED ACREAGE. Lease acreage on which wells have not been drilled
or completed to a point that would permit the production of commercial
quantities of natural gas and oil regardless of whether such acreage contains
proved reserves.
WORKING INTEREST. The operating interest that gives the owner the right
to drill, produce and conduct operating activities on the property and receive a
share of production and requires the owner to pay a share of the costs of
drilling and production operations. The share of production to which a working
interest owner is entitled will always be smaller than the share of costs that
the working interest owner is required to bear, with the balance of the
production accruing to the owners of royalties.
BUSINESS AND PROPERTIES
We are in the business of oil and gas exploration and production and
are currently acquiring and developing coal bed methane ("CBM") and other
unconventional and conventional natural gas properties in Wyoming, Montana,
Texas, Europe and other areas that offer attractive exploitation opportunities
for natural gas. To date, we have engaged in only limited drilling activities
and have mostly undeveloped acreage.
We conduct exploration activities to locate natural gas and crude
petroleum through two wholly-owned subsidiaries, Dolphin Energy Corporation and
Pannonian International, Ltd. Should we commence production of these products,
we anticipate that generally they will be sold at the wellhead to purchasers in
the immediate area where the products are produced. We expect that the principal
markets for oil and gas will be refineries and transmission companies that have
facilities near our producing properties.
CORPORATE BACKGROUND
We were incorporated in the State of Colorado on December 17, 1999
under the name "Galaxy Investments, Inc.," to explore for and, if possible,
develop mineral properties primarily in the Province of British Columbia,
Canada, and other parts of Canada. On November 1, 2002, we entered into an
agreement and plan of reorganization to acquire all of the issued and
outstanding capital stock of Dolphin Energy Corporation, a Nevada corporation,
for approximately 70% of our outstanding common stock. The acquisition of
Dolphin Energy was completed as of November 13, 2002. We changed our name to
"Galaxy Energy Corporation" on May 15, 2003.
Upon completion of the transaction, Dolphin Energy became our wholly
owned subsidiary. However, since this transaction resulted in the existing
stockholders of Dolphin Energy acquiring control of the surviving company, for
financial reporting purposes the business combination was accounted for as a
reverse acquisition with Dolphin Energy as the acquirer. Accordingly, all
financial information presented in this report for periods prior to November 13,
2002 represents the historical information of Dolphin Energy.
On May 7, 2003, we entered into a share exchange agreement with
Pannonian International, Ltd., a Colorado corporation, whereby we would acquire
that company solely for shares of our common stock. We completed the acquisition
as of June 2, 2003 and issued 1,951,241 shares of our common stock, making
Pannonian International a wholly-owned subsidiary.
COAL BED METHANE
Methane is the clean-burning primary component of natural gas. While
conventional natural gas is often comprised of a mixture of methane and other
gases, coal bed methane (CBM) is attractive because it usually has very high
percentage of methane - up to 96%. Coal bed methane in the Powder River Basin
was generated not by heat and pressure, but by bacterial activity within the
coal itself. These anaerobic bacteria are classified as methanogens for their
ability to generate large quantities of methane. As methane is generated it is
trapped (absorbed) onto microscopic surfaces within the coal by water pressure.
CBM wells drilled into the coal serve a dual purpose: to remove water, thereby
lowering the pressure in the coal, and to allow the liberated gas to move to the
surface.
21
In recent years, coal bed methane has attracted attention from the
energy sector. Methane is generally considered a cleaner form of energy than
traditional coal and oil. Since CBM in this area is found at relatively shallow
predictable depths, exploration and development costs are generally much lower
than for deeper, more geologically complex oil and gas exploration projects. The
wells drilled and completed to extract CBM from these shallower coal seams are
therefore much more cost effective to construct. Operating costs, however, for
these wells are usually higher than for conventional free flowing gas wells due
to the need for pumping and disposing of large volumes of water during the
producing life.
The extraction of coal bed methane involves pumping large volumes of
water from the coal seam aquifer in order to release the water pressure that is
trapping the gas in the coal. Methane travels with the ground water being pumped
from the coal by a well drilled and equipped with a water pump that is completed
in a coal seam that contains methane. Since methane has very low solubility in
water, it separates from the water in the well before the water enters the pump.
Instead of dewatering the coal seam, the goal is to decrease the hydrostatic
pressure above the coal seam. Water moving from the coal seam to the well bore
encourages gas migration toward the producing well. As this water pressure is
released, the gas will rise and is separated from the water and can be piped
away.
In the Rocky Mountain region, significant resources of CBM exist in the
Powder River Basin of Wyoming and Montana, the Greater Green River Basin of
Wyoming, Colorado, and Utah, the Uinta-Piceance Basin of Colorado and Utah, and
the Raton and San Juan Basins of Colorado and New Mexico.
OIL AND GAS ASSETS
POWDER RIVER BASIN - WYOMING (LEITER FIELD). Effective September 30,
2002, we entered into a lease acquisition and drilling agreement with Pioneer
Oil, a Montana limited liability company ("Pioneer"), which entitled us to earn
a 100% working interest and a 78% net revenue interest in leases covering 15,657
acres in the Powder River Basin, near Leiter, Wyoming. The project area is 20 to
30 miles west of the main north-south CBM fairway in Campbell County, Wyoming,
and is approximately 9 miles west of the nearest established CBM production.
Most of our acreage is positioned along roads and pipelines. There is 20-inch
gas transmission line crossing our leased property, and U.S. Highway 14 runs
through the project area and provides year-round access.
Ten producible coal seams have been identified throughout the lease
area, which range from 10 feet to 35 feet in thickness and with depths of 600 to
2,500 feet below the surface. The primary targets are coal beds in the Fort
Union Formation. Drilling depths range from 1,700 to 2,600 feet. The Fort Union
Formation is expected to have about 130 feet of aggregate coal separated into 8
to 10 widely spaced beds. The coals are widespread and have a nearly continuous
distribution. The successful implementation of multi-seam well completion
technology and cost effective produced water management in accordance with
existing established practices and requirements will greatly enhance results.
Mud logs from the five existing wells on this property indicate the presence of
gas in these coal seams. The mud log gas shows are consistent with other Fort
Union coals in the western portion of the Powder River Basin. Based on
historical production from other similar areas within this basin, which are
producing gas from the same Fort Union Formation coals in approximately 11,000
active wells, we are optimistic that economically recoverable amounts of gas
will be present here. However, we do not yet have any production tests from
these wells on this property that substantiate the amount of gas, and we
recognize that analogies drawn from available data from other wells or producing
fields may not be applicable to our drilling prospects.
We have started a continuous drilling program into the potential
productive seams and intend to maintain and develop the Leiter area as long as
it produces marketable quantities of gas. We have determined that the initial
target seams will be the Cook, Wall, and Pawnee seams at depths of 1,700 to
1,800 feet. These zones have exhibited the highest consistent gas shows in the
area and comprise 35 to 40 feet of total coal across an interval of
approximately 100 feet. Depending on pricing and water disposal capacity, an
additional 70 to 80 feet of shallower prospective coal could be accessed through
future perforations or by drilling additional wells to accelerate gas
production.
To acquire the leases covering this acreage, we were required to pay
and did pay $100,000 by January 31, 2003. We were required to pay $1,650,000 by
October 1, 2003, deposit the estimated costs to drill and complete 30 pilot
wells into an escrow account by October 1, 2003, and drill at least 25 pilot
wells by March 1, 2004. The agreement also provided for the acquisition of a
100% interest in five natural gas wells, for $500,000, by October 1,
22
2003. Pioneer extended the obligations due October 1, 2003 to October 31, 2003,
to allow for negotiation of a new agreement.
Instead of negotiating a new agreement, on December 22, 2003, we
purchased Pioneer's position for $1,000,000 cash and 2,000,000 shares of our
common stock, valued at $1.40 per share. By purchasing Pioneer's position, we
are now the lessee under the leases and the owner of the five natural gas wells.
These wells were drilled in late 2001, have been equipped with downhole
production pumps, and one coal zone is partially dewatered. We expect to
commence production from these five completed wells and several additional wells
during 2004. We do not have any estimates as to reserves attributed to these
wells. The leases had required the drilling of 60 wells by March 9, 2004.
However, we reached an agreement to extend this date to October 10, 2004. We
deposited $150,000 into an escrow account, which was to be returned to us if we
met this drilling requirement by October 10, 2004 or forfeited if the drilling
requirement was not met by the deadline.
On October 1, 2004, we completed further negotiations whereby, for the
payment of $150,000 previously held in escrow, the lessors agreed that the
drilling commitment had been met and we acquired an additional 360 acres of oil
and gas leases in the area adjacent to these current lease holdings. We are now
obligated to drill a total of 125 wells on the leased acreage by December 31,
2005 under the terms of the amended lease.
During the nine months ended August 31, 2004, we purchased five
existing natural gas wells and transferred 16 existing permits from Pioneer to
us, drilled 30 new wells and set seven-inch production casing in those wells,
and commenced location surveying, permit procedures, and obtained surface use
agreement approval for an additional portion of these leases.
Effective October 1, 2002, we entered into a Coal Bed Methane
Participation Agreement with Horizon Exploitation, Inc., a Colorado corporation
("Horizon"), to provide funding for the development of our Pioneer leasehold
interests and establish an area of mutual interests in the Powder River Basin
located in Wyoming and Montana for future projects on the same terms as
described below.
Under the terms of the agreement Horizon was given the right to
participate, subject to funding, in the development of up to 120 wells and the
purchase of the five existing wells from Pioneer. Horizon's commitment to
participate in the development was subject to an initial funding by Horizon of
$100,000, a $500,000 payment for the purchase of the five existing wells, and
the placement of $1,650,000, plus the estimated amount to drill and complete 30
pilot wells, into escrow as a partial payment for a 30-well pilot project on or
before September 15, 2003. The estimated AFE cost per well was $150,000. We were
to earn an initial 15% carried interest in all wells drilled and purchased. We
were also given an option to purchase additional working interest from Horizon
at Horizon's initial well cost. After the completion of a 30-well pilot program,
we had the right to purchase an additional 25% working interest in each of the
wells at Horizon's initial well and land cost. An additional 25% could be
purchased on the same terms from Horizon within two years after the completion
of the pilot program. These dates were extended to January 15, 2004. Since this
agreement has now expired, we are negotiating a new agreement.
Horizon Exploitation, Inc. is a Colorado corporation and the general
partner of two U.S. limited liability limited partnerships, which are
subsidiaries of a German-based fund, the Horizon Exploitation Fund GmbH & Co.
KG, managed by Horizon Exploitation Fund Verwaltung GmbH, a German corporation,
in Basel, Switzerland. The German-based fund would be the actual entity
providing the monies needed for drilling. The Colorado corporation only provides
administrative support for any investments made by the German-based fund. The
German-based fund is in the process of raising its capital. As of the date of
this prospectus, it had not yet obtained its desired funding.
POWDER RIVER BASIN - WYOMING (BUFFALO RUN, PIPELINE RIDGE, HORSE HILL
AND DUTCH CREEK). In January 2004, we acquired an operating interest in 61
non-producing CBM wells and approximately 12,000 gross acres in the Powder River
Basin in Wyoming (the "Continental acreage") from DAR, LLC, in consideration for
3,000,000 restricted shares of our common stock, valued at $1.80 per share,
$163,655, and $2,600,000 in future payments. The amount of $1,000,000 is due
January 14, 2005 and $1,600,000 is due June 24, 2005.
23
This property is located approximately 12 miles southeast of Sheridan,
Wyoming, and is divided into four CBM development projects: Buffalo Run,
Pipeline Ridge, Horse Hill, and Dutch Creek. The project area contains up to
eight separate coals, ranging in depth from 150 feet to 1,800 feet. Coal
thickness ranges from 20 feet to 70 feet, generally thinning with depth. Gas
content ranges from 30 to 90 cubic feet per ton, generally increasing with
depth. We estimate that full development of this project area is expected to
require up to 280 wells, with two or three wells per location and up to four
coal zone completions per well.
The four projects are in the early implementation stages with 97 wells
drilled to various depths as of August 31, 2004. Of these, 60 have been
completed and approximately one-third of those exhibit shut-in gas pressures of
up to 50 pounds per square inch at the wellhead. The remaining wells have all
had significant gas shows during drilling and completion operations. None of
these wells has been stimulated or placed on production yet. Contracts for
electrical power supply have been executed with two utilities, Powder River
Energy and Montana Dakota Utilities, and construction is nearly complete in the
Pipeline Ridge area. A gas gathering agreement for pipeline access has been
executed, and a compression facility will be constructed by the time the
remaining wells are completed and the field is electrified and the gathering
infrastructure is in place. We began to drill additional development wells
throughout these project areas commencing spring 2004.
We propose to accomplish water disposal without surface discharge
through re-injection and off-channel storage ponds. Injectivity tests have been
performed to confirm that the Bar N Coal and shallow water sands will
accommodate a significant volume of water injection. This method of water
disposal has been implemented in several CBM projects and is approved by the
regulatory authorities.
In March 2004, we acquired the remaining 35% working interest in the
Buffalo Run project for $592,464. In April 2004, we acquired the remaining 50%
working interest in the Dutch Creek project for $300,000 and 360,000 restricted
shares of our common stock, valued at $2.63 per share.
As a result of these acquisitions we have approximately a 100% working
interest in the Buffalo Run project, which has 19 wells drilled and completed
and another 25 wells in various stages of completion, and a 100% working
interest in the Dutch Creek project, which has 13 wells drilled and completed
and another four wells in various stages of completion.
Also in April 2004, we acquired various working interests in
approximately 27,000 net acres adjacent to, and in the vicinity of, the Leiter
and Continental acreage. The acquisition price for these new interests was
$739,550.
In June 2004, we entered into a letter of intent to acquire
approximately 4,400 net acres of oil and gas leases in Campbell and Converse
Counties. Under the terms of the agreement, we committed to pay 100% of the cost
to drill 12 wells on the acreage, to earn a 50% interest in those wells along
with a 50% working interest in nine existing wells, seven of which have been
completed. We paid the seller $100,000 and have the right to acquire for an
additional $1,900,000 payable no later than November 1, 2004, a 90% working
interest in the entire leasehold acreage including all wells on the property.
During the period ended August 31, 2004, we drilled 16 wells on the
acreage thereby completing our drilling commitment. Subsequent to August 31,
2004, we drilled an additional 8 wells on the acreage. On September 30, 2004, we
exercised our option to acquire the additional working interest in the wells and
a 90% working interest in the leasehold acreage in the prospects. After closing
adjustments, we paid approximately $1,886,000 for these interests.
We have executed a contract with Continental Industries, LC, an
affiliate of DAR, LLC, to act as contract operator on our Wyoming Powder River
Basin leases. Continental, a privately-held exploration and production company
based in Casper, Wyoming, was among the first CBM participants in the Powder
River Basin and has extensive CBM experience. Since 1999, Continental has
implemented successfully five CBM projects with over 200 wells. Continental was
chosen as the contract operator on these properties because of its in-depth
knowledge and plans in place to fully develop these properties.
24
In addition, we have engaged Continental to conduct operations on our
Leiter Field acreage because of the following factors:
o the proximity of the Leiter Field to the Buffalo Run, Pipeline
Ridge, Horse Hill and Dutch Creek projects;
o Continental's close relationship with the technical and legal
representatives of the Leiter Field mineral owners; and
o Continental's demonstrated capabilities.
We are compensating Continental under the terms and provisions of a
contract operator agreement with normal industry standard rates for personnel
and expenses.
POWDER RIVER BASIN - MONTANA. On August 5, 2003, we entered into a
Lease Option and Acquisition Agreement with Quaneco, L.L.C. ("Quaneco"). Quaneco
is a privately-held oil and gas company operating primarily in the Rocky
Mountain region.
Under the terms of the agreement, we had an option to acquire up to 50%
of Quaneco's 50% working interest in certain oil and gas leases covering
approximately 214,000 gross acres in the Powder River Basin area of Montana. If
the option were fully exercised, we would acquire the working interests in
approximately 53,500 net acres. The primary geologic target associated in the
acreage is natural gas from shallow coal beds located at depths of 200 feet to
2,500 feet. The purchase price of the option was $6,625,000 payable in six
installments of varying amounts. The first three installments, totaling
$2,787,500, were paid. In addition, Quaneco credited us with payment of $600,000
under the agreement through its purchase of $600,000 in convertible debentures
(discussed below), thereby entitling us to a 12.5% working interest.
We determined this to be a fair transaction for us, based on our study
of the area. Multiple coal seams are present in this prospect area, with a total
coal thickness of approximately 100 feet. There are several surface structures
and faults in the prospect area that were mapped by the U.S. Geological Survey
and the Montana Bureau of Mines. We believe that these structural features are
expected to enhance the CBM gas production. Data used in defining the prospect
area was taken from these agencies, as well as information from abandoned deeper
oil and gas wells drilled in the area. CBM gas production has been established
approximately 6 miles south of the area where cumulative production to date is
about 20 billion cubic feet of natural gas. Leasing costs for similar acreage,
including initial bonus fees, broker costs, title work, and some rentals, vary
between $100 and $200 per acre. This agreement with Quaneco provides for a cost
of $125 per acre.
This acreage is divided into two projects: the Kirby prospect and the
Castle Rock prospect. We intend to participate in a 16-well pilot program on the
Kirby prospect for our 25% working interest share during 2004. We participated
in an initial core hole program on the Castle Rock prospect, the results of
which are being evaluated.
On September 1, 2004, we determined not to increase our working
interest position beyond our existing 12.5% (approximately 26,750 net acres and
2 gross wells (0.5 net wells)), so that we can focus our efforts on our coal bed
methane development program in the Powder River Basin of Wyoming. Accordingly,
we are not paying the balance of the option purchase price in the amount of
$3,237,500, the installments of which were due September 1, 2004 and December 1,
2004. There were no penalties to us associated with this decision.
EAST TEXAS. As of August 31, 2004, we have paid-up leases covering
approximately 2,780 acres in the vicinity of the Trawick Field, located in Rusk
and Nacogdoches Counties, Texas. Leases covering approximately 1,118 acres are
for a three-year term expiring in late 2005 and early 2006, while the leases
covering the remaining approximately 1,662 acres are for a five-year term
expiring in 2007. With the exception of two leases with an 18.75% royalty
interest covering approximately 79 acres, and one lease with a 20% royalty
interest covering approximately 170 acres, all of the leases provide for a
16.67% royalty interest to the mineral owner.
All of the leases were originally held by Harbor Petroleum, LLC or
Florida Energy, Inc. on behalf of Dolphin Energy Corporation, but have been
assigned to Dolphin Energy Corporation. Dolphin is responsible for payment of
all of the acquisition costs and maintenance costs of the leases. Both Harbor
Petroleum, LLC and Florida Energy, Inc. are related parties. See "Certain
Relationships and Related Transactions." Dolphin Energy
25
owns all of the working interests acquired under the leases, and a 2% overriding
royalty interest is shared equally by Harbor Petroleum and Florida Energy.
However, with respect to 400 contiguous acres designated by Florida Energy,
Florida Energy shall have a 3.125% overriding royalty interest instead of a 1%
overriding royalty interest. In addition, Dolphin Energy agreed to pay Florida
Energy a bonus of $50,000 for identifying this lease play. This bonus obligation
was evidenced by a promissory note due March 7, 2004 that accrued interest at
the annual rate of 7-1/2%. That note was paid in March 2004.
Dolphin Energy has agreed that the geological and geophysical
information acquired by our operations on this acreage shall belong to Dolphin
as well as Harbor Petroleum and Florida Energy. Dolphin shall be the operator
for and shall have full control of all operations conducted with respect to this
acreage.
In 2005, we propose to drill a vertical wellbore through the deepest
potential Travis Peak sandstone in the first specific prospect area we are
targeting.
JIU VALLEY - ROMANIA. Pannonian International has a concession
agreement covering 21,538 gross acres for a term of 30 years in the Jiu Valley
Coal Basin, Romania. This acreage contains up to 18 coal seams with a cumulative
thickness up to 52 meters at depths of 985 to 3,280 feet. The main target seam
averages 22 meters in thickness in the concession area. The concession from the
Romanian government was issued October 22, 2002. During the first five years of
the concession, the concession holder is required to expend a specified amount
for exploratory work. If that specified amount is not spent, the concession
holder must pay that amount to the Romanian government. If no payment is made,
the concession is cancelled. Pannonian's minimum exploration expenditure
commitments are as follows:
o $2,000 by October 21, 2003
o $2,000 by October 21, 2004
o $252,000 by October 21, 2005
o $182, 000 by October 21, 2006
o $182,000 by October 21, 2007
Pannonian has already spent in excess of $6,000, thereby satisfying its
requirements through October 21, 2004.
Pannonian proposes to drill two wells in 2005, as Pannonian management
believes that it has two drill sites in close proximity to where earlier wells
have blown out methane. These drill sites are approximately 1.5 miles from a
20-inch gas trunk pipeline, and is approximately the same distance from an
electrical generation plant that uses both natural gas and coal as fuel.
Pannonian estimates that it would cost approximately $475,000 to test and
complete each well as a producing well. If Pannonian could drill a successful
producing well, it could then attract the necessary capital to drill other
offset development wells.
We believe that the proximity to the gas trunk pipeline is a
significant factor in analyzing the economic viability of a project in this
area. We estimate the cost of tying-in to this pipeline to range from
approximately $168,000 to $863,000, depending upon whether gas/water separators
and a compressor would be required. Since we have not yet drilled any wells on
this property and thus do not have any proved reserves, we can analyze economic
viability using only conservative CBM production model curves. Based upon these
conservative CBM production model curves, current natural gas/CBM sales prices
in Romania, and existing Romanian currency rates, we estimate that we would need
13 wells to justify a tie-in to the pipeline.
The property is subject to a royalty interest of approximately 7-1/2%
to the Romanian government and 2-1/2% to the coal mining company.
Pannonian has applied for a concession on an additional 120,000 acres
in Romania and has identified further European license areas for which it is in
the application process.
NEUES BERGLAND - GERMANY. In December 2003, the 149,435-acre Neues
Bergland Exploration Permit was granted for a three-year term to Pannonian
International (50%) and two co-permitees (each with 25%). Both of the
co-permittees are privately-held oil and gas companies that are not affiliated
with us. Under the terms of the permit, we and our co-permittees have the
exclusive right to explore for natural resources within the permit area, subject
to the obtaining the approval from third-party landowners. Permit holders must
pay field taxes by May 31 of each year for the previous calendar year. Permit
holders can deduct from field taxes those expenditures incurred by the permit
26
holder that were necessary to obtain geophysical, geochemical, petrological or
reservoir data, such as geophysical work with processing, drilling operations,
reprocessing work, and fracturing with the goal of transforming a non-producing
into a producing reservoir. The field tax for 2003 has been paid.
The permit requires the drilling of an initial exploration test
borehole during 2004. The estimated cost of phase one of this work program,
which consists of building the drillsite, drilling and testing the first
exploration test borehole, evaluating the borehole with a long-term flow-test
program, evaluating the test results, and re-evaluating the economic,
environmental, regulatory, and technical issues is $1,800,000. Our current plan
is to proceed with phase one only if we can obtain the necessary funding through
a farm-out arrangement. The costs incurred in connection with phase one would
offset all of the field taxes for 2004.
The initial drill site is approximately two miles from a local gas
distribution grid (8" pipeline) and about 4 miles from a 38", 1000 pounds per
square inch, international trunk pipeline. The proximity to these in-place gas
distribution systems would provide excellent marketing potential in what is
considered to be one of Europe's best natural gas markets. A drilling schedule
for this permit will be announced once we know whether the necessary funding is
available.
PRODUCTIVE GAS WELLS
The following summarizes our productive and shut-in gas wells as of
August 31, 2004. Productive wells are producing wells and wells capable of
production. Shut-in wells are wells that are capable of production but are
currently not producing. Gross wells are the total number of wells in which we
have a working interest. Net wells are the sum of our fractional working
interests owned in the gross wells.
PRODUCTIVE GAS WELLS
GROSS NET
Producing gas wells 8 7.2
Shut-in gas wells 112 110.5
--- -----
Total 120 117.7
=== =====
OIL AND GAS ACREAGE
The following table sets forth the undeveloped and developed leasehold
acreage, by area, held by us as of August 31, 2004. Undeveloped acres are acres
on which wells have not been drilled or completed to a point that would permit
the production of commercial quantities of oil and gas, regardless of whether or
not such acreage contains proved reserves. Developed acres are acres, which are
spaced or assignable to productive wells. Gross acres are the total number of
acres in which we have a working interest. Net acreage is obtained by
multiplying gross acreage by our working interest percentage in the properties.
The table does not include acreage in which we have a contractual right to
acquire or to earn through drilling projects, or any other acreage for which we
have not yet received leasehold assignments.
UNDEVELOPED ACRES DEVELOPED ACRES
GROSS NET GROSS NET
Wyoming 71,617 44,681 9,440 9,376
Montana 232,532 32,383 80 20
East Texas 2,780 2,780 -- --
Romania 21,538 21,538 -- --
------- ------- ----- -----
Total 328,467 101,382 9,520 9,396
======= ======= ===== =====
DRILLING ACTIVITY
We had no drilling activity during the year ended November 30, 2003.
27
PRESENT ACTIVITIES
As of August 31, 2004, we had active operations in Wyoming. Four rigs
were working in Wyoming conducting drilling and completion operations.
DEVELOPMENT AND ACQUISITION CAPITAL EXPENDITURES
During the fiscal years ended November 30, 2003 and 2002, we incurred
$2,312,011 and $873,797, respectively, in identifying and acquiring petroleum
and natural gas leases and prospect rights.
PRINCIPAL PRODUCTS
We conduct exploration activities to locate natural gas and crude
petroleum. Should we commence production of these products, we anticipate that
generally they will be sold at the wellhead to purchasers in the immediate area
where the products are produced. We expect that the principal markets for oil
and gas will be refineries and transmission companies that have facilities near
our producing properties.
COMPETITION
Oil and gas exploration and acquisition of undeveloped properties is a
highly competitive and speculative business. We compete with a number of other
companies, including major oil companies and other independent operators which
are more experienced and which have greater financial resources. We do not hold
a significant competitive position in the oil and gas industry.
COMPLIANCE WITH GOVERNMENTAL REGULATIONS
Our operations are subject to various levels of government controls and
regulations in the United States and internationally.
UNITED STATES REGULATION. In the United States, legislation affecting
the oil and gas industry has been pervasive and is under constant review for
amendment or expansion. Pursuant to such legislation, numerous federal, state
and local departments and agencies have issued extensive rules and regulations
binding on the oil and gas industry and its individual members, some of which
carry substantial penalties for failure to comply. Such laws and regulations
have a significant impact on oil and gas drilling, gas processing plants and
production activities, increase the cost of doing business and, consequently,
affect profitability. Inasmuch as new legislation affecting the oil and gas
industry is commonplace and existing laws and regulations are frequently amended
or reinterpreted, we are unable to predict the future cost or impact of
complying with such laws and regulations.
We consider the cost of environmental protection a necessary and
manageable part of our business. We believe we will be able to plan for and
comply with new environmental initiatives without materially altering our
operating strategies.
EXPLORATION AND PRODUCTION. Our United States operations are or will be
subject to various types of regulation at the federal, state and local levels.
Such regulation includes requiring permits for the drilling of wells;
maintaining bonding requirements in order to drill or operate wells;
implementing spill prevention plans; submitting notification and receiving
permits relating to the presence, use and release of certain materials
incidental to oil and gas operations; and regulating the location of wells, the
method of drilling and casing wells, the use, transportation, storage and
disposal of fluids and materials used in connection with drilling and production
activities, surface usage and the restoration of properties upon which wells
have been drilled, the plugging and abandoning of wells and the transporting of
production. Our operations are or will be also subject to various conservation
matters, including the regulation of the size of drilling and spacing units or
proration units, the number of wells which may be drilled in a unit, and the
unitization or pooling of oil and gas properties. In this regard, some states
allow the forced pooling or integration of tracts to facilitate exploration
while other states rely on voluntary pooling of lands and leases, which may make
it more difficult to develop oil and gas properties. In addition, state
conservation laws establish maximum rates of production from oil and gas wells,
generally limit the venting or flaring of gas, and impose certain requirements
regarding the ratable purchase of production. The effect of these regulations is
to limit the amounts of
28
oil and gas we may be able to produce from our wells and to limit the number of
wells or the locations at which we may be able to drill.
ENVIRONMENTAL AND OCCUPATIONAL REGULATIONS. Various federal, state and
local laws and regulations concerning the discharge of incidental materials into
the environment, the generation, storage, transportation and disposal of
contaminants or otherwise relating to the protection of public health, natural
resources, wildlife and the environment, affect our existing and proposed
exploration, development, processing, and production operations and the costs
attendant thereto. These laws and regulations increase our overall operating
expenses. We plan to maintain levels of insurance customary in the industry to
limit our financial exposure in the event of a substantial environmental claim
resulting from sudden, unanticipated and accidental discharges of oil, salt
water or other substances. However, we do not intend to maintain 100% coverage
concerning any environmental claim, and we do not intend to maintain any
coverage with respect to any penalty or fine required to be paid by us because
of our violation of any federal, state or local law. We are committed to meeting
our responsibilities to protect the environment wherever we operate and
anticipate making increased expenditures of both a capital and expense nature as
a result of the increasingly stringent laws relating to the protection of the
environment. We cannot predict with any reasonable degree of certainty our
future exposure concerning such matters. We consider the cost of environmental
protection a necessary and manageable part of our business. We believe we will
be able to plan for and comply with new environmental initiatives without
materially altering our operating strategies.
We are also subject to laws and regulations concerning occupational
safety and health. Due to the continued changes in these laws and regulations,
and the judicial construction of same, we are unable to predict with any
reasonable degree of certainty our future costs of complying with these laws and
regulations. We consider the cost of occupational safety and health a necessary
and manageable part of our business. We believe we will be able to plan for and
comply with new occupational safety and health initiatives without materially
altering our operating strategies.
INTERNATIONAL REGULATION. The oil and gas industry is subject to
various types of regulation throughout the world. Legislation affecting the oil
and gas industry has been pervasive and is under constant review for amendment
or expansion. Pursuant to such legislation, government agencies have issued
extensive rules and regulations binding on the oil and gas industry and its
individual members, some of which carry substantial penalties for failure to
comply. Such laws and regulations have a significant impact on oil and gas
drilling and production activities, increase the cost of doing business and,
consequently, affect profitability. Inasmuch as new legislation affecting the
oil and gas industry is commonplace and existing laws and regulations are
frequently amended or reinterpreted, we are unable to predict the future cost or
impact of complying with such laws and regulations. The following are
significant areas of regulation.
EXPLORATION AND PRODUCTION. Pannonian's oil and gas concessions and
permits are granted by host governments and administered by various foreign
government agencies. Such foreign governments require compliance with detailed
regulations and orders which regulate, among other matters, drilling and
operations on areas covered by concessions and permits and calculation and
disbursement of royalty payments, taxes and minimum investments to the
government.
Regulation includes requiring permits for the drilling of wells;
maintaining bonding requirements in order to drill or operate wells;
implementing spill prevention plans; submitting notification and receiving
permits relating to the presence, use and release of certain materials
incidental to oil and gas operations; and regulating the location of wells, the
method of drilling and casing wells, the use, transportation, storage and
disposal of fluids and materials used in connection with drilling and production
activities, surface usage and the restoration of properties upon which wells
have been drilled, the plugging and abandoning of wells and the transporting of
production. Pannonian's operations are also subject to regulations, which may
limit the number of wells or the locations at which Pannonian can drill.
ENVIRONMENTAL REGULATIONS. Various government laws and regulations
concerning the discharge of incidental materials into the environment, the
generation, storage, transportation and disposal of contaminants or otherwise
relating to the protection of public health, natural resources, wildlife and the
environment, affect Pannonian's exploration, development, processing and
production operations and the costs attendant thereto. In general, this consists
of preparing Environmental Impact Assessments in order to receive required
environmental
29
permits to conduct drilling or construction activities. Such regulations also
typically include requirements to develop emergency response plans, waste
management plans, and spill contingency plans. In some countries, the
application of worldwide standards, such as ISO 14000 governing Environmental
Management Systems, are required to be implemented for international oil and gas
operations.
EMPLOYEES
As of August 31, 2004, we had a total of 8 full time employees and no
part-time employees. None of our employees is covered by a collective bargaining
agreement.
PRINCIPAL OFFICES
Our principal executive offices are located at 1331 - 17th Street,
Suite 730, Denver, Colorado, where we lease approximately 2,580 square feet of
office space under a lease expiring February 28, 2007.
We also have an office at 1001 Brickell Bay Drive, Suite 2202, Miami,
Florida, where we lease approximately 1,300 square feet of space on a lease
expiring June 30, 2005.
LEGAL PROCEEDINGS
There are no legal proceedings pending against us.
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
Our executive officers and directors are:
NAME AGE POSITION
Marc E. Bruner 31 President and Director
Carmen Lotito 60 Executive Vice President, Chief Financial
Officer, Treasurer and Director
Cecil D. Gritz 60 Chief Operating Officer and Director
Richard E. Kurtenbach 49 Vice President - Administration and
Controller
Gerri Baratz 54 Secretary
Nathan C. Collins 69 Director
Dr. James M. Edwards 58 Director
Robert Thomas Fetters, Jr. 64 Director
Thomas W. Rollins 72 Director
Our shareholders elect our directors annually and our board of
directors appoints our officers annually. Vacancies in our board are filled by
the board itself. Set forth below are brief descriptions of the recent
employment and business experience of our executive officers and directors.
MARC E. BRUNER, PRESIDENT AND DIRECTOR
Marc E. Bruner became our President and director upon the acquisition
of Dolphin Energy in November 2002. He has served as president of Dolphin Energy
since June 2002. From September 1999 to June 2002], he worked as an investment
banker and analyst for Resource Venture Management AG, a Swiss-based energy
sector consulting firm. From January 1999 to September 1999, Mr. Bruner did
miscellaneous consulting work He was a senior account executive for J.B. Oxford
& Co., a national securities firm, from February 1997 to January 1999; and an
account executive for GKN Securities, Boca Raton, Florida, from June 1996 to
November 1996. Mr. Bruner holds a B.S. degree in accounting from the University
of Notre Dame. Mr. Bruner devotes all of his working time to the business of the
company.
30
CARMEN LOTITO, EXECUTIVE VICE PRESIDENT, CHIEF FINANCIAL OFFICER, TREASURER AND
DIRECTOR
Carmen Lotito became our Chief Financial Officer, Treasurer and
director upon the acquisition of Dolphin Energy in November 2002. He became our
Executive Vice President in August 2004. He has been a director and the chairman
of the audit and compensation committees of Gasco Energy, Inc., a
publicly-traded natural gas and petroleum exploitation and development company
based in Englewood, Colorado, since April 2001. He served as vice president,
chief financial officer and director of Coriko Corporation, a private business
development company, from November 2000 to August 2002. From July 1998 to
October 1999, Mr. Lotito served as director of marketing and business
development for Impact Web Development, Salt Lake City, Utah. Prior to joining
Coriko, Mr. Lotito was self-employed as a financial consultant. In 1988, Mr.
Lotito joined ConAgra, Inc., in San Antonio, Texas as a brand manager. In 1966,
Mr. Lotito joined the firm of Pannell, Kerr Forester & Co. as a senior
accountant in management and audit services for the company's Los Angeles and
San Diego, California offices. Mr. Lotito holds a BS degree in Accounting from
the University of Southern California. Mr. Lotito is the stepfather of Marc E.
Bruner. Mr. Lotito devotes all of his working time to the business of the
company.
CECIL D. GRITZ, CHIEF OPERATING OFFICER AND DIRECTOR
Cecil D. Gritz became a director upon the acquisition of Dolphin Energy
in November 2002 and became our chief operating officer in October 2003. He has
worked in the oil and gas industry for more than three decades and holds an
advanced degree in petroleum engineering and is a graduate of the Colorado
School of Mines. Mr. Gritz worked as an engineer in various capacities for Shell
Oil Company from June 1966 to August 1973. After leaving Shell Oil Company, he
worked as a drilling and production manager, president of a drilling company,
and petroleum engineer for companies in Denver, Colorado. He was the vice
president of engineering and operations for Vista Resources, Inc., Denver,
Colorado, from July 1977 to September 1982, and the drilling and production
manager for Trend Exploration Limited, Denver, Colorado, from September 1982 to
September 1986. As an in-house full-time consultant, he provided services as a
petroleum engineer and project manager for David Schlachter Oil & Gas, an
independent oil and gas company based in Dallas, Texas, from September 1986 to
March 1988. He was vice president of operations for Dantex Oil & Gas, Inc.,
Dallas, Texas, from March 1988 to August 1993. Mr. Gritz has been a manager and
consulting petroleum engineer for Harbor Petroleum, LLC in Granbury, Texas,
since August 1993. He is a 50% owner of that company. Mr. Gritz devotes all of
his working time to the business of the company.
RICHARD E. KURTENBACH, VICE PRESIDENT - ADMINISTRATION AND CONTROLLER
Richard E. Kurtenbach became our Vice President - Administration and
Controller in April 2004, after having worked for us on a part-time basis since
January 2004. He has over 25 years of experience in domestic and international
oil and gas operations and auditing. From May 2003 to January 2004, he was an
accounting supervisor with respect to the Powder River business unit for
Marathon Oil Company, with responsibility for the preparation and analytical
review of monthly and quarterly financial statements for local management and
corporate consolidation purposes. He was the finance and administration manager
for Hilton Petroleum, Inc./STB Energy, Inc. from March 1998 to January 2001. He
provided management of all financial, administrative and accounting functions
for these companies that were U.S. subsidiaries of a Canadian publicly traded
company. Between his employment with Marathon Oil and Hilton/STB, he was
self-employed as a financial, accounting, auditing, tax, and administrative
consultant. Mr. Kurtenbach received a bachelor of science degree in accounting
from Illinois State University and is licensed as a certified public accountant
in Illinois and Colorado (inactive status).
GERRI BARATZ, SECRETARY
Gerri Baratz became our Secretary in January 2004. She joined Dolphin
Energy Corporation as an administrative assistant in August 2003. From February
1992 to September 2002, she served as an administrative assistant and office
manager for VALIC, a company in Miami, Florida, that provided school, hospital,
and government employees with a range of financial services, including various
savings plans, IRAs, mutual funds, life insurance, long-term care insurance, and
short-term disability insurance. After leaving VALIC, Ms. Baratz took a few
months off. She then worked for two temporary services agencies in Miami,
Florida, from December 2002 to August 2003. Ms. Baratz devotes all of her
working time to the business of the company.
31
NATHAN C. COLLINS, DIRECTOR
Nathan C. Collins became a director in April 2004. He has served as a
director of First State Bank of Flagstaff, Arizona, since September 1998. Mr.
Collins retired in 2003 after a long career in banking. Most recently, he served
as president and CEO of Bank of the Southwest from February 2002 to September
2003, a community bank in Tempe, Arizona. From September 1999 to February 2002,
he was the president of Nordstrom fsb in Scottsdale, Arizona. Nordstrom fsb, a
wholly-owned subsidiary of Nordstrom, Inc., issues Nordstrom branded credit and
debit cards, offers checking account and other financial services to Nordstrom
customers, and provides related services and support for a number of other
Nordstrom activities. His banking career spans 39 years, including serving as
executive vice president, chief lending officer, and chief audit officer of
Valley National Bank of Arizona, where he served from August 1964 to September
1987.
DR. JAMES M. EDWARDS, DIRECTOR
Dr. James M. Edwards became a director upon the acquisition of Dolphin
Energy in November 2002. He has been actively involved in international oil and
gas exploration and exploitation for more than 27 years. He has participated in
oil and gas discoveries in Australia, Columbia, Equatorial Guinea, France,
Norway, Trinidad, Thailand, the United Kingdom, and the United States. Dr.
Edwards previously worked as chief geologist for Triton Energy Corporation.
While with Triton, he participated in the discovery efforts of the
Cusiana/Cupiagua Field Complex, Columbia. Since June 1991, he has been the
president of Equinox Energy Corp., an oil and gas consulting company located in
Dallas, Texas. Dr. Edwards holds advanced degrees in geology, including a Master
of Science from the University of Georgia and a Ph.D. from Rice University. Mr.
Edwards devotes approximately 25 hours per month to the business of the company.
ROBERT THOMAS FETTERS, JR., DIRECTOR
Robert Thomas Fetters, Jr. became a director in March 2004. He began
his career in the oil and gas industry in 1966 when he joined Exxon, USA (then
known as Humble Oil and Refining). He served in various capacities including
exploration, production, and research management and as exploration planning
manager. Internationally, he held positions as chief geologist for Esso
Production Malaysia and exploration manager for Esso Australia. In 1983, Mr.
Fetters joined Consolidated Natural Gas, serving as the president and CEO of its
subsidiary, CNG Producing Company, from 1984 to 1989. From 1990 to 1995, he was
the president of exploration and production for the Exploration Company of
Louisiana, and from 1995 to 1997, he was the senior vice president of operations
for National Energy Group in Dallas, Texas. In 1997, Mr. Fetters co-founded Beta
Oil and Gas, Inc., based in Houston, Texas, and served as its managing director
of exploration to September 2002. He continued to act as a consultant to Beta
Oil and Gas after leaving his position to December 2002. In January 2003, he
co-found Delta Resources, LLC, Houston, Texas, which was formed specifically to
utilize leading edge technology in oil and gas exploration. He continues to
serve as Delta's CEO and a director. In January 2003, he also co-founded
Alliance Oil & Gas Company, LLC, Houston, Texas, which is principally involved
in oil and gas acquisitions. He continues to serve as Alliance's chairman and a
director. Since January 2004, Mr. Fetters has served as the president of
Waveland Energy Partners, LLC, of Irvine, California. He holds both a bachelor's
and master's degree in geology from the University of Tennessee.
THOMAS W. ROLLINS, DIRECTOR
Thomas W. Rollins became a director in March 2004. He has been the
chief executive officer of Rollins Resources, his natural gas and oil consulting
firm in Houston, Texas, since 1985. He has also been a director of Remington Oil
and Gas Corporation, a publicly-traded company headquartered in Dallas, Texas,
since July 1996 and a member of the executive committee of its board of
directors. Mr. Rollins previously held executive positions and/or directorships
with Shell Oil Company, Pennzoil Company, Florida Gas Transmission Company, Pogo
Producing Company, Magma Copper Company, and Felmont Oil Corporation. In 1953,
he received his degree in geological engineering and is a distinguished graduate
medallist from the Colorado School of Mines. He is a member of the American
Association of Petroleum Geologists and the American Petroleum Institute.
32
ADVISORY COMMITTEE
We established an Advisory Committee to obtain advice and
recommendations from persons with significant experience in capitalizing and
operating unconventional natural gas exploration and development companies.
These persons did not want and do not have any authority to make decisions on
our behalf or to bind us. However, they have committed to provide consulting
services to us as requested in the following areas: identification of properties
for acquisition, negotiation of deal terms, assistance in making presentations
about our operations, and assistance in structuring financing arrangements.
While members of the Advisory Committee have full access to our proprietary
information that is relevant to particular tasks assigned to them, they are
obligated to maintain the confidentiality of that information. Currently, the
Advisory Committee meets informally with our officers through telephone
conference calls or in person on average at least once a week, and our officers
also speak with each member of the committee at least twice a week for input on
various projects. Members of the Advisory Committee also participate at times
during meetings of our board of directors when requested by the board and attend
only those portions of the meeting relevant to assigned tasks. We pay each of
our Advisory Committee members according to individually-negotiated consulting
agreements. There is no set rate of compensation or benefits for service as an
Advisory Committee member.
Marc A. Bruner serves as Chairman of our Advisory Committee. He has
served as the Chairman of the Board of Directors of Gasco Energy, Inc., a
publicly-held oil and gas exploration company, since February 2001. From January
1996 to January 1999, Mr. Bruner was founding Chairman of the Board of Ultra
Petroleum, an American Stock Exchange listed natural gas company. Ultra's
business is focused on tight sand development in the Green River Basin of
Wyoming. In late 1997, Mr. Bruner co-founded Pennaco Energy, Inc., a coal bed
methane company that had land holdings in the Powder River Basin. Pennaco was
acquired in March 2001 by Marathon Oil Company. In 1996, Mr. Bruner co-founded
RIS Resources International, a natural gas company, and served as a director
until late 1997. Marc A. Bruner is the father of Marc E. Bruner. Mr. Bruner
currently devotes approximately 20 hours per week to the business of the
company. We pay for his services through a consulting agreement with his
company, Resource Venture Management.
Brian Hughes joined our Advisory Committee in March 2004. He started
his career in the oil and gas industry in 1985, as a production engineer for
Shell Oil Company. While employed by Shell through 1988, he was responsible for
hydraulic fracturing operations for Shell's operated units in West Texas. Mr.
Hughes then worked as a consultant from 1989 to 1996. During that period, he
planned and supervised exploration and production operations in the Rocky
Mountains and West Texas, including coal bed methane exploration programs in the
Sand Wash Basin, Piceance Basin, and San Juan Basin. His research into tight gas
sand and coal bed methane plays resulted in his involvement with Ultra Petroleum
and RIS Resources International from 1996 to 1998, where he served as vice
president exploration and production for those companies. Mr. Hughes briefly
served as vice president exploration and production for Pennaco Energy, Inc. in
1998. Mr. Hughes has been a consultant since 1998, focusing on coal bed methane
opportunities in the Powder River Basin, Forest City Basin, Arkoma Basin, Uinta
Basin, Green River Basin, Bellingham Basin, Vancouver Island, Hat Creek, Western
Alberta, Southeast Alberta, Alaska, and Zimbabwe. Mr. Hughes has been the
manager of Crusader Resources, LLC, since that entity's inception in May 2002.
Crusader Resources is wholly-owned by Mr. Hughes and is engaged in providing oil
and gas contractor services, as well as making oil and gas investments.
CONFLICTS OF INTEREST
Members of our management are associated with other firms involved in a
range of business activities. Consequently, there are potential inherent
conflicts of interest in their acting as officers and directors of our company.
While the officers and directors are engaged in other business activities, we
anticipate that such activities will not interfere in any significant fashion
with the affairs of our business.
Our officers and directors are now and may in the future become
shareholders, officers or directors of other companies, which may be formed for
the purpose of engaging in business activities similar to us. Accordingly,
additional direct conflicts of interest may arise in the future with respect to
such individuals acting on behalf of us or other entities. Moreover, additional
conflicts of interest may arise with respect to opportunities which come to the
attention of such individuals in the performance of their duties or otherwise.
Currently, we do not have a right of first refusal pertaining to opportunities
that come to their attention and may relate to our business operations.
33
Our officers and directors are, so long as they are our officers or
directors, subject to the restriction that all opportunities contemplated by our
plan of operation which come to their attention, either in the performance of
their duties or in any other manner, will be considered opportunities of, and be
made available to us and the companies that they are affiliated with on an equal
basis. A breach of this requirement will be a breach of the fiduciary duties of
the officer or director. If we or the companies with which the officers and
directors are affiliated both desire to take advantage of an opportunity, then
said officers and directors would abstain from negotiating and voting upon the
opportunity. However, all directors may still individually take advantage of
opportunities if we should decline to do so. Except as set forth above, we have
not adopted any other conflict of interest policy with respect to such
transactions.
INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS
From November 2002 to April 2004, Chris D. Wright served as one of our
directors. Mr. Wright resigned on April 8, 2004, in order to assure that certain
legal proceedings in his background would not impair our ability to proceed with
a proposed listing of our common stock on a stock exchange.
On December 20, 2002, Mr. Wright consented to an order by the British
Columbia Securities Commission finding violations of insider trading and acting
contrary to the public interest. He was ordered to cease trading in any
securities, acting as a director or officer of any British Columbia resident
issuers (except for his private holding companies), and engaging in any investor
relations activities for a four-year period ending December 20, 2006. In
addition, Mr. Wright agreed to pay $107,937.50 in profits made from the
violations and $34,000, of which $4,000 represented costs of the investigation.
EXECUTIVE COMPENSATION
The following table sets forth information about the remuneration of
our chief executive officers for the last three completed fiscal years.
SUMMARY COMPENSATION TABLE
- ---------------------------------------------------------------------------------------------------------------------
LONG TERM COMPENSATION
--------------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
---------------------------------------------- --------------------------------------
OTHER RESTRICTED SECURITIES
NAME AND ANNUAL STOCK UNDERLYING LTIP ALL OTHER
PRINCIPAL COMPENSA- AWARD(S) OPTIONS/ PAYOUTS COMPENSA-
POSITION YEAR SALARY ($) BONUS ($) TION ($) ($) SARS (#) ($) TION ($)
- ---------------------------------------------------------------------------------------------------------------------
Marc E. Bruner 2003 $72,000 -0- -0- -0- -0- -0- -0-
President (1)<F1> 2002 $47,000 -0- -0- -0- -0- -0- -0-
- ---------------------------------------------------------------------------------------------------------------------
Gregory C. 2002 -0- -0- -0- -0- -0- -0- -0-
Burnett 2001 -0- -0- -0- -0- -0- -0- -0-
President (2)<F2>
- ---------------------------------------------------------------------------------------------------------------------
- -------------------
<FN>
(1)<F1> Mr. Bruner has been the President from November 13, 2002. The salary
shown above includes consulting fees paid to Mr. Bruner.
(2)<F2> Mr. Burnett was the President from December 17, 1999 to November 13,
2002.
</FN>
During the last fiscal year, there were no grants of stock options,
stock appreciation rights, benefits under long-term incentive plans or other
forms of compensation involving our officers. We reimburse our officers and
directors for reasonable expenses incurred during the course of their
performance.
From April 1, 2003 through February 29, 2004, we paid our two outside
directors a stipend of $1,500 per month. On May 15, 2003, we also granted each
of them options to purchase 60,000 shares at $1.00 per share, exercisable
through May 15, 2013. One-third of these options vests each year beginning May
15, 2004.
Beginning March 1, 2004, we pay our outside directors $2,500 per month,
plus an additional $500 per month for each committee on which they serve.
Outside directors were also granted 60,000 stock options, which vested
immediately and are exercisable through March 2, 2014 at $3.51 per share. Each
January 1, beginning
34
January 1, 2005, we will grant our outside directors options to purchase 60,000
shares of common stock, which shall vest immediately and be exercisable for ten
years at the market price as of date of grant.
STOCK OPTION PLAN
Our stockholders adopted a 2003 Stock Option Plan in May 2003, under
which options to purchase up to 3,500,000 shares of common stock may be granted.
The plan provides for the granting of incentive stock options to our employees
and non-statutory options to our employees, advisors and consultants. The
compensation committee of our board of directors administers the plan. The
maximum aggregate number of common shares underlying all options to be granted
to any one person may not exceed 60% of authorized options.
The committee determines the exercise price for each option at the time
the option is granted. The exercise price for shares under an incentive stock
option may not be less than 100% of the fair market value of the common stock on
the date such option is granted. The fair market value price is the closing
price per share on the date the option is granted. The committee also determines
when options become exercisable. The plan permits payment to be made by cash,
check, broker assisted same day sales, and by delivery of other shares of our
stock which optionees have owned for six (6) months or more as of the exercise
date. The term of an option may be no more than ten (10) years from the date of
grant. No option may be exercised after the expiration of its term.
Unless otherwise expressly provided in any option agreement, the
unexercised portion of any option granted to an optionee shall automatically
terminate one year after the date on which the optionee's employment or service
is terminated for any reason, other than by reason of cause, voluntary
termination of employment or service by the optionee, or the optionee's death.
Options shall terminate immediately upon the termination of an optionee's
employment for cause or 30 days after the voluntary termination of employment or
service by the optionee. If an optionee's employment or consulting relationship
terminates as a result of his or her death, then all options he or she could
have exercised at the date of death, or would have been able to exercise within
the following year if the employment or consulting relationship had continued,
may be exercised within the one year period following the optionee's death by
his or her estate or by the person who acquired the exercise right by bequest or
inheritance.
Options granted under the plan are not transferable other than by will
or the laws of descent and distribution and may be exercised during the
optionee's lifetime only by the optionee, except that a non-statutory stock
option may be transferred to a family member or trust for the benefit of a
family member if the committee's prior written consent is obtained.
We have the right to redeem any shares issued to any optionee upon
exercise of the option granted under the plan immediately upon the termination
of optionee's employment or service arising from disability, the death of the
optionee, the voluntary termination of employment or services of the optionee,
or the termination of employment or services of the optionee for cause. The
redemption price is the fair market value of the shares on the date of the event
of redemption.
In the event that our stock changes by reason of any stock split,
dividend, combination, reclassification or other similar change in our capital
structure effected without the receipt of consideration, appropriate adjustments
shall be made in the number and class of shares of stock subject to the plan,
the number and class of shares of stock subject to any option outstanding under
the plan, and the exercise price for shares subject to any such outstanding
option.
In the event of a merger in which our shareholders immediately before
the merger own 50% or more of the issued and outstanding shares of stock of the
resulting entity after the merger, then existing options shall automatically
convert into options to receive stock of the resulting entity. Unless otherwise
expressly provided in any option, the committee in its sole discretion may
cancel, effective upon the date of the consummation of any change of control,
any option that remains unexercised on such date.
The board may amend, alter, suspend, or terminate the plan, or any part
thereof, at any time and for any reason. However, we must obtain shareholder
approval for any amendment to the plan to the extent necessary and desirable to
comply with applicable laws. No such action by the board or shareholders may
alter or impair any option previously granted under the plan without the written
consent of the optionee. The plan shall remain in effect until terminated by
action of the board or operation of law.
35
As of August 31, 2004, options to purchase 3,500,000 shares were
outstanding at an average exercise price of $2.37 per share and no shares were
available for future grant. We are calling a special shareholders' meeting to
adopt an amendment to the plan to increase to 6,500,000 the aggregate number of
shares of common stock authorized for issuance under the plan.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table provides certain information as to the officers and
directors individually and as a group, and the holders of more than 5% of the
our common stock, as of September 21, 2004:
NAME AND ADDRES OF AMOUNT AND NATURE OF
BENEFICIAL OWNER (1)<F1> BENEFICIAL OWNERSHIP PERCENT OF CLASS (2)<F2>
Marc A. Bruner 12,628,354 (3)<F3>(4)<F4> 21.4%
29 Blauenweg
Metzerlen, Switzerland 4116
Resource Venture Management 5,222,729 (4)<F4> 8.9%
29 Blauenweg
Metzerlen, Switzerland 4116
Bruner Group, LLP 4,500,000 (4)<F4> 7.7%
1775 Sherman Street #1375
Denver, Colorado 80203
DL Family Partnership 3,000,000 5.1%
P.O. Box 656
Casper, Wyoming 82602
Marc E. Bruner 1,612,500 (4)<F4>(5)<F5> 2.7%
Carmen Lotito 1,075,000 (4)<F4>(6)<F6> 1.8%
Dr. James Edwards 127,500 (7)<F7> *
Robert Thomas Fetters, Jr. 107,500 (8)<F8> *
Thomas W. Rollins 107,500 (8)<F8> *
Nathan C. Collins 107,500 (8)<F8> *
Cecil D. Gritz 93,750 (9)<F9> *
Richard E. Kurtenbach 56,250 (10)<F10> *
Gerri Baratz 18,750 (11)<F11> *
All officers and directors as a group (9 persons) 3,306,250 (12)<F12> 5.5%
*less than one percent (1%)
- ------------------
<FN>
(1)<F1> To our knowledge, except as set forth in the footnotes to this table
and subject to applicable community property laws, each person named in
the table has sole voting and investment power with respect to the
shares set forth opposite such person's name.
36
(2)<F2> This table is based on 58,817,509 shares of Common Stock outstanding as
of September 21, 2004. If a person listed on this table has the right
to obtain additional shares of Common Stock within sixty (60) days from
September 21, 2004, the additional shares are deemed to be outstanding
for the purpose of computing the percentage of class owned by such
person, but are not deemed to be outstanding for the purpose of
computing the percentage of any other person.
(3)<F3> Included in Mr. Bruner's share ownership are shares owned of record by
Resource Venture Management and Bruner Group, LLP. Mr. Bruner is a
control person of both these entities. Also included in Mr. Bruner's
share ownership are 203,390 shares issuable upon conversion of a
convertible debenture and exercise of warrants.
(4)<F4> This shareholder has signed a lock-up agreement restricting the sale or
transfer of one-half of the shares owned until September 24, 2004 and
the remaining half until March 24, 2005.
(5)<F5> Includes 112,500 shares issuable upon exercise of stock options.
(6)<F6> Includes 75,000 shares issuable upon exercise of stock options.
(7)<F7> Includes 127,500 shares issuable upon exercise of stock options.
(8)<F8> Includes 107,500 shares issuable upon exercise of stock options.
(9)<F9> Includes 93,750 shares issuable upon exercise of stock options.
(10)<F10>Includes 56,250 shares issuable upon exercise of stock options.
(11)<F11>Includes 18,750 shares issuable upon exercise of stock options.
(12)<F12>Includes 806,250 shares issuable upon exercise of stock options.
</FN>
CHANGES IN CONTROL
There are no agreements known to management that may result in a change
of control of our company.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Other than as disclosed below, none of our present directors, officers
or principal shareholders, nor any family member of the foregoing, nor, to the
best of our information and belief, any of our former directors, senior officers
or principal shareholders, nor any family member of such former directors,
officers or principal shareholders, has or had any material interest, direct or
indirect, in any transaction, or in any proposed transaction which has
materially affected or will materially affect us.
MARC A. BRUNER/RESOURCE VENTURE MANAGEMENT. Marc A. Bruner is one of
our principal shareholders, one of the founders of Dolphin Energy, and the
father of Marc E. Bruner, who serves as our president and a director. We utilize
the services of Marc A. Bruner as a consultant and pay for his services through
his company, Resource Venture Management. The nature of his ongoing consulting
services is such that we have identified him as Chairman of our Advisory
Committee. During the fiscal year ended November 30, 2002, we agreed to pay
Resource Venture Management a total of $692,500 for monthly management fees of
$162,000 through November 30, 2002, for finding oil and gas projects ($300,000),
and for reimbursement of costs and expenses ($230,500). We paid $259,296 in cash
and $200,000 by issuing 4,000,000 shares of our common stock, leaving $233,204
due at November 30, 2002. At February 28, 2003, Resource Venture Management
agreed to convert its outstanding debt of $233,204, into 233,204 shares of our
common stock, valued at $1.00 per share.
We have agreed to enter into a consulting agreement with Resource
Venture Management to provide future consulting services for a fee of up to
$30,000 per month. Beginning October 1, 2003, we and Resource Venture Management
agreed to a reduced fee of $10,000 per month. Such consulting services include
service as Chairman of the Advisory Committee. During the year ended November
30, 2003, consulting fees of $320,000 were incurred. We paid Resource Venture
Management part of its consulting fees through the issuance of 90,000 shares of
common stock valued at $1.00 per share. We subsequently agreed to pay Resource
Venture Management additional
37
consulting fees and expenses of $77,500 during the year ended November 30, 2003,
of which $42,500 is included in accounts payable at November 30, 2003. Resource
Venture Management currently has only one employee, Marc A. Bruner. During the
nine months ended August 31, 2004, we incurred management fees of $90,000 and
other costs and expenses of $51,914 with Resource Venture Management, of which
$43,689 remained outstanding at August 31, 2004.
At November 30, 2003 and August 31, 2004, we also owed Marc A. Bruner
$39,500 for amounts advanced to Pannonian International prior to its acquisition
by us. Upon our acquisition of Pannonian, we assumed this obligation.
CRUSADER RESOURCES, LLC/MARC A. BRUNER. Our agreement with Horizon
Exploitation, Inc., which expired January 15, 2004, identified Crusader
Resources, LLC, as the contract operator for the drilling of any wells under the
agreement. Crusader Resources, LLC is a Colorado limited liability company of
which Brian Hughes and Marc A. Bruner were the only members at the time of the
agreement. Mr. Bruner has since sold his interest in Crusader Resources, LLC to
Brian Hughes, who is also the manager of Crusader Resources.
The agreement stated that a contract operatorship well fee of $5,000
was to be paid to the Crusader Resources as contract operator. To date, no
amounts have been paid to Crusader Resources, LLC, as no wells have been drilled
under the agreement. Further, the contract operating agreement with Crusader
stated that all wells on the subject leases were to be drilled on a competitive
contract basis at the usual rates prevailing in the area. Since we have retained
Continental Industries as operator with respect to our Powder River Basin
acreage in Wyoming, it is anticipated that our new agreement with Horizon will
identify Continental Industries instead of Crusader Resources as the contract
operator.
Crusader Resources, based in Denver, Colorado and organized in May
2002, was recommended to Horizon Exploitation because of the extensive drilling
experience of Brian Hughes in the Powder River Basin area. While Crusader
Resources has no clients and has not served as a contract operator, Mr. Hughes
has drilled over 1,500 wells in that area. We have retained Brian Hughes to
serve as a member of our Advisory Committee, and have completed a strategic
consulting agreement with him. The term of the agreement is from April 1, 2004
to January 31, 2007 and is automatically extended for additional one-year terms
unless we elect to terminate the agreement. We have agreed to pay Mr. Hughes a
consulting fee of $95 per hour for all services in excess of 40 hours per
calendar month and a location fee of $5,000 per well for each well drilled in
the Powder River Basin in Wyoming and Montana, which is drilled on either
undrilled properties we owned at April 1, 2004 or subsequently acquired
undrilled properties. The location fee is multiplied by our working interest in
the well. In addition, we have agreed to pay Mr. Hughes an overriding royalty
interest in oil and gas production from all of our properties in the Powder
River Basin not to exceed 2%. For the fiscal year ended November 30, 2003, we
reimbursed Brian Hughes $25,000 for expenses incurred on our behalf. For the
nine months ended August 31, 2004, we incurred consulting and location fees of
$370,000 of which $130,000 was owed to Mr. Hughes at August 31, 2004.
PANNONIAN INTERNATIONAL, LTD./THOMAS G. FAILS. On November 15, 2002, we
executed a letter of intent to acquire Pannonian International, Ltd., a Colorado
corporation, solely for shares of our common stock. Thomas G. Fails became one
of our directors on November 13, 2002 and resigned March 2, 2004. Mr. Fails is
the president and a director of Pannonian International, Ltd. At November 30,
2002, Pannonian International owed us $25,000 for advances made in contemplation
of the acquisition transaction. We completed the acquisition of Pannonian
International on June 2, 2003, by issuing 1,951,241 shares.
At November 30, 2003 and August 31, 2004, we, through Pannonian
International, owed Thomas G. Fails and his company $139,843 and $68,200,
respectively, for amounts paid by him for the benefit of Pannonian International
and/or advanced to Pannonian. Pannonian International shares office space with
Mr. Fails and is charged a proportionate share of the office rent and other
expenses.
HARBOR PETROLEUM, LLC AND FLORIDA ENERGY, INC. From May 2002 through
the present, Dolphin Energy has advanced funds to Harbor Petroleum, LLC for the
purposes of acquiring oil, gas and mineral interest leases in Rusk and
Nacogdoches Counties, Texas. Harbor Petroleum is 50%-owned and managed by Cecil
Gritz, our chief operating officer and one of our directors. During the years
ended November 30, 2003 and 2002, we incurred total costs with Harbor Petroleum
of $344,294 and $355,817, respectively. Of those amounts, $254,084 in 2003 and
38
$266,617 in 2002 were for reimbursement of costs incurred by Harbor to acquire
oil and gas leases, and $90,210 in 2003 and $89,200 in 2002 represented
consulting fees and expenses from Harbor.
As of November 30, 2003, leases covering approximately 2,780 acres had
been acquired. No additional leases have been acquired since November 30, 2003.
While the leases are in the names of Harbor Petroleum or Florida Energy, Inc.,
such leases have been assigned to Dolphin Energy. Florida Energy is owned and
controlled by Stephen E. Bruner, the brother of Marc A. Bruner, our controlling
shareholder, and the uncle of Marc E. Bruner, our president.
An agreement dated March 6, 2003 confirms that Dolphin is responsible
for payment of all of the acquisition costs and maintenance costs of the leases.
Dolphin Energy owns all of the working interests acquired under the leases,
except for a 2% overriding royalty interest, shared equally by Harbor Petroleum
and Florida Energy. However, with respect to 400 contiguous acres designated by
Florida Energy, Florida Energy shall have a 3.125% overriding royalty interest
instead of a 1% overriding royalty interest. In addition, Dolphin Energy has
agreed to pay Florida Energy a bonus of $50,000 for identifying this lease play.
This bonus obligation was evidenced by a promissory note due March 7, 2004 that
bore interest at the annual rate of 7-1/2%. Accrued interest at November 30,
2003 on this note was $2,742. We paid this note on March 8, 2004.
During the fiscal year ended November 30, 2003 we paid Harbor $13,900
for Mr. Gritz's services as our chief operating officer. At November 30, 2003
and August 31, 2004, $4,375 and $-0-, respectively, was owed to Harbor for Mr.
Gritz's services and expense reimbursement.
FUTURE TRANSACTIONS. All future affiliated transactions will be made or
entered into on terms that are no less favorable to us than those that can be
obtained from any unaffiliated third party. A majority of the independent,
disinterested members of our board of directors will approve future affiliated
transactions.
We believe that of the transactions described above have been on terms
as favorable to us as could have been obtained from unaffiliated third parties
as a result of arm's length negotiations.
DESCRIPTION OF SECURITIES
COMMON STOCK
We are authorized to issue up to 100,000,000 shares of common stock,
$0.001 par value per share. As of September 21, 2004, there were 58,817,509
shares of common stock outstanding, which were held of record by 147
stockholders. The holders of the common stock are entitled to one vote for each
share held of record on all matters submitted to a vote of the stockholders. We
do not have cumulative voting rights in the election of directors, and
accordingly, holders of a majority of the shares voting are able to elect all of
the directors. Subject to preferences that may be granted to any then
outstanding preferred stock, holders of common stock are entitled to receive
ratably such dividends as may be declared by the board of directors out of funds
legally available therefor as well as any distributions to the stockholders. In
the event of our liquidation, dissolution or winding up, holders of common stock
are entitled to share ratably in all of our assets remaining after payment of
liabilities and the liquidation preference of any then outstanding preferred
stock. Holders of common stock have no preemptive or other subscription of
conversion rights. There are no redemption or sinking fund provisions applicable
to the common stock.
We are calling a special shareholders' meeting to adopt an amendment to
our Articles of Incorporation to increase to 400,000,000 the number of
authorized shares of common stock.
PREFERRED STOCK
We are authorized to issue up to 25,000,000 shares of preferred stock,
$0.001 par value per share. There are no shares of preferred stock issued or
outstanding.
39
CONVERTIBLE DEBENTURE FINANCING
In October 2003 we completed the sale of secured convertible debentures
in the principal amount of $5,640,000. The debentures paid quarterly interest at
7% per annum, matured two years from the date of issuance, were secured by all
of our assets (subject to an agreement to subordinate in favor of a senior bank
lender), and were convertible at any time at the option of the holder into
shares of our common stock based on a price of $0.59 per share. This price was
subject to adjustment for stock splits, combination or reclassification of our
capital stock, capital issuances below $0.59 per share.
Interest was payable in shares of our common stock at the lesser of (i)
$0.59 and (ii) 90% of the lesser of (a) the average of the daily volume weighted
average price of the common stock on the OTC Bulletin Board for the 20 trading
days (the "20 VWAPs") immediately prior to the interest payment date or (b) the
average of the 20 VWAPs immediately prior to the date the interest payment
shares are issued and delivered if after the interest payment date.
As of August 31, 2004, all of the debentures were converted into
9,559,322 shares of common stock.
Investors received five-year warrants to purchase up to 2,867,797
shares at $0.71 per share and 2,867,797 shares at $0.83 per share. The warrant
exercise prices may be adjusted for stock splits, combination or
reclassification of our capital stock, capital issuances below $0.71 or $0.83
per share, as the case may be. The warrants provide for cashless exercise.
In connection with the sale of the debentures and warrants, we issued
warrants to purchase a total of 230,847 shares of common stock at $0.59 per
share as compensation.
CONVERTIBLE NOTE FINANCING
On August 19, 2004, we issued in a private placement $15 million of
secured convertible notes initially convertible by the holders into 8,021,390
shares of common stock and warrants initially exercisable for 5,194,806 shares
of common stock. These investors have agreed to purchase, and we have agreed to
sell, an additional $5 million of secured convertible notes (with substantially
the same terms) upon approval of this proposal and subject to satisfaction of
certain customary closing conditions. These additional notes would be initially
convertible by the holders into 2,673,797 shares of common stock (based on the
current conversion price of the existing convertible notes). The initially
issued convertible notes and the additional convertible notes that may be issued
will be referred to in this prospectus as the convertible notes. Under the terms
of the convertible notes, we may make certain payments of principal and interest
through the issuance of common stock in partial conversion of the notes. Under
the terms of the warrants, once our common stock trades at or above 150% of the
warrant exercise price for any 20 consecutive trading days, the holder would
automatically be required to exercise its warrants for cash. The holder would
then receive back the same number of replacement warrants having substantially
the same terms as the initial warrants, but at a new warrant exercise price at a
15% premium to the then current price. In addition, once our common stock trades
at or above 150% the holders may exercise their warrants for cash and receive
replacement warrants, but at a new warrant exercise price at a 15% premium to
the then current price. The initial warrants and any additional warrants issued
in replacement of such warrants are referred to in this prospectus as the
warrants.
PRINCIPAL TERMS OF CONVERTIBLE NOTES AND WARRANTS. The convertible
notes have a term of 24 months and bear interest at the prime rate plus 7.25%,
adjusted quarterly. If the additional $5 million of notes are issued, all of the
convertible notes will have a term of 30 months. Our obligation to pay interest
on the convertible notes begins on January 14, 2005 and our obligation to pay
principal and interest under the convertible notes begins March 1, 2005. We may
meet our payment obligations under the convertible notes in either cash or by
issuing common stock through mandatory conversions, provided certain conditions
are met. We also have the right under specified circumstances to make voluntary
prepayments of all or any portion of the outstanding principal under the
convertible notes. The note holders have the right at any time to convert the
convertible notes into shares of our common stock at an initial conversion price
of $1.87 (subject to adjustment to prevent dilution), which was 140% of the
average of the volume weighted average price of the Common Stock for the 20
consecutive trading days immediately preceding August 19, 2004. All of the
convertible notes, excluding accrued interest, are initially convertible into
10,695,187 shares of common stock (the "Initial Conversion Shares"). This number
of conversion
40
shares is subject to adjustment from time to time upon the occurrence of certain
events described in the convertible notes. The terms of the convertible notes
prohibit the conversion of any principal in excess of that amount of principal
which, after giving effect to such conversion, would cause a note holder and its
affiliates to beneficially own at any time more than 4.99% of our outstanding
common stock.
The convertible notes are secured by a security interest in all of the
assets of our subsidiaries and us. In addition, our subsidiaries have guaranteed
payment of the convertible notes. Accordingly, on August 19, 2004, we and/or our
subsidiaries executed and delivered a security agreement, an account control
agreement, a guaranty, a pledge agreement, and mortgages to create a valid
security interest with respect to all of the assets.
The warrants were also issued on August 19, 2004. They may be exercised
for a term of three years. The number of shares of our common stock initially
issuable upon exercise of the warrants is 5,194,806 shares at an initial per
share exercise price of $1.54. Both the number of warrant shares and the
exercise price are subject to adjustment from time to time upon the occurrence
of certain events described in the warrants.
In connection with the issuance of the convertible notes and the
warrants, we also entered into a registration rights agreement under which we
are required to register 110% of the number of shares of common stock issuable
upon exercise of the warrants and 175% of the greater of (i) the number of
shares of common stock issuable upon conversion of the convertible notes, at an
assumed conversion price approximately equal to the market price of the common
stock and (ii) the Initial Conversion Shares.
CONVERSION OF CONVERTIBLE NOTES IN LIEU OF CASH PAYMENTS; ADJUSTMENTS.
On January 14, 2005, we are obligated to pay accrued interest on the principal
amount of the then outstanding convertible notes at the prime rate plus 7.25%
per annum. Beginning March 1, 2005, and ending March 1, 2007, we are obligated
to repay the convertible notes in monthly installments of principal in the
amount of $833,333.33, plus accrued interest on the principal amount of the then
outstanding convertible notes at the prime rate plus 7.25% per annum, assuming
the issuance of the additional $5 million of convertible notes. At our option,
we may pay our monthly installments in cash or through a partial conversion of
the convertible notes into shares of our common stock at a conversion rate equal
to the lesser of $1.87 (as may be adjusted to prevent dilution), or 93% of the
weighted average trading price of our common stock on the trading day preceding
the conversion, assuming the satisfaction of certain conditions. Among other
things, our common stock must be trading above $1.00 per share, the common stock
to be issued must be registered in a currently effective registration statement,
and the conversion must not result in the holder converting an amount that
exceeds 10% of the trading volume at the time of conversion.
Any determination of the number of shares of the Company's Common Stock
into which the convertible notes may be converted is subject to adjustment in
the event of certain future issuances of securities or derivative securities,
stock dividends, stock splits, stock combinations and other similar
transactions. The convertible notes give the holders the right to any additional
rights, including those obtained through the consolidation, merger or sale of
assets of the company or a similar transaction, that are granted, issued or sold
to our shareholders as if the holders had held the number of shares of common
stock acquirable upon the complete conversion of the convertible notes at the
time such rights become available to the shareholders. The convertible notes
also give the holders the right to any dividends or distributions that are made
to our shareholders as if the holders had held the number of shares of common
stock acquirable upon the complete conversion of the convertible notes at the
time such rights become available to the shareholders.
CONVERSION OF CONVERTIBLE NOTES AT THE OPTION OF THE HOLDER. The notes
are convertible at the option of the holder, in whole or in part, at any time
prior to their maturity at the initial conversion price of $1.87. Any
determination of the number of shares of our common stock into which the
convertible notes may be converted is subject, however, to adjustment in the
event of certain future issuances of securities or derivative securities, stock
dividends, stock splits, stock combinations and other similar transactions. If
we do not timely effect a conversion of the convertible notes, we will be
subject to cash penalties, additional adjustments to the applicable conversion
price, and other penalties described in the convertible notes. Moreover, in such
case, the holders of the convertible notes may require us to redeem all of the
outstanding principal amount of the convertible notes at that time (as discussed
below), which could ultimately result in a further adjustment to the applicable
conversion price.
41
MANDATORY CONVERSION OR REDEMPTION. Starting January 1, 2005 and as
measured monthly thereafter, the holders of the convertible notes may elect to
have a portion of the principal amount repaid early by us, if we fail to meet an
equity liquidity test or a share availability test. The equity liquidity test
means that the product of 20% of the average monthly dollar trading volume
during the prior 3 months and the number of months then remaining in the term of
the convertible notes must be greater than the outstanding principal balance of
and accrued interest on the convertible notes. The share availability test means
that the product of (i) the average of the weighted average price for the 10
consecutive trading days immediately preceding the date of determination
multiplied by (ii) the number of shares registered for resale and reserved for
issuance, less the number of warrant shares then outstanding, must be greater
than the outstanding principal balance of and accrued interest on the
convertible notes. In the event of a failure of either test, we would be
required to redeem in cash and/or provide for the early conversion of a
sufficient amount of the convertible notes in order to meet that test.
REDEMPTION AND DEFAULT PROVISIONS IN THE CONVERTIBLE NOTES. Upon the
occurrence of a Triggering Event, the holders of the convertible notes may cause
us to redeem the convertible notes in cash. Circumstances that are deemed
Triggering Events under which the holders may cause us to redeem the convertible
notes include:
o our failure to obtain and/or maintain the effectiveness of the
registration statement covering the resale of the common
stock underlying the convertible notes and the warrants,
o the failure of the common stock to be listed on the OTC
Bulletin Board or listed on a national securities exchange or
on the NASDAQ National Market or the NASDAQ SmallCap Market
(if the common stock gets listed on a national securities
exchange or on the NASDAQ National Market or the NASDAQ
SmallCap Market),
o the suspension from trading of our common stock for a period
of five consecutive trading days or for more than 10 trading
days in any 365-day period,
o our failure to timely deliver shares of common stock upon
conversion of the convertible notes or exercise of the
warrants,
o material breaches by us under the applicable securities
purchase agreement, the convertible notes, the warrants, the
registration rights agreement or any other agreement entered
into in connection with the transactions contemplated by such
agreements, and
o our failure to make our monthly installments as provided in
the convertible notes.
However, if we do not have sufficient cash to effect a redemption as a
result of a Triggering Event, the holders are entitled to void their redemption
notices and receive a reset of their applicable conversion price to the lesser
of the conversion price then in effect, or the lowest weighted average price of
our common stock during the period beginning on the date on which the notice of
redemption is delivered to us and ending on the date the holder delivers notice
to us of its intent to void the redemption notice.
If an event of default occurs, the holders of the convertible notes may
declare the convertible notes, including all amounts due thereunder, to be due
and payable immediately. Such amount shall bear interest at the rate of 2.0% per
month until paid in full. If we do not timely pay the amounts due, the holders
of the convertible notes may void the acceleration and the conversion price
shall be adjusted to the lesser of the conversion price then in effect, or the
lowest weighted average price of our common stock during the period beginning on
the date on which the convertible notes became accelerated and ending on the
date on which the holders of the convertible notes notify us of their intent to
void the acceleration. The events of default include any failure to pay any
principal amount of the convertible notes when due, failure to comply with any
material provision of the convertible notes, some payment defaults of our other
indebtedness, initiation of bankruptcy proceedings by or against us and our
failure to timely file any report with the SEC under the Securities Exchange Act
of 1934.
WARRANTS. In connection with the sale of the convertible notes, we
issued warrants and may issue additional warrants to the purchasers of the
convertible notes. The warrants give the holders the right to initially purchase
from us, for a period of three years, an aggregate of 5,194,806 shares of our
common stock for $1.54 per share as of the date of issuance. Certain events may
transpire that lower the applicable exercise price under the warrants, increase
the number of warrants, or otherwise give the holders rights to additional
shares of common stock. Both the number of warrants and the exercise price of
the warrants are subject to anti-dilution adjustments in the event of certain
future issuances of securities or derivative securities, stock dividends, stock
splits, stock combinations and any other similar transactions. The warrants also
give the holders the right to any additional
42
rights, including those obtained through the consolidation, merger or sale of
assets of the company or a similar transaction, that are granted, issued or sold
to our shareholders as if the holders had held the number of shares of common
stock acquirable upon the complete exercise of the warrants at the time such
rights become available to the shareholders.
We also issued to the "finders" of this convertible note financing
transaction five-year warrants to purchase 300,000 shares of our common stock at
an exercise price of $1.54 per share.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is Computershare
Trust Company, Inc. Its address is 350 Indiana Street, Suite 800, Golden,
Colorado 80401, and its telephone number is (303) 262-0600.
SELLING STOCKHOLDERS
The shares of common stock being offered by the selling shareholders
are issuable upon conversion of or as interest on the convertible notes or upon
exercise of the warrants. We are registering the shares in order to permit the
selling shareholders to offer the shares of common stock for resale from time to
time. Except for the ownership of the convertible notes and the warrants, the
selling shareholders have not had any material relationship with us within the
past three years.
We are also registering shares of common stock underlying warrants
issued to The Shemano Group, Inc. as the "finders" of this convertible note
financing transaction. The Shemano Group, Inc. assigned its warrants to the
selling shareholders listed below, Gary Shemano and Michael Jacks.
The table below lists the selling shareholders and other information
regarding the beneficial ownership of the common stock by the selling
shareholders. The second column lists the number of shares of common stock held,
plus the number of shares of common stock, based on its ownership of the
convertible notes and the warrants, that would have been issuable to the selling
shareholders as of September 15, 2004, assuming conversion of all convertible
notes and exercise of the warrants held by the selling shareholders on that
date, without regard to any limitations on conversions or exercise. The third
column lists the shares of common stock being offered by this prospectus by the
selling shareholders.
In accordance with the terms of the registration rights agreement with
the holders of the convertible notes and the warrants, this prospectus generally
covers the resale of at least that number of shares of common stock equal to the
sum of (1) 175% of the greater of (A) $15,000,000 divided by the trading price
of our common stock and (B) the number of shares of common stock issuable upon
conversion of the convertible notes, and (2) 110% of the number of shares of
common stock issuable upon exercise of the warrants, determined as if the
outstanding convertible notes and warrants were converted or exercised, as
applicable, in full as of the second trading day immediately preceding the
filing of this registration statement. The fourth column assumes the sale of all
of the shares offered by the selling shareholders pursuant to this prospectus.
Under the terms of the convertible notes and the warrants, the selling
shareholders may not convert the convertible notes, or exercise the warrants, to
the extent such conversion or exercise would cause the selling shareholder,
together with its affiliates, to have acquired a number of shares of common
stock which would exceed 4.99% of our then outstanding common stock, excluding
for purposes of such determination shares of common stock issuable upon
conversion of the convertible notes which have not been converted and upon
exercise of the warrants which have not been exercised. The number of shares in
the second column does not reflect this limitation. The selling shareholders may
sell all, some or none of their shares in this offering. See "Plan of
Distribution."
43
OWNERSHIP AFTER OFFERING
NUMBER OF
SHARES SHARES
BENEFICIALLY REGISTERED FOR NUMBER OF
NAME OF SELLING SHAREHOLDER OWNED (1)<F1>(2)<F2> RESALE (2)<F2> SHARES PERCENT
HFTP Investment L.L.C (3)<F3> 6,864,390 14,677,548 0 0%
Gaia Offshore Master Fund, Ltd. (3)<F3> 1,771,456 3,787,754 0 0%
Caerus Fund Ltd. (3)<F3> 221,432 473,469 0 0%
AG Domestic Convertibles, L.P. (4)<F4> 1,328,592 2,840,816 0 0%
AG Offshore Convertibles, Ltd. (4)<F4> 3,100,047 6,628,570 0 0%
Gary Shemano 318,719 165,000 168,719 *
Michael Jacks 285,401 165,000 135,401 *
*Less than 0.1%
- -----------------
<FN>
(1)<F1> The shares of common stock considered beneficially owned by each
selling shareholder equal that number of shares of our common stock
that such selling shareholder could acquire by converting its
convertible notes at the initial conversion price of $1.87 per share,
taking into account accrued but unpaid interest as of September 15,
2004, and by exercising the warrants.
(2)<F2> The selling shareholders may sell up to 28,738,157 shares of our common
stock under this document. As discussed in footnote (1) above, the
selling shareholders, other than Messrs. Shemano and Jacks, may convert
the convertible notes into shares of our common stock at any time at
the initial conversion price of $1.87 per share, subject to certain
adjustments. We may elect to satisfy our obligation to make payments
under the convertible notes, and under certain circumstances we may be
obligated to satisfy such obligations, by requiring partial conversions
of the convertible notes into shares of our common stock. If such a
partial conversion takes place, the conversion price, subject to
certain anti-dilution adjustments, would be the lower of:
o $1.87, representing 140% of the average of the volume weighted
average price of our common stock for the 20 consecutive
trading days immediately preceding the issuance date of the
convertible notes; or
o 93% of the average of the weighted average trading price of
our common stock on the trading day prior to conversion during
the time period to which the installment relates.
Therefore, as required by the registration rights agreement entered
into among us and the selling shareholders, which requires us to
register at least 110% of the shares of our common stock issuable on
exercise of the warrants and 175% of the shares of our common stock
underlying the convertible notes at the lower of the conversion prices
discussed above, and based on the average of the weighted average
trading prices of our common stock during the five trading days ended
September 15, 2004, the total number of shares of common stock covered
by this document and which may be offered by the selling shareholders
is 28,738,157 shares.
(3)<F3> Promethean Asset Management, LLC, a New York limited liability company
("Promethean"), serves as investment manager to HFTP Investment L.L.C.
("HFTP"), Gaia Offshore Master Fund, Ltd. ("Gaia"), and Caerus Fund
Ltd. ("Caerus") and may be deemed to share beneficial ownership of the
shares beneficially owned by HFTP, Gaia, and Caerus. The ownership
information for each of these three selling shareholders does not
include the ownership information for the others. Promethean disclaims
beneficial ownership of the shares beneficially owned by HFTP, Gaia,
and Caerus and each of HFTP, Gaia, and Caerus disclaims beneficial
ownership of the shares beneficially owned by the others. James F.
O'Brien, Jr. indirectly controls Promethean. Mr. O'Brien disclaims
beneficial ownership of the shares beneficially owned by Promethean,
HFTP, Gaia, and Caerus.
(4)<F4> Angelo, Gordon & Co., L.P., a Delaware limited partnership, serves as
managing member of the general partner of AG Domestic Convertibles, L.P
and as director of AG Offshore Convertibles, Ltd. John M. Angelo and
Michael L. Gordon are the principal executive officers of Angelo,
Gordon & Co., L.P. Each of
44
Angelo, Gordon & Co., L.P. and Messrs. Angelo and Gordon disclaim
beneficial ownership of the shares held by AG Domestic Convertibles,
L.P. and AG Offshore Convertibles, Ltd.
</FN>
PLAN OF DISTRIBUTION
We are registering the shares of common stock issuable upon conversion
of the convertible notes and upon exercise of the warrants to permit the resale
of the shares of common stock by the holders of the convertible notes and the
warrants from time to time after the date of this prospectus. We will not
receive any of the proceeds from the sale by the selling shareholders of the
shares of common stock. We will bear all fees and expenses incident to our
obligation to register the shares of common stock.
The selling shareholders may sell all or a portion of the common stock
beneficially owned by them and offered hereby from time to time directly or
through one or more underwriters, broker-dealers or agents. If the common stock
is sold through underwriters or broker-dealers, the selling shareholders will be
responsible for underwriting discounts or commissions or agent's commissions.
The common stock may be sold in one or more transactions at fixed prices, at
prevailing market prices at the time of the sale, at varying prices determined
at the time of sale, or at negotiated prices. These sales may be effected in
transactions, which may involve crosses or block transactions,
(1) on any national securities exchange or quotation service on
which the securities may be listed or quoted at the time of sale,
(2) in the over-the-counter market,
(3) in transactions otherwise than on these exchanges or systems or
in the over-the-counter market,
(4) through the writing of options, whether such options are listed
on an options exchange or otherwise, or
(5) through the settlement of short sales.
If the selling shareholders effect such transactions by selling shares
of common stock to or through underwriters, broker-dealers or agents, such
underwriters, brokers-dealers or agents may receive commissions in the form of
discounts, concessions or commissions from the selling shareholders or
commissions from purchasers of the shares of common stock for whom they may act
as agent or to whom they may sell as principal (which discounts, concessions or
commissions as to particular underwriters, brokers-dealers or agents may be in
excess of those customary in the types of transactions involved). In connection
with sales of the common stock or otherwise, the selling shareholders may enter
into hedging transactions with broker-dealers, which may in turn engage in short
sales of the common stock in the course of hedging in positions they assume. The
selling shareholders may also sell shares of common stock short and deliver
shares of common stock covered by this prospectus to close out short positions,
provided that the short sale is made after the registration statement is
declared effective and a copy of this prospectus is delivered in connection with
the short sale. The selling shareholders may also loan or pledge shares of
common stock to broker-dealers that in turn may sell such shares.
The selling shareholders may pledge or grant a security interest in
some or all of the convertible notes, warrants, or shares of common stock owned
by them and, if they default in the performance of their secured obligations,
the pledgees or secured parties may offer and sell the shares of common stock
from time to time pursuant to the prospectus. The selling shareholders also may
transfer or donate the shares of common stock in other circumstances, in which
case the transferees, donees or other successors in interest will be the selling
beneficial owners for purposes of the prospectus.
The selling shareholders and any broker-dealer participating in the
distribution of the shares of common stock may be deemed to be "underwriters"
within the meaning of the Securities Act, and any commissions paid, or any
discounts or concessions allowed to any such broker-dealer may be deemed to be
underwriting commissions or discounts under the Securities Act. At the time a
particular offering of the shares of common stock is made, a prospectus
supplement, if required, will be distributed which will set forth the aggregate
amount of shares of common stock being offered and the terms of the offering,
including the name or names of any broker-dealers or agents, any discounts,
commissions and other terms constituting compensation from the selling
shareholders and any discounts, commissions or concessions allowed or reallowed
or paid to broker-dealers.
45
Under the securities laws of some states, the shares of common stock
may be sold in such states only through registered or licensed brokers or
dealers. In addition, in some states the shares of common stock may not be sold
unless such shares have been registered or qualified for sale in such state or
an exemption from registration or qualification is available and is complied
with.
There can be no assurance that any selling shareholder will sell any or
all of the shares of common stock registered pursuant to the registration
statement of which this prospectus forms a part.
The selling shareholders and any other person participating in such
distribution will be subject to applicable provisions of the Exchange Act and
the rules and regulations thereunder, including, without limitation, Regulation
M of the Exchange Act, which may limit the timing of purchases and sales of any
of the shares of common stock by the selling shareholders and any other
participating person. Regulation M may also restrict the ability of any person
engaged in the distribution of the shares of common stock to engage in
market-making activities with respect to the shares of common stock. All of the
foregoing may affect the marketability of the shares of common stock and the
ability of any person or entity to engage in market-making activities with
respect to the shares of common stock.
We will pay all expenses of the registration of the shares of common
stock pursuant to the registration rights agreement estimated to be $25,000 in
total, including, without limitation, Commission filing fees and expenses of
compliance with state securities or "blue sky" laws; provided, however, that the
selling shareholders will pay all underwriting discounts and selling
commissions, if any. In connection with sales made pursuant to this prospectus,
we will indemnify the selling shareholders against liabilities, including some
liabilities under the Securities Act, or the selling shareholders will be
entitled to contribution, in accordance with the registration rights agreement.
We will be indemnified by the selling shareholders against civil liabilities,
including liabilities under the Securities Act that may arise from any written
information furnished to us by the selling shareholders for use in this
prospectus, or we will be entitled to contribution, in accordance with the
registration rights agreement.
Once sold under the registration statement of which this prospectus
forms a part, the shares of common stock will be freely tradable in the hands of
persons other than our affiliates.
LEGAL MATTERS
Dill Dill Carr Stonbraker & Hutchings, P.C., Denver, Colorado, has
given an opinion on the validity of the securities.
EXPERTS
We have included the financial statements of the company as of November
30, 2003 and 2002, and for the year ended November 30, 2003, the period from
inception (June 18, 2002) to November 30, 2002, and cumulative amounts from
inception (June 18, 2002) to November 30, 2003, in reliance upon the report of
Wheeler Wasoff, P.C., independent certified public accountants, whose report has
been included in this prospectus given upon the authority of that firm as
experts in accounting and auditing.
ADDITIONAL INFORMATION
We have been subject to the reporting requirements under federal
securities laws since March 2001. We have filed with the SEC a registration
statement on Form SB-2 and amendments to the registration statement with respect
to the securities offered through this prospectus. This prospectus does not
contain all of the information set forth in the registration statement and the
exhibits and schedules that are part of the registration statement. For further
information about the securities and us, you should review the registration
statement and the exhibits and schedules. Statements made in this prospectus
regarding the contents of any contract or document filed as an exhibit
46
to the registration statement are not necessarily complete. You should review
the copy of such contract or document so filed.
You can inspect the registration statement, as well as the exhibits and
the schedules, filed with the SEC without charge, at the SEC's office at
Judiciary Plaza, 450 Fifth Street, NW, Washington, D.C. 20549. You can also
obtain copies of these materials from the SEC's Public Reference Section at 450
Fifth Street, NW, Washington, D.C. 20549, at prescribed rates. The SEC maintains
a web site on the Internet that contains reports, proxy and information
statements, and other information regarding issuers that file electronically
with the SEC at
REPORTS TO STOCKHOLDERS
We are subject to the reporting requirements of the federal securities
laws, and are required to file periodic reports, proxy statements, and other
information with the SEC. We will furnish our shareholders with annual reports
containing audited financial statements certified by independent public
accountants following the end of each fiscal year, proxy statements, and
quarterly reports containing unaudited financial information for the first three
quarters of each fiscal year following the end of such fiscal quarter.
INDEX TO FINANCIAL STATEMENTS
Unaudited Interim Consolidated Financial Statements - Nine Months Ended August
31, 2004 and 2003
Consolidated Balance Sheet
August 31, 2004 (Unaudited)............................................F-1
Consolidated Statements of Operations (Unaudited)
Nine Months Ended August 31, 2004 and 2003 and
Cumulative Amounts from Inception (June 18, 2002) to
August 31, 2004........................................................F-2
Consolidated Statements of Stockholders' Equity (Deficit) (Unaudited)
Nine Months Ended August 31, 2004......................................F-3
Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended August 31, 2004 and 2003 and
Cumulative Amounts from Inception (June 18, 2002) to
August 31, 2004........................................................F-4
Notes to Consolidated Financial Statements (Unaudited)....................F-6
Financial Statements - November 30, 2003
Report of Independent Registered Public Accounting Firm..................FF-1
Consolidated Balance Sheets
November 30, 2003 and 2002............................................FF-2
Consolidated Statement of Operations
Year Ended November 30, 2003, Period from Inception
(June 18, 2002) to November 30, 2002, and Cumulative
Amounts from Inception to November 30, 2003...........................FF-3
Consolidated Statement of Stockholders' (Deficit)
Period from Inception (June 18, 2002) to November 30, 2002
Year ended November 30, 2003 .........................................FF-4
Consolidated Statement of Cash Flows
Year Ended November 30, 2003, Period from Inception
(June 18, 2002) to November 30, 2002, and Cumulative
Amounts from Inception to November 30, 2003...........................FF-5
Notes to Consolidated Financial Statements...............................FF-7
47
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEET
AUGUST 31, 2004
(UNAUDITED)
CURRENT ASSETS
Cash $ 15,526,740
Prepaid and other 162,202
----------------
Total Current Assets 15,688,942
----------------
OIL AND GAS PROPERTIES 28,468,559
----------------
FURNITURE AND EQUIPMENT, NET 113,107
----------------
OTHER ASSETS
Deferred financing costs, net 1,294,312
Other 31,165
----------------
1,325,477
----------------
TOTAL ASSETS $ 45,596,085
================
CURRENT LIABILITIES
Accounts payable - trade $ 2,437,983
Accounts payable - related 244,443
Current portion of notes payable - related 33,946
Current portion of notes payable 2,600,000
Interest payable 167,259
----------------
Total Current Liabilities 5,483,631
----------------
ASSET RETIREMENT OBLIGATION 212,285
----------------
NON-CURRENT LIABILITIES
Convertible debentures -
Convertible notes payable 10,734,966
Notes payable - related -
----------------
Total Non-Current Liabilities 10,734,966
----------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT)
Preferred stock, $.001 par value
Authorized - 25,000,000 shares
Issued - none
Common stock, $.001 par value
Authorized - 100,000,000 shares
Issued and outstanding - 58,817,509 shares (2004)
and 33,971,503 shares (2003) 58,818
Capital in excess of par value 38,677,780
(Deficit) accumulated during the development stage (9,571,395)
----------------
Total Stockholders' Equity 29,165,203
----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 45,596,085
================
The accompanying notes are an integral part of these financial statements.
F-1
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
CUMULATIVE FROM
INCEPTION
NINE MONTHS ENDED NINE MONTHS ENDED (JUNE 18, 2002) TO
AUGUST 31, 2004 AUGUST 31, 2003 AUGUST 31, 2004
REVENUE
Natural gas sales, net $ 8,565 $ - $ 8,565
---------------- ---------------- ---------------
COSTS AND EXPENSES
General and administrative 2,598,051 1,525,189 5,833,613
Abandoned oil and gas properties - - 65,769
Depreciation and amortization 168,188 - 217,870
---------------- ---------------- ---------------
2,766,239 1,525,189 6,117,252
---------------- ---------------- ---------------
OTHER INCOME (EXPENSE)
Interest income 30,886 - 30,886
Interest and financing costs (3,124,945) - (3,493,594)
---------------- ---------------- ---------------
(3,094,059) - (3,462,708)
---------------- ---------------- ---------------
NET (LOSS) $ (5,851,733) $ (1,525,189) $ (9,571,395)
================ ================ ===============
NET (LOSS) PER COMMON SHARE -
BASIC AND DILUTED $ (0.11) $ (0.05) $ (0.25)
================ ================ ===============
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING - BASIC AND DILUTED 51,725,065 31,871,683 38,079,674
================ ================ ===============
The accompanying notes are an integral part of these
consolidated financial statements.
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE NINE MONTHS ENDED AUGUST 31, 2004
(UNAUDITED)
DEFICIT
ACCUMULATED
CAPITAL DURING THE
COMMON STOCK IN EXCESS DEVELOPMENT
SHARES AMOUNT PAR VALUE STAGE
Balance, November 30, 2003 33,971,503 $ 33,972 $ 6,320,248 $ (3,719,661)
Issuance of common stock upon warrant
conversion 45,763 46 26,954 -
Issuance of common stock for cash at
$1.40 per share 2,503,571 2,504 3,502,496 -
Costs of offering - - (291,840) -
Issuance of common stock for oil and
gas properties at $1.40 per share 2,000,000 2,000 2,798,000 -
Issuance of common stock for oil and
gas properties at $1.80 per share 3,000,000 3,000 5,397,000 -
Issuance of common stock for cash at
$1.80 per share 6,637,671 6,638 11,941,162 -
Costs of offering - - (883,941) -
Issuance of common stock upon
conversion of convertible debenture 1,525,424 1,525 898,475 -
Amortization of discount on convertible
debentures upon conversion of
convertible debentures - - (146,039) -
Amortization of deferred financing cost
upon conversion of convertible
debenture - - (83,529) -
Issuance of common stock for oil and
gas properties at $2.63 per share 360,000 60 946,440 -
Issuance of common stock upon
conversion of convertible debenture
and accrued interest 8,054,364 8,054 4,744,021 -
Issuance of common stock for cashless
exercise of placement agent warrants 719,213 719 (719) -
Amortization of deferred financing costs
upon conversion of convertible
debentures - - (358,356) -
Amortization of discount on convertible
debentures upon conversion of -
convertible debentures - - (719,853) -
Fair value of stock options issued to
consultants - - 23,015 -
Fair value of warrants issued to
placement agents - - 227,930 -
Discount on convertible notes due to
issuance of detachable warrants - - 4,336,136 -
Net Loss
- - - (5,851,733)
------------ ----------- -------------- -------------
Balance, August 31, 2004 58,817,509 $ 58,818 $ 38,677,780 $ (9,571,395)
============ =========== ============== =============
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
CUMULATIVE FROM
NINE MONTHS NINE MONTHS INCEPTION (JUNE
ENDED AUGUST ENDED AUGUST 18, 2002) TO
31, 2004 31, 2003 AUGUST 31, 2004
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) $ (5,851,733) $ (1,525,189) $ (9,571,395)
Adjustments to reconcile net (loss) to net
cash (used) by operating activities
Stock for services - 154,600 264,600
Stock for services - related - - 90,000
Stock for interest and debt 12,075 - 245,279
Amortization of discount on convertible notes and
debentures 2,383,782 - 2,676,464
Amortization of deferred financing costs 126,879 - 175,876
Depreciation expense 41,309 487 41,994
Abandonment of oil and gas properties - - 65,769
Other 23,014 - 34,193
Changes in assets and liabilities
(Decrease) increase in accounts payable - trade (91,763) 249,255 (110,907)
Increase in accounts payable - related 84,411 - 244,443
Increase in interest payable 92,540 - 167,260
(Increase) in prepaids and other assets (128,836) (10,345) (193,369)
--------------- --------------- ---------------
Net cash (used) by operating activities (3,308,322) (1,131,192) (5,869,793)
--------------- --------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to oil and gas properties (11,402,554) (419,686) (13,542,363)
Purchase of furniture and equipment (122,276) (454) (127,488)
Advance to affiliate - (20,000) (60,000)
Cash received upon recapitalization and merger - 1,260 4,234
--------------- --------------- ---------------
Net cash (used) by investing activities (11,524,830) (438,880) (13,725,617)
--------------- --------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of common stock 15,452,800 1,599,830 17,905,300
Proceeds from sale of convertible notes and debentures 15,000,000 - 20,040,000
Debt and stock offering costs (2,263,796) - (2,754,518)
Payment of note payable - related (95,632) - (95,632)
Proceeds from exercise of warrants 27,000 - 27,000
--------------- --------------- ---------------
Net cash provided by financing activities 28,120,372 1,599,830 35,122,150
--------------- --------------- ---------------
NET INCREASE IN CASH 13,287,220 29,758 15,526,740
CASH, BEGINNING OF PERIODS 2,239,520 41,320 -
--------------- --------------- ---------------
CASH, END OF PERIODS $ 15,526,740 $ 71,078 $ 15,526,740
=============== =============== ===============
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
(UNAUDITED)
CUMULATIVE FROM
NINE MONTHS NINE MONTHS INCEPTION (JUNE
ENDED AUGUST ENDED AUGUST 18, 2002) TO
31, 2004 31, 2003 AUGUST 31, 2004
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Cash paid for interest $ 92,347 $ - $ 95,964
============== ============== ===============
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING
ACTIVITIES
Debt incurred for oil and gas properties $ 2,600,000 $ - $ 3,646,000
============== ============== ===============
Stock issued for services $ - $ 154,600 $ 354,600
============== ============== ===============
Stock issued for interest and debt $ 12,075 $ 233,204 $ 245,279
============== ============== ===============
Stock issued for convertible debt $ 5,640,000 $ - $ 5,640,000
============== ============== ===============
Warrants issued for offering and financing costs $ 227,930 $ - $ 335,508
============== ============== ===============
Discount on convertible notes and debentures issued $ 4,336,316 $ - $ 7,807,387
============== ============== ===============
Conversion of interest to debt $ - $ - $ 11,178
============== ============== ===============
Stock issued for subsidiary - related $ - $ - $ (202,232)
============== ============== ===============
Stock issued for oil and gas properties $ 9,149,600 $ - $ 9,149,600
============== ============== ===============
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The accompanying interim financial statements of Galaxy Energy Corporation are
unaudited. In the opinion of management, the interim data includes all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the results for the interim period. The results of
operations for the nine months ended August 31, 2004 are not necessarily
indicative of the operating results for the entire year.
We have prepared the financial statements included herein pursuant to the rules
and regulations of the Securities and Exchange Commission. Certain information
and footnote disclosure normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations. We believe the disclosures made
are adequate to make the information not misleading and recommend that these
condensed financial statements be read in conjunction with the financial
statements and notes for the year ended November 30, 2003 included elsewhere
herein.
Galaxy Energy Corporation (the "Company") was incorporated under the laws of the
State of Colorado on December 17, 1999, for the purpose of acquiring and
developing mineral properties. On November 13, 2002, the Company completed an
Agreement and Plan of Reorganization (the "Agreement") whereby it issued
20,997,058 shares of its common stock to acquire all of the shares of Dolphin
Energy Corporation ("Dolphin"), a private corporation incorporated on June 18,
2002, under the laws of the State of Nevada. The Company was a public company
and had no operations prior to entering into the Agreement. Dolphin, an
independent energy company engaged in the exploration, development and
acquisition of crude oil and natural gas reserves in the western United States,
is considered a development stage company as defined by Statement of Financial
Accounting Standards (SFAS) No. 7. Dolphin was an exploration stage oil and gas
company and had not earned any production revenue, nor found proved resources on
any of its properties. Dolphin's principal activities had been raising capital
through the sale of its securities and identifying and evaluating potential oil
and gas properties.
As a result of this transaction, Dolphin became a wholly owned subsidiary of the
Company. Since this transaction resulted in the former shareholders of Dolphin
acquiring control of the Company, for financial reporting purposes the business
combination was accounted for as an additional capitalization of the Company (a
reverse acquisition with Dolphin as the accounting acquirer).
On June 2, 2003, the Company completed a Share Exchange Agreement whereby it
issued 1,951,241 shares of its common stock to acquire all the shares of
Pannonian International, Ltd. ("Pannonian"), a related entity. Pannonian is a
private corporation incorporated on January 18, 2000, under the laws of the
State of Colorado. The shares issued were valued at the predecessor cost of the
net assets of Pannonian acquired. Pannonian is an independent energy company
engaged in the exploration, development and acquisition of crude oil and natural
gas reserves in Europe and is considered a development stage company as defined
by SFAS 7. Pannonian had not earned any production revenue, nor found proved
resources on any of its properties. As a result of the June 2, 2003 transaction,
Pannonian became a wholly owned subsidiary of the Company.
F-6
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements at November 30, 2003
include the Company for the period from November 13, 2002 to November
30, 2003, its wholly owned subsidiaries, Dolphin, for the period from
June 18, 2002 to November 30, 2003, and Pannonian, for the period from
June 2, 2003 to November 30, 2003. For the three and nine months ended
August 31, 2003 the consolidated financial statements include the
Company and Dolphin for the entire period and Pannonian for the three
months ended August 31, 2003. For the three and nine months ended
August 31, 2004, the consolidated financial statements include the
Company, Dolphin and Pannonian for the entire period. All significant
intercompany transactions have been eliminated upon consolidation.
OIL AND GAS PROPERTIES
The Company utilizes the full cost method of accounting for oil and gas
activities. Under this method, subject to a limitation based on
estimated value, all costs associated with property acquisition,
exploration and development, including costs of unsuccessful
exploration, are capitalized within a cost center. No gain or loss is
recognized upon the sale or abandonment of undeveloped or producing oil
and gas properties unless the sale represents a significant portion of
oil and gas properties and the gain significantly alters the
relationship between capitalized costs and proved oil and gas reserves
of the cost center. Depreciation, depletion and amortization of oil and
gas properties are computed on the units of production method based on
proved reserves. Amortizable costs include estimates of future
development costs of proved undeveloped reserves.
Capitalized costs of oil and gas properties may not exceed an amount
equal to the present value, discounted at 10%, of the estimated future
net cash flows from proved oil and gas reserves plus the cost, or
estimated fair market value, if lower, of unproved properties. Should
capitalized costs exceed this ceiling, an impairment is recognized. The
present value of estimated future net cash flows is computed by
applying year end prices of oil and natural gas to estimated future
production of proved oil and gas reserves as of year end, less
estimated future expenditures to be incurred in developing and
producing the proved reserves and assuming continuation of existing
economic conditions. As of August 31, 2004, the Company has no proved
reserves and recognized initial natural gas production from certain
wells acquired in June 2004. The Company is in the process of
completing and hooking up a number of wells and believes sufficient
data will be developed by the end of the fiscal year to enable the
Company to record proved reserves.
PROPERTY AND EQUIPMENT
Furniture and equipment is recorded at cost. Depreciation is to be
provided by use of the straight-line method over the estimated useful
lives of the related assets of three to five years. Expenditures for
replacements, renewals, and betterments are capitalized. Maintenance
and repairs are charged to operations as incurred. Long-lived assets,
other than oil and gas properties, are evaluated for impairment to
determine if current circumstances and market conditions indicate the
carrying amount may not be recoverable.
Depreciation expense of $7,549 and $13,696 was recorded for the three
and nine months ended August 31, 2004, respectively.
F-7
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
The Company recognizes oil and gas revenues from its interests in
producing wells as oil and gas is produced and sold from these wells.
IMPAIRMENT
The Company has adopted SFAS 144, "Accounting for the Impairment and
Disposal of Long-Lived Assets," which requires that long-lived assets
to be held and used be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Oil and gas properties accounted for using the
full cost method of accounting, a method utilized by the Company, are
excluded from this requirement, but will continue to be subject to the
ceiling test limitations.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
The oil and gas industry is subject, by its nature, to environmental
hazards and clean-up costs. At this time, management knows of no
substantial costs from environmental accidents or events for which the
Company may be currently liable. In addition, the Company's oil and gas
business makes it vulnerable to changes in wellhead prices of crude oil
and natural gas. Such prices have been volatile in the past and can be
expected to be volatile in the future. By definition, proved reserves
are based on current oil and gas prices and estimated reserves. Price
declines reduce the estimated quantity of proved reserves and increase
annual amortization expense (which is based on proved reserves).
(LOSS) PER COMMON SHARE
Basic (loss) per share is based on the weighted average number of
common shares outstanding during the period. Diluted (loss) per share
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common
stock. Options, warrants and convertible debentures are excluded from
the computation of diluted loss per share, as the effect of the assumed
exercises was antidilutive.
F-8
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ASSET RETIREMENT OBLIGATION
In 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 addresses financial accounting and reporting
for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. This statement
requires companies to record the present value of obligations
associated with the retirement of tangible long-lived assets in the
period in which it is incurred. The liability is capitalized as part of
the related long-lived asset's carrying amount. Over time, accretion of
the liability is recognized as an operating expense and the capitalized
cost is depreciated over the expected useful life of the related asset.
The Company's asset retirement obligations ("ARO") relate primarily to
the plugging, dismantlement, removal, site reclamation and similar
activities of its oil and gas properties. Prior to adoption of this
statement, such obligations were accrued ratably over the productive
lives of the assets through its depreciation, depletion and
amortization for oil and gas properties without recording a separate
liability for such amounts.
During the nine months ended August 31, 2004, the Company, through
acquisition and drilling, acquired working interests in natural gas
wells. A limited number of these wells had initial production during
the period, and the others are in various stages of completion and hook
up at August 31, 2004. The Company adopted the provisions of SFAS 143
to record the ARO associated with those wells on the date such
obligation arose. Depreciation of the related asset, and accretion of
the ARO, has been calculated using the Company's estimate of the life
of the wells, based upon the lives of comparable wells in the area. The
amounts recognized upon adoption are based upon numerous estimates and
assumptions, including future retirement costs, future recoverable
quantities of oil and gas, future inflation rates and the
credit-adjusted risk-free interest rate. The information below reflects
the change in the ARO and ARO asset during the nine months ended August
31, 2004:
ARO
Balance beginning of period $ -
Initial calculation of ARO 201,167
Accretion of liability 11,118
------------
Balance end of period $ 212,285
============
RECENT ACCOUNTING PRONOUNCEMENTS
During March 2004, the Emerging Issues Task Force ("EITF") determined
that mineral rights as defined in EITF Issue No. 04-2, "Whether Mineral
Rights are Tangible or Intangible Assets," are tangible assets and
should not be considered intangible assets in Statement of Financial
Accounting Standards No. 141 "Business Combinations" (SFAS 141) and
Statement of Financial Accounting Standards No. 142, "Goodwill and
Intangible Assets" (SFAS 142). The Financial Accounting Standards Board
(FASB), in agreement with this determination, amended SFAS Nos. 141 and
142 through the issuance of FASB Staff Position ("FSP") FSP Nos. 141-1
and 142-1. In addition, the proposed FSP 142-b confirms that FAS 142
did not change the balance sheet classification or disclosures of
mineral rights of oil and gas producing entities. The Company has
historically classified its oil and gas leaseholds as tangible oil and
gas properties which is consistent with EITF 04-02, FSP Nos. 141-1 and
142-1 and therefore such pronouncements have not impacted the Company's
financial condition or results of operations.
F-9
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SHARE BASED COMPENSATION
In October 1995, the FASB issued SFAS 123, Accounting for Stock-Based
Compensation, effective for fiscal years beginning after December 15,
1995. This statement defines a fair value method of accounting for
employee stock options and encourages entities to adopt that method of
accounting for its stock compensation plans. SFAS 123 allows an entity
to continue to measure compensation costs for these plans using the
intrinsic value based method of accounting as prescribed in Accounting
Pronouncement Bulletin Opinion No. 25, Accounting for Stock Issued to
Employees (APB 25). The Company has elected to continue to account for
its employee stock compensation plans as prescribed under APB 25. Had
compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under
those plans consistent with the method prescribed in SFAS 123, the
Company's net (loss) and (loss) per share would have been adjusted to
the pro forma amounts indicated below.
Cumulative
from inception
Three months ended Nine months ended (June 18, 2002)
August 31, August 31, to August 31,
2004 2003 2004 2003 2004
---------------------------- ----------------------------- ----------------
Net (loss) as reported $ (1,067,259) $ (654,990) $ (5,851,733) $ (1,525,189) $ (9,571,394)
Deduct: stock based
compensation cost
under SFAS 123 (730,326) - (1,215,818) - (1,215,818)
---------------------------- ----------------------------- --------------
Pro forma net (loss) $ (1,797,585) $ (654,990) $ (7,067,551) $ (1,525,189) $ (10,787,212)
============================ ============================= ==============
Pro forma basic and diluted
net income per share
Pro forma shares used in
the calculation of pro
forma net income per
common share
basic and diluted 58,817,509 33,971,503 51,725,065 31,871,683 38,079,674
Reported net income per
common share basic and
diluted $ (0.02) $ (0.02) $ (0.11) $ (0.05) $ (0.25)
Pro forma net income per
common share basic and $ (0.03) $ (0.02) $ (0.14) $ (0.05) $ (0.28)
Pro forma information regarding net income is required by SFAS 123. The
value of options granted were estimated using the Black-Scholes
valuation model. The following weighted average assumptions were used
for the three and nine month periods ended August 31, 2004
Volatility 79% to 110%
Expected life of
options (in years) 10
Dividend Yield 0.00%
Risk free interest rate 2.0% to 4.75%
F-10
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - OIL AND GAS PROPERTIES
At August 31, 2004, the Company's oil and gas properties consist of
undeveloped oil and gas leases and interest in 160 natural gas wells, 5
of which had initial production during the period. The remaining wells
are in various stages of completion or awaiting hook up to pipelines.
The Company has no proved reserves as of that date.
WYOMING
In March 2004, the Company negotiated an extension of time to complete
its drilling commitment on the acreage acquired earlier in the year
from Pioneer Oil, LLC, until October 10, 2004. On October 1, 2004, the
Company completed further negotiations whereby, for the payment of
$150,000 previously held in escrow, the lessors agreed that the
drilling commitment had been met and the Company acquired an additional
360 acres of oil and gas leases in the area adjacent to its current
lease holdings. The Company is now obligated to drill a total of 125
wells on the leased acreage by December 31, 2005 under the terms of the
amended lease. As of August 31, 2004, 35 wells have been completed
toward the commitment.
On June 16, 2004 the Company entered into a letter of intent to acquire
4,400 net acres of oil and gas leases in Campbell and Converse
Counties. Under the terms of the agreement, the Company committed to
pay 100% of the cost to drill twelve wells on the acreage, to earn a
50% interest in those wells along with a 50% working interest in nine
existing wells, seven of which have been completed. The Company paid
the seller $100,000 and has the right to acquire for an additional
$1,900,000, a 90% working interest in the entire leasehold acreage
including all wells on the property.
During the period ended August 31, 2004, the Company drilled 16 wells
on the acreage thereby completing its drilling commitment. Subsequent
to August 31, 2004 the Company drilled an additional 8 wells on the
acreage. On September 30, 2004 the Company exercised its option to
acquire the additional working interest in the wells and a 90% working
interest in the leasehold acreage in the prospects. After closing
adjustments, the Company paid approximately $1,886,000 for these
interests.
MONTANA
On August 5, 2003, the Company entered into a Lease Option and
Acquisition Agreement with Quaneco, L.L.C. ("Quaneco"). Quaneco is a
privately-held oil and gas company operating primarily in the Rocky
Mountain region. Under the terms of the agreement, Galaxy had an option
to acquire up to 50% of Quaneco's working interest in certain oil and
gas leases covering approximately 214,000 gross acres in the Powder
River Basin area of southern Montana. If Galaxy were to fully exercise
the option, it would have acquired the working interests in
approximately 53,500 net acres. The total purchase price of the option
is $6,625,000, of which $3,387,500 has been paid, thereby entitling
Galaxy to a 12.5% working interest.
On September 1, 2004, Galaxy determined not to increase its working
interest position beyond its existing 12.5% (approximately 26,750 net
acres and 2 gross wells (0.5 net wells)), so that it can focus its
efforts on its coal bed methane development program in the Powder River
Basin of Wyoming. Accordingly, it notified Quaneco it would not pay the
balance of the option purchase price in the amount of $3,237,500, the
installments of which were due September 1, 2004 and December 1, 2004.
There were no penalties to Galaxy associated with this decision.
F-11
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - OIL AND GAS PROPERTIES (CONTINUED)
TEXAS
Under the terms of an agreement executed March 6, 2003, the Company is
engaged in an ongoing leasing program with Harbor Petroleum LLC
("Harbor") and Florida Energy, Inc. ("Florida") (both related parties)
for the acquisition of oil, gas and mineral leases in Rusk and
Nacogdoches Counties in the State of Texas. Under the terms of the
agreement, Harbor and Florida will each retain a 1% overriding royalty
interest in the acquired leases, including those leases acquired as of
the date of the agreement. However, with respect to 400 contiguous
acres designated by Florida, Florida shall have a 3.125% overriding
royalty instead of a 1% overriding royalty interest.
OTHER
The Company, through its acquisition of Pannonian, acquired an interest
in a concession agreement in the Jiu Valley Coal Basin in Romania. The
terms of the concession require the holder to expend a minimum amount
for exploratory work on the concession or pay an equivalent amount to
the government of Romania. The Company has met the minimum required
expenditure for the concession year ending in October 2004.
In December 2003, Pannonian, together with two unrelated privately held
oil and gas companies, was granted an exploration permit to explore for
natural resources within the 149,435 acres Neues Bergland permit area
in Germany. The permit has a three-year term and requires the drilling
of a test borehole during 2004 to maintain the permit.
Effective October 1, 2002, the Company entered into a Coal Bed Methane
Participation Agreement ("CBM Agreement") with Horizon Exploitation,
Inc. ("Horizon") which potentially provided for funding of the
development of certain of the Company's leasehold interests in Wyoming
and established an AMI (Area of Mutual Interest) in the Powder River
Basin located in Wyoming and Montana for future projects. The CBM
Agreement expired, and the Company is in the process of negotiating a
new agreement.
NOTE 3 - NOTES PAYABLE
On January 15, 2004, the Company entered into a Purchase and Sale
Agreement with DAR, LLC, a Wyoming limited liability company to acquire
certain oil and gas leases in the Powder River Basin area of Wyoming.
Under the terms of the Agreement, the Company paid $163,655 in cash,
issued 3,000,000 shares of common stock, valued at $1.80 per share, and
executed a promissory note for $2,600,000, with interest payable at 6%
per annum. The promissory note requires payments of $1,000,000 on
January 15, 2005, and $1,600,000 on June 24, 2005.
F-12
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 3 - NOTES PAYABLE (CONTINUED)
At August 31, 2004 and November 30, 2003, notes payable consists of the
following:
August 31, November 30,
2004 2003
Payable to Related Party:
Payable to Florida Energy,
Due March 7, 2004, Interest rate - 7.5% $ - $ 50,000
Payable to the President of Pannonian
Due February 5, 2005, Interest rate 10% 33,946 39,946
Payable to a company wholly owned by the
President of Pannonian
Due August 1, 2004, Interest rate 6.5% - 17,132
Due October 5, 2001, Interest rate 15% - 10,000
Due November 29, 2001, Interest rate 15% - 10,000
Due January 12, 2002, Interest rate 15% - 2,500
------------ -------------
33,946 129,578
Less current portion 33,946 (107,632)
------------ -------------
Long term portion $ - $ 21,946
============ =============
Payable to DAR LLC, current portion $ 2,600,000 $ -
============ =============
NOTE 4 - CONVERTIBLE DEBENTURES
In October 2003, the Company completed a private offering of Secured
Convertible Debentures and Warrants (the "Debentures"). Gross proceeds
from the offering were $5,640,000 ($5,040,000 in cash (including
$200,000 from a founder/shareholder of the Company) and $600,000 as
partial consideration for oil and gas properties). The debentures paid
interest at 7% per annum, were scheduled to mature two years from the
date of issue, were secured by substantially all the Company's assets
(subject to an agreement to subordinate in favor of a senior bank
lender), and were convertible into shares of the Company's common stock
based on a conversion price of $0.59 per share. Debenture purchasers
received warrants to purchase 2,867,797 shares of the Company's common
stock at an exercise price of $0.71 per share, and 2,867,797 shares at
an exercise price of $0.83 per share, for a period of five years (the
"debenture warrants").
The Company calculated the value of the debenture warrants and the
beneficial conversion feature to the debentures in accordance with
Emerging Issues Task Force Issue No. 98-5 ("EITF 98-5"), "Accounting
for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios," and EITF 00-27,
"Application of Issue No. 98-5 to Certain Convertible Instruments." The
fair value of the debenture warrants was estimated as of the issue date
under the Black-Scholes pricing model, with the following assumptions:
common stock based on a market price of $.63 and $.80 per share, zero
dividends, expected volatility of 46% and 55%, risk free interest rate
of 3.125% and expected life of five years. The fair value of the
debenture warrants of $1,823,211, resulted in a discount to the
debentures of $1,178,417, and a beneficial conversion feature to the
debentures of $2,292,654. The beneficial conversion feature reflects
the fact the market price of the Company's common stock exceeded the
conversion price of the debentures as of the respective issue dates.
The resulting discount attributable to the debenture warrants and the
beneficial conversion
F-13
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 4 - CONVERTIBLE DEBENTURES (CONTINUED)
feature of the debentures aggregating $3,471,071 has been recorded as a
discount to the debentures and is being amortized over the term of the
debentures. Amortization of the discount of $640,874 is included in
interest expense for the nine months ended August 31, 2004.
During the nine months ended August 31, 2004, all investors converted
their debentures into 9,558,332 shares of common stock in accordance
with the terms of the Securities Purchase Agreement. On the dates of
conversion, the unamortized discount on those debentures attributable
to the fair value of the debenture warrant, $865,989, was credited to
capital in excess of par value. The unamortized discount of the
beneficial conversion feature, $1,671,627 was recognized as interest
expense. At the time of conversion, certain investors elected to
convert interest accrued through the conversion date into shares of
common stock, rather than receive cash payments of such interest.
During the nine months ended August 31, 2004, $12,075 of accrued
interest was converted into 20,466 shares of common stock.
Deferred financing costs associated with the debentures were amortized
through the dates of conversion of the debentures into common stock. As
of the conversion dates the remaining unamortized balance of deferred
financing costs was credited to capital in excess of par value in the
amount of $441,886 for the nine-month period ended August 31, 2004.
During the nine months ended August 31, 2004 the registration statement
covering the resale of common stock underlying the debentures was
declared effective by the Securities and Exchange Commission. Because
the Company did not meet the deadline for registration of the common
stock to become effective as required by the Securities Purchase
Agreement, the Company was required to pay liquidated damages to
investors in the amount of $404,000. This amount was recorded as
interest and financing costs during the nine months ended August 31,
2004.
The placement agents for the debentures received warrants to purchase
230,847 shares of the Company's common stock at an exercise price of
$.59 per share for a term of 5 years from the date of grant. The
$107,758 fair value of the warrants was estimated at the grant date
under the Black-Scholes pricing model.
NOTE 5 - CONVERTIBLE NOTES
In August 2004, the Company completed a private offering of Senior
Secured Convertible Notes and Warrants (the "Notes"). Gross proceeds
from the initial tranche of the offering were $15,000,000. The second
tranche for $5,000,000 is subject to various conditions, and if
completed, will be issued under similar terms to the initial tranche.
The Notes pay interest at the prime rate plus 7.25% per annum, mature
two years from the date of issue, are secured by substantially all the
Company's assets, and are convertible into 8,021,390 shares of the
Company's common stock based on a conversion price of $1.87 per share.
On January 14, 2005, the Company is obligated to pay accrued interest
on the principal amount of the then outstanding Notes. Beginning March
1, 2005, and ending March 1, 2007, the Company is obligated to repay
the Notes in monthly installments of principal in the amount of
$833,333, plus accrued interest on the principal amount of the then
outstanding Notes. At the Company's option, and assuming the
satisfaction of certain conditions, we may pay the monthly installments
in cash or through a partial conversion of the Notes into shares of our
common stock at a conversion rate equal to the
F-14
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5 - CONVERTIBLE NOTES (CONTINUED)
lesser of $1.87 (as may be adjusted to prevent dilution), or 93% of the
weighted average trading price of our common stock on the trading day
preceding the conversion. Note purchasers received warrants to purchase
5,194,806 shares of the Company's common stock at an exercise price of
$1.54 per share, for a period of three years (the "Warrants").
Pursuant to EITF 98-5 and EITF 00-27, the fair value of the Warrants
was estimated as of the issue date under the Black-Scholes pricing
model, with the following assumptions: common stock based on a market
price of $1.21 per share, zero dividends, expected volatility of
109.21%, risk free interest rate of 2.75% and expected life of three
years. The fair value of the Warrants of $3,946,833, resulted in a
discount to the notes of $4,336,316. Amortization of the discount of
$71,282 is included in interest expense for the nine months ended
August 31, 2004.
Deferred financing costs associated with the notes in the amount of
$1,315,944 have been capitalized and are being amortized over the life
of the notes. For the nine months ended August 31, 2004 amortization of
financing costs of $21,632 was recorded.
The placement agents for the notes received warrants to purchase
300,000 shares of the Company's common stock at an exercise price of
$1.54 per share for a term of 5 years from the date of grant. The
$227,930 fair value of these warrants was estimated at the grant date
under the Black-Scholes pricing model.
NOTE 6 - STOCKHOLDERS' EQUITY
During the nine months ended August 31, 2004 the Company issued shares
of its common stock as follows:
o 360,000 shares for partial consideration of acquired oil and gas
properties at $2.63 share
o 8,033,898 shares upon conversion of $4,740,000 of convertible
debentures at a conversion price of $.59 per share
o 20,466 shares upon conversion of $12,075 of accrued interest on
convertible debentures at a conversion price of $.59 per share
o 371,206 shares issued in conjunction with the cashless exercise
of 508,475 Series "A" warrants associated with the convertible
debentures dated September 24, 2003
o 348,005 shares issued in conjunction with the cashless exercise
of 508,475 Series "B" warrants associated with the convertible
debentures dated October 3, 2003
o 45,763 shares for cash of $.59 per share upon conversion of
warrants issued to placement agents of the convertible debentures
o 2,503,571 shares for cash at $1.40 per share
o 2,000,000 shares for partial consideration of acquired oil and
gas properties at $1.40 per share
o 3,000,000 shares for partial consideration of acquired oil and
gas properties at $1.80 per share
o 6,637,671 shares for cash of $1.80 per share
o 1,525,424 shares upon conversion of $900,000 of convertible
debentures at $.59 per share
F-15
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 6 - STOCKHOLDERS' EQUITY (CONTINUED)
Common stock issued for oil and gas properties was valued at the market
price on the closing date of the transaction, or at the price per share
of the private placement sold for cash that took place at the time of
the transaction.
During the nine months ended August 31, 2004 the registration statement
covering the resale of common stock sold in the December 2003 private
placement was declared effective by the Securities and Exchange
Commission. Because the Company did not meet the deadline for
registration of the common stock to become effective, as required by
the Securities Purchase Agreement, the Company was required to pay
liquidated damages to investors in the amount of $35,050. This amount
was recorded as interest and financing costs during the nine months
ended August 31, 2004.
WARRANTS
In connection with sales of common stock in December 2003 and January
2004, the Company issued warrants to purchase 500,715 shares of common
stock at $2.71 per share, and 1,327,535 shares of common stock at $4.05
per share to purchasers of the stock, and issued warrants to purchase
105,166 and 358,435 shares of common stock at $1.40 and $1.80 per
share, respectively, to placement agents for the issue. In accordance
with the terms of the warrants, the exercise prices of those warrants
with original exercise prices in excess of the exercise price of the
warrants issued in association with the Senior Secured Convertible Note
offering (see Note 5) have been reset to $1.54 per share.
In August 2004, in connection with the private placement of convertible
notes, the Company issued warrants to purchase 5,194,806 shares of
common stock at $1.54 per share for a period of three years. In
addition, placement agents for the convertible notes received warrants
to purchase 300,000 shares of common stock at $1.54 per share for a
period of five years.
During the nine months ended August 31, 2004, a holder of the warrants
issued with the convertible debentures exercised their warrants. An
aggregate of 719,211 shares of common stock were issued upon exercise
in accordance with the cashless exercise provisions of the Securities
Purchase Agreement.
NOTE 7 - STOCK OPTION PLAN
In May 2003, the Company adopted the 2003 Stock Option Plan (the
"Plan"). Under the Plan, stock options may be granted at an exercise
price not less than the fair market value of the Company's common stock
at the date of grant. Options may be granted to key employees and other
persons who contribute to the success of the Company. The Company has
reserved 3,500,000 shares of common stock for the plan.
In March and April 2004, the Company granted each of the Company's four
outside directors options to each to purchase 60,000 shares of the
Company's common stock for a term of 10 years at the closing price of
common stock as of the date of grant. The options were vested upon
grant.
F-16
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 7 - STOCK OPTION PLAN (CONTINUED)
On April 6, 2004, the Company granted certain employees options to
purchase a total of 2,375,000 shares of the Company's common stock for
term of 10 years at the closing price of the common stock as of the
date of grant. The options vest over a 5-year period.
On April 28, 2004, the Company granted two consultants options to
purchase a total of 300,000 shares of the Company's common stock over a
term of 10 years at the closing price of the common stock as of the
date of grant. The options vest over terms of up to 5 years. The
options were valued utilizing the Black-Scholes valuation model. At
August 31, 2004, 25,000 options were vested.
On July 1, 2004, the Company granted an employee options to purchase
325,000 shares of the Company's common stock for term of 10 years at
the closing price of the common stock as of the date of grant. The
options vest over a 5-year period.
On August 12, 2004, the Company granted an employee options to purchase
10,000 shares of the Company's common stock for term of 10 years at the
closing price of the common stock as of the date of grant. The options
vest over a 5-year period.
On August 12, 2004, the Company granted each of the Company's outside
directors options to each purchase 47,500 shares of the Company's
common stock for term of 10 years at the closing price of the common
stock as of the date of grant. The options were vested upon grant.
As of August 31, 2004, there were no options to purchase shares of the
Company's common stock available to be granted pursuant to the stock
option agreement.
F-17
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To The Board of Directors and Stockholders
Galaxy Energy Corporation
We have audited the accompanying consolidated balance sheets of Galaxy Energy
Corporation (formerly Galaxy Investments, Inc.) (a development stage company) as
of November 30, 2003 and 2002, and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for the year ended
November 30, 2003, for the period from inception (June 18, 2002) to November 30,
2002 and cumulative amounts from inception (June 18, 2002) to November 30, 2003.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Galaxy Energy
Corporation as of November 30, 2003 and 2002, and the results of its operations
and its cash flows for the year ended November 30, 2003, for the period from
inception (June 18, 2002) to November 30, 2002 and cumulative amounts from
inception (June 18, 2002) to November 30, 2003 in conformity with accounting
principles generally accepted in the United States of America.
/s/ WHEELER WASOFF, P.C.
Wheeler Wasoff, P.C.
Denver, Colorado
February 24, 2004
FF-1
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEETS
NOVEMBER 30, 2003 AND 2002
2003 2002
ASSETS
CURRENT ASSETS
Cash $ 2,239,520 $ 41,320
Prepaid and other 54,573 -
---------------- ----------------
Total Current Assets 2,294,093 41,320
---------------- ----------------
UNDEVELOPED OIL AND GAS ASSETS 2,799,720 873,797
---------------- ----------------
FURNITURE AND EQUIPMENT, NET 4,527 3,247
---------------- ----------------
OTHER ASSETS
Deferred financing costs, net 547,133 -
Due from Pannonian International Ltd. - 25,000
Other 9,960 10,975
---------------- ----------------
557,093 35,975
---------------- ----------------
TOTAL ASSETS $ 5,655,433 $ 954,339
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Accounts payable - trade $ 194,933 $ 425,032
Accounts payable - related 160,032 233,204
Current portion of notes payable - related 107,632 -
Interest payable 74,720 -
Property purchase payable - 396,000
---------------- ----------------
Total Current Liabilities 537,317 1,054,236
---------------- ----------------
CONVERTIBLE DEBENTURES, NET (NOTE 5) 2,461,611 -
---------------- ----------------
NOTES PAYABLE - RELATED 21,946 50,000
---------------- ----------------
COMMITMENTS AND CONTINGENCIES (NOTES 3, 11 AND 12)
STOCKHOLDERS' EQUITY (DEFICIT)
Preferred stock, $.001 par value
Authorized - 25,000,000 shares
Issued - none
Common stock, $.001 par value
Authorized - 100,000,000 shares
Issued and outstanding - 33,971,503 shares (2003)
and 30,025,058 shares (2002) 33,972 30,025
Capital in excess of par value 6,320,248 960,144
(Deficit) accumulated during the development stage (3,719,661) (1,140,066)
---------------- ----------------
Total Stockholders' Equity (Deficit) 2,634,559 (149,897)
---------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 5,655,433 $ 954,339
================ ================
The accompanying notes are an integral part of these financial statements.
FF-2
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS
PERIOD FROM CUMULATIVE FROM
INCEPTION (JUNE 18, INCEPTION
YEAR ENDED 2002) TO (JUNE 18, 2002) TO
NOVEMBER 30, 2003 NOVEMBER 30, 2002 NOVEMBER 30, 2003
REVENUE $ - $ - $ -
---------------- ---------------- ----------------
COSTS AND EXPENSES
General and administrative 2,095,495 1,140,066 3,235,561
Abandoned oil and gas properties 65,769 - 65,769
Depreciation and amortization 49,682 - 49,682
---------------- ---------------- ----------------
2,210,946 1,140,066 3,351,012
---------------- ---------------- ----------------
OTHER EXPENSE
Interest 368,649 - 368,649
---------------- ---------------- ----------------
368,649 - 368,649
---------------- ---------------- ----------------
NET (LOSS) $ (2,579,595) $ (1,140,066) $ (3,719,661)
================ ================ ================
NET (LOSS) PER COMMON SHARE -
BASIC AND DILUTED $ (0.08) $ (0.04) $ (0.12)
================ ================ ================
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING - BASIC AND DILUTED 32,391,981 27,837,822 31,036,140
================ ================ ================
The accompanying notes are an integral part of these consolidated
financial statements.
FF-3
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
PERIOD FROM INCEPTION (JUNE 18, 2002) TO NOVEMBER 30, 2002
AND YEAR ENDED NOVEMBER 30, 2003
(DEFICIT)
ACCUMULATED
CAPITAL IN DURING THE
COMMON STOCK EXCESS OF DEVELOPMENT
SHARES AMOUNT PAR VALUE STAGE
BALANCE, JUNE 18, 2002 (INCEPTION) - $ - $ - $ -
Issuance of common stock for
services at $.05 per share 4,000,000 4,000 196,000 -
Sale of common stock for cash at:
$.001 per share 11,500,000 11,500 - -
$.02 per share 500,000 500 9,500 -
$.05 per share 3,000,000 3,000 147,000 -
$.34 per share 1,997,058 1,997 677,003 -
Recapitalization of shares
issued prior to merger 9,028,000 9,028 (69,359) -
Net (loss) - - - (1,140,066)
----------- --------- ------------- --------------
BALANCE, NOVEMBER 30, 2002 30,025,058 30,025 960,144 (1,140,066)
Issuance of common stock for
cash at $1.00 per share 1,602,000 1,602 1,600,398 -
Costs of offering - - (2,170) -
Issuance of common stock for services at:
$1.00 per share 10,000 10 9,990 -
$.91 per share 60,000 60 54,540 -
Issuance of common stock to related party
upon conversion of outstanding debt
at $1.00 per share 233,204 233 232,971 -
Issuance of common stock to related party
for services at $1.00 per share 90,000 90 89,910 -
Issuance of common stock to acquire
Subsidiary 1,951,241 1,952 (204,184) -
Discount on convertible debentures due to
issuance of detachable warrants and
beneficial conversion feature - - 3,471,071 -
Warrants issued to placement agent in
connection with convertible debenture
offering - - 107,578 -
Net (loss) - - - (2,579,595)
----------- --------- ------------- --------------
BALANCE, NOVEMBER 30, 2003 33,971,503 $ 33,972 $ 6,320,248 $ (3,719,661)
=========== ========= ============= ==============
The accompanying notes are an integral part of these consolidated
financial statements.
FF-4
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIOD FROM CUMULATIVE
INCEPTION FROM INCEP-
(JUNE 18, TION (JUNE 18,
YEAR ENDED 2002) TO 2002) TO
NOVEMBER 30, NOVEMBER 30, NOVEMBER 30,
2003 2002 2003
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) $ (2,579,595) $ (1,140,066) $ (3,719,661)
Adjustments to reconcile net (loss) to net
cash (used) by operating activities
Stock for services 64,600 200,000 264,600
Stock for services - related 90,000 - 90,000
Stock for debt-related 233,204 - 233,204
Amortization of discount on convertible debentures 292,682 - 292,682
Amortization of deferred financing costs 48,997 - 48,997
Depreciation expense 685 - 685
Abandonment of oil and gas properties 65,769 - 65,769
Interest converted to debt 11,178 - 11,178
Changes in assets and liabilities
(Decrease) increase in accounts payable - trade (303,488) 284,344 (19,144)
(Decrease) increase in accounts payable - related (73,172) 233,204 160,032
Increase in interest payable 74,720 - 74,720
(Increase) in prepaids and other current assets (54,573) - (54,573)
Other - (9,960) (9,960)
-------------- --------------- ---------------
Net cash (used) by operating activities (2,128,993) (432,478) (2,561,471)
-------------- --------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to oil and gas properties (1,787,926) (351,883) (2,139,809)
Purchase of furniture and equipment (2,419) (2,793) (5,212)
Advance to affiliate (35,000) (25,000) (60,000)
Cash received upon recapitalization and merger 1,260 2,974 4,234
-------------- --------------- ---------------
Net cash (used) by investing activities (1,824,085) (376,702) (2,200,787)
-------------- --------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of common stock 1,602,000 850,500 2,452,500
Proceeds from sale of convertible debentures 5,040,000 - 5,040,000
Debt and stock offering costs (490,722) - (490,722)
-------------- --------------- ---------------
Net cash provided by financing activities 6,151,278 850,500 7,001,778
-------------- --------------- ---------------
NET INCREASE IN CASH 2,198,200 41,320 2,239,520
CASH, BEGINNING OF PERIODS 41,320 - -
-------------- --------------- ---------------
CASH, END OF PERIODS $ 2,239,520 $ 41,320 $ 2,239,520
============== =============== ===============
The accompanying notes are an integral part of these consolidated
financial statements.
FF-5
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
PERIOD FROM CUMULATIVE
INCEPTION FROM INCEP-
(JUNE 18, TION (JUNE 18,
YEAR ENDED 2002) TO 2002) TO
NOVEMBER 30, NOVEMBER 30, NOVEMBER 30,
2003 2002 2003
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Cash paid for interest $ 3,617 $ - $ 3,617
=============== ============= ===============
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND
FINANCING ACTIVITIES
Debt incurred for oil and gas properties $ 600,000 $ 446,000 $ 1,046,000
=============== ============= ===============
Stock issued for services $ 154,600 $ 200,000 $ 354,600
=============== ============= ===============
Stock issued for debt $ 233,204 $ - $ 233,204
=============== ============= ===============
Warrants issued for financing costs $ 107,578 $ - $ 107,578
=============== ============= ===============
Discount on convertible debentures issued $ 3,471,071 $ - $ 3,471,071
=============== ============= ===============
Conversion of interest to debt $ 11,178 $ - $ 11,178
=============== ============= ===============
Stock issued for subsidiary - related $ (202,232) $ - $ (202,232)
=============== ============= ===============
The accompanying notes are an integral part of these consolidated
financial statements.
FF-6
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND BUSINESS COMBINATION
Galaxy Energy Corporation (formerly Galaxy Investments, Inc.) (the
"Company") was incorporated under the laws of the State of Colorado on
December 17, 1999, for the purpose of acquiring and developing mineral
properties. On November 13, 2002, the Company completed an Agreement
and Plan of Reorganization (the "Agreement") whereby it issued
20,997,058 shares of its common stock to acquire all of the shares of
Dolphin Energy Corporation ("Dolphin"), a private corporation
incorporated on June 18, 2002, under the laws of the State of Nevada.
The Company was a public company and had no operations prior to
entering into the Agreement. Dolphin, an independent energy company
engaged in the exploration, development and acquisition of crude oil
and natural gas reserves in the western United States, is considered a
development stage company as defined by Statement of Financial
Accounting Standards (SFAS) No. 7. Dolphin was an exploration stage oil
and gas company and had not earned any production revenue, nor found
proved resources on any of its properties. Dolphin's principal
activities had been raising capital through the sale of its securities
and identifying and evaluating potential oil and gas properties.
As a result of this transaction, Dolphin became a wholly owned
subsidiary of the Company. Since this transaction resulted in the
former shareholders of Dolphin acquiring control of the Company, for
financial reporting purposes the business combination was accounted for
as an additional capitalization of the Company (a reverse acquisition
with Dolphin as the accounting acquirer). In accounting for this
transaction:
i. Dolphin was deemed to be the purchaser and parent company for
financial reporting purposes. Accordingly, its net assets were
included in the consolidated balance sheet at their historical
book value; and
ii. Control of the net assets and business of the Company was
acquired effective November 13, 2002 for no consideration.
The fair value of the assets acquired and liabilities assumed pursuant
to the transaction with Dolphin are as follows:
Net cash acquired $ 2,974
Liabilities assumed (63,305)
--------------
Common stock issued $ (60,331)
==============
On June 2, 2003, the Company completed a Share Exchange Agreement
whereby it issued 1,951,241 shares of its common stock to acquire all
the shares of Pannonian International, Ltd. ("Pannonian"), a related
entity. Pannonian is a private corporation incorporated on January 18,
2000, under the laws of the State of Colorado. The shares issued were
valued at the predecessor cost of the net assets of Pannonian acquired.
Pannonian is an independent energy company engaged in the exploration,
development and acquisition of crude oil and natural gas reserves in
Europe and is considered a development stage company as defined by SFAS
7. Pannonian has not earned any production revenue, nor has it found
proved resources on any of its properties. As a result of the June 2,
2003 transaction, Pannonian became a wholly owned subsidiary of the
Company.
FF-7
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND BUSINESS COMBINATION (CONTINUED)
The predecessor cost of the assets acquired and liabilities assumed
pursuant to the transaction with Pannonian are:
Net cash acquired $ 1, 260
Undeveloped oil and gas properties 75,680
Liabilities assumed (279,173)
----------
Common stock issued $(202,233)
==========
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the Company
for the period from November 18, 2002 to November 30, 2002, and its
wholly owned subsidiary, Dolphin, for the period from June 18, 2002 to
November 30, 2002. For the year ended November 30, 2003, the
consolidated financial statements include the Company and Dolphin for
the entire year and Pannonian from the effective date of the
acquisition, June 2, 2003, to November 30, 2003. All significant
intercompany transactions have been eliminated upon consolidation.
OIL AND GAS PROPERTIES
The Company utilizes the full cost method of accounting for oil and gas
activities. Under this method, subject to a limitation based on
estimated value, all costs associated with property acquisition,
exploration and development, including costs of unsuccessful
exploration, are capitalized within a cost center. No gain or loss is
recognized upon the sale or abandonment of undeveloped or producing oil
and gas properties unless the sale represents a significant portion of
oil and gas properties and the gain significantly alters the
relationship between capitalized costs and proved oil and gas reserves
of the cost center. Depreciation, depletion and amortization of oil and
gas properties is computed on the units of production method based on
proved reserves. Amortizable costs include estimates of future
development costs of proved undeveloped reserves.
Capitalized costs of oil and gas properties may not exceed an amount
equal to the present value, discounted at 10%, of the estimated future
net cash flows from proved oil and gas reserves plus the cost, or
estimated fair market value, if lower, of unproved properties. Should
capitalized costs exceed this ceiling, an impairment is recognized. The
present value of estimated future net cash flows is computed by
applying year end prices of oil and natural gas to estimated future
production of proved oil and gas reserves as of year end, less
estimated future expenditures to be incurred in developing and
producing the proved reserves and assuming continuation of existing
economic conditions. As of November 30, 2003, the Company has no proved
reserves or production. All oil and gas property costs are considered
to be unevaluated and are recorded at the lower of cost or fair market
value.
FF-8
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In June 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS 141, "Business Combinations," which requires the purchase method
of accounting for business combinations initiated after June 30, 2001
and eliminates the pooling-of-interests method. In July 2001, the FASB
issued SFAS 142, "Goodwill and Other Intangible Assets," which
discontinues the practice of amortizing goodwill and indefinite lived
intangible assets and initiates an annual review for impairment.
Intangible assets with a determinable useful life will continue to be
amortized over that period. The oil and gas industry is currently
discussing the appropriate balance sheet classification of oil and gas
mineral rights held by lease or contract. The Company classifies these
assets as a component of oil and gas properties in accordance with the
full cost mtethod of accounting for oil and gas activities and common
industry practice. There is also a view that these mineral rights are
intangible assets as defined in SFAS 141, "Business Combinations", and,
therefore, should be classified separately on the balance sheet as
intangible assets.
The Company did not change or reclassify contractual mineral rights
included in oil and gas properties on the balance sheet upon adoption
of SFAS 141. The Company believes its current accounting of such
mineral rights, as part of oil and gas properties is appropriate under
the full cost method of accounting. However, if the accounting for
mineral rights held by lease or contract is ultimately changed so that
costs associated with mineral rights not held under fee title and
pursuant to the guidelines of SFAS 141 are required to be classified as
long term intangible assets, then the reclassified amount as of
November 30, 2003 and 2002 would be approximately $2,800,000 and
$874,000 respectively. Management does not believe that the ultimate
outcome of this issue will have a significant impact on the Company's
cash flows, results of operations or financial condition.
In 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement
Obligations." SFAS 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS 143 requires
companies to record the present value of obligations associated with
the retirement of tangible long-lived assets in the period in which it
is incurred. The liability is capitalized as part of the related
long-lived asset's carrying amount. Over time, accretion of the
liability is recognized as an operating expense and the capitalized
cost is depreciated over the expected useful life of the related asset.
As of November 30, 2003, the Company has no producing oil and gas wells
and its oil and gas properties are all considered unevaluated.
Accordingly, no asset retirement obligation has been recognized as of
that date.
PROPERTY AND EQUIPMENT
Furniture and equipment is recorded at cost. Depreciation is to be
provided by use of the straight-line method over the estimated useful
lives of the related assets of three to five years. Expenditures for
replacements, renewals, and betterments are capitalized. Maintenance
and repairs are charged to operations as incurred. Long-lived assets,
other than oil and gas properties, are evaluated for impairment to
determine if current circumstances and market conditions indicate the
carrying amount may not be recoverable. The Company has not recognized
any impairment losses on non oil and gas long-lived assets.
Depreciation expense of $685 was recorded for the year ended November
30, 2003.
FF-9
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
The Company will recognize oil and gas revenues from its interests in
producing wells as oil and gas is produced and sold from these wells.
IMPAIRMENT
The Company has adopted SFAS 144, "Accounting for the Impairment and
Disposal of Long-Lived Assets," which requires that long-lived assets
to be held and used be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Oil and gas properties accounted for using the
full cost method of accounting, a method utilized by the Company, are
excluded from this requirement, but will continue to be subject to the
ceiling test limitations.
INCOME TAXES
The Company has adopted the provisions of SFAS 109, "Accounting for
Income Taxes." SFAS 109 requires recognition of deferred tax
liabilities and assets for the expected future tax consequences of
events that have been included in the financial statements or tax
returns. Under this method, deferred tax liabilities and assets are
determined based on the difference between the financial statement and
tax basis of assets and liabilities using enacted tax rates in effect
for the year in which the differences are expected to reverse.
At November 30, 2003, the Company had a net operating loss carryforward
of approximately $3,200,000 that may be offset against future taxable
income through 2023. These carryforwards are subject to review by the
Internal Revenue Service.
The Company has fully reserved the approximate $1,100,000 tax benefit
of this operating loss because the likelihood of realization of the tax
benefit cannot be determined. Of the total tax benefit, approximately
$738,000 is attributable to 2003.
Temporary differences between the time of reporting certain items for
financial and tax reporting purposes consist primarily of amortization
of discount on convertible debentures.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
The oil and gas industry is subject, by its nature, to environmental
hazards and clean-up costs. At this time, management knows of no
substantial costs from environmental accidents or events for which the
Company may be currently liable. In addition, the Company's oil and gas
business makes it vulnerable to changes in wellhead prices of crude oil
and natural gas. Such prices
FF-10
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
have been volatile in the past and can be expected to be volatile in
the future. By definition, proved reserves are based on current oil and
gas prices and estimated reserves. Price declines reduce the estimated
quantity of proved reserves and increase annual amortization expense
(which is based on proved reserves).
(LOSS) PER COMMON SHARE
Basic (loss) per share is based on the weighted average number of
common shares outstanding during the period. Diluted (loss) per share
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common
stock. At November 30, 2003, all outstanding options, warrants and
convertible debentures are excluded from the computation of diluted
loss per share, as the effect of the assumed exercises was
antidilutive.
RECLASSIFICATION
Certain amounts in the 2002 financial statements have been reclassified
to conform to the 2003 financial statement presentation.
DEFERRED FINANCING COSTS
The Company capitalizes costs associated with the issuance of debt
instruments. These costs are amortized on a straight-line basis over
the term of the debt agreements. Amortization expense of deferred
financing costs was $48,997 for the year ended November 30, 2003.
SHARE BASED COMPENSATION
In October 1995, the FASB issued SFAS 123, Accounting for Stock-Based
Compensation, effective for fiscal years beginning after December 15,
1995. This statement defines a fair value method of accounting for
employee stock options and encourages entities to adopt that method of
accounting for its stock compensation plans. SFAS 123 allows an entity
to continue to measure compensation costs for these plans using the
intrinsic value based method of accounting as prescribed in Accounting
Pronouncement Bulletin Opinion No. 25, Accounting for Stock Issued to
Employees (APB 25). The Company has elected to continue to account for
its employee stock compensation plans as prescribed under APB 25. Had
compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under
those plans consistent with the method prescribed in SFAS 123, the
Company's net (loss) and (loss) per share for the year ended November
30, 2003 would not have changed as no options granted by the Company
during the year ended November 30, 2003 were exercisable at November
30, 2003.
FF-11
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH EQUIVALENTS
For purposes of reporting cash flows, the Company considers as cash
equivalents all highly liquid investments with a maturity of three
months or less at the time of purchase. On occasion, the Company may
have cash in banks in excess of federally insured amounts.
CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist of cash. The Company maintains
cash accounts at two financial institutions. The Company periodically
evaluates the credit worthiness of financial institutions, and
maintains cash accounts only in large high quality financial
institutions.
FAIR VALUE
The carrying amount reported in the balance sheet for cash, prepaids,
and accounts payable and accrued liabilities approximates fair value
because of the immediate or short-term maturity of these financial
instruments.
Based upon the borrowing rates currently available to the Company for
loans with similar terms and average maturities, the fair value of
long-term debt approximates its carrying value.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS 146 addresses
financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity." SFAS 146 generally requires a
liability for a cost associated with an exit or disposal activity to be
recognized and measured initially at its fair value in the period in
which the liability is incurred. The pronouncement is effective for
exit or disposal activities initiated after December 31, 2002. The
Company does not believe the adoption of SFAS 146 will have any impact
on its financial position or results of operations.
SFAS 147, "Acquisitions of Certain Financial Institutions," was issued
in December 2002 and is not expected to apply to the Company's current
or planned activities.
In December 2002, the FASB approved SFAS 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an amendment of
FASB Statement 123." SFAS 148 amends SFAS 123, "Accounting for
Stock-Based Compensation", to provide alternative methods of transition
for a voluntary change to the fair value based method of accounting for
stock-based employee compensation. In addition, SFAS 148 amends the
disclosure requirements of SFAS 123 to require prominent disclosures in
both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the
method used on reported results. SFAS 148 is effective for financial
statements for fiscal years ending after December 15, 2002.
FF-12
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company will continue to account for stock based compensation using
the methods detailed in the stock-based compensation accounting policy.
In April 2003, the FASB approved SFAS 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities". SFAS 149 is not
expected to apply to the Company's current or planned activities.
In June 2003, the FASB approved SFAS 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity". SFAS 150 establishes standards for how an issuer classifies
and measures certain financial instruments with characteristics of both
liabilities and equity. This Statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning
after June 15, 2003. SFAS 150 is not expected to have an effect on the
Company's financial position.
NOTE 3 - OIL AND GAS PROPERTIES
WYOMING
In August 2002, the Company entered into an option agreement to acquire
undeveloped oil and gas leases in Wyoming subject to a 15% net profits
interest. Under the terms of the option agreement, the Company paid
$46,000 as of November 30, 2003, an additional $5,000 on December 15,
2003, and was, at the option of the Company, scheduled to pay $396,000
by January 15, 2004. The company has notified the operator it will not
exercise its option to complete the transaction and the investment in
the prospect as of November 30, 2003, $46,000, was written off as
abandoned oil and gas properties.
In September 2002, the Company entered into an agreement for the
acquisition of undeveloped oil and gas leases with Pioneer Oil, LLC, a
Montana limited liability company. Under the terms of the agreement,
for an intitial cash payment of $100,000, the Company was entitled to
earn a 100% working interest and a 78% net revenue interest in oil and
gas leases covering 15,657 acres in the Powder River Basin near Lieter,
Wyoming. The agreement required the Company to make an additional
payment of $1,650,000 and to deposit the estimated cost to drill and
complete 30 pilot wells, into an escrow account. During the year ended
November 30, 2003, the Company negotiated term extensions with Pioneer
and made two additional payments of $100,000 each to Pioneer.
Subsequent to November 30, 2003, the Company purchased Pioneer's
interest in the subject leases for $1,000,000 cash and 2,000,000 shares
of common stock. (Note 12).
Subsequent to November 30, 2003 the Company entered into an agreement
with DAR, LLC, a Wyoming limited liability company, to acquire certain
oil and gas leases in the Powder River Basin of Wyoming for
approximately $2,764,000 in cash and 3,000,000 shares of the Company's
common stock. (Note 12).
FF-13
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - OIL AND GAS PROPERTIES (CONTINUED)
MONTANA
On August 5, 2003 the Company entered into a Lease Option and
Acquisition Agreement with Quaneco, L.L.C. ("Quaneco"), a privately
held oil and gas company operating primarily in the Rocky Mountain
region Under the terms of the agreement, the Company has an option to
acquire up to 50% of Quaneco's working interest in oil and gas leases
covering approximately 206,000 gross acres in Montana, and an option to
earn an undivided 25% interest in up to one hundred twenty-eight (128)
drilling locations by paying its proportionate share of costs to drill
wells on such locations. The purchase price of the option is
$6,625,000. As of November 30, 2003, $1,700,000 of the purchase price
has been paid by the Company, $1,100,000 in cash and $600,000 in
convertible Debentures issued on September 24, 2003. The balance of the
purchase price is due in installments as follows: $1,612,500 on April
15, 2004; $1,656,250 on September 1, 2004 and $1,656,250 on December 1,
2004.
TEXAS
Under the terms of an agreement executed March 6, 2003, the Company is
engaged in an ongoing leasing program with Harbor Petroleum LLC
("Harbor") and Florida Energy, Inc. ("Florida") (both related parties)
for the acquisition of oil, gas and mineral leases in Rusk and
Nacogdoches Counties in the State of Texas. Under the terms of the
agreement, Harbor and Florida will each retain a 1% overriding royalty
interest in the acquired leases, including those leases acquired as of
the date of the agreement.
OTHER
The Company, through its acquisition of Pannonian, acquired an interest
in a concession agreement in the Jui Valley Coal Basin in Romania. The
terms of the concession require the holder to expend a minimum amount
for exploratory work on the concession or pay an equivalent amount to
the government of Romania. The Company has met the minimum required
expenditure for the concession year ending in October 2004.
Subsequent to November 30, 2003, Pannonian, together with two unrelated
privately held oil and gas companies, was granted an exploration permit
to explore for natural resources within the 149,435 acres Neues
Bergland permit area in Germany. The permit has a three-year term and
requires the drilling of a test borehole during 2004 to maintain the
permit.
Effective October 1, 2002, the Company entered into a Coal Bed Methane
Participation Agreement ("CBM Agreement") with Horizon Exploitation,
Inc. ("Horizon") which potentially provided for funding of the
development of certain of the Company's leasehold interests in Wyoming
and established an AMI (Area of Mutual Interest) in the Powder River
Basin located in Wyoming and Montana for future projects. Subsequent to
November 30, 2003, the CBM Agreement expired, and the Company is in the
process of negotiating a new agreement with Horizon.
FF-14
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - OIL AND GAS PROPERTIES (CONTINUED)
At November 30, 2003 and 2002, the Company's unevaluated oil and gas
properties consist of leasehold costs in the following areas:
2003 2002
Wyoming $230,250 $462,250
Montana 1,762,900 -
Texas 739,336 405,818
Other 67,234 5,729
---------- --------
$2,799,720 $873,797
========== ========
NOTE 4 - NOTES PAYABLE - RELATED
In connection with the March 6, 2003 agreement between the Company,
Harbor and Florida, the Company agreed to pay Florida $50,000 for
identifying prospective oil and gas leases in Texas, and executed a
promissory note in that amount with interest payable at 7.5% due March
7, 2004. The Company recorded this obligation as of November 30, 2002
because the underlying agreement was effective retroactively to the
time the leasing program commenced, prior to November 30, 2002. Accrued
interest of $2,742 is included in interest payable at November 30,
2003.
In connection with the acquisition of Pannonian effective June 2, 2003,
the Company assumed notes payable to the President of Pannonian in the
amount of $32,400, and to a related company, wholly owned by the
President of Pannonian, in the amount of $36,000. On November 30, 2003,
certain of those notes together with accrued interest were rolled into
two new notes.
At November 30, 2003 and 2002, notes payable consists of the following:
2003 2002
Payable to Florida Energy,
Due March 7, 2004, Interest rate - 7.5% $50,000 $50,000
Payable to the President of Pannonian
Due February 5, 2005, Interest rate 10% 39,946 -
Payable to a company wholly owned by the
President of Pannonian
Due August 1, 2004, Interest rate 6.5% 17,132 -
Due October 5, 2001, Interest rate 15% 10,000 -
Due November 29, 2001, Interest rate 15% 10,000 -
Due January 12, 2002, Interest rate 15% 2,500 -
--------- -------
129,578 50,000
Less current portion (107,632) -
--------- -------
Long term portion $21,946 $50,000
========= =======
Subsequent to November 30, 2003, notes payable to the company wholly
owned by the President of Pannonian totaling $22,500, plus accrued
interest, were paid by the Company.
FF-15
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - CONVERTIBLE DEBENTURES
In October 2003, the Company completed a private offering of Secured
Convertible Debentures and Warrants (the "Debentures"). Gross proceeds
from the offering were $5,640,000 ($5,040,000 in cash (including
$200,000 to a founder\shareholder of the Company) and $600,000 as
partial consideration for oil and gas properties). The debentures pay
interest at 7% per annum, mature two years from the date of issue, are
secured by substantially all the Company's assets (subject to an
agreement to subordinate in favor of a senior bank lender), and are
convertible into shares of the Company's common stock based on a
conversion price of $0.59 per share. Debenture purchasers received
warrants to purchase 2,867,797 shares of the Company's common stock at
an exercise price of $0.71 per share, and 2,867,797 shares at an
exercise price of $0.83 per share, for a period of five years (the
"debenture warrants").
In accordance with Emerging Issues Task Force Issue No. 98-5 ("EITF
98-5"), "Accounting for Convertible Securities with Beneficial
Conversion Features or Contingently Adjustable Conversion Ratios", and
EITF 00-27, "Application of Issue No. 98-5 to Certain Convertible
Instruments", the Company recognizes the advantageous value of
conversion rights attached to convertible debt and warrants. Such
rights give the debenture holder the ability to convert debt into
common stock and exercise warrants at a price per share that is less
than the trading price to the public on the day of issuance. The
beneficial value is calculated as the intrinsic value (the market price
of the stock at the commitment date in excess of the conversion price)
of the beneficial conversion feature of debentures and is recorded as a
discount to the related debt and an addition to capital in excess of
par value. The discount is amortized over the outstanding period of the
related debt using the interest method.
The fair value of the debenture warrants was estimated as of the issue
date under the Black-Scholes pricing model, with the following
assumptions: common stock based on a market price of $.63 and $.80 per
share, zero dividends, expected volatility of 46% and 55%, risk free
interest rate of 3.125% and expected life of five years. The fair value
of the debenture warrants of $1,823,211, resulted in a discount to the
debentures of $1,178,417, and a beneficial conversion feature to the
debentures of $2,292,654. The beneficial conversion feature reflects
the fact the market price of the Company's common stock exceeded the
conversion price of the debentures as of the respective issue dates.
The resulting discount attributable to the debenture warrants and the
beneficial conversion feature of the debentures aggregating $3,471,071
has been recorded as a discount to the debentures and is being
amortized over the term of the debentures. Amortization of the discount
of $292,682 is included in interest expense for the year ended November
30, 2003.
The placement agents for the debentures received warrants to purchase
230,847 shares of the Company's common stock at an exercise price of
$.59 per share for a term of 5 years from the date of grant. The
$107,758 fair value of the warrants was estimated at the grant date
under the Black-Scholes pricing model using the same assumptions set
forth above, and was recorded as financing costs.
FF-16
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - CONVERTIBLE DEBENTURES (CONTINUED)
At November 30, 2003, convertible debentures consists of:
Debentures issued September 24, 2003 $3,100,000
Debentures issued October 3, 2003 2,540,000
Less: Unamortized discount (3,178,389)
-----------
$2,461,611
===========
The debentures are due during the fiscal year ended November 30, 2005.
Subsequent to November 30, 2003, $900,000 of the debentures were
converted to 1,525,424 shares of common stock.
NOTE 6 - STOCKHOLDERS' EQUITY
During the year ended November 30, 2003, the Company issued shares of
its common stock as follows;
o 1,602,000 shares for cash at $1.00 per share
o 10,000 shares for services at $1.00 per share
o 60,000 shares for services at $.91 per share
o 233,204 shares to Resource Venture Management (RVM), an entity
owned by a founder of the Company, as payment of an
outstanding debt, at $1.00 per share
o 90,000 shares to RVM for services rendered, valued at $90,000
($1.00 per share)
o 1,951,241 shares to the shareholders of Pannonian in
accordance with the Share Exchange Agreement to acquire all
the outstanding shares of Pannonian (Note 1).
During the period ended November 30, 2002, the Company issued shares of
its common stock as follows:
o 11,500,000 shares at inception to officers/directors/founders
for cash at $.001 per share
o 500,000 shares for cash at $.02 per share
o 4,000,000 shares to RVM, for services rendered, valued at
$200,000 ($.05 per share)
o 3,000,000 shares for cash at $.05 per share
o 1,997,058 shares for cash at $.34 per share
Effective November 13, 2002, the Company completed the acquisition of
Dolphin (Note 1). In conjunction with the acquisition, the Company
exchanged 20,997,058 shares of its common stock for 100% of the
outstanding common shares of Dolphin. The 9,028,000 shares of common
stock of the Company outstanding at the date of acquisition were
recapitalized at the net asset value of the Company at that date of
$(60,331). For financial statement reporting purposes this transaction
was treated as a reverse acquisition whereby Dolphin was considered the
surviving and reporting entity. For legal purposes, the Company
remained as the surviving entity; therefore, the capital structure of
the Company was accordingly restated.
The value of all common stock issued for non-cash consideration
represents the non-discounted trading price of the Company's common
stock at the transaction date.
FF-17
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - STOCKHOLDERS' EQUITY (CONTINUED)
WARRANTS
In connection with the issuance of convertible debentures in September
and October 2003 (Note 5), the Company issued warrants to purchase
2,867,797 shares of common stock at $.71 per share, and 2,867,797,
shares of common stock at $.83 per share to purchasers of the
debentures, and issued warrants to purchase 230,847 shares of common
stock at $.59 per share to placement agents for the issue.
As of November 30, 2003 warrants issued and outstanding are as follows:
Issue Shares Exercise Expiration
Date Exercisable Price Date
September 24, 2003 1,576,270 $.71 September 24, 2008
September 24, 2003 1,576,270 $.83 September 24, 2008
September 24, 2003 101,694 $.59 September 24, 2008
October 3, 2003 1,291,527 $.71 October 3, 2008
October 3, 2003 1,291,527 $.83 October 3, 2008
October 3, 2003 129,153 $.59 October 3, 2008
---------
5,966,441
=========
At November 30, 2003 the weighted average exercise price for warrants
outstanding is $.76 and the weighted average remaining contractual life
is 4.8 years.
NOTE 7 - STOCK OPTION PLAN
In May 2003, the Company adopted the 2003 Stock Option Plan (the
"Plan"). Under the Plan, stock options may be granted at an exercise
price not less than the fair market value of the Company's common stock
at the date of grant. Options may be granted to key employees and other
persons who contribute to the success of the Company. The Company has
reserved 3,500,000 shares of common stock for the plan. At November 30,
2003, options to purchase 3,380,000 shares were available to be granted
pursuant to the stock option plan.
The status of outstanding options granted pursuant to the plans are as
follows:
Number Weighted Avg. Weighted Avg.
of Shares Exercise Price Fair Value
Options Outstanding - November 30, 2002 - $ - $ -
Granted 120,000 $ 1.00 $ 0.52
Exercised - - -
-------- ------ ------
Options Outstanding - November 30, 2003
(None exercisable) 120,000 $ 1.00 $0.52
======== ====== =====
FF-18
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - STOCK OPTION PLAN (CONTINUED)
The calculated value of stock options granted under these plans,
following calculation methods prescribed by SFAS 123, uses the
Black-Scholes stock option pricing model with the following assumptions
used:
Expected option life-years 10
Risk-free interest rate 3.625%
Dividend yield 0
Volatility 39%
NOTE 8 - RELATED PARTY TRANSACTIONS
The Company incurred consulting expenses related to services rendered
by RVM in the amount of $397,500 for the year ended November 30, 2003.
The Company paid RVM $ 265,000 in cash and issued 90,000 shares of
common stock valued at $1.00 per share. As of November 30, 2003,
$42,500 remains outstanding and is included in accounts - payable
related parties.
During the year ended November 30, 2003, the Company issued 233,204
shares of common stock at $1.00 per share to RVM to convert an
outstanding debt owed by the Company to RVM at November 30, 2002.
The Company incurred Directors fees and expenses totaling $27,500
during the year ended November 30, 2003, of which $3,500 is included in
accounts payable - related at November 30, 2003.
During the years ended November 30, 2003 and 2002 the Company incurred
total costs with Harbor Petroleum of $344,294 and $355,817
respectively. Of those amounts $254,084 in 2003, and $266,617 in 2002
were for reimbursement of costs incurred by Harbor to acquire leases,
and $90,210 in 2003 and $89,200 in 2002 represented consulting fees and
expenses from Harbor.
In connection with the acquisition of Pannonian, the Company assumed
liabilities due from Pannonian to related parties including advances
from the founder of the Company of $39,500; notes payable and accrued
interest due to the President of Pannonian of $37,508; notes payable
and accrued interest to a company wholly owned by the President of
Pannonian of $44,400; and accounts payable to Directors of the Company
for services rendered and costs advanced of $63,346.
During the period ended November 30, 2002, the Company (i) incurred
consulting fees for services rendered by its officers/directors in the
aggregate amount of $102,000, of which $38,000 is included in accounts
payable; and (ii) agreed to pay RVM an aggregate $692,500, of which
$233,204 is due as of November 30, 2002, as follows:
o $162,000 for monthly management fees through November 30, 2002;
o $100,000 for finding oil and gas projects in Wyoming;
FF-19
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - RELATED PARTY TRANSACTIONS (CONTINUED)
o $230,500 for reimbursement of costs and expenses;
o $200,000 for services rendered paid in common stock (Note 6).
At November 30, 2002, the Company had advanced $25,000 to Pannonian in
contemplation of the merger.
NOTE 9 - SEGMENT REPORTING
In June 1997, SFAS 131, "Disclosure about Segments of an Enterprise and
Related Information," was issued, which amends the requirements for a
public enterprise to report financial and descriptive information about
its reportable operating segments. Operating segments, as defined in
the pronouncement, are components of an enterprise about which separate
financial information is available and that are evaluated regularly by
the Company in deciding how to allocate resources and in assessing
performance. The financial information is required to be reported on
the basis that is used internally for evaluating segment performance
and deciding how to allocate resources to segments.
The Company has one reportable segment, the exploration and development
of oil and gas properties. Substantially all of the Company's oil and
gas exploration and development activities have been concentrated in
the United States, primarily Texas and the Rocky Mountain region.
NOTE 10 - COMPREHENSIVE INCOME
There are no adjustments necessary to the net (loss) as presented in
the accompanying statement of operations to derive comprehensive income
in accordance with SFAS 130, "Reporting Comprehensive Income."
NOTE 11 - COMMITMENTS AND CONTINGENCIES
a) The Company may be subject to various possible contingencies,
which are derived primarily from interpretations of federal and
state laws and regulations affecting the oil and gas industry.
Although management believes it has complied with the various laws
and regulations, new rulings and interpretations may require the
Company to make future adjustments.
b) In October 2002, the Company entered into a lease for office
facilities in Miami, Florida, through June 30, 2005. Under the
terms of the lease the Company paid a deposit of $9,960. Minimum
payments due under this lease are as follows:
Year ending November 30,
2004 $45,490
2005 26,738
Rent expense for the years ended November 30, 2003 and 2002, was
$50,565, and $3,924, respectively.
FF-20
GALAXY ENERGY CORPORATION
(FORMERLY GALAXY INVESTMENTS, INC.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
c) In January 2004, the Company entered into a lease for office
facilities in Denver, Colorado, through February 27, 2007. Minimum
payments due under the lease are $36,233, $50,541, $53,517 and
$13,564 for the years ended November 30, 2004, 2005, 2006 and 2007
respectively.
NOTE 12 - SUBSEQUENT EVENTS
In December 2003, the Company completed the sale of 2,503,571 shares of
its common stock at $1.40 per share and warrants to purchase 500,715
common shares at $2.71 per share in a private placement exempt from
registration with the Securities and Exchange Commission pursuant to
Section 4(2) of the Securities Act of 1933 and Rule 506 of Regulation D
promulgated thereunder. Gross proceeds from the sale were $3,505,000.
In December 2003, the Company entered into a Sale and Escrow Agreement
with Pioneer Oil LLC to acquire all of Pioneer's interest in those oil
and gas leases and coalbed methane gas wells previously covered under
the Lease Acquisition and Drilling Agreement dated October 9, 2002. The
Company paid $1,000,000 in cash and issued 2,000,000 shares of common
stock, valued at $1.40 per share, to acquire the leases.
In December 2003, 45,763 warrants issued to a placement agent in
connection with the Convertible Debenture offering in September 2003,
were exercised for shares of common stock at $.59 per share.
In January 2004, certain holders of Convertible Debentures totaling
$900,000 converted their debentures to 1,524,424 shares of common stock
in accordance with the terms of the Convertible Debenture offering.
In January 2004 the Company entered into a Purchase and Sale Agreement
with DAR, LLC, a Wyoming limited liability company to acquire certain
oil and gas leases in the Powder River Basin area of Wyoming. Under the
terms of the Agreement, the Company paid $163,655 in cash, issued
3,000,000 shares of common stock, valued at $1.80 per share, and
executed a promissory note for $2,600,000, with interest payable at 6%
per annum. The promissory note requires payments of $1,000,000 on
January 15, 2005, and $1,600,000 on June 24, 2005.
In January 2004, the Company completed the sale of 6,637,671 shares of
its common stock at $1.80 per share and warrants to purchase 1,327,555
common shares at $4.05 per share in a private placement exempt from
registration with the Securities and Exchange Commission pursuant to
Section 4(2) of the Securities Act of 1933 and Rule 506 of Regulation D
promulgated thereunder. Gross proceeds from the sale were, $11,947,800.
FF-21