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Exhibit A
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Daugherty Resources, Inc.:
We have audited the accompanying combined statement of revenues and
direct operating expenses for certain oil and gas interests of Environmental
Energy, Inc. and its affiliates, Environmental Operating, Inc. and affiliated
limited partnerships ("Environmental Interest") to be acquired from the
Environmental Interest Owners for the year ended December 31, 1998. This
statement is the responsibility of Environmental Energy, Inc.'s management. Our
responsibility is to express an opinion on this financial statement based on our
audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statement is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statement. 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 audit provides a reasonable basis for our opinion.
The statement of revenues and direct operating expenses for the
Environmental Interests acquired from the Environmental Interest Owners was
prepared for the purpose of complying with the rules and regulations of the
Securities and Exchange Commission as described in Note A and are not intended
to be a complete presentation of revenues and expenses.
In our opinion, the statement referred to above presents fairly, in all
material respects, the revenues and direct operating expenses of the
Environmental Interests acquired from the Environmental Interest Owners for the
year ended December 31, 1998, in conformity with generally accepted accounting
principles.
Hall, Kistler & Company, LLP
Certified Public Accountants
Canton, Ohio
April 19, 1999
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COMBINED STATEMENT OF REVENUES
AND DIRECT OPERATING EXPENSES
ENVIRONMENTAL INTERESTS
YEAR ENDED DECEMBER 31, 1998
Revenues ........................................ $ 281,217
Direct operating expenses ....................... (59,688)
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Excess of revenues over direct operating expenses $ 221,529
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The accompanying notes are an integral part of this statement.
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NOTES TO COMBINED STATEMENT
OF REVENUE AND DIRECT OPERATING EXPENSES
ENVIRONMENTAL INTERESTS
DECEMBER 31, 1998
NOTE A Summary of Significant Accounting Policies.
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Basis of Presentation.
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The accompanying statements present the revenues and direct operating
expenses of certain oil and gas interests ("Environmental Interests") of
Environmental Energy, Inc. and its affiliates, Environmental Operating, Inc.,
and Environmental Holding Company, LLC, and affiliated limited partnerships:
Environmental Energy Partners I, LTD., Environmental Energy Partners II, LTD.,
Environmental Operating Partners, LTD., Environmental Processing Partners, LTD.,
(collectively referred to as "Sellers") , which are to be acquired by Daugherty
Resources, Inc. ("DRI") pursuant to an Agreement for Purchase and Sale dated
January 26, 1999 ("Agreement"). Under the terms of the Agreement, DRI is to
acquire working interests in various wells in exchange for 1,024,924 shares of
Limited Series Non-Cumulative, Non-Voting Preferred Stock (DRI Preferred") and
170,821 Units of Acquisitions Warrants ("DRI Warrants"). The DRI Preferred are
convertible on a share for share basis into Common Stock of DRI ("DRI Common").
The DRI Preferred may be converted (1) by the Sellers at any time within two
years of issuance, and (2) by DRI at any time within two years of issuance if
last sales price of DRI Common equals or exceeds Ten Dollars ($10.00) for at
least 20 consecutive trading days and notice of conversion is given to Sellers
no sooner than ten days after the 20th consecutive trading day equaling or
exceeding Ten Dollars ($10.00). Any DRI Preferred so converted will receive a
Conversion Bonus of DRI Common of one half of one percent of the number of DRI
Preferred converted times the number of months from issuance to the date of
conversion. Any DRI Preferred that has not been converted before the second
anniversary date of its issue shall be converted on a share for share basis by
DRI into DRI Common and the Holders will receive a Conversion Bonus of DRI
Common equal to 12% of the number of DRI Preferred so converted. The DRI
Preferred and DRI Common shall bear Rule 144 restrictive legends and shall be
subject to the requirements of Rule 144. The Units of Acquisition Warrants shall
consist of two (2) Series A Acquisition Warrants, one (1) Series B Acquisition
Warrant, one (1) Series C Acquisition Warrant, one (1) Series D Acquisition
Warrant, one (1) Series E Acquisition Warrant, one (1) Series F Acquisition
Warrant, and one (1) Series G Acquisition Warrant with the following features:
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WARRANTS HOLDER MAY PURCHASE PRICE EXPIRY
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Series A One Share of DRI Common $1.75 5 years from issuance
Series B One Share of DRI Common $2.00 5 years from issuance
Series C One Share of DRI Common $2.50 5 years from issuance
Series D One Share of DRI Common $3.00 5 years from issuance
Series E One Share of DRI Common $3.50 5 years from issuance
Series F One Share of DRI Common $4.00 5 years from issuance
Series G One Share of DRI Common $4.50 5 years from issuance
Each Series of Acquisition Warrants is redeemable by DRI as an entire
series, at a price of $.05 per Acquisition Warrant, at the option of DRI if (1)
the last sales price of DRI Common equals or exceeds 200% of the exercise price
of the Series of Acquisition Warrants being redeemed for 20 consecutive trading
days and (2) notice of redemption is given to the Warrantholder no sooner than
one day after and no later than ten days after the 20th consecutive trading day.
The notice of redemption must give a minimum of 90 days notice to the
Warrantholder and the Warrantholder shall have the right to exercise the Warrant
until the close of business of the date fixed for redemption in the notice.
Omitted Historical Financial Information
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Full historical financial statements, including general and
administrative expenses and interest expense, have not been presented due to the
fact that (a) the sellers of the Environmental Interests cannot make a
practicable determination of the portion of their general and administrative
expenses, interest expense or other indirect expenses which is attributable to
the properties subject to the above transactions, and (b) the property interests
acquired pursuant to the above transactions are primarily fully developed
producing properties in which DRI has had no management involvement. Total
incurred exploration and development costs associated with the Environmental
Energy, Inc. Interests through December 31, 1998 were approximately $12,500,000.
Accrual Basis Statements
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Memorandum adjustments have been made to the financial information
derived from the Sellers in order to present the accompanying statements in
accordance with generally accepted accounting principles.
NOTE B Unaudited Supplemental Oil and Gas Information.
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The determination of oil and gas reserves is complex and highly
interpretive. Assumptions used to estimate reserve information may significantly
increase or decrease such reserves in future periods. The estimates of reserves
are subject to continuing changes and therefore, an accurate determination of
reserves may not be possible for many years because of the time needed for
development, drilling, testing and studies of the reservoirs. Net proved oil and
gas reserves and the discounted future net cash flows related to the acquired
properties were estimated by the Company's petroleum engineers as of December
31, 1998 in accordance with
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Statement of Financial Accounting Standards No. 69, "Disclosures about Oil and
Gas Producing Activities." Since reserve evaluations for earlier dates had not
been prepared, it is not practical to include any information as to changes in
reserve quantities, nor any change in present value disclosures. At December 31,
1998, net proved reserves for the acquired properties were estimated as 4.9
MBbls of oil and 334 MMcf of natural gas. Net production for the year ended
December 31, 1998, was 2.7 MBbls of oil and 114.2 MMcf of natural gas.
The standardized measure of discounted future net cash flows at
December 31, 1998, related to the estimated proved oil and gas reserves is as
follows:
Future net revenue $ 814,316
Future production costs (168,424)
Future development costs (8,039)
Future income taxes -0-
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Future net cash flows $ 637,853
Discount (209,017)
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Standardize measure of discounted future net cash flows $ 428,836
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The calculated weighted average sales prices utilized for the purposes
of estimating the acquired properties' proved reserves and future net revenue
were $11.98 per barrel of oil and between $2.17 and $2.25, per Mcf of natural
gas. Total estimated future net cash flows before income taxes, discounted at
10% per annum, was $428,836 as of December 31, 1998.
During 1998, $42,000 was expended for capital improvements to the
properties, none of which related to exploration.
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