As filed with the Securities and Exchange Commission on August____, 2006
Registration Number 333-131802
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Amendment No. 4 to
FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
CONSOLIDATED ENERGY, INC.
(Name of Small Business Issuer in its Charter)
Wyoming 1220 86-0852222
(State or other jurisdiction of (Primary Standard Industrial I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
76 GEORGE ROAD, P.O. BOX 537
BETSY LAYNE, KENTUCKY 41605
(606) 478-1333
(Address, Including Zip Code, and Telephone Number,
Including Area Code, of Registrant's Principal Executive Offices)
DAVID GUTHRIE, PRESIDENT
76 GEORGE ROAD, P.O. BOX 537
BETSY LAYNE, KENTUCKY 41605
(606) 478-1333
(Name, Address, Including Zip Code, and Telephone Number,
Including Area Code, of Agent for Service)
WITH COPIES TO:
RICHARD A. FRIEDMAN, ESQ.
LOUIS A. BRILLEMAN, ESQ.
SICHENZIA ROSS FRIEDMAN FERENCE LLP
1065 AVENUE OF THE AMERICAS, 21ST FLOOR
NEW YORK, NEW YORK 10018
Tel: (212) 930-9700
Fax: (212) 930-9725
Approximate date of commencement of proposed sale to the public: From time to
time after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. [X]
If this form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, please check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
(COVER CONTINUES ON FOLLOWING PAGE)
If this form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the same
offering. [ ] ________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
========================================== ===================== ====================== ===================== =====================
Proposed Maximum Proposed Maximum
Title of Each Class of Securities Amount to be Offering Price Per Aggregate Offering Amount of
to be Registered Registered(1) Share(2) Price Registration Fee
- ------------------------------------------ --------------------- ---------------------- --------------------- ---------------------
Common Stock, $0.001 par value (3) 15,277,778 $2.425 $37,048,611.65 $3,964.20
Common Stock, $0.001 par value (5) 1,058,822 $2.425 $2,567,643.35 $274.74
Common Stock, $0.001 par value (6) 6,933,256 $2.425 $16,813,145.80 $1,799.01
Common Stock, $0.001 par value (8) 672,140 $2.425 $1,629,939.50 $174.40
- ------------------------------------------ --------------------- ---------------------- --------------------- ---------------------
Total 35,081,996 $2.425 $85,073,840.30 $9,102.90 (9)
========================================== ===================== ====================== ===================== =====================
(1) Includes shares of our common stock, $0.001 par value per share, which may
be offered pursuant to this registration statement, which shares are
issuable upon conversion of our 6% senior secured convertible notes,
conversion of our 8% senior secured convertible notes and exercise of
warrants held by the selling shareholders. In addition to the shares set
forth in the table, the amount to be registered includes an indeterminate
number of shares issuable upon conversion of the 6% senior secured
convertible notes, conversion of the 8% senior secured convertible notes
and exercise of the warrants, as such number may be adjusted as a result of
stock splits, stock dividends and similar transactions in accordance with
Rule 416.
(2) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457(c) under the Securities Act of 1933, as amended. The average of
the bid and ask price per share of our common stock on the OTC Bulletin
Board as of February 7, 2006 was $2.425 per share.
(3) Represents shares issuable upon conversion of $13,750,000 principal amount
of 6% senior secured convertible notes at a conversion price of $0.90 per
share.
(4) Represents presently outstanding shares of common stock issued pursuant to
the cashless exercise of common stock purchase warrants which were issued
in connection with our 6% senior secured convertible notes.
(5) Represents presently outstanding shares of common stock issued as payment
of accrued interest pursuant to the terms of $1,800,000 principal amount of
promissory notes originally issued on September 23, 2005, as amended on
November 24, 2005 to increase the principal amount from $1,500,000 to
$1,800,000.
(6) Represents shares issuable upon conversion of $6,239,930 principal amount
of 8% senior secured convertible notes at a conversion price of $0.90.
(7) Represents shares issuable upon exercise of common stock purchase warrants
issued in connection with our 8% senior secured convertible note financing.
(8) Represents presently outstanding shares of common stock issued upon
exercise of warrants which were issued as consideration for financial
consulting services and placement agent fees.
(9) Previously paid.
The registrant hereby amends this registration statement on such date or date(s)
as may be necessary to delay its effective date until the registrant shall file
a further amendment which specifically states that this registration statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933, as amended, or until the registration statement shall
become effective on such date as the commission acting pursuant to said Section
8(a) may determine.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. THE
SECURITIES MAY NOT BE SOLD 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.
PRELIMINARY PROSPECTUS
Subject to Completion, Dated August___, 2006
CONSOLIDATED ENERGY, INC.
35,081,996 Shares of Common Stock
The selling shareholders named in this prospectus are offering to sell up
to 35,081,996 shares of common stock including up to 15,277,778 shares of common
stock of Consolidated Energy, Inc. underlying 6% senior secured convertible
notes, 6,933,256 shares of common stock underlying 8% senior secured convertible
notes, 9,046,694 shares of common stock underlying common stock purchase
warrants that were previously issued by us to the selling shareholders in
private transactions, and 3,824,268 shares of common stock previously issued and
currently outstanding. We will not receive any proceeds from the conversion of
our 6% senior secured convertible notes, from the conversion of our 8% senior
secured convertible notes or the resale of shares of our common stock. We will,
however, receive proceeds from the exercise of our common stock purchase
warrants if such warrants are exercised for cash.
Our common stock currently trades on the Over the Counter Bulletin Board
("OTC Bulletin Board") under the symbol "CEIW.OB."
On August 7, 2006, the last reported sale price for our common stock on the
OTC Bulletin Board was $0.90 per share.
THE SECURITIES OFFERED IN THIS PROSPECTUS INVOLVE A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 2 OF THIS PROSPECTUS TO READ ABOUT FACTORS
YOU SHOULD CONSIDER BEFORE BUYING SHARES OF OUR COMMON STOCK.
The selling shareholders are offering these shares of common stock. The
selling shareholders may sell all or a portion of these shares from time to time
in market transactions through any market on which our common stock is then
traded, in negotiated transactions or otherwise, and at prices and on terms that
will be determined by the then prevailing market price or at negotiated prices
directly or through a broker or brokers, who may act as agent or as principal or
by a combination of such methods of sale. For additional information on the
methods of sale, you should refer to the section entitled "Plan of
Distribution."
Scott R. Griffith, Jesse B. Shelmire IV and Robert Blakely are registered
representatives of Stonegate Securities, Inc., a registered broker-dealer, and
are "underwriters" within the meaning of the Securities Act of 1933 in
connection with the sale of common stock under this prospectus. With the
exception of Messrs. Griffith, Shelmire and Blakely, no other underwriter or
person has been engaged to facilitate the sale of shares of common stock in this
offering.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined whether
this prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The date of this Prospectus is __________, 2006
TABLE OF CONTENTS
Page
-------
Prospectus Summary...................................................................................... 1
Risk Factors............................................................................................ 2
Forward-Looking Statements.............................................................................. 10
Recent Developments..................................................................................... 10
Use of Proceeds......................................................................................... 17
Management's Discussion and Analysis of Financial Condition or Plan of Operation........................ 17
Description of Business................................................................................. 33
Description of Property................................................................................. 42
Legal Proceedings....................................................................................... 46
Directors and Executive Officers........................................................................ 46
Executive Compensation.................................................................................. 48
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................... 51
Market for Common Equity and Related Shareholder Disclosure............................................. 52
Security Ownership of Certain Beneficial Owners and Management.......................................... 52
Selling Shareholders.................................................................................... 54
Certain Relationships and Related Transactions.......................................................... 61
Description of Securities............................................................................... 63
Plan of Distribution.................................................................................... 64
Legal Matters........................................................................................... 66
Experts................................................................................................. 66
Where You Can Find More Information..................................................................... 66
Disclosure of Commission Position on Indemnification for Securities Act Liabilities..................... 66
Index to Consolidated Financial Statements.............................................................. F-1
You may only rely on the information contained in this prospectus or that
we have referred you to. We have not authorized anyone to provide you with
different information. This prospectus does not constitute an offer to sell or a
solicitation of an offer to buy any securities other than the common stock
offered by this prospectus. This prospectus does not constitute an offer to sell
or a solicitation of an offer to buy any common stock in any circumstances in
which such offer or solicitation is unlawful. Neither the delivery of this
prospectus nor any sale made in connection with this prospectus shall, under any
circumstances, create any implication that there has been no change in our
affairs since the date of this prospectus or that the information contained by
reference to this prospectus is correct as of any time after its date.
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
You should read the entire prospectus carefully, including, the section entitled
"Risk Factors" before deciding to invest in our common stock. Consolidated
Energy, Inc. is referred to throughout this prospectus as "Consolidated Energy,"
the "Company," "we" "us" and "our."
General
We were incorporated in Nevada on December 18, 1996, under the name
Barbeque Capital Corporation. In September 2002, we filed our articles of
incorporation in the State of Wyoming, and in October 2002, Barbeque Capital
Corporation merged with and into Consolidated Energy, Inc. Our principal
executive office is located at 76 George Road, Betsy Layne, Kentucky 41605 and
our telephone number is (606) 478-1333.
This Offering
Shares offered by Selling Shareholders............................ 35,081,996 shares of common stock, of which
15,277,778 shares are issuable upon conversion
of 6% senior secured convertible notes,
6,933,256 shares are issuable upon conversion
of 8% senior secured convertible notes,
9,046,694 shares are issuable upon the exercise
of warrants, and 3,824,268 shares are issued
and outstanding as of the date of this
prospectus.
Use of proceeds................................................... We will not receive any proceeds from the
conversion of the 6% senior secured convertible
notes, the conversion of the 8% senior secured
convertible notes or the sale of the common
stock. We will, however, receive proceeds from
the exercise of our common stock purchase
warrants if such warrants are exercised for
cash.
Risk Factors...................................................... The purchase of our common stock involves a
high degree of risk. You should carefully
review and consider the "Risk Factors"
beginning on page 2 of this prospectus.
OTC Bulletin Board Trading Symbol................................. CEIW.OB
1
RISK FACTORS
An investment in our shares involves a high degree of risk. Before making
an investment decision, you should carefully consider all of the risks described
in this prospectus. Each of the following risks could materially adversely
affect our business, financial condition and results of operations, which could
cause the price of our shares to decline significantly and you may lose all or a
part of your investment. Our forward-looking statements in this prospectus are
subject to the following risks and uncertainties. Our actual results could
differ materially from those anticipated by our forward-looking statements as a
result of the risk factors below. See "Forward-Looking Statements."
RISKS RELATED TO OUR BUSINESS
OUR MINING OPERATIONS ARE RELATIVELY NEW AND WE HAVE NO EXTENSIVE HISTORY OF
OPERATING COAL MINES.
Our mining operations began in September 2003 when we acquired our current
mining operation in Kentucky. Since that time, we have had nominal production
and development operations. Since inception of our current business in September
2003 through March 31, 2006 we have had only $5,728,176 in revenue. Accordingly,
our success is dependent on our ability to manage further mine development,
increase production levels and achieve profitable sales with the resources we
have available or can secure. In addition, we will have to adjust our planning
to changing conditions in the highly competitive coal industry. None of these
requirements for success can be demonstrated by our performance to date and
there is no assurance we will be able to accomplish them in order to sustain the
company's operations.
OUR FINANCIAL STATUS CREATES SUBSTANTIAL DOUBT WHETHER WE WILL CONTINUE AS A
GOING CONCERN FOR MORE THAN 12 MONTHS FROM THE DATE OF THIS PROSPECTUS. IF WE DO
NOT CONTINUE AS A GOING CONCERN, INVESTORS WILL LOSE THEIR ENTIRE INVESTMENT.
We have suffered recurring losses from operations and we have limited
capital resources. We reported net losses totaling $24,555,121 for the fiscal
quarter ended March 31, 2006 and losses totaling $6,418,284 and $6,413,900 for
the fiscal years ended December 31, 2005 and 2004, respectively. Because of
these factors, the accompanying financial statements are prepared using
generally accepted accounting principles applicable to a going concern, which
contemplates realization of assets and the liquidation of liabilities in the
normal course of business. There are no assurances that we will be able to
achieve a level of revenues adequate to generate sufficient cash flow from
operations or obtain additional financing through private placements, public
offerings and/or bank financing necessary to support our working capital
requirements. To the extent that funds generated from any private placements,
public offerings and/or bank financing are insufficient, we will have to raise
additional working capital. No assurance can be given that additional financing
will be available, or if available, will be on acceptable terms. If adequate
working capital is not available we will be forced to discontinue operations,
which would cause investors to lose the entire amount of their investment.
OUR MANAGEMENT AND AUDITORS HAVE IDENTIFIED SIGNIFICANT DEFICIENCIES IN OUR
INTERNAL CONTROLS THAT, IN AGGREGATE, CONSTITUTED A MATERIAL WEAKNESS IN THE
DESIGN AND OPERATION OF OUR INTERNAL CONTROLS AS OF DECEMBER 31, 2004, WHICH, IF
NOT PROPERLY REMEDIATED COULD RESULT IN MATERIAL MISSTATEMENTS IN OUR FINANCIAL
STATEMENTS IN FUTURE PERIODS.
Our independent auditors, Killman, Murrell & Company, P.C. issued a letter
to the audit committee of our board of directors and our management in which
they identified certain matters that they consider to constitute a material
weakness in the design and operation of our internal controls as of December 31,
2004. A material weakness is defined by the Public Company Accounting Oversight
Board (United States) as a significant deficiency, or combination of significant
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. A significant deficiency is a control deficiency, or combination of
control deficiencies, that results in more than a remote likelihood that a
misstatement of the financial statements that is more than inconsequential will
not be prevented or detected. A control deficiency exists when the design or
2
operation of a control does not allow management or employees, in the normal
course of performing their assigned functions, to prevent or detect
misstatements on a timely basis. Below is a description of each of the material
weaknesses which were identified.
o During the year ended December 31, 2004, a bank account was maintained
by an individual who is not an officer, employee or director. During
the 2004 audit, it was determined that certain fourth quarter
transactions for this account were not properly reflected on our books
and records.
o During the year ended December 31, 2004, equipment purchases were
authorized by an individual who is not an officer, employee or
director, without prior approval by an officer or the board of
directors.
o Since inception, we have had transactions with certain of our common
shareholders, including the issuance of common stock for the
assignment of coal leases. We initially reported the transactions at
historical cost basis as determined under GAAP because we believed
this was the appropriate valuation method for such transactions,
believing that the fair value of the stock issued or assets acquired
was not objectively measurable. In November 2005 we discovered that we
incorrectly accounted for those transactions , which caused us to
restate our financial statements for the year ended December 31, 2004
and the fiscal quarters ended March 31, 2005, June 30, 2005 and
September 30, 2005.
o Since inception, we have issued common stock for consulting services
rendered to us. The valuation of this stock has been inconsistent and
not necessarily related to the stock's market price. As a result, we
restated our Statement of Operations for the fiscal year ended
December 31, 2004 to reflect a $145,100 increase in consulting
expenses.
o We have received cash advances from individuals based on future
promises to repay the cash advances based on coal mined from our
Warfield lease. We improperly recorded these advances as loans (notes
payable) instead of the sale of mineral interests. We discovered this
error in 2005 and as a result we restated our Statement of Operations
for the fiscal year ended December 31, 2004 to reflect a $31,900
increase in cost of revenue expenses and a $129,100 decrease in our
depreciation and amortization expenses.
Please refer to "Weakness in Disclosure Controls and Procedures" beginning
on page 15 of this prospectus for further information regarding the material
weaknesses which were identified by our independent auditors. If we become aware
of other material weaknesses in our internal controls in the future, it is
possible that a material misstatement of our annual or interim financial
statements will not be prevented or detected. Any failure in preventing or
detecting a material misstatement of our annual or interim financial results
could have a material adverse effect on our stock price and on our results of
operations.
WE HAVE A SIGNIFICANT AMOUNT OF DEBT, WHICH LIMITS OUR FLEXIBILITY AND IMPOSES
RESTRICTIONS ON US. WE WERE IN DEFAULT OF INTEREST PAYMENTS ON OUR OUTSTANDING
6% SENIOR SECURED CONVERTIBLE NOTES FROM JULY 1, 2005 THROUGH JANUARY 13, 2006.
WHILE THE NOTE HOLDERS WAIVED THE PRIOR DEFAULTS, IF WE DEFAULT AGAIN ON ANY OF
OUR OUTSTANDING SENIOR SECURED CONVERTIBLE NOTES, THE NOTE HOLDERS WILL BE ABLE
TO TAKE IMMEDIATE POSSESSION OF ALL OF OUR ASSETS.
As of March 31, 2006, we had current liabilities totaling $42,657,616 and
long-term liabilities totaling $3,429,731. To date in 2006, we have issued 8%
senior secured convertible notes totaling $6,239,930, increasing our debt
obligations. We also have significant lease and royalty obligations. On July 1,
2005, we failed to pay interest as required pursuant the terms of certain 6%
senior secured convertible notes executed on February 24, 2005 for an aggregate
total face amount of $7,000,000, and thereby caused a default under the terms of
such notes. As a result of the event of default, the holders of the notes could
have declared the entire outstanding principal amount immediately due and
payable along with any interest accrued thereon. On September 23, 2005, we
entered into a Consent and Waiver Agreement with the 6% note holders, pursuant
to which they consented to a bridge note financing resulting in $1,800,000 in
total gross proceeds and waived the application of default provision under the
6% Notes for a period of ten business days. The waiver was extended to November
3
18, 2005. On January 13, 2006, the 6% note holders waived the prior defaults in
connection with a private placement of 8% senior secured convertible notes. If
we default again, the note holders will have the right to take immediate
possession of all of our assets. Based on past experience with the current
lenders, our management believes additional waivers will be granted by the
lenders, if necessary.
OUR PROFITABILITY MAY BE ADVERSELY AFFECTED BY THE STATUS OF OUR LONG-TERM COAL
SUPPLY CONTRACTS.
We intend to sell a substantial portion of our coal under a long-term coal
supply agreement, which is a contract with a term greater than 12 months. The
prices for coal shipped under these contracts may be below the current market
price for similar-type coal at any given time. Due to the substantial volume of
our potential sales that are subject to these long-term agreements, we may have
less coal available with which to capitalize on higher coal prices if and when
they arise. In addition, because long-term contracts typically allow the
customer to elect volume flexibility, our ability to realize the higher prices
that may be available in the spot market may be restricted when customers elect
to purchase higher volumes under such contracts. Our exposure to market-based
pricing may also be increased should customers elect to purchase fewer tons. In
addition, the increasingly short terms of sales contracts and the consequent
absence of price adjustment provisions in such contracts make it more likely
that we will not be able to recover inflation related increases in mining costs
during the contract term.
WE SUSPENDED MINING OPERATIONS AT OUR WARFIELD MINE IN 2005 AND ONLY RECENTLY
RE-ACTIVATED OUR MINING OPERATIONS. WE WILL NOT BE ABLE TO GENERATE ANY
SIGNIFICANT REVENUE FROM SUCH MINE UNTIL MINING OPERATIONS RECOMMENCE AT
PROJECTED LEVELS.
In January 2005, we suspended production at our Warfield Mine to construct
three slopes and the ancillary ventilation necessary to allow us to access the
Pond Creek coal seam. As a result, there has been minimal production at the mine
since February 2005. In early January 2006, we restarted production as we
anticipated the completion of our coal washing facility. If we are unable to
increase our mining operations at our Warfield Mine such that we can produce
greater than 40,000 tons per month, we may not be able to financially sustain
our operations without additional outside funds. Without achieving 40,000 tons
produced per month, we may not be able to continue as a going concern.
A SMALL NUMBER OF CUSTOMERS ACCOUNT FOR A SIGNIFICANT PORTION OF OUR REVENUE AND
IF WE ARE UNABLE TO MAINTAIN OUR CURRENT CUSTOMER BASE OR ATTRACT A NEW CUSTOMER
BASE WE WILL BE REQUIRED TO CURTAIL OR CEASE OPERATIONS.
For the three months ended March 31, 2006, all of our sales were to three
customers: Cinergy accounted for 6% of total coal sales, American Electric Power
accounted for 84% of coal sales and New River Energy accounted for 10% of coal
sales. For the years ended December 31, 2005 and 2004, approximately 99% and 96%
of our sales were to three customers, respectively: Progress Fuels accounted for
less than 1% of total coal sales during 2005 and 24% of total coal sales during
2004, Eastern Consolidated Mining, Inc. accounted for 45% of total coal sales
during 2005 and 35% of total coal sales during 2004, and New River Energy
accounted for 41% of total coal sales during 2005 and 37% of total coal sales
during 2004. In addition, we have a 36 month contract for coal sales to American
Electric Powerfor 40,000 tons per month which began in April 2006. We have an
additional 12 month contract with American Electric Power with a 24 month option
for 50,000 tons per month. If American Electric Power exercises its option on
this contract, the two contracts combined will account for approximately 100% of
our production capacity over the next three years and account for approximately
15% of our current recoverable reserves. If American Electric Power does not
exercise its option on this contract, American Electric Power will account for
approximately 80% of our production capacity for the first 12 months and 33% of
our production and approximately 9% of our current recoverable reserves. We
intend to discuss the extension of existing agreements or entering into new
long-term agreements with American Electric Power and other customers, but the
negotiations may not be successful, and those other customers may not agree to
purchase coal from us under long-term coal supply agreements, or at all. If
American Electric Power were to significantly reduce their purchases of coal
from us, or if we were unable to sell coal to them on terms as favorable to us
as the terms under our current agreements, and we were unable to secure
agreements with other customers, we will be required to curtail or cease
operations.
4
OUR PROFITABILITY MAY FLUCTUATE DUE TO UNANTICIPATED MINE OPERATING CONDITIONS
AND OTHER FACTORS THAT ARE NOT WITHIN OUR CONTROL.
Our mining operations are inherently subject to changing conditions that
can affect levels of production and production costs for varying lengths of time
and can result in decreases in our profitability. We are exposed to commodity
price risk related to our purchase of diesel fuel, explosives and steel. In
addition, weather conditions, equipment replacement or repair, fires, variations
in thickness of the layer, or seam, of coal, amounts of overburden, rock and
other natural materials and other geological conditions have had, and can be
expected in the future to have, a significant impact on our operating results.
During January 2006 16 men died in four coal mining accidents in West Virginia.
As a result, West Virginia's Governor ordered a halt in coal mining until safety
checks could be conducted. If a similar significant accident was to occur at our
mines or other mines in Kentucky, such an accident would cause a minimum of 30
days of delayed production. A prolonged disruption of production at our mines
would result in a decrease in our revenues and profitability, which could be
material. Other factors affecting the production and sale of our coal that could
result in decreases in our profitability include:
o continued high pricing environment for our raw materials, including,
among other things, diesel fuel, explosives and steel;
o expiration or termination of, or sales price redeterminations or
suspension of deliveries under, coal supply agreements;
o disruption or increases in the cost of transportation services;
o changes in laws or regulations, including permitting requirements;
o litigation;
o work stoppages or other labor difficulties;
o mine worker vacation schedules and related maintenance activities; and
o changes in coal market and general economic conditions.
Decreases in our profitability as a result of the factors described above
could adversely impact our quarterly or annual results materially.
Agreements to which we are a party contain limitations on our ability to
manage our operations exclusively and impose significant potential
indemnification obligations on us.
In order to obtain financing to develop and expand operations at our
Warfield Mine, we have agreed to limit certain capital expenditures and maintain
certain cash reserves subject to anticipated operating revenues and other
benchmarks.
RISKS RELATING TO OUR INDUSTRY
THE DEMAND FOR AND PRICING OF OUR COAL IS GREATLY INFLUENCED BY CONSUMPTION
PATTERNS OF THE DOMESTIC ELECTRIC GENERATION INDUSTRY, AND ANY REDUCTION IN THE
DEMAND FOR OUR COAL BY THIS INDUSTRY MAY CAUSE OUR PROFITABILITY TO DECLINE.
Demand for our coal and the prices that we may obtain for our coal are
closely linked to coal consumption patterns of the domestic electric generation
industry, which has accounted for approximately 92% of domestic coal consumption
in recent years. These coal consumption patterns are influenced by factors
beyond our control, including the demand for electricity, which is significantly
dependent upon general economic conditions, summer and winter temperatures in
the United States, government regulation, technological developments and the
location, availability, quality and price of competing sources of coal,
alternative fuels such as natural gas, oil and nuclear and alternative energy
sources such as hydroelectric power. Demand for our low sulfur coal and the
prices that we will be able to obtain for it will also be affected by the price
and availability of high sulfur coal, which can be marketed in tandem with
emissions allowances in order to meet Clean Air Act requirements. Any reduction
in the demand for our coal by the domestic electric generation industry would
result in a decline in our revenues and profit, which could be material.
5
EXTENSIVE ENVIRONMENTAL LAWS AND REGULATIONS AFFECT THE END-USERS OF COAL AND
COULD REDUCE THE DEMAND FOR COAL AS A FUEL SOURCE AND CAUSE THE VOLUME OF OUR
SALES TO DECLINE.
The Clean Air Act and similar state and local laws extensively regulate the
amount of sulfur dioxide, particulate matter, nitrogen oxides, and other
compounds emitted into the air from electric power plants, which are the largest
end-users of our coal. Such regulations, which can take a variety of forms, may
reduce demand for coal as a fuel source because they may require significant
emissions control expenditures for coal-fired power plants to attain applicable
ambient air quality standards, which may lead these generators to switch to
other fuels that generate less of these emissions and may also reduce future
demand for the construction of coal-fired power plants. The U.S. Department of
Justice, on behalf of the EPA, has filed lawsuits against several investor-owned
electric utilities and brought an administrative action against one
government-owned utility for alleged violations of the Clean Air Act. We supply
coal to some of the currently affected utilities, and it is possible that other
customers of ours will be sued. These lawsuits could require the utilities to
pay penalties, install pollution control equipment or undertake other emission
reduction measures, any of which could adversely impact their demand for our
coal, and require that we find alternative customers. If we could not find
alternative customers, our revenues will be significantly impaired and we could
be forced to reduce operations.
A regional haze program initiated by the EPA to protect and to improve
visibility at and around national parks, national wilderness areas and
international parks restricts the construction of new coal-fired power plants
whose operation may impair visibility at and around federally protected areas
and may require some existing coal-fired power plants to install additional
control measures designed to limit haze-causing emissions.
The Clean Air Act also imposes standards on sources of hazardous air
pollutants. For example, the EPA has announced that it would regulate hazardous
air pollutants from coal-fired power plants. Under the Clean Air Act, coal-fired
power plants will be required to control hazardous air pollution emissions by no
later than 2009, which likely will require significant new investment in
controls by power plant operators. These standards and future standards could
adversely affect our business by decreasing demand for coal.
Other proposed initiatives, such as the Bush administration's announced
Clear Skies Initiative, may also have an adverse effect upon coal operations. As
proposed, this initiative is designed to further reduce emissions of sulfur
dioxide, nitrogen oxides and mercury from power plants. Other so-called
multi-pollutant bills, which could regulate additional air pollutants, have been
proposed by various members of Congress. If such initiatives are enacted into
law, power plant operators could choose other fuel sources to meet their
requirements, reducing the demand for coal and lowering our revenues.
BECAUSE OUR INDUSTRY IS HIGHLY REGULATED, OUR ABILITY TO CONDUCT MINING
OPERATIONS IS RESTRICTED AND OUR PROFITABILITY MAY DECLINE.
The coal mining industry is subject to regulation by federal, state and
local authorities on matters such as: employee health and safety; permitting and
licensing requirements regarding environmental and safety matters; air quality
standards; water quality standards; plant and wildlife and wetland protection;
blasting operations; the management and disposal of hazardous and non-hazardous
materials generated by mining operations; the storage of petroleum products and
other hazardous substances; reclamation and restoration of properties after
mining operations are completed; discharge of materials into the environment,
including air emissions and wastewater discharge; surface subsidence from
underground mining; and the effects of mining operations on groundwater quality
and availability.
Extensive regulation of these matters could have a significant effect on
our costs of production and competitive position. Further regulations,
legislation or orders may also cause our sales or profitability to decline by
hindering our ability to continue our mining operations, by increasing our costs
or by causing coal to become a less attractive fuel source.
Mining companies must obtain numerous permits that strictly regulate
environmental and health and safety matters in connection with coal mining, some
of which have significant bonding requirements. Regulatory authorities exercise
6
considerable discretion in the timing of permit issuance. Also, private
individuals and the public at large possess rights to comment on and otherwise
engage in the permitting process, including through intervention in the courts.
Accordingly, the permits we need for our mining operations may not be issued,
or, if issued, may not be issued in a timely fashion, or may involve
requirements that may be changed or interpreted in a manner which restricts our
ability to conduct our mining operations or to do so profitably.
For a more detailed discussion of governmental regulation of our business,
please refer to pages 32-36 of this prospectus.
WE MAY NOT BE ABLE TO OBTAIN OR RENEW SURETY BONDS ON ACCEPTABLE TERMS.
Federal and state laws require us to obtain surety bonds to guaranty
performance or payment of certain long-term obligations, including mine closure
or reclamation costs, federal and state workers' compensation costs, coal leases
and other miscellaneous obligations. Many of these bonds are renewable on a
yearly basis. It may be increasingly difficult for us to secure new surety bonds
or retain existing bonds without the posting of collateral, which could limit
our available working capital. In addition, the market terms of such bonds have
generally become more unfavorable. For example, it may become increasingly
difficult to obtain adequate coverage limits, and surety bonds increasingly
contain additional cancellation provisions in favor of the surety.
MINING IN CENTRAL APPALACHIA IS COMPLEX AND INVOLVES EXTENSIVE REGULATORY
CONSTRAINTS.
The geological characteristics of Central Appalachia coal reserves, such as
depth of overburden and coal seam thickness, make them complex and costly to
mine. As mines become depleted, replacement reserves may not be available when
required or, if available, may not be capable of being mined at costs comparable
to those characteristic of the depleting mines. In addition, as compared to
mines in other coal producing regions, permitting and licensing and other
environmental and regulatory requirements are more costly and time-consuming to
satisfy. These factors could materially adversely affect the mining operations
and cost structures of, and customers' ability to use coal produced by,
operators in Central Appalachia, including us.
INTENSE COMPETITION AND EXCESS INDUSTRY CAPACITY IN THE COAL PRODUCING REGIONS
IN WHICH WE OPERATE HAS ADVERSELY AFFECTED MINING REVENUES AND PROFITABILITY IN
PAST YEARS AND MAY AGAIN DO SO IN THE FUTURE.
The coal industry is intensely competitive, primarily as a result of the
existence of numerous producers in the coal producing regions in which we
operate. We compete with a large number of coal producers in the markets that we
serve. Additionally, we are subject to the continuing risk of reduced
profitability as a result of excess industry capacity and weak power demand by
the industrial sector of the economy, which affected many of our competitors in
the years prior to our commencement of operations. If economic conditions change
substantially from the current relatively high demand and low available supply
levels, it could require us to reduce the rate of coal production from planned
levels which will reduce our revenues.
DEREGULATION OF THE ELECTRIC UTILITY INDUSTRY MAY CAUSE OUR CUSTOMERS TO BE MORE
PRICE-SENSITIVE IN PURCHASING COAL, WHICH COULD CAUSE OUR PROFITABILITY TO
DECLINE.
Electric utility deregulation is expected to provide incentives to
generators of electricity to minimize their fuel costs and is believed to have
caused electric generators to be more aggressive in negotiating prices with coal
suppliers. To the extent utility deregulation causes our customers to be more
cost-sensitive, deregulation may reduce our profit margins and accordingly have
a negative effect on our profitability.
BECAUSE OUR PROFITABILITY IS SUBSTANTIALLY DEPENDENT ON THE AVAILABILITY OF AN
ADEQUATE SUPPLY OF COAL RESERVES THAT CAN BE MINED AT COMPETITIVE COSTS, THE
UNAVAILABILITY OF THESE TYPES OF RESERVES WOULD CAUSE OUR PROFITABILITY TO
DECLINE.
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Our profitability depends substantially on our ability to mine coal
reserves that have the geological characteristics that enable them to be mined
at competitive costs. Replacement reserves may not be available when required
or, if available, may not be capable of being mined at costs comparable to those
characteristic of the depleting mines. If we do not accurately assess the
geological characteristics of any reserves that we acquire, we may not be able
to mine such properties at competitive costs, which would decrease our margins.
Exhaustion of reserves at existing mines would have a similar adverse effect on
our operating results.
DISRUPTION IN, OR INCREASED COSTS OF, TRANSPORTATION SERVICES COULD ADVERSELY
AFFECT OUR PROFITABILITY.
The coal industry depends on rail, barge and trucking transportation to
deliver shipments of coal to customers, and transportation costs are a
significant component of the total cost of supplying coal. Disruptions of these
transportation services could temporarily impair our ability to supply coal to
our customers and thus reduce our revenues. In addition, increases in
transportation costs associated with our coal, or increases in our
transportation costs relative to transportation costs for coal produced by our
competitors or of other fuels, could adversely affect our business and
profitability by reducing our margins and causing us to lose customers to such
competitors.
WE FACE NUMEROUS UNCERTAINTIES IN ESTIMATING OUR ECONOMICALLY RECOVERABLE COAL
RESERVES, AND INACCURACIES IN OUR ESTIMATES COULD RESULT IN LOWER THAN EXPECTED
REVENUES, HIGHER THAN EXPECTED COSTS OR DECREASED PROFITABILITY.
We base our reserve information on geological data assembled and analyzed
by our staff and outside consultants, which includes various engineers and
geologists. The reserve estimates are periodically updated to reflect production
of coal from the reserves and new drilling or other data received. There are
numerous uncertainties inherent in estimating quantities of recoverable
reserves, including many factors beyond our control. Estimates of economically
recoverable coal reserves and net cash flows necessarily depend upon a number of
variable factors and assumptions, such as geological and mining conditions which
may not be fully identified by available exploration data or which may differ
from experience in current operations, historical production from the area
compared with production from other producing areas, the assumed effects of
regulation by governmental agencies and assumptions concerning coal prices,
operating costs, severance and excise tax, development costs and reclamation
costs, all of which may vary considerably from actual results.
For these reasons, estimates of the economically recoverable quantities
attributable to any particular group of properties, classifications of reserves
based on risk of recovery and estimates of net cash flows expected from
particular reserves prepared by different engineers or by the same engineers at
different times may vary substantially. Actual coal tonnage recovered from
identified reserve areas or properties may vary materially from estimates, which
could significantly increase our costs and reduce revenues.
DEFECTS IN TITLE OR LOSS OF ANY LEASEHOLD INTERESTS IN OUR PROPERTIES COULD
LIMIT OUR ABILITY TO MINE THESE PROPERTIES OR RESULT IN SIGNIFICANT
UNANTICIPATED COSTS.
We conduct our mining operations on properties that we lease. The loss of
any lease would cause us to lose revenue related to our ability to mine the
associated reserves. Because title to most of our leased properties and mineral
rights is not usually verified until we make a commitment to develop a property,
which may not occur until after we have obtained necessary permits and completed
exploration of the property, our right to mine some of our reserves has in the
past, and may again in the future, be lost if defects in title or boundaries
exist. In order to obtain leases or mining contracts to conduct our mining
operations on property where these defects exist, we have had to, and may in the
future have to, incur unanticipated costs. In addition, we may not be able to
successfully negotiate new leases or mining contracts for properties containing
additional reserves, or maintain our leasehold interests in properties where we
have not commenced mining operations during the term of the lease.
ACQUISITIONS THAT WE MAY UNDERTAKE WOULD INVOLVE A NUMBER OF INHERENT RISKS, ANY
OF WHICH COULD CAUSE US NOT TO REALIZE THE BENEFITS ANTICIPATED TO RESULT.
8
We continually seek to expand our operations and coal reserves through
acquisitions of businesses and assets, including leases of coal reserves.
Acquisition transactions involve various inherent risks, such as:
o uncertainties in assessing the value, strengths, weaknesses,
contingent and other liabilities and potential profitability of
acquisition or other transaction candidates;
o the potential loss of key personnel of an acquired business;
o the ability to achieve identified operating and financial synergies
anticipated to result from an acquisition or other transaction;
o problems that could arise from the integration of the acquired
business;
o unanticipated changes in business, industry or general economic
conditions that affect the assumptions underlying the acquisition or
other transaction rationale; and
o unexpected development costs that adversely affect our profitability.
Any one or more of these factors could cause us not to realize the benefits
anticipated to result from the acquisition of businesses or assets.
THE FOLLOWING RISKS RELATE PRINCIPALLY TO OUR COMMON STOCK AND ITS MARKET VALUE:
THERE IS A LIMITED MARKET FOR OUR COMMON STOCK WHICH MAKES IT DIFFICULT FOR
INVESTORS TO ENGAGE IN TRANSACTIONS IN OUR SECURITIES.
Our common stock is quoted on the OTC Bulletin Board under the symbol
"CEIW.OB." There is a limited trading market for our common stock. If public
trading of our common stock does not increase, a liquid markets will not develop
for our common stock. The potential effects of this include difficulties for the
holders of our common stock to sell our common stock at prices they find
attractive. If liquidity in the market for our common stock does not increase,
investors in our business may never realize a profit on their investment.
OUR STOCK PRICE IS VOLATILE WHICH MAY MAKE IT DIFFICULT FOR INVESTORS TO SELL
OUR SECURITIES FOR A PROFIT.
The market price of our common stock is likely to be highly volatile and
could fluctuate widely in price in response to various factors, many of which
are beyond our control, including:
o technological innovations or new products and services by us or our
competitors;
o additions or departures of key personnel;
o sales of our common stock
o our ability to integrate operations, technology, products and
services;
o our ability to execute our business plan;
o operating results below expectations;
o loss of any strategic relationship;
o industry developments;
o economic and other external factors; and
o period-to-period fluctuations in our financial results.
Because we have a limited operating history with little revenues to date,
you may consider any one of these factors to be material. Our stock price may
fluctuate widely as a result of any of the above.
In addition, the securities markets have from time to time experienced
significant price and volume fluctuations that are unrelated to the operating
performance of particular companies. These market fluctuations may also
materially and adversely affect the market price of our common stock.
OUR COMMON STOCK IS DEEMED A "PENNY STOCK" UNDER THE RULES OF THE SEC, WHICH
MAKES TRANSACTIONS IN OUR STOCK CUMBERSOME.
9
Our common stock is currently listed for trading on the OTC Bulletin Board
which is generally considered to be a less efficient market than markets such as
NASDAQ or other national exchanges, and which may cause difficulty in conducting
trades and difficulty in obtaining future financing. Further, our securities are
subject to the "penny stock rules" adopted pursuant to Section 15(g) of the
Securities Exchange Act of 1934, as amended, or Exchange Act. The penny stock
rules apply to non-NASDAQ companies whose common stock trades at less than $5.00
per share or which have tangible net worth of less than $5,000,000 ($2,000,000
if the company has been operating for three or more years). Such rules require,
among other things, that brokers who trade "penny stock" to persons other than
"established customers" complete certain documentation, make suitability
inquiries of investors and provide investors with certain information concerning
trading in the security, including a risk disclosure document and quote
information under certain circumstances. Many brokers have decided not to trade
"penny stock" because of the requirements of the penny stock rules and, as a
result, the number of broker-dealers willing to act as market makers in such
securities is limited. In the event that we remain subject to the "penny stock
rules" for any significant period, there may develop an adverse impact on the
market, if any, for our securities. Because our securities are subject to the
"penny stock rules," investors will find it more difficult to dispose of our
securities. Further, for companies whose securities are traded in the OTC
Bulletin Board, it is more difficult: (i) to obtain accurate quotations, (ii) to
obtain coverage for significant news events because major wire services, such as
the Dow Jones News Service, generally do not publish press releases about such
companies, and (iii) to obtain needed capital.
A SALE OF A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK MAY CAUSE THE PRICE
OF OUR COMMON STOCK TO DECLINE.
If our shareholders sell substantial amounts of our common stock in the
public market, including shares issued upon the exercise of outstanding options
or warrants, the market price of our common stock could fall. These sales also
may make it more difficult for us to sell equity or equity-related securities in
the future at a time and price that we deem reasonable or appropriate. As of
August 7, 2006, approximately 7,596,344 shares of our restricted common stock
are eligible for sale pursuant to Rule 144. In addition, the 35,081,996 shares
of common stock offered pursuant to this prospectus will be freely tradable upon
effectiveness of the registration statement.
FORWARD-LOOKING STATEMENTS
We and our representatives may from time to time make written or oral
statements that are "forward-looking," including statements contained in this
prospectus and other filings with the Securities and Exchange Commission,
reports to our shareholders and news releases. All statements that express
expectations, estimates, forecasts or projections are forward-looking
statements. In addition, other written or oral statements which constitute
forward-looking statements may be made by us or on our behalf. Words such as
"expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates,"
"projects," "forecasts," "may," "should," variations of such words and similar
expressions are intended to identify such forward-looking statements. These
statements are not guarantees of future performance and involve risks,
uncertainties and assumptions which are difficult to predict. Therefore, actual
outcomes and results may differ materially from what is expressed or forecasted
in or suggested by such forward-looking statements. We undertake no obligation
to update publicly any forward-looking statements, whether as a result of new
information, future events or otherwise. Among the important factors on which
such statements are based are assumptions concerning uncertainties associated
with product development, the risk that we will not obtain approval to market
our products, the risk that our technology will not gain market acceptance, our
ability to obtain additional financing, our ability to attract and retain key
employees, our ability to protect intellectual property, and our ability to
adapt to economic, political and regulatory conditions affecting the healthcare
industry.
RECENT DEVELOPMENTS
Liquidity and Capital Resources
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July 12, 2006 Private Placement
On July 12, 2006 (the "Closing Date"), we completed the transactions
contemplated by a Securities Purchase Agreement, effective as of June 30, 2006
(the "Purchase Agreement"). Under the terms of the Purchase Agreement, we issued
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to four institutional investors (the "Senior Investors") $4,444,444 in face
amount of Variable Rate Original Issue Discount Convertible Secured Debentures
(the "Secured Debentures") due June 2008. We realized gross proceeds of
$4,000,000 from the issuance. The Secured Debentures bear interest at the annual
rate of the higher of 12% or prime rate plus 4%, and may be convertible into
shares of our common stock at a fixed conversion price of $1.36. The Secured
Debentures are secured by a first priority security interest in equipment to be
purchased with the proceeds from the Secured Debentures (the "Equipment") and a
subordinated security interest in all our assets as well as certain of our real
estate located in Martin County, Kentucky. In addition, the Secured Debentures
are guaranteed by our subsidiaries.
Of the amount raised, $3,750,000 was deposited into a blocked account and
will be released upon the purchase of the Equipment. The balance of the funds
was deposited into a control account and will be released when we issue one or
more widely disseminated press releases reporting that we have produced and sold
at least 70,000 tons of coal during each of three consecutive calendar months.
On the same date, pursuant to an Unsecured Debt Securities Purchase
Agreement, effective as of June 30, 2006 (the "Unsecured Purchase Agreement,"
together with the Purchase Agreement, the "Agreements"), we also issued to six
institutional investors (the "Junior Investors," together with the Senior
Investors, the "Investors") unsecured convertible debentures in the principal
amount of $1,750,000 (the "Unsecured Debentures"). The Unsecured Debentures are
due in July 2008, accrue interest at the annual rate of 15% and may be converted
into shares of our common stock at a fixed conversion price of $0.90.
Under the terms of the Agreements, we also issued to the Investors an
aggregate of 4,000,000 shares of common stock (the "Investor Shares") and
five-year warrants to purchase up to 5,875,000 shares of our common stock at
$0.01 per share (the "Warrants"). The sale and issuance of all securities
pursuant to the Agreements was exempt from registration requirements pursuant to
Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 promulgated
thereunder.
Pursuant to the terms of a registration rights agreement, we agreed to file
a registration statement with the Securities and Exchange Commission (the
"Commission") registering the resale of (i) the shares of common stock issuable
upon conversion of the Secured Debentures and the Unsecured Debentures, (ii) the
Investor Shares, and (iii) the shares of common stock issuable upon the exercise
of the Warrants on the earlier of (a) the 60th calendar day following the
Closing Date, or (b) the 20th calendar day following the date on which the
Company's registration statement currently on file with the Commission is
declared effective and cause such registration statement to be declared
effective no later than 60 days after the filing thereof.
In connection with the execution of the Agreements and as a condition to
the completion thereof, the holders of (i) an aggregate of $7,000,000 in
principal amount of our 6% Senior Secured Convertible Notes due 2008 dated
February 24, 2005, (ii) an aggregate of $6,750,000 in principal amount of our 6%
Senior Secured Convertible Notes due 2008 dated March 18, 2005, June 8, 2005 and
June 30, 2005, and (iii) an aggregate of $6,239,930 in principal amount of our
8% Senior Secured Convertible Notes due 2008 dated January 13, 2006 have agreed
to subordinate their security interests in our assets to liens granted to the
holders of the Secured Debentures in the Equipment. They also agreed to waive,
until November 30, 2006, certain penalties due to them and agreed to allow us to
pay some of the accrued interest on their existing notes in shares of common
stock.
As a further condition to the completion of the Agreements, approximately
$708,000 of outstanding debentures and approximately $497,000 of accrued
salaries were converted into shares of common stock at a $0.90 conversion price.
In connection with the transactions contemplated under the Agreement, we
paid (i) a placement agent fee of $140,000 in cash and issued five-year warrants
to purchase 400,000 shares of common stock at $0.01 per share to Ascendiant
Securities, LLC, and (ii) a placement agent fee of $262,500 in cash and issued
five-year warrants to purchase 100,000 shares of common stock at $0.01 per share
to Stonegate Securities and its principals Jesse Shelmire and Scott Griffith,
each a director of the Company.
As an inducement to one of the Junior Investors to purchase the Unsecured
Debentures, Messrs. Shelmire and Griffith sold to that Junior Investor Company
securities owned by them, consisting of $300,000 face amount of promissory
notes, warrants to purchase 150,000 of common stock, and 300,000 shares of
common stock for a total purchase price of $300,000.
11
January 13, 2006 Private Placement
On January 13, 2006, we sold approximately $6.24 million principal amount
of 8% senior secured convertible notes due June 30, 2008 to 18 accredited
investors. In connection with the sale of the 8% senior secured convertible
notes, we issued investors warrants to purchase an aggregate of approximately
3.5 million shares of common stock, calculated as 50% of each investor's
subscription amount divided by $0.90. Of the $6.24 million principal amount of
8% senior secured convertible notes, we received gross proceeds of $3.4 million.
The remaining approximate $2.84 million principal amount of 8% senior secured
convertible notes was paid by investors as follows: (a) $1.8 million was paid by
the cancellation of promissory notes sold by us on September 23, 2005; (b)
$102,000 represents a management fee owed to the lead investor, Gryphon Master
Fund, L.P.; (c) $586,000 represents interest accrued on our 6% senior secured
convertible notes sold February 24, 2005 and pursuant to certain Additional
Investment Rights sold February 24, 2005; and (d) $352,000 represents $352,000
of placement agent fees in connection with the sale of the 8% senior secured
convertible notes.
The 8% senior secured convertible notes have a final maturity date of June
30, 2008, accrue interest at the rate of 8% per annum, are secured by all of our
properties and assets and the properties and assets of each of our subsidiaries,
and are guaranteed by each of our subsidiaries. The 8% senior secured
convertible notes rank pari passu with our outstanding 6% senior secured
convertible notes. Interest may be paid either in cash or with shares of common
stock in our sole discretion. Holders of the 8% senior secured convertible notes
have the right to convert the outstanding principal amount into shares of our
common stock from time to time based on a conversion price of $0.90, subject to
adjustment. Beginning July 1, 2006, on the first day of each month we are
required to redeem 1/24th of the outstanding principal of the 8% senior secured
convertible notes (the "Monthly Redemption Amount"). If the transaction is
registered on an effective registration statement and certain other conditions
are satisfied, we may pay the Monthly Redemption Amount with shares of common
stock based on a conversion price equal to the lesser of (a) the then conversion
price and (b) 80% of the daily volume weighted average price of the common stock
for the 10 consecutive trading days prior to the applicable monthly redemption
date. In the event our annualized EBITDA for the two fiscal quarters ending
December 31, 2006 (the "Annualized EBITDA") is less than $17 million, the
conversion price of the 8% senior secured convertible notes will be reset to
equal the greater of (a) $0.30 or (b) a price determined by the following
formula: [3 * X/Y], where X equals the Annualized EBITDA and Y equals the number
of shares of common stock outstanding on a fully diluted basis on December 31,
2006. In addition, if we issue or commit to issue or distribute new securities
at a price per share less than the current market price or the current
conversion price, then the conversion price will be adjusted to reflect such
lower price. The conversion price is also subject to adjustment for stock
dividends, stock splits, stock combinations and similar dilutive transactions.
The warrants issued in connection with the 8% senior secured convertible
notes have an exercise price of $0.90 per share and are exercisable until
January 14, 2011. Holders may exercise the warrants on a cashless basis after
the first anniversary of the initial issuance date and then only in the event
that a registration statement covering the resale of the warrant shares is not
then effective. In the event our annualized EBITDA for the two fiscal quarters
ending December 31, 2006 (the "Annualized EBITDA") is less than $17 million, the
exercise price of the warrants will be reset to equal the greater of (a) $0.30
or (b) a price determined by the following formula: [3 * X/Y], where X equals
the Annualized EBITDA and Y equals the number of shares of common stock
outstanding on a fully diluted basis on December 31, 2006. In addition, if we
issue or commit to issue or distribute new securities at a price per share less
than the current market price or the current exercise price, then the exercise
price will be adjusted to reflect such lower price. The exercise price is also
subject to adjustment for stock dividends, stock splits, stock combinations and
similar dilutive transactions.
The investors have agreed to restrict their ability to convert the 8%
senior secured convertible notes and exercise the warrants such that the number
of shares of common stock held by them in the aggregate and their affiliates
after such conversion or exercise does not exceed 4.99% of our then issued and
outstanding shares of common stock.
We agreed to file a registration statement with the SEC registering the
resale of the shares of common stock issuable upon conversion of the 8% senior
secured convertible notes and related warrants on or before February 12, 2006
and cause such registration statement to be declared effective no later than May
31, 2006. We filed the required registration statement on February 13, 2006, a
subsequent amendment #1 on April 12, 2006 and amendment #2 on May 8, 2006. We
have not been able to cause such registration statement to be declared effective
by May 31, 2006 and may be subject to pay liquidated damages. We are currently
negotiating with our lenders for a waiver of such damages.
Forbearance Agreement
On January 13, 2006, we entered into a forbearance agreement with the
holders of our 6% senior secured convertible notes. In connection with the
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January 13, 2006 private placement described above, holders of the 6% senior
secured convertible notes waived certain events of default (the "Existing
Defaults") by us including: (a) our failure to pay accrued but unpaid interest
on the 6% senior secured convertible notes when due; (2) our failure to comply
with certain negative and financial covenants of the securities purchase
agreement dated February 22, 2005; (3) our failure to comply with certain
registration requirements of the registration rights agreement dated February
24, 2005; and (4) our failure to comply with certain other provisions of the 6%
senior secured convertible notes, the February 22, 2005 securities purchase
agreement and the February 24, 2005 registration rights agreement to the extent
that completion of the January 13, 2006 private placement may cause any
processing delay of our prior registration statement (SEC File No. 333-127261)
with the SEC.
In connection with the forbearance agreement, we agreed to release and
discharge each of the parties thereto and each of their affiliates from any and
all claims that we have or ever had against such parties through January 13,
2006. Solely for the purpose of completing the January 13, 2006 private
placement, the parties waived the anti-dilution provisions of the 6% senior
secured convertible notes and the related warrants, any existing rights
associated with Additional Investment Rights and the right to liquidated damages
and other remedies under the February 24, 2005 registration rights agreement.
The parties also agreed to forbear from enforcing certain remedies as a result
of the Existing Defaults through December 30, 2005.
Pursuant to the terms of the forbearance agreement, the following
substantive amendments were made to the February 22, 2005 securities purchase
agreement, the 6% senior secured convertible notes, the related warrants and the
February 24, 2005 registration rights agreement:
o The minimum EBITDA financial covenants required by the February 22,
2005 securities purchase agreement through March 31, 2006 were
deleted.
o The maximum capital expenditures required by the February 22, 2005
securities purchase agreement were deleted in their entirety.
o The minimum cash level requirements of the February 22, 2005
securities purchase agreement through June 30, 3006 were deleted.
o The minimum cash level requirement of the February 22, 2005 securities
purchase agreement for the period from July 1, 2006 through September
30, 2006 was changed from $2 million to $1 million.
o The definition of "Conversion Price" in the 6% senior secured
convertible notes and "Exercise Price" in the related warrants was
changed from $1.70 to $0.90.
o The interest requirement of the 6% senior secured convertible notes
was changed to require interest payments beginning July 1, 2006.
o A provision was added to the 6% senior secured convertible notes and
the related warrants requiring an adjustment to the conversion price
and exercise price in the event our annualized EBITDA for the two
fiscal quarters ending December 31, 2006 (the "Annualized EBITDA") is
less than $17 million. In such event, the conversion price and
exercise price will be reset to equal the greater of (a) $0.30 or (b)
a price determined by the following formula: [3 * X/Y], where X equals
the Annualized EBITDA and Y equals the number of shares of common
stock outstanding on a fully diluted basis on December 31, 2006.
o A provision was added to the 6% senior secured convertible notes and
the related warrants requiring an adjustment to the conversion price
and exercise price in the event we issue or commit to issue or
distribute new securities at a price per share less than the current
conversion or exercise price.
o The "Events of Default" provision of the 6% senior secured convertible
notes was amended replacing the event of default for failure to have
an effective registration statement within 270 days of the closing
date with an event of default for failure to have an effective
registration statement within 270 days of the closing date for the
January 13, 2006 private placement.
o An event of default was added to the 6% senior secured convertible
notes for a breach of any of our representations, warranties or
covenants contained in any agreement or document executed in
connection with the January 13, 2006 private placement.
o The required filing date and earliest required effectiveness date of
the February 24, 2005 registration rights agreement was changed to
February 12, 2006 and May 31, 2006, respectively.
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Notwithstanding the availability of Rule 144, each investor agreed not to
sell, offer or otherwise transfer any shares of our common stock beneficially
owned by them until the earlier of: (a) May 31, 2006 or (b) the date the
required registration statement is declared effective by the SEC.
The parties also entered into an amended and restated security agreement
reflecting the pari passu nature of the 6% senior secured convertible notes with
the 8% senior secured convertible notes.
In lieu of cash payment of accrued but unpaid interest due pursuant to the
6% senior secured convertible notes, we issued holders 8% senior secured
convertible notes and warrants pursuant to the terms of the January 13, 2006
private placement.
In addition, the Company issued promissory notes to holders of the 6%
senior secured convertible notes in the aggregate principal amount of $2,640,000
which represents liquidated damages which had accrued and is payable pursuant to
the February 24, 2005 registration rights agreement. The promissory notes bear
interest at the rate of 3% per annum, compounded annually. The full amount of
principal and interest is due on June 30, 2008. Our obligations pursuant to the
promissory notes are secured by all of our properties and assets and the
properties and assets of each of our subsidiaries pari passu with the 6% senior
secured convertible notes and 8% senior secured convertible notes.
As additional incentive to enter into the forbearance agreement, we issued
certain 6% note holders who acquired their 6% senior secured convertible notes
pursuant to exercise of Additional Investment Rights additional warrants to
purchase an aggregate of 3,750,000 shares of common stock calculated pursuant to
the following formula: X = [((Y/$0.90) * 0.50) - Z)], where: X = the number of
shares of common stock underlying the warrant certificate; Y = the stated
aggregate principal amount of all 6% senior secured convertible notes; and Z =
the number of shares of common stock underlying all warrants issued to such
party in connection with the 6% senior secured convertible notes. The additional
warrants issued have identical terms to the warrants sold by us pursuant to the
January 13, 2006 private placement.
Other Agreements Executed in Connection with the January 13, 2006 Private
Placement
Also in connection with the January 13, 2006 private placement:
(a) we secured a directors and officers liability insurance policy which
provides $10,000,000 of total coverage;
(b) each of our then-current officers and directors entered into an
agreement to vote all shares of common stock owned by them to increase our
authorized shares of common stock from 50 million shares to 100 million shares;
(c) each of our then-current officers and directors entered into an
agreement to vote for Timothy M. Stobaugh, Robert Chmiel, Jesse Shelmire and
Scott Griffith as additional directors and for a fifth additional director
designated by Gryphon Master Fund, L.P. within 60 days of closing;
(d) each of our officers and directors entered into lock-up agreements
agreeing not to offer, sell, contract to sell, pledge or otherwise dispose of
any shares of common stock or other of our equity securities for the period
ending on January 13, 2007;
(e) our subsidiary Eastern Consolidated Energy, Inc. entered into an
agreement with Kentucky Energy Consultants, Inc. whereby Kentucky Energy
Consultants, Inc. agreed to: (i) change its coal sales commission to 2.5% of the
gross sales price received by Eastern Consolidated Energy, Inc. on any purchase
orders and/or contracts on either spot or contract arrangements, and (ii)
forfeit its coal sales commission of 2.5% of gross revenues less trucking costs
until such time that we reach $20 million in aggregate EBITDA production;
(f) our subsidiary Eastern Consolidated Energy, Inc. entered into an
agreement with New River Energy Sales Company, Inc. whereby, among other things,
New River Energy Sales Company, Inc. agreed to reduce its coal sales commission
14
from 5% to 2.5% of gross coal sales until such time that we reach $20 million in
aggregate EBITDA production;
(g) together with our subsidiary CEI Holdings, Inc., we entered into an
agreement with Saudi American Minerals, Inc. whereby, among other things: (i)
the parties terminated that certain Agreement and Plan of Acquisition and Merger
dated May 30, 2003 and all subsequent amendments to such agreement; and (ii) we
agreed to pay $750,000 cash and issue 3,000,000 shares of common stock to Saudi
American Minerals, Inc. in exchange for the assignment by Saudi American
Minerals, Inc. of a 25% interest in its patented clean coal technology (Patent
No. 6,447,559) including any subsequent improvements thereto. This revised
agreement with Saudi American Minerals, Inc. was subsequently terminated by the
parties on May 1, 2006; and
(h) we entered into a consulting agreement with RC Financial Group, LLC,
pursuant to which Robert Chmiel was retained as a non-exclusive financial
advisor for a term of 24 months in exchange for the following compensation: (i)
$17,500 each month from January 1, 2006 through June 30, 2006; (ii) $12,500 each
month thereafter; and (iii) issuance of a warrant to purchase 150,000 shares of
common stock with an exercise price of $0.90 per share and an expiration date of
December 31, 2011.
Operational Developments
- ------------------------
We have experienced unanticipated delays and considerable additional
expenses in connection with our mine development activities. The agreements
described above were necessary due to a series of events as described below.
The Pond Creek mine development which began in late February 2005, involved
a ventilation development plan and a slope development plan. The ventilation
development plan called for increasing the height of the existing Alma mine
intake and return air entries along with the connecting corridors. The planned
increase was from approximately 40 inches in height to approximately 108 inches
in height. This increase in height was scheduled for 1100 feet in both corridors
and the connecting corridors. Management initially estimated that the overall
plan would require 90 days to complete.
However, in late April 2005, the ventilation development crew, while
developing the ventilation improvement plan, encountered a geological fault
after completing approximately 1000 feet of both the fresh and return air
corridors. The condition threatened the ongoing useful life of the Alma mine.
Management decided in early May 2005 that it was imperative that we mitigate the
negative affects of the geological fault in order to secure the coal reserves
contained in the Alma coal seam. As a result of the necessary development
changes, management redesigned the actual slope portion of the project to allow
the slopes to be relocated approximately 100 feet away from the geological
fault. The slope construction portion of the project was re-engaged and in
February 2006 the three slopes had been advanced to the Pond Creek coal seam.
This corrective action began in early May 2005 and cost approximately $3.5
million to address.
In the third week of July 2005, a more detailed review of the existing Alma
seam was conducted by the Mine Safety and Health Administration. As a result of
the review, it was strongly recommended that we re-secure approximately 9,600
feet of roof in a portion of the mine that had been mined by a previous mine
owner/operator. Management immediately directed a full time crew with the
appropriate equipment to address the concerns offered by the regulatory agency.
This project was completed during the first quarter of 2006 at a cost of
approximately $2 million.
The wash plant construction project was initiated in mid March 2005. The
initial plan provided for a certain location and equipment type. However, during
the rework of the Pond Creek project, management negotiated to have a
significant amount of Alma coal washed by third parties. Management sought to
have this product washed in order to verify earlier laboratory reports.
Information obtained during this process indicated that we could potentially
realize greater profits from the washed coal if some adjustments were made to
the initial wash plant plans. In early June 2005, management determined to
change the design, final location, and overall size of the proposed wash plant
to accommodate this new information. As a result of these changes, the overall
budgeted cost of the wash plant was increased by approximately 12.5% (from $4
million to $4.5 million) and delayed completion of the wash plant. The wash
plant became operational in early April 2006 and we have begun processing coal
15
at the wash plant. Although the wash plant is operational, the contractor hired
to complete the wash plant has not completed certain aspects of the project that
management feels are necessary for the wash plant to operate at full capacity.
The events described above have caused delays and increased development
costs significantly. As a result, management, in January 2006, obtained the
additional financing described above in order to (1) sustain operations and (2)
complete mine development and construction of the coal washing plant.
In addition to the increased costs, the delay in full scale production has
caused us to miss our delivery deadlines for supplying coal pursuant to the two
contracts we signed with American Electric Power. The first contract called for
36 months of delivery of 40,000 tons of coal per month to Kentucky Power Company
beginning as early as March 2005. That contract was amended to allow us to begin
shipping under the contract in April 2006, and on April 24, 2006 we commenced
shipping our mined coal to American Electric Power pursuant to this coal supply
agreement. The second contract called for delivery of approximately 50,000 tons
per month beginning in July 2005 through December 2005 and 50,000 tons per month
from January 2006 through June 2006 to Ohio Valley Electric Corporation's Kyger
Creek Plant in Cheshire, Ohio. On this second contract, we have arranged for an
unrelated third party, New River Energy, LLC, to supply and deliver up to 40,000
tons of coal per month as an alternative supplier through December 2005. The
supply agreement with New River Energy, LLC is oral. For this alternative
supply, we have agreed to pay New River Energy, LLC up to $2 per ton of
delivered coal, payable in stock or cash at our option. New River Energy, LLC
began supplying coal pursuant to this oral agreement to the Kyger Creek Plant in
July 2005 and has shipped approximately 138,000 tons through the end of December
2005. We are scheduled to begin supplying coal under the second contact with
coal mined from the Alma coal seam as early as August 2006.
Weakness in Disclosure Controls and Procedures
- ----------------------------------------------
Our independent auditors issued a letter to the audit committee of our
board of directors and our management in which they identified certain matters
that they consider to constitute a material weakness in the design and operation
of our internal controls as of December 31, 2004. The five matters described
below resulted in incorrect reporting in our financial statements.
1. During the year ended December 31, 2004, a bank account was
maintained by an individual who is not an officer, employee or director.
During the 2004 audit, it was determined that certain fourth quarter,
transactions for this account were not properly reflected on our books and
records, however we were able to record these transactions prior to closing
our books for the year ended December 31, 2004. We have since revised our
banking practices to ensure that the books and records will be properly
maintained to reflect all transactions in a timely fashion. All bank
accounts are currently maintained by authorized officers of the
corporation.
2. During the year ended December 31, 2004, equipment purchases were
authorized by an individual who is not an officer, employee or director,
without prior approval by an officer or the board of directors. We have
since revised our authorization procedures to require prior approval of
purchases by an authorized officer up to $5,000, and by the board of
directors above that amount. Such purchases will be supported by
documentation from the vendor.
3. Since inception, we have had transactions with certain of our
common shareholders, including the issuance of common stock for the
assignment of coal leases. We initially reported the transactions at
historical cost basis as determined under GAAP because we believed this was
the appropriate valuation method for such transactions, believing that the
fair value of the stock issued or assets acquired was not objectively
measurable. In November 2005 we discovered that we incorrectly accounted
for those transactions which caused us to restate our financial statements
for the year ended December 31, 2004 and the fiscal quarters ended March
31, 2005, June 30, 2005 and September 30, 2005. We intend to use the market
valuation method on any similar transactions in the future.
4. Since inception, we have issued common stock for consulting
services rendered to us. The valuation of this stock has been inconsistent
16
and not necessarily related to the stock's market price. As a result, we
restated our Statement of Operations for the fiscal year ended December 31,
2004 to reflect a $145,100 increase in consulting expenses. We will
henceforth value such issuances based on the listed closing price of the
stock on the date we agree to issue such stock without any discount or
adjustment.
5. We have received cash advances from individuals based on future
promises to repay the cash advances based on coal mined from our Warfield
lease. We improperly recorded these advances as loans (notes payable)
instead of the sale of mineral interests. We discovered and corrected this
error in 2005 and as a result we restated our Statement of Operations for
the fiscal year ended December 31, 2004 to reflect a $31,900 increase in
cost of revenue expenses and a $129,100 decrease in our depreciation and
amortization expenses. Henceforth, we will review any such transactions in
detail to ascertain the appropriate accounting treatment.
As of March 31, 2005, we believe we have addressed and remediated these
material weaknesses through enhanced supervisory review and improvements in our
internal accounting processes and procedures. If we become aware of other
material weaknesses in our internal controls in the future, it is possible that
a material misstatement of our annual or interim financial statements will not
be prevented or detected. Any failure in preventing or detecting a material
misstatement of our annual or interim financial results could have a material
adverse effect on our stock price and on our results of operations.
USE OF PROCEEDS
We will not receive any proceeds from the conversion of the 6% senior
secured convertible notes, the conversion of the 8% senior secured convertible
notes or the sale of the common stock. We will, however, receive proceeds from
the exercise of our common stock purchase warrants if such warrants are
exercised for cash. We currently have a total of 14,921,694 warrants
outstanding; 9,046,694 with an issue date of January 13, 2006 and an exercise
price of $0.90, and 5,375,000 with an issue date of July 12, 2006 and an
exercise price of $0.01. If all warrants were exercised for cash, we would
receive cash proceeds totaling $8,200,775. We would use any such proceeds
received to accelerate the development of coal seams located on the properties
currently under lease.
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion should be read in conjunction with our
consolidated financial statements and notes to those statements. In addition to
historical information, the following discussion and other parts of this
quarterly report contain forward-looking information that involves risks and
uncertainties. References in this section to the "Company," "we," "us," and
"our" refer to Consolidated Energy, Inc. together with its consolidated
operating subsidiaries.
OVERVIEW
Consolidated Energy, Inc. engages principally in the business of mining
coal in Eastern Kentucky. Our business focus is the operation of profitable coal
mines conducted through our wholly-owned coal mining subsidiary, Eastern
Consolidated Energy, Inc. We have the right to mine an estimated 20.2 million
tons of recoverable coal pursuant to multiple lease agreements. We do not own
any coal mineral rights.
Through Eastern Consolidated Energy, Inc., which we refer to as "Eastern,"
we produce and market Appalachian coal, which is supplied to domestic electric
utilities. Coal sales are made through the spot market and through long-term
supply contracts. Over the next 6-12 months we expect all coal production to be
sold solely through existing long-term contracts. If no other long-term
contracts are executed, we anticipate selling any coal not covered by the
existing contracts in the spot market.
We have committed nearly 100% of our current anticipated overall run-rate
to American Electric Power. We have two contracts with American Electric Power,
one of which is a 36-month coal supply contract for 40,000 tons per month
beginning March 2006. The second is a 12-month contract for approximately 50,000
tons per month, with a 24-month option. If American Electric Power exercises its
option on the second contract, the two contracts combined will account for
nearly 100% of our production capacity over the next three years and account for
approximately 15% of our current recoverable reserves. If American Electric
17
Power does not exercise its option on this contract, American Electric Power
will account for approximately 70% of our production capacity for the first 12
months and approximately 9% of our current recoverable tonnage.
We lease rights to mine approximately 4.17 million recoverable tons of
proven and probable coal in the Alma coal seam and other seams above drainage in
Martin County, Kentucky. In December 2004, we issued 700,000 shares of common
stock, valued at approximately $1.1 million, to Eastern Land Development
Company, Inc., a privately-held Kentucky corporation, which at the time of the
transaction was a related party, and acquired the right to mine approximately
3.74 million recoverable tons of proven and probable coal located within the
Alma, Pond Creek, Coalburg, Taylor, Richardson, and Broas seams above and below
drainage. We refer to this lease as the "Copley Lease." In February 2005, we
issued 2,500,000 additional shares of common stock, valued at $4.9 million, to
Eastern Land Development Company, Inc. and acquired the right to mine an
additional approximately 12.33 million recoverable tons of proven and probable
coal in the Alma, Pond Creek, Coalburg, Taylor, Richardson, and Broas seams. We
refer to this lease as the "Dempsey Heir Lease."
The Alma seam lease provides access to mine the Alma seam using underground
methods for an initial period of eighteen months and thereafter until we fail to
mine the coal reserves, or we choose not to continue to mine the coal reserves,
or until the coal reserves have been exhausted. This lease also gives us the
right to access and mine by whatever mining method necessary for the extraction
of coal all other seams "above drainage" on the leased property for an initial
period of thirty-six months and thereafter until we fail to mine the coal
reserves, or we choose not to continue to mine the coal reserves, or until the
coal reserves have been exhausted. The Copley Lease and the Dempsey Heir Lease
are for an initial period of thirty-six months and thereafter until we fail to
mine the coal reserves, fail to pay the minimum royalty payments, or until we
choose not to continue to mine the coal reserves, or until the coals reserves
have been exhausted. The minimum royalty for the Alma seam lease is $12,000
annually, the minimum royalty for the Copley Lease is $10,000 annually, and the
minimum royalty for the Dempsey Heir Lease is $12,000 annually. We sometimes
refer to all of such mine seams as the "Martin County Property."
The Coalburg, Richardson, and Broas seams are best mined by surface mining
methods whereas the Pond Creek, Taylor and Alma seams are best mined by
underground methods. Production from the Pond Creek seam commenced in early
January 2006. Renewed production from the Alma seam is expected in August 2006.
Production from the other seams will be as follows - surface mine tonnage will
commence as the permits are obtained and as the underground mining advances from
under the surface reserves. Production on the Coalburg, Taylor, Richardson, and
Broas seams could commence as early as the first quarter of 2007.
In June 2003, we entered into a definitive agreement with Saudi American
Minerals, Inc. to acquire 100% ownership of that company with an effective date
to coincide with an effective date of a Form S-4 registration statement. In
connection with our January 13, 2006 private placement, we entered into an
agreement with Saudi American Minerals, Inc. whereby, among other things: (i)
the parties terminated the agreement to acquire 100% ownership of Saudi American
Minerals, Inc.; and (ii) we agreed to pay $750,000 cash and issue 3,000,000
shares of common stock to Saudi American Minerals, Inc. in exchange for the
assignment by Saudi American of a 25% interest in its patented clean coal
technology (Patent No. 6,447,559) including any subsequent improvements thereto.
On May 1, 2006, we received a letter from Saudi American Minerals Inc. informing
us that they were exercising their right to immediately terminate the agreement
with us. We accepted their termination of the agreement, thus completely
eliminating all obligations of Saudi American Minerals Inc to us and/or our
subsidiaries, and reciprocally eliminating any obligations of ours and/or our
subsidiaries to Saudi American Minerals Inc.
For the fiscal quarter ended March 31, 2006, $277,040 of our $278,840 of
revenue was derived from coal sales. The remaining $1,800 was derived from oil
and gas sales. For the year ended December 31, 2005, $2.048 million of our
$2.053 million of revenue was derived from coal sales. The remaining $4,600 was
derived from oil and gas sales.
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. 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 disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
18
related to computing depreciation, depletion, amortization, accretion,
reclamation liability, asset impairment, valuation of non-cash transactions, and
recovery of receivables. Estimates are then based on historical experience and
on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
We believe our most critical accounting policies include revenue
recognition, the corresponding accounts receivable and the methods of estimating
depletion and reclamation expense of actual mining operations in relation to
estimated total mineable tonnage on our leased properties. We believe the
following accounting policies affect our more significant judgments and
estimates used in preparation of the consolidated financial statements.
Revenue Recognition. Under SEC Staff Accounting Bulletin No. 104, "Revenue
Recognition," we recognize revenue when all of the following criteria are met:
(1) persuasive evidence of an arrangement exists, (2) delivery has occurred or
services have been rendered, (3) the seller's price to the buyer is fixed or
determinable, and (4) collectibility is reasonably assured.
Mined Coal. In the case of mined coal which is sold, we negotiate a
specific sales contract with each customer, which includes a fixed price per
ton, a delivery schedule, and terms for payment. We recognize revenue from sales
made pursuant to these contracts at the time of delivery.
Accounts Receivable. Accounts receivable balances are evaluated on a
continual basis and allowances, if any, are provided for potentially
uncollectible accounts based on management's estimate of the collectibility of
customer accounts. If the financial condition of a customer were to deteriorate,
resulting in an impairment of its ability to make payments, an additional
allowance may be required. Allowance adjustments, if any, are charged to
operations in the period in which the facts that give rise to the adjustments
become known. To date, we have not had any customer whose payment was considered
past due, and as such, have not recorded any reserves for doubtful
collectibility.
Asset Retirement Obligation. The Surface Mining Control and Reclamation Act
of 1977 and similar state statutes require that mine properties be restored in
accordance with specified standards and an approved reclamation plan.
Significant reclamation activities include reclaiming refuse and slurry ponds,
reclaiming the pit and support acreage at surface mines, and sealing portals at
deep mines. Reclamation activities that are performed outside of the normal
mining process are accounted for as asset retirement obligations in accordance
with the provisions of Statement of Financial Accounting Standards, or SFAS, No.
143, "Accounting For Asset Retirement Obligations". We record our reclamation
obligations on a mine-by-mine basis based upon current permit requirements and
estimated reclamation obligations for such mines as determined by the Office of
Surface Mining when we post a predetermined amount of reclamation bonds prior to
commencing mining operations. The Office of Surface Mining's estimates of
disturbed acreage are determined based on approved mining plans and related
engineering data. Cost estimates are based upon estimates approved by OSM based
on historical costs. In accordance with SFAS No. 143, we determine the fair
value of our asset retirement obligations using a discounted cash flow
methodology based on a discount rate related to the rates of US treasury bonds
with maturities similar to the expected life of a mine, adjusted for our credit
standing.
On at least an annual basis, we review our entire reclamation liability and
make necessary adjustments for permit changes granted by state authorities,
additional costs resulting from accelerated mine closures, and revisions to cost
estimates and productivity assumptions, to reflect current experience. At March
31, 2006, we had recorded asset retirement obligation liabilities of
approximately $52,291. While the precise amount of these future costs cannot be
determined with certainty, as of March 31, 2006, we estimate that the aggregate
undiscounted cost of final mine closure is approximately $121,700.
Convertible Debt Issued with Warrants Accounted for as Derivative Financial
Instruments. In accordance with Emerging Issues Task Force No. 00-19,
"Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company's Own Stock", we recognize the value of convertible debt
issued with warrants as a derivative financial instrument. Our senior secured
convertible debt was accounted for as an embedded derivative and valued on the
transaction date using a Binomial Lattice pricing model. The warrants were
accounted for separately and also as a derivative and were valued on the
19
transaction date using a Binomial Lattice pricing model also in accordance with
EITF 00-19. At every reporting balance sheet date, the values of the derivatives
are evaluated and any change to fair market value is recorded as a gain or loss
in our statement of operations. The notice conversion feature and the warrants
may be exercised at any time and, therefore, have been reported as current
liabilities.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 2 of the accompanying consolidated financial statements for the
year ended December 31, 2005 for a full description of recent accounting
pronouncements including the respective expected dates of adoption and effects
on results of operations and financial condition.
RESULTS OF OPERATIONS FOR THE FISCAL QUARTER ENDED MARCH 31, 2006 COMPARED TO
THE FISCAL QUARTER ENDED MARCH 31, 2005
Revenues decreased for the three month period ended March 31, 2006 compared
to the same three month period in the prior year period because operations were
limited in the current period as we transitioned back into a producing entity,
having suspended operations during most of 2005 to complete the wash plant
facility and complete the ventilation and slope projects.
For the three months ended March 31, 2006, we had revenues of $278,840, of
which $277,040 was derived from coal sales and $1,800 was derived from oil and
gas sales. Of the approximately $277,000 in coal sales, two customers accounted
for 97% of these sales - $160,700, or 58%, was to a regional coal producer and
$108,000, or 39%, was to a coal broker. Costs and expenses totaled
$24,834,961 for a net loss of $24,555,121 or $1.55 per share. For the three
months ended March 31, 2005, we had had coal sales of $433,033 and did not have
any sales from oil and gas. Costs and expenses totaled $14,841,799 for net loss
of $14,408,766 or $1.14 per share. The approximate $156,000 decrease in revenue
for the three months ended March 31, 2006 compared to the three months ended
March 31, 2005 was attributable to the fact we had limited production as we
completed our construction projects.
For the three months ended March 31, 2006, the cost of revenue was
approximately $1.13 million and consisted primarily of salary, benefits,
worker's compensation and other compensation costs directly attributable to the
employment of miners of approximately $764,000, and direct costs paid to third
party vendors whose goods and services were directly used in producing coal,
which primarily included equipment leases and maintenance expenses of $42,000,
parts and supplies used in the process of coal production of approximately
$241,000, transportation costs of approximately $18,000, and royalties and taxes
of approximately $62,000. For the three months ended March 31, 2005, the cost of
revenue was approximately $385,500 and consisted primarily of salary, benefits,
worker's compensation and other compensation costs directly attributable to the
employment of miners of approximately $136,000, and direct costs paid to third
party vendors whose goods and services were directly used in producing coal,
which primarily included equipment leases and maintenance expenses of
approximately $27,000, parts and supplies used in the process of coal production
of approximately $36,000, transportation costs of approximately $60,000, and
royalties and taxes of approximately $79,000.
Operating expenses for the three months ended March 31, 2006 were
approximately $911,545 compared to operating expense of approximately $559,900
for the three months ended March 31, 2005. This approximately $351,700 increase
was mainly attributable to an increase of approximately $213,000 in consulting
and professional fees from $239,000 for the three month period in 2005 compared
to $452,000 for the same three month period in 2006. Officer salaries and
related expenses increased from $35,800 for the three month period ended March
31, 2005 to approximately $104,300 for the three month period ended March 31,
2006 due to additional officers being added to our payroll as we scaled
management for the re-commencement of coal production.
Other income and expenses for the three months ended March 31, 2006 were
approximately $22.59 million compared to other income and expenses of
approximately $13.78 million for the three months ended March 31, 2005. This
difference of approximately $8.79 million was attributed to an approximately
$5.00 million decrease in the fair value of the warrants and convertible share
liability recorded, offset by an approximate $13.31 million increase in interest
expense, and an approximately $0.5 million loss on sale of assets.
20
RESTATEMENT OF MARCH 31, 2005 AND MARCH 31, 2006 BALANCES
On January 3, 2005, we issued 2,500,000 shares of our common stock for
additional coal seams on the Dempsey Lease, to certain shareholders who at the
time were deemed to be controlling shareholders. The 2,500,000 shares of stock
were valued and originally booked at par value of $2,500 which approximated the
cost basis of the Lease in the hands of the controlling shareholders. In
November 2005, we discovered the error and the correction is reflected in our
financial statements for the fiscal year ended December 31, 2005 which reflect
the 2,500,000 shares of stock valued at fair market of $4,875,000 which
represents the closing quoted market value of our stock on the date of the
acquisition of the additional seams. As summarized below, the restatements only
affected the value of certain balance sheet items and accordingly, did not
result in a change to earnings.
The following sets forth the balance sheet items affected by these changes:
As As
Reported Restatement Restated
3/31/05 Adjustment 3/31/05
------------- ------------- --------------
Coal Leases, Net of Amortization $ 1,343,226 $ 5,956,800 $ 7,300,026
Additional Paid-in-Capital $ 8,315,536 $ 5,956,800 $ 14,272,336
During the first calendar quarter of 2005, we issued 3,639,706 warrants to
purchase shares of our common stock to investors and Stonegate Securities as
additional consideration for their investment in our business and as placement
agent fees, respectively. These warrants were originally valued using the
Black-Scholes method and originally booked as a debit to debt discount and a
credit to additional paid-in capital. In July 2006, we discovered that these
warrants along with the conversion feature should have been valued using the
Binomial Lattice model and should have been recorded in accordance with EITF
00-19, which requires us to record the credit as a liability, and to assess the
fair market value of the outstanding warrants at the end of every reporting
period thereafter. Any change in the warrants and convertible shares fair value
is then reflected in our statement of operations. The corrections are reflected
in our restated financial statements for the quarter ended March 31, 2005, which
reflect a liability of the warrants valued on the dates of issuance and adjusted
at the end of the quarter to reflect the change in value with a corresponding
charge to earnings attributed to the change in the value of the warrants as of
March 31, 2005.
As of March 31, 2005, we recorded an aggregate derivative liability of
$19,280,882 and a derivative valuation loss of $13,778,161 to reflect the change
in value of the aggregate derivative liability since February 14, 2005. The
aggregate derivative liability of $19,280,882 included $14,995,588 for the
warrants and $4,285,294 for the conversion feature. These values at issuance in
February 2005 were calculated using the Binomial Lattice pricing model with the
following assumptions: (i) risk free interest rate of 3.67% for the conversion
feature and 3.91% for the warrants; (ii) expected life of 3.0 years for the
conversion feature and 5.0 years for the warrants; (iii) expected volatility of
83.24%; (iv) expected dividend yield of 0.00%; and (v) stock valuation of $1.70
for the conversion feature and $4.00 for the warrants. At the end of the first
quarter 2005, these values were calculated using the Binomial Lattice pricing
model with the following assumptions.: (i) risk free interest rate of 3.96% for
the conversion feature and 4.18% for the warrants; (ii) expected life of 2.92
years for the conversion feature and 4.92 for the warrants; (iii) expected
volatility of 83.28%; (iv) expected dividend yield of 0.00%; and (v) stock
valuation of $1.70 for the for the conversion feature and $4.95 for the
warrants.
The following sets forth the statement of operations and balance sheet
items affected by these changes at March 31, 2005:
As As
Reported Restatement Restated
3/31/05 Adjustment 3/31/05
------------------- ------------------- ---------------------
Derivative liability warrants $ -- $ 14,995,588 $ 14,995,588
Derivative liability convertible shares -- 4,285,294 4,285,294
Long term notes payable 5,581,735 (3,039,069) 2,542,666
Coal Leases Net of Amortization 7,300,026 (30,245) 7,269,781
Additional Paid-in-Capital 14,272,336 ( 2,493,897) 11,778,439
Retained deficit (8,446,128 ) (13,778,161) (22,224,289)
Change in fair value of convertible shares -- (1,276,470) (1,276,470)
Change in fair value of warrants $ -- $ (12,501,691) $ (12,501,691)
21
During the first calendar quarter of 2006, we issued an additional
9,624,472 warrants to purchase shares of our common stock to investors and
Stonegate Securities as additional consideration for their investment in our
business and as placement agent fees, respectively, as well as 150,000 warrants
as additional consideration for consulting services. These warrants were
originally valued using the Black-Scholes method and originally booked as a
debit to debt discount and a credit to additional paid-in capital. In July 2006,
we discovered that these warrants and convertible shares should have been valued
using the Binomial Lattice model and should have been recorded in accordance
with EITF 00-19, which requires us to record the credit as a liability, and to
assess the fair market value of the outstanding warrants at the end of every
quarter thereafter. Any change in the warrants fair value is then reflected in
our statement of operations. The corrections are reflected in our restated
financial statements for the quarter ended March 31, 2006, which reflect a
liability of the warrants and convertible shares valued on the dates of issuance
and adjusted at the end of the quarter to reflect the change in value with a
corresponding charge to earnings attributed to the change in the value of the
warrants as of March 31, 2006.
As of March 31, 2006, we recorded an aggregate derivative liability of
$36,957,858 and a derivative valuation loss of $8,777,985 to reflect the change
in value of the aggregate derivative liability since February 14, 2005 and June
8, 2005. The aggregate derivative liability of $36,957,858 included $26,964,012
for the warrants and $10,993,846 for the conversion feature. These values were
calculated using the Binomial Lattice pricing model with the following
assumptions: (i) risk free interest rate of 4.82%; (ii) expected life of 1.92
and 2.79 years for the conversion feature and 4.83 years for the warrants ;
(iii) expected volatility of 96.23%; (iv) expected dividend yield of 0.00%; and
(v) stock trading valuation of $0.90 for the for the conversion feature and
$3.25 for the warrants.
The following sets forth the statement of operations and balance sheet
items affected by these changes as well as the change due to the warrants issued
during the first calendar quarter of 2005, at March 31, 2006:
As As
Reported Restatement Restated
3/31/06 Adjustment 3/31/06
------------------- ------------------- ---------------------
Derivative liability warrants $ -- $ 25,964,012 $ 25,964,012
Derivative liability convertible shares -- 10,993,846 10,993,846
6% Senior Secured Notes 2,424,528 (2,095,188) 329,340
Coal Leases Net of Amortization 15,454,881 440,371 15,895,252
Additional Paid-in-Capital 33,757,634 (14,685,839) 19,071,795
Retained deficit (19,052,567 ) (19,736,460) (38,789,027)
Interest Expense 1,021,080 12,285,684 13,306,764
Change in fair value of convertible shares -- 1,362,690 1,362,690
Change in fair value of warrants $ -- $ (10,140,675) $ (10,140,675)
RESULTS OF OPERATIONS FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005 COMPARED TO
THE FISCAL YEAR ENDED DECEMBER 31, 2004
Revenues were down for the twelve month period ended December 31, 2005
compared to the prior year period because management suspended mining operations
in February 2005 and began slope construction and other preparations to mine an
additional coal seam in the Company's Martin County Property. Mining operations
resumed on a limited basis in June 2005 to allow management to make several
mining and coal quality evaluations and assessments. After management obtained
the coal quality information in June, all mining operations were suspended or
reduced to mine development until such time as the wash facility was completed
and ready to process coal. The implications and significance of suspending
operations in February included diminished revenues and increased expenses.
Slope construction is complete and the Pond Creek seam is currently being
developed. Coal from the Pond Creek seam commenced shipping to American Electric
Power in the latter part of April 2006. Roof rehabilitation in the Alma seam is
22
progressing as manpower is available. The Company has substantially completed
the construction of a coal washing plant at the Martin County Property in order
to further enhance the quality and sales value of the mined coal, and commenced
washing coal in early April 2006. The Alma seam is scheduled to engage two
production shifts per day as soon as the Alma roof rehabilitation project and
the Martin County washing facility is complete and ready to process coal.
Management anticipates that production from the Alma and Pond Creek coal seams
should be sufficient to allow the Company to earn a profit from operations.
For the year ended December 31, 2005, the Company had revenues of
$2,052,748 of which approximately $403,000 was derived from the sale of coal
that was purchased from a third party. Costs and expenses totaled $8,471,032 for
a net loss of $6,418,284, or $0.46 per share. For the year ended December 31,
2004, the Company had revenues of $2,746,983 of which $0 was derived from the
sale of coal purchased from a third party. Costs and expenses totaled $9,160,883
for net loss of $6,413,900 or $0.67 per share. The approximate $700,000 decrease
in revenue for the year ended December 31, 2005 compared to the year ended
December 31, 2004 was attributable to the reduction in coal production as a
result of the Company's decision to suspend mining operations as it sought to
raise additional funds, and once funds were raised, to spend such funds on the
construction of mine ventilation and slopes from the Alma seam to the Pond Creek
seam, as well as commence construction of a wash plant.
For the year ended December 31, 2005, the cost of revenue was approximately
$3.27 million and consisted primarily of salary, benefits, worker's compensation
and other compensation costs directly attributable to the employment of miners
of approximately $1.08 million, and direct costs paid to third party vendors
whose goods and services were directly used in producing coal inventory, which
primarily included coal purchases of approximately $403,000, coal washing costs
of approximately $55,000, equipment leases and maintenance expenses of $11,500,
transportation costs of approximately $200,000, and royalties and taxes of
approximately $360,000. For the year ended December 31, 2004, the cost of
revenue was approximately $3.73 million and consisted primarily of salary,
benefits, worker's compensation and other compensation costs directly
attributable to the employment of miners of approximately $1.40 million, and
direct costs paid to third party vendors whose goods and services were directly
used in producing coal inventory, which primarily included approximately
$403,000 paid to third party coal producers, equipment leases and maintenance
expenses of approximately $111,000, transportation costs of approximately
$270,000, and royalties and taxes of approximately $704,000.
Operating expenses for the year ended December 31, 2005 were $3,105,265
compared to operating expense of $4,205,518 for the year ended December 31,
2004. This approximately $1.1 million decrease was mainly attributable to an
approximately $2.66 million decrease in consulting fees from $3,134,800 in 2004
to $476,559 in 2005, and an approximately $390,000 decrease in legal and
professional fees from $448,086 in 2004 to 56,435 in 2005. These operating
expense decreases were mainly offset by an approximate $1.13 million increase in
salaries and related expenses as the Company transitioned from using consultants
to full time and part time employees to handle the Company's business.
There was also a significant increase in expenses incurred during the year
ended December 31, 2005, most notably from $2,520,833 of liquidated damages. The
Company incurred the liquidated damages for its failure to have an effective
registration statement registering the sale of common stock underlying the
February 24, 2005 financing transaction described below under "Liquidity and
Capital Resources."
Depreciation expense increased from $265,000 in 2004 to approximately
$682,000 in 2005 as the Company increased the amount of equipment used to
prepare for the production process. Amortization expense related to the
amortization of coal leases, which the Company calculates on a
units-of-production basis, on the other hand, decreased from $15,000 in 2004 to
only $2,800 in 2005 as the Company had limited coal production during 2005.
Other income for the year ended December 31, 2005 was approximately $1.10
million compared to other expenses of approximately $1.0 million for the year
ended December 31, 2004. This difference of approximately $2.10 million was
mainly attributed to a $1.33 million increase in the fair value of the warrants
and convertible share liability recorded, a decrease of an approximately $0.7
million in interest expense. Specifically, interest expense decreased from
approximately $879,000 in 2004 to approximately $172,000 in 2005 due to
capitalized interest costs. Other changes include the loss on sale of assets
23
decreased from approximately $84,000 in 2004 to approximately $64,000 in 2005.
These costs were offset by an increase in interest income from $0 in 2004 to
$16,000 in 2005 due to the Company's average cash balance maintained in a
checking account which earned interest.
RESTATEMENT OF 2004 AND 2005 BALANCES
During the year ended December 31, 2004 the Company issued 700,000 shares
of its common stock to certain controlling shareholders for the Copley coal
lease. The 700,000 shares of stock were valued and originally booked at par
value of $700 which approximated the cost basis of the Copley lease in the hands
of the controlling shareholders. In November 2005 the Company discovered the
error and amended its financial statements to record the 700,000 shares of stock
at fair market value of $1,085,000 which represents the closing quoted market
value of its stock on the date of acquisition. As summarized below, the
restatements only affected the value of certain balance sheet items and,
accordingly, did not result in a change to earnings.
The following sets forth the balance sheet items affected by these changes:
As As
Reported Restatement Restated
12/31/2004 Adjustment 12/31/2004
------------- ------------ ------------
Coal Leases, Net of Amortization $ 98,157 $ 1,084,300 $ 1,182,457
Additional Paid-in-Capital $ 3,686,035 $ 1,084,300 $ 4,770,335
Also, on January 3, 2005, the Company issued 2,500,000 shares of its common
stock to certain controlling shareholders for additional coal seams on the
Dempsey Lease. The 2,500,000 shares of stock were valued and originally booked
at par value of $2,500 which approximated the cost basis of the Lease in the
hands of the controlling shareholders. In November 2005, the Company discovered
the error and the correction is reflected in the Company's financial statements
for the fiscal year ended December 31, 2005 which reflect the 2,500,000 shares
of stock at fair market value of $4,875,000 which represents the closing quoted
market value of its stock on the date of acquisition. As summarized below, the
restatements only affected the value of certain balance sheet items and,
accordingly, did not result in a change to earnings.
The following sets forth the balance sheet items affected by these changes:
As As
Reported Restatement Restated
3/31/05 Adjustment 3/31/05
------------ ----------- ------------
Coal Leases, Net of Amortization $ 1,343,226 $5,956,800 $ 7,300,026
Additional Paid-in-Capital $ 8,315,536 $5,956,800 $14,272,336
As As
Reported Restatement Restated
6/30/05 Adjustment 6/30/05
------------ ----------- -----------
Coal Leases, Net of Amortization $ 3,253,462 $5,956,800 $ 9,210,262
Additional Paid-in-Capital $ 9,375,487 $5,956,800 $15,332,287
As As
Reported Restatement Restated
9/30/05 Adjustment 9/30/05
------------ ----------- -----------
Coal Leases, Net of Amortization $ 6,020,708 $5,956,800 $11,977,508
Additional Paid-in-Capital $ 10,571,052 $5,956,800 $16,527,852
During the first calendar quarter of 2005, we issued 3,639,704 warrants to
purchase shares of our common stock to investors and Stonegate Securities as
additional consideration for their investment in our business and as placement
agent fees, respectively.
24
These warrants were originally valued using the Black-Scholes method and
originally booked as a debit to debt discount and a credit to additional paid-in
capital. In July 2006, we discovered that these warrants and convertible shares
should have been valued using the Binomial Lattice model and should have been
recorded in accordance with EITF 00-19, which requires us to record the credit
as a liability, and to assess the fair market value of the outstanding warrants
at the end of every quarter thereafter. Any change in the warrants fair value is
then reflected in our statement of operations. The corrections are reflected in
our restated financial statements for the year ended December 31, 2005, which
reflect a liability of the warrants valued on the dates of issuance and adjusted
at the end of each quarter to reflect the change in value with a corresponding
charge to earnings attributed to the change in the value of the warrants as of
December 31, 2005.
As of December 31, 2005, we recorded an aggregate derivative liability
of $11,154,412 and a derivative valuation gain of $1,327,209 to reflect the
change in value of the aggregate derivative liability since February 14, 2005
and June 8, 2005. The aggregate derivative liability of $11,154,412 included
$3,551,471 for the warrants and $7,602,941 for the conversion feature. These
values were calculated using the Binomial Lattice pricing model with the
following assumptions: (i) risk free interest rate of 4.41% for the conversion
feature and 4.35% for the warrants; (ii) expected life (in years) of 2.17 for
the conversion feature and 4.17 for the warrants; (iii) expected volatility of
97.87%; (iv) expected dividend yield of 0.00%; and (v) stock trading valuation
of $0.90 for the for the conversion feature and $1.90 for the warrants.
The following sets forth the statement of operations and balance sheet
items affected by these changes at December 31, 2005:
As As
Reported Restatement Restated
12/31/05 Adjustment 12/31/05
------------------- ------------------- ---------------------
$ $ 3,551,471 $ 3,551,471
Derivative liability - warrants --
Derivative liability - convertible shares -- 7,602,941 7,602,941
6% Senior Secured Notes 11,039,642 (9,627,277) 1,412,365
Coal Leases Net of Amortization 14,717,350 440,371 15,157,721
Additional Paid-in-Capital 16,680,287 (2,413,973) 14,266,314
Retained deficit (15,561,115 ) 1,327,209 (14,233,906)
Change in fair value of convertible shares -- 2,464,707 2,464,707
Change in fair value of warrants $ -- $ (1,137,498) $ (1,137,498)
25
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2006, we had cash and cash equivalents of approximately
$9,500. As of March 31, 2006, we had negative working capital of approximately
$92.8 million. We expect a significant use of cash during the remaining three
calendar quarters of 2006, as we continue to expand our coal mining operations.
We anticipate the need to acquire additional assets and/or mining operations,
and may be required to raise additional funds by issuing additional equity or
debt securities, the amount and timing of which will depend in large part on our
spending program. In March 2006, we entered into a Memorandum of Understanding
for a Line of Credit with Community Trust Bank, Inc., Pikeville, KY pursuant to
which we may borrow 80% of our accounts receivable, up to $5 million. We are
required to make monthly payments of interest-only, calculated by multiplying
the then principal balance outstanding by an interest rate determined to be the
Prime Rate plus 1%. We received approval from greater than 60% of our
outstanding note holders, as required by our January 2006 agreement prior to
incurring any additional indebtedness, and subsequently signed the Line of
Credit Agreement on April 24, 2006. As of June 30, 2006, we had total accounts
receivable of approximately $870,500. Pursuant to the terms of the line of
credit agreement with Community Trust Bank, as of June 30, 2006 we received cash
of approximately $696,400 (80% of $870,500) based on accounts receivable at June
30, 2006.
To date, we have funded operations primarily through the issuance of notes
payable and convertible debentures. We have also issued stock for services in
lieu of cash. In September and November 2005, we obtained a $1.8 million bridge
loan. This allowed us to continue operating through the middle of January 2006.
Subsequently in January 2006, we were able to secure additional financing with
terms agreeable to the Bridge Note holders which transferred the bridge note
into the additional funding, the material terms of which are described above in
the section titled Recent Developments. In April 2006, we entered into the Line
of Credit Agreement described above with Community Trust Bank, Inc. In July
2006, we closed an additional financing transaction, the material terms of which
are also described above in the section titled Recent Developments. Now that (i)
the wash plant is operational as further described under "Operational
Developments" beginning on page 15 of this prospectus, (ii) we have re-commenced
coal production in the Pond Creek seam, generating approximately 20,000 tons per
month, (iii) we have commenced selling coal pursuant to our sales contract with
American Electric Power, and (iv) have completed the July 2006 financing, the
proceeds of which will be used to purchase additional equipment and provide
working capital which we believe will allow us to a monthly production level in
excess of 60,000 tons within 45 days, management believes we now have enough
cash, and the availability of cash pursuant to this Line of Credit, to continue
operations with no further influx of cash. However, we estimate that our monthly
production must exceed 55,000 tons per month in order for us to generate cash
flow from operations sufficient enough for to service our debt and conduct
operations without any additional outside sources of capital. We may seek
additional capital in order to expand our operations, with a goal to raise an
additional approximately $1 to $3 million, which would allow us to produce
approximately 80,000 to 100,000 tons per month, subject to the availability of
capital at terms favorable to us. If we are unable to produce in excess of
55,000 tons per month, then we will scale back operations to reduce operating
expenditures. No assurances, however, can be made that we will reduce costs
enough to continue operations and we may be forced to suspend or completely
cease operations, the results of which may be detrimental to the investment of
our shareholders and existing note holders.
26
As of March 31, 2006, we had not established revenues sufficient to cover our
operating costs, and there remains substantial doubt about our ability to
continue as a going concern consistent with the report of our auditor at
December 31, 2005. At this filing date, we believe we have sufficient capital to
complete mine development, operate the wash plant, and upgrade and/or purchase
the equipment necessary to substantially increase the production capability of
the Alma and pond Creek seams, however, we may seek additional financing to
increase operations until the planned production is fully implemented. If
additional funds are raised through the issuance of equity securities, the
current stockholders may experience dilution. Furthermore, there can be no
assurance that additional financings will be available when needed or that if
available, such financings will include terms favorable to us and our
stockholders. If such financings are not available when required or are not
available on acceptable terms, we may be unable to take advantage of business
opportunities or respond to competitive pressures, any of which could have a
material adverse effect on our business, financial condition and results of
operations. If such funding is received and we successfully complete the planned
increase in production, management believes we will have adequate resources for
operations without any additional outside infusion of capital. However, if such
operations are substantially delayed or impaired, we may be forced to suspend or
cease operations.
Non-Cash Investing and Financing Activities
During 2005 we entered into an agreement with Fairchild International
pursuant to which our subsidiary Eastern Consolidated Energy, Inc. returned
equipment previously purchased from Fairchild International in exchange for the
release of $514,017 of notes payable and $75,000 in cash. As of the end of 2004
we had not received the $75,000 cash from Fairchild International, and therefore
had a receivable on the books. In February 2005, we received the $75,000 payment
from Fairchild International and reduced the accounts receivable.
Cash Flows During the Three Months Ended March 31, 2005 and March 31, 2006
We currently satisfy our working capital requirements through cash flows
generated from the sale of coal as well as the sale of notes payable and
convertible debentures. For the three months ended March 31, 2006, we had a net
increase in cash of approximately $8,400. Cash flows from operating, financing
and investing activities for the three months ended March 31, 2005 and March 31,
2006 are summarized in the following table:
Three Months Ended Three Months Ended
Activity March 31,2005 March 31,2006
- -------------------------------------- ---------------- -----------------
Operating activities $ (652,973) $ (1,732,890)
Investing activities: (2,959,666) (1,219,733)
Financing activities 6,473,098 2,961,018
---------------- -----------------
Net increase (decrease) in cash $ 2,860,459 $ 8,395
================ =================
27
Operating Activities
The net cash used in operating activities of approximately $1,732,890
during the three months ended March 31, 2006 was primarily the result of the net
loss of approximately $24.56 million and increases in accounts receivable of
approximately $125,000 offset by an increase in accrued liabilities of
approximately $0.4 million as we completed our slope construction and began
operating our wash plant and commenced coal sales, an increase in accounts
payable and royalties payable of approximately $48,000 and non-cash expenses of
approximately $74.87 million. The non-cash expenses recorded during the period
primarily included approximately $21.06 million in change in fair value of
warrant liability, approximately $208,000 for depreciation and amortization and
$228,000 of non-cash consulting and compensation expenses related to the
issuance of common stock for services rendered, accretion of debt discount of
$665,000 and $506,894 of gain on sale of capital assets.
The net cash used in operating activities of approximately $653,000 during
the three months ended March 31, 2005 was primarily the result of the net loss
of approximately $14.41 million partially offset by an increase in accounts
payable and accrued liabilities of approximately $310,700 and non-cash expenses
of approximately $119,000 of which $2,875 was the non-cash amortization of debt
discount and $116,000 for depreciation and amortization and non-cash expenses of
approximately $26.24 million. The non-cash expenses recorded during the period
primarily included approximately $13.78 million attributable to the change in
fair value of warrant liability, approximately $116,000 in depreciation expense
and $2,800 in amortization of debt discount.
Investing Activities
Approximately $1.22 million of the cash used in investing activities during
the three months ended March 31, 2006 was due primarily to the addition of
approximately $494,000 of property, plant and equipment, and $726,000 pursuant
to the capitalization of lease costs. To the extent that we make additional
asset acquisitions in the three remaining quarters of 2006 similar to our
investing activities in the past year, we will need to raise additional cash
from outside sources. If additional funds are raised through the issuance of
equity securities, the current stockholders may experience dilution.
Furthermore, there can be no assurance that additional financings will be
available when needed or that if available, such financings will include terms
favorable to us or our stockholders. If such financings are not available when
required or are not available on acceptable terms, we may be unable to take
advantage of business opportunities or respond to competitive pressures, any of
which could have a material adverse effect on our business, financial condition
and results of operations.
Financing Activities During the Three Months Ended March 31, 2006
On January 11, 2005, we closed a financing transaction for $2,500,000 in
bridge financing to be used exclusively for the purchase of equipment and to
fund expenditures for the consummation of mining activities at our Warfield Mine
operations. The financing consisted of a senior secured promissory note for the
face amount of $2,500,000 with an interest rate of 9% per annum and a payment
date (principal and interest) of March 31, 2005. Gryphon Master Fund, LP and
GSSF Master Fund, LP, both Bermuda limited partnerships, were collectively the
payees on the note. The note was repaid with the proceeds from our February 2005
financing.
In consideration for the above note, we paid a commitment fee of $50,000 to
the Gryphon Master Fund and GSSF Master Fund, and a flat fee of $10,000 as
reimbursement for fees and expenses incurred in connection with the negotiation,
preparation and delivery of the note, all deducted from the proceeds of funding
the note. As additional consideration, we issued to Gryphon Master Fund and GSSF
Master Fund a warrant for the purchase of an aggregate of 514,706 shares of our
common stock at an exercise price of $1.70 per share, exercisable for five
years. The warrant also contains so-called "piggyback" registration provisions
under which the warrant holder may request that the shares underlying the
warrant be included in a registration with respect to an offering of our
securities.
In addition to the above bridge note fees and warrants, we paid Stonegate
Securities, Inc., a Texas corporation, which we refer to as Stonegate, a
placement agent fee for a total of $200,000 cash and issued warrants for the
purchase of an aggregate of 51,470 shares of our common stock on the same terms
as the warrants issued to Gryphon Master Fund and GSSF Master Fund. The warrant
issuances were in the form of a warrant issued to Scott R. Griffith and a
28
warrant issued to Jesse B. Shelmire IV, each for the purchase of 25,735 shares.
The cash paid and warrants issued were per the terms of a non-exclusive
Placement Agency Agreement between us and Stonegate.
For a complete description of the material terms of the January 11, 2005
financing transaction, please refer to the discussion under "Recent
Developments" beginning on page 10 of this prospectus.
Cash Flows During the Twelve Months Ended December 31, 2004 and December
31, 2005
For the twelve months ended December 31, 2005 the Company had a net
decrease in cash of approximately $3,300. Cash flows from operating, financing
and investing activities for the twelve months ended December 31, 2004 and
December 31, 2005 are summarized in the following table:
Twelve Months Twelve Months
Activity Ended December 31, 2004 Ended December 31, 2005
Operating activities $ (883,164) $ (2,488,532)
Investing activities: (1,075,132) (12,377,183)
Financing activities 1,956,372 14,862,354
Net increase (decrease) in cash $ (1,924) $ (3,361)
Operating Activities
The net cash used in operating activities of approximately $2,488,532
during the twelve months ended December 31, 2005 was primarily the result of the
net loss of approximately $6.42 million and increases in cash overdrafts of
approximately $377,000 and prepaid and other assets of approximately $82,000 as
the Company continued its development stage, partially offset by an increase in
accounts payable and accrued liabilities of approximately $4.63 million and
non-cash income of approximately $1.31 million. The non-cash expenses recorded
during the period primarily included, approximately $685,000 for depreciation
and amortization and $270,000 of non-cash consulting and compensation expenses
related to the issuance of common stock for services rendered. The non-cash
expenses were offset by non-cash income of approximately $1.33 million due to
the change in fair value of warrant liability.
The net cash used in operating activities of approximately $883,000 during
the twelve months ended December 31, 2004 was primarily the result of the net
loss of approximately $6.41 million partially offset by an increase in accounts
payable and accrued liabilities of approximately $3.60 million and non-cash
expenses of approximately $2 million, of which $485,000 was the non-cash
interest expense recorded related to the beneficial conversion feature of the
convertible debentures, $265,000 for depreciation and amortization, and $1.25
million of non-cash consulting and compensation expenses related to the issuance
of common stock for services rendered.
Investing Activities
Approximately $12.48 million of the cash used in investing activities
during the twelve months ended December 31, 2005 was due primarily to the
purchase of approximately $4.86 million of property, plant and equipment, and
$7.58 million pursuant to the capitalization of lease costs. To the extent that
the Company makes additional asset acquisitions in 2006 similar to its investing
activities in 2005, the Company will need to raise additional cash from outside
sources. If additional funds are raised through the issuance of equity
securities, the current stockholders may experience dilution. Furthermore, there
can be no assurance that additional financings will be available when needed or
that if available, such financings will include terms favorable to the Company's
stockholders. If such financings are not available when required or are not
available on acceptable terms, the Company may be unable to take advantage of
business opportunities or respond to competitive pressures, any of which could
have a material adverse effect on its business, financial condition and results
of operations.
For the twelve months ended December 31, 2004, $1.07 million of cash used
in investing activities resulted primarily from purchase of equipment.
Financing Activities during 2005
29
On January 3, 2005, we issued 550,000 shares of our common stock for
services rendered during the year that ended December 31, 2004. The value of the
stock issued, $1,072,500 (which approximates the value quoted in the OTCBB) has
been recorded as an expense in the year ended December 31, 2004, with a
corresponding increase in accrued liabilities.
On January 11, 2005, we closed a financing transaction for $2,500,000 in
bridge financing to be used exclusively for the purchase of equipment and to
fund expenditures for the consummation of mining activities at our Martin County
Property. The financing consisted of a senior secured promissory note for the
face amount of $2,500,000 with an interest rate of 9% per annum and a payment
date (principal and interest) of March 31, 2005. Gryphon Master Fund, LP and
GSSF Master Fund, LP, both Bermuda limited partnerships, are collectively the
payees on the note. The note was repaid with the proceeds from our February 2005
financing.
In consideration for the above note, we paid a commitment fee of $50,000 to
the Gryphon Master Fund and GSSF Master Fund and a flat fee of $10,000 as
reimbursement for fees and expenses incurred in connection with the negotiation,
preparation and delivery of the note, all deducted from the proceeds of funding
the note. As additional consideration, we issued to Gryphon Master Fund and GSSF
Master Fund a warrant for the purchase of an aggregate of 514,706 shares of our
common stock at an exercise price of $1.70 per share, exercisable for five
years. The warrant also contains so-called "piggyback" registration provisions
under which the warrant holder may request that the shares underlying the
warrant be included in a registration with respect to an offering of our
securities.
In addition to the above fees and warrants, we paid Stonegate Securities,
Inc., a Texas corporation, which we refer to as Stonegate, a total of $200,000
cash and issued warrants for the purchase of an aggregate of 51,470 shares of
our common stock on the same terms as the warrants issued to Gryphon Master Fund
and GSSF Master Fund. The warrant issuances were in the form of a warrant issued
to Scott R. Griffith and a warrant issued to Jesse B. Shelmire IV, each for the
purchase of 25,735 shares. The cash paid and warrants issued were per the terms
of a non-exclusive Placement Agency Agreement between us and Stonegate (filed as
an exhibit to our Current Report on Form 8-K dated January 11, 2005).
On February 24, 2005, we entered into a financing transaction for aggregate
gross proceeds of $7,000,000, with additional investment rights of up to an
additional $7,000,000, such financing to be used for the purchase of equipment
and to fund expenditures for the consummation of mining activities at our
Warfield Mine. The financing is in the form of 6% senior secured convertible
notes for an aggregate total face amount of $7,000,000 and a term of three
years. The 6% senior secured notes may be converted to common stock at a
conversion price of $1.70 per share. Holders of such notes are Gryphon Master
Fund, L.P., GSSF Master Fund, LP, Lonestar Partners, L.P., WS Opportunity
International Fund, Ltd., WS Opportunity Fund (QP), L.P., WS Opportunity Fund,
L.P., Renaissance US Growth Investment Trust PLC, and BFS US Special
Opportunities Trust PLC. As additional consideration, we issued to each of such
holders warrants for the purchase of an aggregate of 2,058,824 shares of our
common stock at an exercise price of $1.70 per share, exercisable for five
years. The conversion price of such notes, and the exercise price of such
warrants, are subject to certain normal and customary anti-dilution adjustment
provisions and also include a one-time reset date provision with a floor price
of $1.00 per share.
In February 2005, simultaneous with the closing of the 6% senior secured
convertible note offering, we used approximately $2,527,000 of the proceeds to
repay the January 2005 bridge loan (principal and interest) from Gryphon Master
Fund and GSSF Master Fund. We also paid a flat fee of $30,000 to Gryphon Master
Fund and GSSF Master Fund as reimbursement for fees and expenses incurred in
connection with the negotiation, preparation and delivery of the 6% senior
secured convertible notes and related investment documents. In addition to the
fees related to the issuance of the 6% senior secured convertible notes, we paid
Stonegate a total of $340,000 cash and issued warrants for the purchase of an
aggregate of 617,647 shares of common stock on the same terms as the warrants
issued to the purchasers of the 6% senior secured convertible note.
During March 2005, two investors in our February 2005 private placement
exercised their additional investment rights for an aggregate of $750,000 in 6%
senior secured convertible notes that may be convertible into 441,176 shares of
the Company's common stock at an exercise price of $1.70 upon the occurrence of
certain events. In connection with the additional investment, we issued warrants
for the purchase of 44,116 shares of our common stock at an exercise price of
$1.70 to the placement agent. In April 2005, the placement agent exercised all
of the 713,223 warrants issued to date to the placement agent through a cashless
30
exercise provision in exchange for the issuance of 485,850 shares of our common
stock. During June 2005, seven investors exercised their additional investment
rights for an aggregate of $6,000,000 in 6% senior secured convertible notes
that may be convertible into 3,529,411 shares of the Company's common stock at
an exercise price of $1.70 upon the occurrence of certain events. In July,
placement agent warrants for the purchase of 352,994 shares issued in connection
with the exercise of the additional investment rights were exercised pursuant to
cashless exercise provisions for the issuance of 166,290 shares.
On March 23, 2005, we authorized the issuance of 200,000 shares of our
common stock for services, which were performed during the year that ended
December 31, 2002. The value of the stock to be issued, $1,010,000 (which
approximates the value quoted in the OTCBB) has been recorded as an expense in
the year that ended December 31, 2004, with a corresponding increase in accrued
liabilities.
As of May 10, 2005, we have used approximately $2,527,000 of the proceeds
of the above offering to repay an outstanding bridge loan (principal and
interest) from Gryphon Master Fund and GSSF Master Fund. We also paid a flat fee
of $30,000 to Gryphon Master Fund and GSSF Master Fund as reimbursement for fees
and expenses incurred in connection with the negotiation, preparation and
delivery of the 6% senior secured convertible notes and related investment
documents.
In addition to the above fees and warrants, we paid Stonegate a total of
$340,000 cash and issued warrants for the purchase of an aggregate of 617,647
shares of our common stock on the same terms as the Warrants issued to the
Holders above. The warrant issuances are in the form of a Warrant issued to
Scott R. Griffith and a warrant issued to Jesse B. Shelmire IV. The cash paid
and warrants issued were per the terms of a non-exclusive Placement Agency
Agreement between the Company and Stonegate referenced above.
In connection with the above transaction, we executed a security agreement
(the "Security Agreement") giving the Holders a security interest in and to any
and all of our assets and properties ("Collateral" as defined in the Security
Agreement). Each of our subsidiaries have also executed a Guaranty for our
obligations under the Notes.
The proceeds received from the financing transaction described above were
budgeted to allow us to:
- access the Pond Creek coal seam at Warfield;
- acquire the equipment necessary to mine the Pond Creek seam;
- prepare to construct a coal washing facility at Warfield; and
- begin engineering and permitting of other coal seams at Warfield.
A portion of the proceeds received from the transaction were used to
provide working capital and materials necessary to construct three slopes and
the ancillary ventilation necessary to allow the Company to access the Pond
Creek coal seam. This construction project was originally scheduled to be near
completion by the end of the third quarter of 2005. The schedule of completion
of this project was rescheduled for the end of February 2006. The company has
experienced additional time and cost associated with repairs to equipment used
in the construction project due to the additional material the equipment had to
remove due to the geological fault encountered.
A portion of the net proceeds were used to prepare the site and to secure
the equipment associated with the planned coal washing facility. The wash plant
construction project was initiated in mid March 2005. The initial plan provided
for a certain location and equipment type. However, during the rework of the
Pond Creek project, management was able to negotiate to have a significant
amount of Alma coal washed by third parties. Management sought to have this
product washed in order to verify the laboratory reports obtained earlier.
Information obtained during this process indicated that the Company could
potentially realize greater profits from the washed coal if some adjustments
were made to the initial wash plant plans. In early June 2005, management
determined to change the design, final location, and overall size of the
proposed wash plant to accommodate this new information. As a result of these
changes, the overall budgeted cost of the wash plant was increased by
approximately 12.5% (from $4 million to $4.5 million) and completion was
delayed. The wash plant became operational in early April 2006 and we have begun
processing coal at the wash plant. Although the wash plant is operational, the
contractor hired to complete the wash plant has not completed certain aspects of
the project that management feels are necessary for the wash plant to operate at
full capacity.
31
A portion of the proceeds received from the financing transaction was used
to secure the equipment which will be used to mine the Alma and Pond Creek coal
seams. A number of pieces of equipment are on site and in position ready to mine
coal.
On July 1, 2005, we failed to pay interest as required pursuant the terms
of certain 6% senior secured convertible notes executed on February 24, 2005 for
an aggregate total face amount of $7,000,000, and thereby caused a default under
the terms of the 6% senior secured convertible notes.
Subsequently, and in order to secure additional financing for continuing
operations, on September 23, 2005, we executed a promissory note (the "Bridge
Note") payable to Cordillera Fund L.P. for an aggregate principal amount of up
to $1,500,000. On November 24, 2005 the existing Bridge Note holders and us
agreed to increase the amount of debt by $300,000 to a total of $1,800,000. The
Bridge Note was subsequently cancelled on January 13, 2006 and exchanged for an
investment in our 8% senior secured convertible notes and warrants. See below
for a description of the material terms of this transaction.
In connection with the Bridge Note, we entered into a Consent and Waiver
with the holders of the 6% senior secured convertible notes, whereby they
consented to the Bridge Note transactions and waived, until resolution of the
Bridge Note transactions, the application of any of the provisions of the 6%
senior secured convertible notes and related transaction documents. We also
entered into a Subordination Agreement in connection with the Bridge Note,
whereby Cordillera Fund L.P. agreed to subordinate the Bridge Note to the prior
payment in full in cash of the 6% senior secured convertible notes. In addition,
the holders of the 6% senior secured convertible notes entered into a Bridge
Forbearance with us whereby they agreed to forebear from exercising any of their
rights or remedies under the 6% senior secured convertible notes and the related
securities purchase agreement, security agreement and any other related
transaction documents for a period of ten business days.
On October 6, 2005, the holders of the 6% senior secured convertible notes
signed an extension to the Bridge Forbearance until the earliest to occur of the
following: (i) November 18, 2005, (ii) the expiration and termination of the
Bridge Note, or (iii) the completion by us of a new financing. As described
below, on January 13, 2006, the 6% note holders signed another forbearance
agreement pursuant to which, among other things, they agreed to waive our prior
defaults on the 6% senior secured convertible notes
On October 27, 2005, we borrowed $329,190 from Community Trust Bank,
Pikeville, KY to purchase mining equipment. The note had a maturity date of
January 27, 2006 and an annual interest rate of the Prime Rate plus one percent
(1%), calculated on the basis of an assumed 360-day year for the actual number
of days elapsed. The note plus all accrued interest was paid in full on January
20, 2006.
CONTRACTUAL OBLIGATIONS
The following summarizes our contractual obligations at March 31, 2006 and
the effects such obligations are expected to have on liquidity and cash flow in
future periods.
Payment due by period
-----------------------------------------------------------------------------------------
Less than 1 to 3 3 to 5 After 5
Total 1 year years years Years
- --------------------------------- ---------------- ---------------- --------------- ------------ ------------
Notes payable $ 22,727,205 $ 1,913,217 $ 20,813,988 $ - $ -
707,959 707,959 -
Convertible Debentures - -
Operating leases 110,298 65,803 44,495 - -
- - -
Capital leases - -
Employment obligations 850,968 850,968 - - -
---------------- ---------------- --------------- ------------ ------------
Total contractual obligations $ 24,396,430 $ 3,537,947 $ 20,858,483 $ - $ -
================ ================ =============== ============ ============
Our notes payable at March 31, 2006 consisted of the following:
32
- ------------------------------------------------------------------------------------------------ --------------------
Amount Due at
Promissory Notes March 31, 2006
- ------------------------------------------------------------------------------------------------ --------------------
Senior secured convertible Note dated February 14, 2005; interest rate of 6% per annum from $ 7,000,000
original issue. Interest due semi-annually with six month anniversary date. Principal and
interest can be converted into shares of the Company's common stock at $0.90 per share.
Principal due 36 months from the date of issue.
Senior secured convertible Note dated June 30, 2005; interest rate of 6% per
annum from original issue. Interest due semi-annually with six month
anniversary date. Principal and interest can be converted into shares of the
Company's common stock at $0.90per share.
Principal due 36 months from the date of issue. 6,750,000
Senior secured convertible note dated January 13, 2006; interest rate of 8%. Principal and
interest are due monthly commencing with June 30, 2006 Principal and interest can be
converted into shares of the company's common stock at $0.90 per share. 6,239,932
Senior secured non-convertible promissory note dated January 13, 2006; Interest rate of 3%
per annum compounded annually with principal and interest due upon final maturity date of
June 30, 2008. 2,640,000
Bank Note Dated June 25, 2005; Interest rate 5.99% payable monthly 14,100
Bank Note Dated July 15, 2005; Interest rate 5.0%, payable monthly 27,358
Bank Note Dated June 25, 2005; Interest rate of 5.99%, payable monthly 27,614
Bank Note Dated June 25, 2005; Interest rate of 5.99%, payable monthly 28,202
--------------------
TOTAL PROMISSORY NOTES $ 22,727,206
Less: debt discount (19,377,968)
Less: current portion of notes payable (126,025)
--------------------
TOTAL LONG-TERM PORTION OF PROMISSORY NOTES $ 3,223,213
- ------------------------------------------------------------------------------------------------ --------------------
We rent mining equipment pursuant to an operating lease agreement, and made
lease payments totaling $15,000 during the three months ended March 31, 2006. We
made lease payments on such agreements totaling $61,692 during the twelve months
ended December 31, 2005.
OFF-BALANCE SHEET ARRANGEMENTS
At March 31, 2006, we did not have any relationships with unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance, variable interest or special purpose entities, which would
have been established for the purpose of facilitating off-balance sheet
arrangements or other contractually narrow or limited purposes. As such, we are
not exposed to any financing, liquidity, market or credit risk that could arise
if it had engaged in such relationships.
DESCRIPTION OF BUSINESS
We are a company engaged in coal mining operations. Our main business focus
in the immediate future will be in operating our mining subsidiary, Eastern
Consolidated Energy, Inc., which we refer to as "Eastern." Through our
acquisition of Eastern in September 2003, we are committed to the successful
development of a profitable coal mining operation in eastern Kentucky.
HISTORY AND ORGANIZATION
We were incorporated in Nevada on December 18, 1996, under the name
Barbeque Capital Corporation, to engage in the manufacture and distribution of
commercial size barbecues for individual, groups, and restaurant use. After two
seasonal business cycles of trying to develop a market for the barbecues, our
management determined that without significant additional funding, we would not
be able to compete in the barbecue business. Accordingly, after several
unsuccessful attempts to obtain additional funding, we determined that it was in
our shareholders' best interest to cease the barbecue business and search for
alternative businesses while we were still solvent. Accordingly, we ceased
business operations and began looking for alternative businesses. In October
2002, a majority of our shareholders approved a change in domicile from Nevada
to Wyoming and a change of name to Consolidated Energy, Inc. We changed our
corporate name to Consolidated Energy, Inc. in order to better reflect our
current business operations. Our management believed changing domicile to
33
Wyoming was in our best interest because Wyoming is one of the leading coal
producing states in the United States and was appropriate since our business
focus changed to coal production. In addition, our new chosen corporate name
Consolidated Energy, Inc. was not available in Nevada.
CURRENT BUSINESS
On September 12, 2003, we entered into an agreement to acquire Eastern
Consolidated Energy, Inc., a privately-held Kentucky Corporation, through the
issuance of 3,000,000 shares of our common stock in exchange for all of the
issued and outstanding stock of Eastern. Eastern is being operated as our
wholly-owned subsidiary.
The assets of Eastern that we acquired include a coal lease in Martin
County, Kentucky. Eastern developed the Alma coal seam at Warfield, Martin
County, Kentucky during 2003 and much of 2004. Eastern began to mine coal and
increase mine development and production by adding additional production shifts
for most of the first three quarters of 2004. However, Eastern entered into a
long-term coal supply contract with American Electric Power in September of
2004. This contact provides that Eastern will supply American Electric Power
with 40,000 tons of coal per month for 36 months at a selling price of $51 per
ton. The coal quality required to satisfy the American Electric Power contract
and which Eastern has under an active permit, is contained in the Pond Creek
coal reserves held by Eastern. The Pond Creek coal seam is located 90 feet below
the Alma coal seam. Our management decided to obtain financing necessary to
allow Eastern to access the Pond Creek coal seam and to fund the ancillary
equipment necessary to mine, prepare and satisfy the American Electric Power
coal supply order.
In January 2005, we obtained a $2,500,000 bridge loan which was used to
begin the process of gaining access to the Pond Creek coal seam. This loan
allowed us to initiate the construction of the proposed slope project at
Warfield Kentucky. This construction project allows us to gain access to the
Pond Creek coal seam. Our management directed that all mining operations be
suspended until after the construction of the slopes is near completion. We also
used a portion of the bridge loan to begin the process of designing and building
a coal washing facility at Warfield.
On February 24, 2005, we entered into a financing agreement which provided
us with gross proceeds of $7,000,000. We used a portion of these proceeds to
retire the $2,500,000 bridge loan which we had obtained in January of 2005.
After payment of transaction fees and expenses, the balance of the funds will be
used by Eastern to finish the construction of the slopes which are designed to
provide access to the Pond Creek seam. A portion of the proceeds will also be
used to purchase equipment necessary to mine the Pond Creek seam and to build
the coal washing facility scheduled to wash the coal produced from the Warfield
mining operation. Eastern began its initial delivery to American Electric Power
in April 2006.
On January 13, 2006, we sold approximately $6.24 million principal amount
of 8% senior secured convertible notes due June 30, 2008 to 18 accredited
investors. Of the $6.24 million principal amount of 8% senior secured
convertible notes, we received gross proceeds of $3.4 million. The remaining
approximate $2.84 million principal amount was paid by investors as follows: (a)
$1.8 million was paid by the cancellation of promissory notes sold by us on
September 23, 2005; (b) $102,000 represents a management fee owed to the lead
investor, Gryphon Master Fund, L.P.; (c) $586,000 represents interest accrued on
our 6% senior secured convertible notes sold February 24, 2005 and pursuant to
certain Additional Investment Rights sold February 24, 2005; and (d) $352,000
represents $352,000 of placement agent fees in connection with the sale of the
8% senior secured convertible notes. The $3.4 million of proceeds were used to
substantially finish the wash plant so that is operational, and for working
capital purposes.
Eastern acquired additional coal reserves on the Dempsey Heir Lease in the
Coalburg Seam, Taylor Seam, Richardson Seam, and Broas Seam containing proven
and probable reserves of approximately 12.33 million recoverable tons of low
sulfur, high BTU coal to be mined by surface and underground mining methods.
Production from some of these surface mine reserves could commence as early as
the fourth quarter of 2006.
Saudi American Minerals, Inc.
In June 2003, we entered into a definitive agreement with Saudi American
Minerals, Inc., which we refer to as "Saudi American," to acquire 100% ownership
of Saudi American Minerals, Inc. with an effective date to coincide with an
effective date of a Form S-4 registration statement. In connection with our
34
January 13, 2006 private placement, we entered into an agreement with Saudi
American Minerals, Inc. whereby, among other things: (i) the parties terminated
the agreement to acquire 100% ownership of Saudi American Minerals, Inc.; and
(ii) we agreed to pay $750,000 cash and issue 3,000,000 shares of common stock
to Saudi American Minerals, Inc. in exchange for the assignment by Saudi
American Minerals, Inc. of a 25% interest in its patented clean coal technology
(Patent No. 6,447,559) including any subsequent improvements thereto. The recent
termination of the original agreement to acquire Saudi American Minerals, Inc.
allows us to focus on our core coal business. The new purchase agreement allows
us to share in 25% of any and all revenues associated with the clean coal
technology. We are not obligated to invest any additional time or money in
development or promotional costs of the clean coal technology. We compensated
Saudi American Minerals for terminating the original agreement by extending to
Saudi American Minerals, in its sole discretion, the exclusive right to
terminate and declare null and void the alternative agreement until we make the
required stock and cash payments. We are required to pay Saudi American Minerals
$750,000 cash no later than July 31, 2007 and we must issue Saudi American
Minerals 3 million shares of common stock within 20 days after we increase our
authorized shares of common stock from 50 million to 100 million shares. On May
1, 2006, we received a letter from Saudi American Minerals Inc. informing us
that they were exercising their sole right to immediately terminate the entire
agreement between Saudi American Minerals Inc. and us. We accepted their
termination of the agreement, thus completely eliminating all obligations of
Saudi American Minerals Inc to us and/or our subsidiaries, and reciprocally
eliminating any obligations of ours and/or our subsidiaries to Saudi American
Minerals Inc.
Principal products
Our principal product currently is high grade coal mined through Eastern,
our operating subsidiary. The coal is being mined at the Warfield property in
Eastern Kentucky. The Warfield property consists of approximately 3,200 coal
acres and we are conducting mining operations in the "Alma" seam, and the Pond
Creek seam which is currently being developed. The Warfield property also
contains the Coalburg Seam, Taylor Seam, Richardson Seam, and Broas Seam. Mining
operations are being conducted in the Alma seam. The coal from each of these
reserves is high BTU or high grade coal with low to medium sulfur and low to
marginal ash content.
The coal reserves currently under lease by Eastern consist of high quality
coal. The Warfield mine began producing coal in September of 2003. In January
2004, Eastern took delivery of a larger, more appropriately suited miner for the
Alma seam of the Warfield mine. This new miner has replaced the earlier miner
and early indications show that this new piece of equipment is capable of
producing twice the amount of coal that the earlier miner was producing.
Distribution methods
Coal, ready to be shipped to customers, can either be shipped via river
barge truck or rail. Coal produced in 2004 was loaded on trucks and delivered to
the river where it is loaded on to a barge for shipping to the end user. Coal
production has been suspended from the Warfield operation during the slope
construction project. However, the coal that will be sold to American Electric
Power under the 36 month supply contract will be delivered to the Louisa power
production facility which is 38 miles from the mine site via truck. Eastern will
contract with others to deliver the coal from the Warfield location to the power
plant
We use a contract consultant, Kentucky Energy Consultants, for mining
consultation, coal reserve study and appropriation, coal sales, marketing and
distribution consultation and coal venture and acquisition consultation.
Kentucky Energy Consultants is owned by Jeff Miller and Larry Hunt who are
related parties.
Kentucky Energy Consultants is under contract to Eastern for five years and
is contractually obligated to consult with us with respect to:
o the marketing and selling of all coal produced from our Eastern
Kentucky coal mining operations; and
o the preparation of all proposal documents required for acquiring coal
sales and contracts along with assisting in the transportation
arrangements, contract negotiations and contract administration.
For these services, effective February 2005, Kentucky Energy Consultants
will receive fees or commissions equal to two and one half (2.5%) percent of the
35
gross sales price received by Eastern for any and all coal sold by Eastern on
purchase orders and/or contracts on either the spot or contract arrangements.
Prior to February 2005, Kentucky Energy Consultants received a five (5%) percent
commission. On May 1, 2006, we received a letter from Kentucky Energy
Consultants informing us that Kentucky Energy Consultants was canceling the
agreement with us dated July 21, 2003. We accepted Kentucky Energy Consultants'
cancellation of the agreement thus completely terminating all past, present and
future obligations of Kentucky Energy Consultants to us and our subsidiary,
Eastern Consolidated Energy, Inc., and reciprocally terminating all past,
present and future obligations of the Company and Eastern Consolidated Energy,
Inc. to Kentucky Energy Consultants.
We use a sales agent "New River Energy Sales Company, Inc.", 8887 Indian
Bluff Dr., Cincinnati, OH 45242 to provide us sales services, including, but not
limited to, the following:
o comprehensive monitoring of opportunities to sell coal on a spot
or term basis;
o consulting advisory services in connection with the solicitation
of coal sales;
o preparation of all proposal documents and assistance in
transportation arrangements, contract negotiations and contract
administration; and
o New River will also assist in the sourcing of venture capital and
assist in the review and construction proposals submitted in
conjunction with the venture capital.
New River is responsible for all office and customary sales and
administrative expenses incurred by New River. ECEI and New River consult
frequently to discuss general conditions and outlook in order to determine coal
availability, sales opportunities and the best contract administration for ECEI.
For these services, as of February, 2005, ECEI will pay to New River, a
commission of 2.5 percent (2.5%) of the selling price (f.o.b. mine market
loading point) on all coal sold by contract or otherwise when the selling price
(f.o.b. mine market loading point) is greater than $45.00 per ton. If and when
the selling price (f.o.b. mine market loading point) is $44.99 per ton or less,
the commission percentage will not remain at 5% but will be renegotiated in good
faith by both ECEI and New River. The commission rate is scheduled to be
increased to 5% as soon as we reach $20 million in aggregate EBITDA.
COMPETITION
Eastern is smaller and has far less capital and resources when compared to
dominant industry coal producers such as Penn Virginia Coal Co., Westmoreland,
or Arch Coal. However, management believes that the current coal mining market
is a sellers' market with the potential for a secure place for a small to medium
sized coal producer. Current and expected future coal production is below that
of last year and substantially below current and expected demand. The current
pipeline and current coal stock piles are diminished when compared to the same
time as last year. Management expects that these stock piles will continue to
diminish due to the reduction in coal production and the expected increase in
demand. Several independent coal producers did not survive the past decade when
the coal market was depressed. Several of the larger coal producers curtailed
production and have not made significant plans to increase production. Several
other domestic suppliers of coal have committed sizable amounts of their
production to export. This export activity contributes additional upward
pressure to the price of the current elevated coal market as the amount of coal
available to satisfy the domestic demand is reduced.
The time and cost associated with obtaining coal mining permits continues
to elevate. The current cost and time required to obtain a permit substantially
reduces the opportunity for new competition to enter the market place in the
near future. The added pressure on equipment suppliers and the resulting
extended ship times required to ascertain mining equipment makes for a difficult
environment for new and existing competition. The limited number of skilled
personnel required to mine coal limits the opportunity for new competition to
enter the coal industry.
TECHNOLOGY
Several companies are working toward developing new clean coal
technologies. We are not aware of any new competitors with an affective
alternative to existing technology.
RAW MATERIALS
36
The Warfield mine operation is an underground operation that uses several
consumables such as roof bolts, rock dust, concrete block, grease and bolt
rosin. Each of the aforementioned is readily available from several sources
within a reasonable delivery distance from the Warfield mine. Water for the
mining operation is readily available from a mountain stream. Eastern has a
collection pond which insures available water in case there is a drought.
Electricity required for mining is available from the local power provider that
has sufficient power capacity for the current operation and is capable of
supplying any planned expansion. Spare parts are used on a regular basis and
Eastern has not had any difficulty finding several suppliers capable and willing
to provide spare parts on an as needed basis. Belt structure for belt
advancement and belt for belt advancement is readily available from several
available local sources also. The elevated cost of steel has resulted in an
elevated cost of several of the raw materials required to mine coal. However, we
have not experienced any particular delays in the supply of raw materials.
DEPENDENCE ON MAJOR CUSTOMERS
Our coal production operation has a varied and quite versatile number of
potential customers for the coal mined and made available for sale. Coal
production from the Pond Creek seam of coal commenced in January 2006.
Management expects coal production from the Alma seam to re-commence in late
June 2006. Management further anticipates coal production from the Taylor seam
to commence by the end of 2006. This coal will be produced from the Alma, Pond
Creek and Taylor seams of coal located on our leased property. Over the next
6-12 months we expect a majority of all coal production to be sold solely
through existing long-term (1-5 years) contracts. One of the existing contracts
is for a 36-month term and the other contract is for a 12-month term. The two
contracts will consume most of our anticipated production for the next 12
months. If no other long-term contracts are executed, we anticipate selling any
coal not covered by the existing contracts in the spot market.
Eastern has committed nearly 100% of its current anticipated overall
run-rate to American Electric Power. Eastern has two contracts with American
Electric Power, one contract is for 40,000 tons per month for 36 months and the
second of which is a 12-month contract for 50,000 tons per month, with a
24-month option. If American Electric Power exercises its option on this
contract, the two contracts combined will account for approximately 100 percent
of our production capacity over the next three years and account for
approximately 15 percent of our current recoverable reserves. If American
Electric Power does not exercise its option on this contract, American Electric
Power will account for approximately 80 percent of our production capacity for
the first 12 months and 50 percent of our production and approximately nine
percent of our current recoverable reserves.
Management is satisfied with the stability of its contracted customer and
the current list of potential customers available to Eastern.
PATENTS, TRADEMARKS, LICENSES, FRANCHISES, CONCESSIONS, ROYALTY AGREEMENTS OR
LABOR CONTRACTS, INCLUDING DURATION
The Warfield mining project, which is operated by Eastern, is authorized
under several lease agreements. One of these agreements, which is referred to as
the "Dempsey Lease" was entered into in March of 2002, and provides for the free
and uninterrupted use and possession of, and rights-of-way into, upon, over,
across, and through, the leased premises for the construction, operation,
repair, maintenance, and reclamation of the mining operations, roads, haulways,
exploration sites, work and service areas, pollution control structures,
telephone, water, electrical and other utility lines devices and structures,
coal tipples, coal processing and storage areas, and all other machinery,
devices, improvements, structures and appurtenances which at such points, and in
such manners, by incidental in or for its exploration, development, mining,
removal, processing, marketing, and /or shipping said leased coal and /or other
coal.
The underground lease provides for Eastern to access and to mine the Alma
seam reserves for an initial period of eighteen months and thereafter until
Eastern fails to mine the coal reserves, or Eastern chooses not to continue to
mine the coal reserves, or until the coal reserves have been exhausted. The
surface lease allows Eastern the right to mine the coal reserves "above
drainage" as long as Eastern begins to mine coal within three years of the
signing of this lease and continues to actively pursue mining these coal
reserves until these coal reserves have been exhausted. Eastern has agreed to
pay to the Lessor the greater of a minimum annual amount or a royalty payment of
6% of the selling price but not less than $1.85 for each and every net ton of
two thousand pounds of coal mined and sold from the leased premises.
37
The second lease agreement is a lease on the Pond Creek seam. This seam is
located directly under the Alma seam. Plans have been developed which utilize a
slope in order to reach the Pond Creek reserves. Eastern completed the planned
slope construction in February 2006.
GOVERNMENTAL REGULATION
The coal mining industry is subject to extensive regulation by federal,
state and local authorities on matters such as: employee health and safety;
permitting and licensing requirements regarding environmental and safety
matters; air quality standards; water quality standards; plant and wildlife and
wetland protection; blasting operations; the management and disposal of
hazardous and non-hazardous materials generated by mining operations; the
storage of petroleum products and other hazardous substances; reclamation and
restoration of properties after mining operations are completed; discharge of
materials into the environment, including air emissions and wastewater
discharge; surface subsidence from underground mining; and the effects of mining
operations on groundwater quality and availability. Complying with these
requirements, including the terms of our permits, has had, and will continue to
have, a significant effect on our costs of operations. We could incur
substantial costs, including clean up costs, fines, civil or criminal sanctions
and third party claims for personal injury or property damage as a result of
violations of or liabilities under these laws and regulations.
In addition, the utility industry, which is the most significant end-user
of coal, is subject to extensive regulation regarding the environmental impact
of its power generation activities, which could affect demand for our coal. The
possibility exists that new legislation or regulations may be adopted which
would have a significant impact on our mining operations or our customers'
ability to use coal and may require us or our customers to change operations
significantly or incur substantial costs.
Need for government approval of our products and services
Numerous governmental permits and approvals are required for mining
operations. In connection with obtaining these permits and approvals, we are, or
may be, required to prepare and present to federal, state or local authorities
data pertaining to the effect or impact that any proposed exploration for or
production of coal may have upon the environment, the public, historical
artifacts and structures, and our employees' health and safety. The requirements
imposed by such authorities may be costly and time-consuming and may delay
commencement or continuation of exploration or production operations. Future
legislation and administrative regulations may emphasize the protection of the
environment and health and safety and, as a consequence, our activities may be
more closely regulated. Such legislation and regulations, as well as future
interpretations of existing laws, may require substantial increases in our
equipment and operating costs and delays, interruptions or a termination of
operations, the extent of which cannot be predicted.
The Warfield mining operation is bonded as a part of the Warfield mining
permit. The Warfield property is operating under a permit issued by the state of
Kentucky which allows Eastern to lawfully engage in the underground mining
operations at Warfield. Eastern has engaged a local engineering company to
update all appropriate mining maps as Eastern advances the mine.
Eastern is current on all permit obligations.
Mine Health and Safety Laws
Stringent health and safety standards were imposed by federal legislation
when the Federal Coal Mine Safety and Health Act of 1969 was adopted. The
Federal Mine Safety and Health Act of 1977, which significantly expanded the
enforcement of safety and health standards of the Coal Mine Safety and Health
Act of 1969, imposes safety and health standards on all mining operations.
Regulations are comprehensive and affect numerous aspects of mining operations,
including training of mine personnel, mining procedures, blasting, the equipment
used in mining operations and other matters. The Federal Mine Safety and Health
Administration monitors compliance with these federal laws and regulations and
can impose penalties ranging from $60 to $60,000 per violation, as well as
closure of the mine. In addition, as part of the Coal Mine Safety and Health Act
of 1969 and the Federal Mine Safety and Health Act of 1977, the Black Lung
38
Benefits Revenue Act of 1977 and the Black Lung Benefits Reform Act of 1977, as
amended in 1981, requires payments of benefits to disabled coal miners with
black lung disease and to certain survivors of miners who die from black lung
disease.
In 2001, Kentucky made significant changes to its mining laws. A new
independent agency, the Kentucky Mine Safety Review Commission, was created to
assess penalties against anyone, including owners or part owners (defined as
anyone owning one percent or more shares of publicly traded stock), whose
intentional violations or order to violate mine safety laws place miners in
imminent danger of serious injury or death. Mine safety training and compliance
with state statutes and regulations related to coal mining is monitored by the
Kentucky Office of Mine Safety and Licensing. The Commission can impose a
penalty of up to $10,000 per violation, as well as suspension or revocation of
the mine license.
It is our responsibility to employees to provide a safe and healthy
environment through training, communication, following and improving safety
standards and investigating all accidents, incidents and losses to avoid
reoccurrence. Most aspects of mine operations are subject to extensive
regulation. This regulation has a significant effect on our operating costs.
However, our competitors are subject to the same level of regulation.
Black Lung Legislation
Under the federal Black Lung Benefits Act (as amended) (the "Black Lung
Act"), each coal mine operator is required to make black lung benefits or
contribution payments to:
o current and former coal miners totally disabled from black lung
disease;
o certain survivors of a miner who dies from black lung disease or
pneumoconiosis; and
o a trust fund for the payment of benefits and medical expenses to any
claimant whose last mine employment was before January 1, 1970, or
where a miner's last coal employment was on or after January 1, 1970
and no responsible coal mine operator has been identified for claims,
or where the responsible coal mine operator has defaulted on the
payment of such benefits.
Federal black lung benefits rates are periodically adjusted according to the
percentage increase of the federal pay rate.
In addition to the Black Lung Act, we also are liable under various state
statutes for black lung claims. To a certain extent, our federal black lung
liabilities are reduced by our state liabilities.
The United States Department of Labor issued a final rule, effective
January 19, 2001, amending the regulations implementing the Black Lung Act. The
amendments give greater weight to the opinion of the claimant's treating
physician, expand the definition of black lung disease and limit the amount of
medical evidence that can be submitted by claimants and respondents. The
amendments also alter administrative procedures for the adjudication of claims,
which, according to the Department of Labor, results in streamlined procedures
that are less formal, less adversarial and easier for participants to
understand. These and other changes to the black lung regulations could
significantly increase our exposure to federal black lung benefits liabilities.
Experience to date related to these changes is not sufficient to determine the
impact of these changes. The National Mining Association challenged the
amendments but the courts, to date, with minor exception, affirmed the rules.
However, the decision left many contested issues open for interpretation.
Consequently, we anticipate increased litigation until the various federal
District Courts have had an opportunity to rule on these issues.
In recent years, proposed legislation on black lung reform has been
introduced in, but not enacted by, Congress and the Kentucky legislature. It is
possible that legislation on black lung reform will be reintroduced for
consideration by these legislative bodies. If any of the proposals that have
been introduced is passed, the number of claimants who are awarded benefits
could significantly increase. Any such changes in black lung legislation, if
approved, or in state or federal court rulings, may adversely affect our
business, financial condition and results of operations.
Environmental Laws and Regulations
39
We are subject to various federal environmental and mining laws, including:
the Surface Mining Control and Reclamation Act of 1977; the Clean Air Act; the
Clean Water Act; the Toxic Substances Control Act; the Comprehensive
Environmental Response, Compensation and Liability Act; the U.S. Army Corps of
Engineers; and the Resource Conservation and Recovery Act. We are also subject
to state laws of similar scope in each state in which we operate. These
environmental laws require reporting, permitting and/or approval of many aspects
of coal operations. Both federal and state inspectors regularly visit mines and
other facilities to ensure compliance. We have ongoing compliance and permitting
programs designed to ensure compliance with such environmental laws.
Surface Mining Control and Reclamation Act (the "SMCRA")
The SMCRA, and its state counterparts, establish operational, reclamation
and closure standards for all aspects of surface mining as well as many aspects
of underground mining. The SMCRA requires that comprehensive environmental
protection and reclamation standards be met during the course of and following
completion of mining activities. Permits for all mining operations must be
obtained from the Federal Office of Surface Mining Reclamation and Enforcement
or, where state regulatory agencies have adopted federally approved state
programs under the SMCRA, the appropriate state regulatory authority. Kentucky
has achieved primary jurisdiction for enforcement of the SMCRA through approved
state programs.
The SMCRA and similar state statutes, among other things, require that
mined property be restored in accordance with specified standards and approved
reclamation plans. The mine operator must submit a bond or otherwise secure the
performance of these reclamation obligations. The earliest a reclamation bond
can be fully released is five years after reclamation has been achieved. All
states impose on mine operators the responsibility for repairing or compensating
for damage occurring on the surface as a result of mine subsidence, a possible
consequence of underground mining. In addition, the Abandoned Mine Reclamation
Fund, which is part of the SMCRA, imposes a tax on all current mining
operations, the proceeds of which are used to restore unreclaimed mines closed
before 1977. The maximum tax is $0.35 per ton on surface-mined coal and $0.15
per ton on underground-mined coal.
Clean Air Act
The federal Clean Air Act and similar state laws and regulations, which
regulate emissions into the air, affect coal mining and processing operations
primarily through permitting and/or emissions control requirements. In addition,
the Environmental Protection Agency (the "EPA") has issued certain, and is
considering further, regulations relating to fugitive dust and particulate
matter emissions that could restrict our ability to develop new mines or require
us to modify our operations. In July 1997, the EPA adopted new, more stringent
National Ambient Air Quality Standards for particulate matter, which may require
some states to change existing implementation plans for particulate matter.
Because coal mining operations and plants burning coal emit particulate matter,
our mining operations and utility customers are likely to be directly affected
when the revisions to the National Ambient Air Quality Standards are implemented
by the states. Regulations under the Clean Air Act may restrict our ability to
develop new mines or could require us to modify our existing operations, and may
have a material adverse effect on our financial condition and results of
operations.
The Clean Air Act also indirectly affects coal mining operations by
extensively regulating the air emissions of coal-fired electric power generating
plants. Coal contains impurities, such as sulfur, mercury and other
constituents, many of which are released into the air when coal is burned. New
environmental regulations governing emissions from coal-fired electric
generating plants could reduce demand for coal as a fuel source and affect the
volume of our sales. For example, the federal Clean Air Act places limits on
sulfur dioxide emissions from electric power plants. In order to meet the
federal Clean Air Act limits for sulfur dioxide emissions from electric power
plants, coal users need to install scrubbers, use sulfur dioxide emission
allowances (some of which they may purchase), blend high sulfur coal with low
sulfur coal or switch to low sulfur coal or other fuels. The cost of installing
scrubbers is significant and emission allowances may become more expensive as
their availability declines. Switching to other fuels may require expensive
modification of existing plants.
On March 15, 2005, the EPA adopted a new federal rule to cap and reduce
mercury emissions from both new and existing coal-fired power plants. The
reductions will be implemented in stages, primarily through a market-based
cap-and-trade program. Nevertheless, the new regulations will likely require
some power plants to install new equipment, at substantial cost, or discourage
the use of certain coals containing higher levels of mercury.
40
Other new and proposed reductions in emissions of sulfur dioxides, nitrogen
oxides, particulate matter or various greenhouse gases may require the
installation of additional costly control technology or the implementation of
other measures, including trading of emission allowances and switching to other
fuels. For example, the EPA recently proposed separate regulations to reduce the
interstate transport of fine particulate matter and ozone through reductions in
sulfur dioxides and nitrogen oxides throughout the eastern United States. The
EPA continues to require reduction of nitrogen oxide emissions in 22 eastern
states and the District of Columbia and will require reduction of particulate
matter emissions over the next several years for areas that do not meet air
quality standards for fine particulates and for certain major sources
contributing to those exceedances. In addition, the EPA has issued draft
regulations, and Congress and several states are now considering legislation, to
further control air emissions of multiple pollutants from electric generating
facilities and other large emitters. These new and proposed reductions will make
it more costly to operate coal-fired plants and could make coal a less
attractive fuel alternative in the planning and building of utility power plants
in the future. To the extent that any new and proposed requirements affect our
customers, this could adversely affect our operations and results.
Along with these regulations addressing ambient air quality, a regional
haze program initiated by the EPA to protect and to improve visibility at and
around national parks, national wilderness areas and international parks may
restrict the construction of new coal-fired power plants whose operation may
impair visibility at and around federally protected areas and may require some
existing coal-fired power plants to install additional control measures designed
to limit haze-causing emissions. These requirements could limit the demand for
coal in some locations.
The United States Department of Justice, on behalf of the EPA, has filed
lawsuits against several investor-owned electric utilities and brought an
administrative action against one government-owned utility for alleged
violations of the Clean Air Act. Some of these lawsuits have settled, requiring
the utilities to pay penalties, install pollution control equipment and/or
undertake other emission reduction measures, and the remaining lawsuits or
future lawsuits could require the utilities involved to take similar steps,
which could adversely impact their demand for coal.
Any reduction in coal's share of the capacity for power generation could
have a material adverse effect on our business, financial condition and results
of operations. The effect such regulations, or other requirements that may be
imposed in the future, could have on the coal industry in general and on us in
particular cannot be predicted with certainty.
We believe we have obtained all necessary permits under the Clean Air Act.
We monitor permits required by operations regularly and take appropriate action
to extend or obtain permits as needed.
Clean Water Act
The federal Clean Water Act and corresponding state laws affect coal mining
operations by imposing restrictions on discharges into regulated effluent
waters. Permits requiring regular monitoring and compliance with effluent
limitations and reporting requirements govern the discharge of pollutants into
regulated waters. We believe we have obtained all permits required under the
Clean Water Act and corresponding state laws and are in substantial compliance
with such permits. However, new requirements under the Clean Water Act and
corresponding state laws may cause us to incur significant additional costs that
could adversely affect our operating results.
In addition, the U.S. Army Corps of Engineers imposes stream mitigation
requirements on surface mining operations. These regulations require that
footage of stream loss be replaced through various mitigation processes, if any
ephemeral, intermittent, or perennial streams are in-filled due to mining
operations. These regulations may also cause us to incur significant additional
operating costs.
Comprehensive Environmental Response, Compensation and Liability Act
The Comprehensive Environmental Response, Compensation and Liability Act
(commonly known as Superfund) and similar state laws create liabilities for the
investigation and remediation of releases of hazardous substances into the
41
environment and for damages to natural resources. Our current and former coal
mining operations incur, and will continue to incur, expenditures associated
with the investigation and remediation of facilities and environmental
conditions, including underground storage tanks, solid and hazardous waste
disposal and other matters under these environmental laws. We also must comply
with reporting requirements under the Emergency Planning and Community
Right-to-Know Act and the Toxic Substances Control Act.
The magnitude of the liability and the cost of complying with environmental
laws with respect to particular sites cannot be predicted with certainty due to
the lack of specific information available, the potential for new or changed
laws and regulations and for the development of new remediation technologies and
the uncertainty regarding the timing of remedial work. As a result, we may incur
material liabilities or costs related to environmental matters in the future and
such environmental liabilities or costs could adversely affect our results and
financial condition. In addition, there can be no assurance that changes in laws
or regulations would not result in additional costs and affect the manner in
which we are required to conduct our operations.
Resource Conservation and Recovery Act
The Resource Conservation and Recovery Act and corresponding state laws and
regulations affect coal mining operations by imposing requirements for the
treatment, storage and disposal of hazardous wastes. Facilities at which
hazardous wastes have been treated, stored or disposed of are subject to
corrective action orders issued by the EPA and other potential obligations,
which could adversely affect our results and financial condition.
Effect of existing or probable government regulations on business
Existing regulations on mining are extensive and require time and personnel
to insure compliance. Eastern has employed full time personnel capable of
responding to any and all state or federal inspection personnel. These persons
are charged with insuring that all mining personnel have been trained and
instructed in safe mining operations. These persons are also charged with
insuring that all other personnel are conducting themselves in a safe and
acceptable manner. Eastern has also hired as part of the Eastern team Jacobs
Risk Management, a risk management consulting company operated as a sole
proprietorship by Joseph G. Jacobs, who is one of our directors. Jacobs Risk
Management provides preventative and ongoing compliance support to help insure
that Eastern remains in compliance with all state and federal mandates.
Eastern is not aware of any new regulations that will unfavorably impact
our business, but expects that any new regulations will apply across the
industry and not impact Eastern more than any other coal mining operation.
Costs and effects of compliance with federal, state, local environmental laws
Underground mining is highly scrutinized and regulated by the federal
government and the state government. Eastern is subject to comply with all state
and federal requirements, many of which are outlined in the Code of Federal
Regulations, Title 30, Volume 3, Parts 700 to end. Some of these regulations can
also be found in more detail at: http://www.access.gpo.gov/nara/cfr/waisidx_00/3
0cfrv3_00.html.
Detailed regulations cover mining operations, potential subsidence issues,
and reclamation of mining areas. Eastern anticipates that such costs will
increase over the next fiscal year due to expanded operations.
EMPLOYEES
As of August 7, 2006 we had one part-time employee and 52 full-time
employees. None of our employees are covered by a collective bargaining
agreement. We believe our employee relations are favorable.
DESCRIPTION OF PROPERTY
Our principal executive office is currently located at 76 George Road,
Betsy Layne, KY 41605. Starting January 1, 2005 we entered into a verbal lease
for $2,000 per month plus utilities averaging approximately $300 per month,
which approximates market rates. The property is leased from Jacobs Risk
Management, a company owned by Mr. Joe Jacobs, our Chief Operating Officer. The
space of this office is adequate for our needs and is located closely with all
42
current operations. Effective February 15, 2005, we entered into a one year
lease for an office in Coral Springs, Florida, with an option to renew for one
additional year. Management determined that there was no need for an
administrative office in Florida and closed this office on February 15, 2006.
Coal
The Company's coal mining operations are conducted in the Eastern Kentucky
Central Appalachian Mountain Range, in rock formation consisting primarily of
shale, sandstone and blue slate. Coal seams of economic significance on the
leased properties include the Alma, Pond Creek, Coalburg, Taylor, Richardson,
and Broas seams. The Alma Seam is permitted and mine-ready. The Pond Creek Seam
which is accessed via three slopes from the Alma seam is permitted and
mine-ready. The Taylor Seam which will be mined via the underground method is
currently in the permitting process. The Coalburg, Richardson and Broas seams
are all to be mined using the surface mining method and mining permits for these
seams have not yet been submitted.
In the third week of July 2005, a more detailed review of the existing Alma
seam was conducted by the Mine Safety and Health Administration. As a result of
the review, it was strongly recommended that the Company re-secure approximately
9,600 feet of roof in a portion of the mine that had been mined by a previous
mine owner/operator. Management immediately directed a full time crew with the
appropriate equipment to address the concerns offered by the regulatory agency.
This project was completed at a cost of approximately $2 million.
The Company's Alma coal seam is scheduled to be mined by the continuous
mining method using one Joy 14 CM-10 AA continuous miner, one Fletcher dual-head
roof bolter and various other pieces of underground mining equipment normally
used in this method of mining. A significant amount of the current operating
equipment has been refurbished or rebuilt and is in near new condition.
The Pond Creek mine development, which began in late February 2005,
involved a ventilation development plan and a slope development plan. The
ventilation development plan called for increasing the height of the existing
Alma mine intake and return air entries along with the connecting corridors. The
planned increase was from approximately 40 inches in height to approximately 108
inches in height. This increase in height was scheduled for 1100 feet in both
corridors and the connecting corridors. Management initially estimated that the
overall plan would require 90 days to complete.
However, in late April 2005, the ventilation development crew, while
developing the ventilation improvement plan, encountered a geological fault
after completing approximately 1000 feet of both the fresh and return air
corridors. The condition threatened the ongoing useful life of the Alma mine.
Management decided in early May 2005 that it was imperative that the Company
mitigate the negative affects of the geological fault in order to secure the
coal reserves contained in the Alma coal seam. As a result of the ventilation
development changes, management redesigned the actual slope portion of the
project to allow the slopes to be relocated approximately 100 feet away from the
geological fault. The slope construction portion of the project was re-engaged
and in February, 2006 the three slopes had been advanced to the Pond Creek coal
seam. The cost of the corrective action was approximately $3.5 million.
The wash plant construction project was initiated in mid March 2005. The
initial plan provided for a certain location and equipment type. However, during
the rework of the Pond Creek project, management negotiated to have a
significant amount of Alma coal washed by third parties. Management sought to
have this product washed in order to verify the earlier laboratory reports.
Information obtained during this process indicated that the Company could
potentially realize greater profits from the washed coal if some adjustments
were made to the initial wash plant plans. In early June 2005, management
determined to change the design, final location, and overall size of the
proposed wash plant to accommodate this new information. As a result of these
changes, the overall budgeted cost of the wash plant was increased by
approximately 12.5% (from $4 million to $4.5 million). The wash plant became
operational in early April 2006 and we have begun processing coal at the wash
plant. Although the wash plant is operational, the contractor hired to complete
the wash plant has not completed certain aspects of the project that management
feels are necessary for the wash plant to operate at full capacity.
The Company accesses the Pond Creek coal seam via three slopes which are
located within the Alma mine. The Pond Creek coal seam is scheduled to be mined
by the continuous mining method using one Joy 14 CM-10 AA continuous miner, one
43
Fletcher dual-head roof bolter and various other pieces of underground mining
equipment normally used in this method of mining. Substantially all of the
current operating equipment has been refurbished or rebuilt and is in near new
condition.
The Martin County mining project is authorized under several lease
agreements. One of these agreements, which is referred to as the "Dempsey
Lease", provides for the free and uninterrupted use and possession of, and
rights-of-way into, upon, over, across, and through, the leased premises for the
construction, operation, repair, maintenance, and reclamation of the mining
operations, roads, haul ways, exploration sites, work and service areas,
pollution control structures, telephone, water, electrical and other utility
lines devices and structures, coal tipples, coal processing and storage areas,
and all other machinery, devices, improvements, structures and appurtenances
which at such points, and in such manners, by incidental in or for its
exploration, development, mining, removal, processing, marketing, and /or
shipping said leased coal and /or other coal. The Dempsey Lease is for an
initial period of thirty-six months and thereafter until the Company fails to
mine the coal reserves, fails to pay the minimum royalty payments, or it chooses
not to continue to mine the coal reserves, or until the coals reserves have been
exhausted. The Company has agreed to pay to the lessor the greater of a minimum
of $12,000 annually or a royalty payment of 6% of the selling price but not less
than $1.50 per ton mined and sold from any and all seams on the leased property.
The mining leases acquired pursuant to the Eastern Reverse Merger provides
for the Company to access and to mine the Alma seam reserves, using underground
methods, for an initial period of eighteen months and thereafter until the
Company fails to mine the coal reserves, or it chooses not to continue to mine
the coal reserves, or until the coal reserves have been exhausted. This lease
also gives the right to access and mine by whatever mining method necessary for
the extraction of coal within all other seams "above drainage" on the leased
property for an initial period of thirty-six months and thereafter until the
Company fails to mine the coal reserves, or it chooses not to continue to mine
the coal reserves, or until the coal reserves have been exhausted. The surface
lease allows the Company the right to mine the Alma coal seam reserves and all
other seams "above drainage" as long as the Company begins to mine coal within
three years of the signing of the lease and continues to actively pursue mining
these coal reserves until these coal reserves have been exhausted. The Company
has agreed to pay to the lessor the greater of a minimum of $12,000 annually or
a royalty payment of 6% of the selling price but not less than $1.50 per ton
mined and sold from the Alma Seam and 6% of the selling price but not less than
$1.85 per ton mined and sold from all other seams above drainage on the leased
premises. The Company is also obligated to pay to the lessor a surface wheelage
royalty of $0.15 per ton mined and sold.
The Copley Lease provides for the free and uninterrupted use and possession
of, and rights-of-way into, upon, over, across, and through, the leased premises
for the construction, operation, repair, maintenance, and reclamation of the
mining operations, roads, haul ways, exploration sites, work and service areas,
pollution control structures, telephone, water, electrical and other utility
lines devices and structures, coal tipples, coal processing and storage areas,
and all other machinery, devices, improvements, structures and appurtenances
which at such points, and in such manners, by incidental in or for its
exploration, development, mining, removal, processing, marketing, and /or
shipping said leased coal and /or other coal. The Dempsey Lease is for an
initial period of thirty-six months and thereafter until the Company fails to
mine the coal reserves, fails to pay the minimum royalty payments, or it chooses
not to continue to mine the coal reserves, or until the coals reserves have been
exhausted. The Company has agreed to pay to the lessor the greater of a minimum
of $10,000 annually or a royalty payment of 6% of the selling price but not less
than $1.50 per ton mined and sold from any and all seams on the leased property.
Consistent with industry practice, the Company conducted a limited
investigation of title to the Company's coal properties prior to leasing and the
property owners provided title warranties. Prior to initiating mining, title to
lands and reserves of the lessors or grantors, and the boundaries of the
Company's leased properties are more completely verified. The Company utilizes a
registered professional surveyor to confirm the meets and bounds and also
advertised the property and the proposed mining operation in the largest
circulation newspaper in the county in which the property is located.
As of March 31, 2006, the Company had invested approximately $15.90 million
in leases, $121,700 for permits, and approximately $10.77 million in property,
plant and equipment associated with the mining of coal on the Martin County
Property.
44
As of March 31, 2006, the Company planned to invest $6 million to $10
million of additional funds to increase the production potential of the Martin
County Property, subject to availability of such funds under terms which the
Company feels are favorable to it.
Electric power for the current operations of the Company is supplied by
American Electric Power. This power source is readily available and upgradeable
when and as power demand increases. In February 2006, the Company conducted a
power upgrade on the Martin County Property.
All information provided in the table below represents minerals under lease
located on the Martin County Property as of March 31, 2006. All mineral tonnage
is leased and none is owned by the Company.
Proven & Probable Average
Tons in Place BTU Per lb. in Recovery % Total
As of Dec. 31, place, including Sulfur Inc. Recoverable
Seam 2005 Type natural moisture Content Processing Tons
- -------------- ------------- ------- ----------------- ----------------- ----------- --------------
Pond Creek 5,400,000 Steam 11,800 to 13,200 less than 1.0 40% 2,160,000
Alma 14,600,000 Steam 11,300 to 12,500 greater than 1.5 45% 6,570,000
Taylor 5,220,300 Steam 12,200 to 13,600 less than 1.0 35% 1,827,105
Coalburg 13,105,855 Steam 11,800 to 13,200 greater than 1.0 48% 6,290,810
Richardson 941,000 Steam 11,800 to 13,200 less than 1.0 50% 470,500
Broas 3,437,250 Steam 11,800 to 13,200 less than 1.0 85% 2,921,663
-------------- --------------
Totals 42,704,405 20,240,078
============== ==============
The Company's estimate of the economic recoverability of the Company's
leased tonnage is based upon a comparison of unassigned tonnage to assigned
tonnage currently in production in the same geologic setting to determine an
estimated mining cost. These estimated mining costs are compared to existing
market prices for the quality of coal expected to be mined and taking into
consideration typical contractual sales agreements for the region and product.
Where possible, the Company also reviews production by competitors in similar
mining areas. Only tonnage expected to be mined economically and with an
acceptable profit margin is included in the Company's recoverable tonnage
estimates. Finally, the Company's tonnage estimates include reductions for
recoverability factors to estimate a saleable product.
The Company's mineable tonnage estimates are calculated by third party
consultants who have significant years of experience in evaluating coal tonnage.
Their reports are reviewed by Company employees with significant experience
within the mining or engineering industry. The latest independent review was
performed by Summit Engineering Inc. in July 2005 and conveyed that the Company
is in control of approximately 20.2 million recoverable coal tons.
The Company's mining operations, including its coal washing facility and
mining offices which are housed in mobile office trailers, are conducted on
leased property located at 820 Hode Road, in Warfield, Martin County, Kentucky.
Access to this property is via Kentucky State Route 292 one half mile north of
Warfield, KY. The Company is not required to make standard month rent payments;
rather it must make monthly royalty payments pursuant to the mining lease
agreement as compensation to the lessor.
The Company engaged a surface mining operation located in Morgan County,
KY. The initial mining activity involved a small surface mining permit with the
option of mining a large contiguous permit. The Company, after exhausting the
mineable coal available under the small permit and after extensive review of the
coal covered under the large, contiguous permit, elected to conclude its mining
activity in Morgan County. The Company completed a majority of the required
reclamation; and will complete the remaining required reclamation as weather
permits.
The Company is current on all permit obligations. The underground permit
for the Alma and Pond Creek coal seams were issued February 2, 2006 and are
scheduled to expire on November 6, 2009. This permit includes the coal washing
facility and approximately one year of refuse disposal. As a general rule, the
Company will need to perform periodic maintenance to remain in compliance with
this permit. The large refuse disposal permit will require a Nation Wide 21
(404) valley fill permit which will be obtained from the U.S. Corp of Engineers.
This permit is currently pending and once approved will be for a 15 year period.
The Taylor seam is in the permitting process and is expected to be available for
issue by the fourth quarter 2006, depending on the review process.
45
The Company is currently out-sourcing all of the required engineering and
permitting services. The Company is providing oversight on this process.
Gas and Oil
The Company, through its wholly-owned subsidiary Consolidated Oil & Gas,
Inc., acquired a lease on approximately 400 permitted acres in Morgan County,
Kentucky for oil and gas production. The Company acquired the lease from the
mineral holder in exchange for a working interest of all future wells
constructed on the leased area. The Company also obtained an interest in an
existing gas well that was on the 400 acre lease. This first well placed in
operation was developed with a funding partner, Cascade Corporate Services, LLC.
The partner owns 15% of the working interest in the well; a third party company
from whom the lease was obtained owns 75% and the Company retained the balance.
The development of oil & gas assets is not part of the Company's operating
strategy and it does not plan on allocating any financial or human resources to
further this business opportunity. Revenues from oil and gas operations for the
fiscal quarter ended March 31, 2006 and for the years ended December 31, 2005
and 2004 were minimal and not material to the operations of the Company.
LEGAL PROCEEDINGS
Except as described below the Company is not a party to any pending legal
proceeding, nor is its property the subject of a pending legal proceeding, that
is not in the ordinary course of business or otherwise material to the financial
condition of the Company's business. None of the Company's directors, officers
or affiliates is involved in a proceeding adverse to the Company's business or
has a material interest adverse to the Company's business.
In March 2006, the Company engaged outside Kentucky counsel to secure a
temporary restraining order or take other legal means, the purpose of which is
to restrict the Company's stock transfer agent from allowing the transfer and/or
sale of an aggregate of 1,500,000 certain stock certificates which the Company
believes may have been inappropriately issued. The Company has since resolved
this issue, the end result being that the shares in question were not cancelled
and are still validly outstanding.
DIRECTORS AND EXECUTIVE OFFICERS
Directors and Executive Officers
The following table sets forth information regarding our executive officers
and directors as of August 7, 2006. There are no family relationships among any
of the Company's executive officers and directors:
Name Age Positions
- ---- --- ---------
David Guthrie.................. 53 President and Director
Robert Chmiel.................. 45 Interim CFO and Director
Joseph Jacobs................... 58 Secretary and Director
Edward Jennings............... 68 Director
Carl Baker....................... 63 Director
Barry Tackett................... 31 Director
Timothy M. Stobaugh......... 35 Director
Jesse Shelmire.................. 48 Director
Scott Griffith.................... 50 Director
Mr. Guthrie has spent the majority of his life in entrepreneurial
endeavors. He began his career in construction where he was the founder of the
first home center in Indianapolis. He developed the business into a sizable
contractor supply facility serving the Greater Indianapolis area. From 1976 to
1998, he was the founder and operator of Guthrie Building materials. From 1990
to 1996, he founded and co-managed Guthrie Rental Station. From 1991 to the
present, he founded and operated Royal Custom Homes, LLC. He also served as a
board member to TruServe (formerly American Hardware & ServiStar) from 1994 to
1996, one of the largest cooperatives in the United States. During his tenure as
a board member, this company grew from less than $1 billion in revenue to $5
billion. From 1996 to the present, Mr. Guthrie has served as President of Saudi
American Minerals, Inc. Mr. Guthrie has recently sold his lumber interest and
retired from his TruServe responsibilities. Mr. Guthrie, who holds a BA from
Purdue University (1976), is currently President of Consolidated Energy, Inc.
46
Mr. Chmiel was appointed interim Chief Financial Officer effective January
13, 2006. Mr. Chmiel is also the CFO and co-founder of SCR Financial Group,
Inc., a marketing company which specializes in financial services to the
insurance industry. Since mid 2003, Mr. Chmiel has run his own CFO Consulting
firm where he provides CFO services to both public and private companies,
typically in the start-up or growth mode. In September 2003, Mr. Chmiel became
the CFO for National Coal Corp. (NASDAQ: NCOC), a coal mining company based in
Knoxville, TN. Prior to starting his own consulting firm, Mr. Chmiel served as
CFO/COO of Brilliant Digital Entertainment, Inc. beginning in 2000 (AMEX: BDE),
a publicly-traded software firm. Previously, he was the President/COO and
co-founder of Phase2Media, Inc., a privately held Internet advertising sales and
marketing firm, and Chief Financial Officer for BarnesandNoble.com (NASDAQ:
BNBN) prior to the online bookseller's IPO. Mr. Chmiel earned his MBA from the
Wharton School of Business at the University of Pennsylvania in 1987, and his BA
in Economics from The College of the Holy Cross in 1982.
Joseph G. Jacobs has held various positions in the coal industry since 1970
including Vice President of the Kentucky Mining Institute and Coal Operators and
Associates from 1999 to the present. He also served as a member of the Kentucky
Mining Board from 1997 to 2002 and currently serves as Vice Chairman of the
Kentucky Coal Producers. Mr. Jacobs is a graduate of the University of Kentucky
in 1969 and is presently the owner of Jacobs Risk Management serving as a mining
consultant to a variety of clients in Kentucky, Virginia and West Virginia.
Dr. Edward H. Jennings is President Emeritus and Professor Emeritus of
Finance at Ohio State University. Dr. Jennings has served in university
leadership assignments including President, Ohio State University (1981-1990),
President, University of Wyoming (1979-1981), and Vice President of Finance and
University Studies, University of Iowa (1976-1979). He has had faculty
assignments at the University of Iowa (1973-1979, University of Dar Es Salaam
(1972-1973), and the University of Hawaii (1974). Dr. Jennings has been widely
published in major academic journals and is the co-author of a basic investment
textbook now in its fourth printing. Prior to his academic career, from 1963 to
1965, he served as production planner, production supervisor and senior
industrial engineer for Merck & Company, Pennsylvania. He has traveled
extensively in the Far East, Europe, and Africa on various trade missions, and
assisted in the development of academic ties with numerous international
universities. He holds degrees from the University of North Carolina, BS in
Industrial Management (1959), Case Western Reserve University, MBA in Finance
(1963), and the University of Michigan, Ph.D. in Finance (1969).
Mr. Baker has been chairman of the board of Harvard Design Group, Ltd.,
Monaco, Pennsylvania, since 1996. He brings 25 years of experience in design and
management. From 1992-1996, he was president of BTI, Moon Township,
Pennsylvania. Form 1990 to 1992; he was a principal in Global Design
Incorporated, Pittsburgh, Pennsylvania. He has been involved in the design and
management of $300 million in healthcare facilities, $250 million in
transportation facilities, $200 million in educational facilities, and four
million square feet of commercial, retail, office, and recreational facilities.
Mr. Baker is a registered architect in Ohio, Pennsylvania, Virginia and West
Virginia. Other experiences include acting as master planner, managing and
developing business plans for corporate growth, coordinating large-volume
projects, and managing all phases of construction detailing and coordination.
Mr. Baker holds a degree from Carnegie Mellon University, BA in Architecture
(1965), and has studied architectural design management and business development
at Pennsylvania State University and Geneva College, and management at
Massachusetts Institute of Technology.
Barry W. Tackett is a Certified Public Accountant and owns his C.P.A. firm
in Stanville, Kentucky from April 2003 to Current. Mr. Tackett served as our
Chief Financial Officer from February 2004 until January 12, 2006. Mr. Tackett
comes from a family of coal operators and has worked for clients in the coal
industry for over ten years. He received his Masters of Accounting from the
University of Tennessee in August 2000 and is a member of the Kentucky Society
of Certified Public Accountants.
Tim Stobaugh was appointed as a director on January 13, 2006. He joined
Gryphon Special Situations Fund as a portfolio manager in May 2004 after
spending over 10 years with the investment banking firm of Stonegate Securities,
Inc. in Dallas, Texas. In his most recent position at Stonegate, Mr. Stobaugh
was responsible for managing the investment banking department's private
placement offerings to institutional investors. Mr. Stobaugh graduated cum laude
from Trinity University with a B.S. in Business Administration (Finance) in
1993, and earned the CFA designation in 1998.
47
Jesse Shelmire was appointed as a director on January 13, 2006. He joined
Stonegate Securities, Inc. in May of 1999. He is a co-owner and principal of
Stonegate, and currently serves as a Managing Director of Investment Banking.
Prior to joining Stonegate, Mr. Shelmire was Managing Director of Investment
Banking for First London Securities from 1996 to 1999 where he managed public
and private offerings. He began his career at Smith Barney in 1980. Mr. Shelmire
received his Bachelor of Science in Economics in 1979 from Wharton School of
Business at the University of Pennsylvania.
Scott Griffith was appointed as a director on January 13, 2006. He joined
Stonegate Securities, Inc. in 1992. Mr. Griffith is a co-owner and principal of
Stonegate Securities, Inc., and serves as a Managing Director of Investment
Banking. Prior to joining Stonegate in 1992, Mr. Griffith was a Vice-President
at Donaldson, Lufkin, & Jenrette from 1980 to 1988 and a Vice-President at Smith
Barney from 1988 to 1992. Mr. Griffith received his Bachelor of Science in
Marketing from Florida State University in 1979.
Committees of the Board of Directors
Our board has a budget committee which consists of the CFO, the President
and the Chief Operating Officer. The board also has established a compensation
committee which includes Tim Stobaugh, Dr. Edward Jennings, Carl Baker and Rob
Chmiel. The board does not currently have any other committees, including an
audit committee. The functions customarily delegated to an audit committee are
performed by our full board of directors. As we do not maintain an audit
committee, we do not have an audit committee financial expert within the meaning
of Item 401(e) of Regulation S-B.
We intend to establish an audit committee, compensation committee, and
nominating and corporate governance committee during the third quarter of 2006.
EXECUTIVE COMPENSATION
The following summary compensation table sets forth certain information
concerning compensation earned by our Chief Executive Officer and the other
named executive officers (the "named executive officers") who served as
executive officers as at the fiscal year ended December 31, 2005, for services
as executive officers for the last three fiscal years.
SUMMARY COMPENSATION TABLE
Long-Term
Compensation
------------------------------------------
Annual Compensation Awards Payouts
------------------------------------- ------------------------------ ------------
Other Securities All
Annual Restricted Underlying Other
Name and Compen- Stock Options/ SARs LTIP Compen-
Principal Position Year Salary ($) Bonus ($) sation ($) Award(s) ($) (#) Payouts ($) sation ($)
- --------------------------- --------- ------------- ---------- ------------ -------------- --------------- ------------ -----------
David Guthrie, 2005 $416,667 -0- -0- -0- -0- -0- -0-
President 2004 -0- -0- -0- -0- -0- -0- -0-
2003 -0- -0- -0- -0- -0- -0- -0-
Joseph G. Jacobs, 2005 $382,667 -0- -0- -0- -0- -0- -0-
Secretary 2004 $ 6,000 -0- -0- $487,500* -0- -0- -0-
2003 $ 3,000 -0- -0- -0- -0- -0- -0-
Barry W. Tackett, 2005 $268,667 -0- -0- -0- -0- -0- -0-
Former Chief Financial 2004 $ 24,000 -0- -0- $487,500* -0- -0- -0-
Officer 2003 $ 4,000 -0- -0- -0- -0- -0- -0-
* Reflects the fair market value 125,000 shares of common stock granted to
each of Mr. Jacobs and Mr. Tackett based on a price of $3.90 per share of common
stock, which was the closing price of the stock on the date of grant.
48
Option Grants in Fiscal Year 2005
We did not grant options in 2005.
Aggregated Option Exercises in 2005 and Year End Option Values
None.
Compensation of Directors
We have agreed to pay outside directors $25,000 per year. Each director, at
his or her sole discretion, can elect to be paid in either cash or common stock.
An additional fee, to be determined, will be awarded to directors for service on
committees.
Termination of Employment and Change of Control Arrangement
There are no compensatory plans or arrangements, including payments to be
received from us, with respect to any person named in Cash Compensation set out
above which would in any way result in payments to any such person because of
his resignation, retirement, or other termination of such person's employment
with us or our subsidiaries, or any change in control of us, or a change in the
person's responsibilities following a changing in control of us.
Executive Employment/Consulting Agreements
Effective January 2005, we entered into an oral agreement with David
Guthrie, our President and a director, pursuant to which we agreed to pay to Mr.
Guthrie a base salary of $8,667 per month as compensation for his services as
our President. We have not finalized a written employment agreement in
connection with Mr. Guthrie's employment due to our limited management
resources.
Effective January 13, 2006, Robert Chmiel was appointed as our interim
Chief Financial Officer upon the resignation of Barry Tackett on January 12,
2006. In connection with our January 13, 2006 private placement, we entered into
a consulting agreement with RC Financial Group, LLC, pursuant to which Mr.
Chmiel was retained as a non-exclusive financial advisor for a term of 24
months. In addition, we issued RC Financial Group, LLC 20,000 shares of common
stock in exchange for financial advisory services rendered by Mr. Chmiel during
the four months ended December 31, 2005 assisting us with a number of issues
including, but not limited to, the January 13, 2006 private placement. On June
1, 2006, we amended our agreement with RC Financial Group the results of which
increase the monthly fees paid to RC Financial and included a one time grant of
200,000 shares of common stock.
Securities Authorized for Issuance under Equity Compensation Plans
The shareholders approved an equity compensation plan on May.25, 2006. The
approved plan is summarized as follows:
Award Plan Summary
- ------------------
Our Board of Directors believes that employees and other individuals who
contribute to our success should have a stake in the enterprise as shareholders.
Consistent with this belief, the award of stock and stock options has been and
will continue to be an important element of our compensation program.
We intend to use the Award Plan to (a) attract competent directors,
executive personnel, and other employees, (b) aid in the retention of the
services of existing directors, executive personnel, and employees, and (c)
provide incentives to all of such personnel to devote the utmost effort and
skill to our company's advancement by permitting them to participate in
ownership and thereby permitting them to share in increases in the value which
they help produce.
49
The Award Plan is to be administered either by our Board of Directors or by
a committee (the "Committee") to be appointed from time to time by our Board of
Directors. Awards granted under the Award Plan may be incentive stock options
("ISOs") as defined in the Internal Revenue Code of 1986, as amended (the
"Code"), appreciation rights, options which do not qualify as ISOs, or stock
bonus awards which are awarded to our employees, including officers and
directors, who, in the opinion of the board or the Committee, have contributed,
or are expected to contribute, materially to our success. In addition, at the
discretion of the Board of Directors or the Committee, options or bonus stock
may be granted to individuals who are not employees but contribute to our
success.
The exercise price of options granted under the Award Plan will be based on
the fair market value of the underlying Common Stock at the time of grant and,
in the case of ISOs may not be less than 100% of the fair market value of such
capital stock on the date the option is granted (110% of the fair market value
in the case of 10% stockholders). Options granted under the Award Plan shall
expire no later than ten years after the date of grant (five years in the case
of ISOs granted to 10% stockholders). The option price may be paid by cash or,
at the discretion of the Board of Directors or Committee, by delivery of a
promissory note or shares of our Common Stock already owned by the optionee
(valued at their fair market value at the date of exercise), or a combination
thereof.
All of our employees, officers, and directors are eligible to participate
under the Award Plan. A maximum of 2,000,000 shares will be available for grant
under the Award Plan. The identification of individuals entitled to receive
awards, the terms of the awards, and the number of shares subject to individual
awards, are determined by our Board of Directors or the Committee, in their sole
discretion: provided, however, that in no event may the aggregate fair market
value of shares for which an ISO is first exercisable in any calendar year by
any eligible employee exceed $100,000.
The aggregate number of shares with respect to which options or stock
awards may be granted under the Award Plan, the number of shares covered by each
outstanding option, and the purchase price per share shall be adjusted for any
increase or decrease in the number of issued shares resulting from a
recapitalization, reorganization, merger, consolidation, exchange of shares,
stock dividend, stock split, reverse stock split, or other subdivision or
consolidation of shares.
Our Board of Directors or the Committee may from time to time alter, amend,
suspend, or discontinue the Award Plan with respect to any shares as to which
options or stock awards have not been granted. However, no such alteration or
amendment (unless approved by our stockholders) shall (a) increase (except
adjustment for an event of dilution) the maximum number of shares for which
options or stock awards may be granted under the Award Plan either in the
aggregate or to any eligible employee: (b) reduce (except adjustment for an
event of dilution) the minimum option prices which may be established under the
Award Plan; (c) extend the period or periods during which options may be granted
or exercised; (d) materially modify the requirements as to eligibility for
participation in the Award Plan; (e) change the provisions relating to events of
dilution; or (f) materially increase the benefits accruing to the eligible
participants under the Award Plan.
Under the Award Plan, stock appreciation rights ("SARs") can be granted at
the time an option is granted with respect to all or a portion of the shares
subject to the related option. SARs can only be exercised to the extent the
related option is exercisable and cannot be exercised for the six-month period
following the date of grant, except in the event of death or disability of the
optionee. The exercise of any portion of either the related option or the tandem
SARs will cause a corresponding reduction in the number of shares remaining
subject to the option or the tandem SARs thus maintaining a balance between
outstanding options and SARs. SARs permit the holder to receive an amount (in
cash, shares, or a combination of cash and shares, as determined by the Board of
Directors at the time of grant) equal to the number of SARs exercised multiplied
by the excess of the fair market value of the shares on the exercise date over
the exercise price of the related options.
Under the terms of the Award Plan, our Board of Directors or the Committee
may also grant stock awards which may, at the discretion of our Board of
Directors or Committee, be subject to forfeiture under certain conditions.
Recipients of stock awards will realize ordinary income at the time of the lapse
of any forfeiture provisions equal to the fair market value of the shares less
any amount paid in connection with the issuance (the Board of Directors or the
Committee can require the payment of par value at the time of the grant). We
50
will realize a corresponding compensation deduction. The holder will have a
basis in the shares acquired equal to any amount paid on exercise plus the
amount of any ordinary income recognized by the holder. On sale of the shares,
the holder will have a capital gain or loss equal to the sale proceeds minus his
or her basis in the shares.
The following table shows information with respect to each equity
compensation plan under which our common stock is authorized for issuance as of
the fiscal year ended December 31, 2005.
EQUITY COMPENSATION PLAN INFORMATION
Number of securities
remaining available for
Number of securities future issuance under
Plan category to be issued upon Weighted average equity compensation
exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected in
warrants and rights warrants and rights column (a)
- ----------------------------------- ----------------------- ----------------------- -------------------------
(a) (b) (c)
- ----------------------------------- ----------------------- ----------------------- -------------------------
Equity compensation plans
approved by security holders -0- -0- -0-
- ----------------------------------- ----------------------- ----------------------- -------------------------
Equity compensation plans not
approved by security holders
1,161,760 $1.70 -0-
- ----------------------------------- ----------------------- ----------------------- -------------------------
Total 1,161,760 $1.70 -0-
- ----------------------------------- ----------------------- ----------------------- -------------------------
Material Features of Individual Equity Compensation Plans not Approved by
Stockholders
On January 3, 2005, we issued the following shares of common stock to our
officers and directors for services rendered during the year that ended December
31, 2004: 250,000 issued to Joseph Jacobs, COO, Secretary and Director; 250,000
shares to Barry Tackett, CFO and Director, 25,000 shares to Carl Baker, Director
and 25,000 shares to Edward Jennings, Director. We recognized a $1,072,500
compensation expense, which approximates the value quoted that day on the OTC
Bulletin Board.
In January 2005, we issued warrants for the purchase of an aggregate of
51,470 shares of common stock with a term of five years and an exercise price of
$1.70 per share to Stonegate Securities, Inc., a Texas corporation, which we
refer to as Stonegate, as additional placement agent compensation related to the
January 2005 bridge financing. The warrant issuances were in the form of a
warrant issued to Scott R. Griffith and a warrant issued to Jesse B. Shelmire
IV, each for the purchase of 25,735 shares. In February 2005, we issued Messrs.
Griffith and Shelmire warrants to purchase 1,110,290 shares (555,145 shares
each) of common stock with term of five years and an exercise price of $1.70 per
share as additional compensation for the placement of 6% senior secured
convertible notes and related warrants in February 2005 and the exercise of
Additional Investment Rights during 2005. These warrants were exercised on a
cashless basis and we thereby issued an aggregate of 652,144 shares (326,072
shares each) of common stock to Messrs. Griffith and Shelmire.
CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
We have had no disagreements with our certified public accountants with
respect to accounting practices or procedures or financial disclosure. On April
1, 2005, we accepted the resignation of Clyde Bailey, PC as our independent
auditor. Also on April 1, 2005, we engaged Killman Murrell & Company, PC as our
successor independent audit firm. Neither us, nor anyone acting on our behalf,
consulted Killman Murrell regarding any matters specified in Items 304(a)(2)(i)
or 304(a)(2)(ii) of Regulation S-B. Our acceptance of Bailey's resignation and
subsequent engagement of Killman Murrell was approved by our Board of Directors.
51
MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Market Information
Since October 18, 2002, our common stock has been quoted on the OTC
Bulletin Board under the symbol "CEIW.OB." Prior to that date, our common stock
was quoted on the OTC Bulletin Board under the symbol "BBQA.OB." Set forth below
are the high and low bid prices for our common stock for the last two fiscal
years and subsequent interim periods. Although our common stock is quoted on the
OTC Bulletin Board it has traded sporadically with no significant volume.
Consequently, the information provided below may not be indicative of our common
stock price under different conditions.
On August 7, 2006, the closing sale price of our common stock on the OTC
Bulletin Board was $0.90 per share. All prices listed herein reflect
inter-dealer prices, without retail mark-up, mark-down or commissions and may
not represent actual transactions.
Quarter Ended High Low
------------- ----- -----
June 30, 2006 $2.93 $0.91
March 31, 2006 $3.49 $1.60
Quarter Ended High Low
------------- ----- -----
December 2005 $2.66 $1.10
September 2005 $3.05 $2.15
June 2005 $2.24 $2.16
March 2005 $3.27 $3.06
Quarter Ended High Low
------------- ----- -----
December 2004 $2.20 $1.40
September 2004 $2.30 $1.01
June 2004 $1.93 $1.20
March 2004 $2.05 $0.75
Number of Shareholders
As of August 1, 2006, there were approximately 235 holders of record of our
common stock.
Dividend Policy
Since our inception, we have not paid any dividends on our common stock,
and we do not anticipate that we will pay dividends in the foreseeable future.
The payment of dividends, if any, in the future, rests within the discretion of
our Board of Directors and will depend, among other things, upon our earnings,
capital requirements and financial condition, as well as other relevant factors.
There are no restrictions in our Articles of Incorporation or Bylaws that
restrict us from declaring dividends.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of August 7, 2006, the name, address and
the number of shares of our Common Stock, par value $0.001 per share, held of
record or beneficially by each person who held of record, or was known by us to
own beneficially, more than 5% of the issued and outstanding shares of our
Common Stock, and the name and shareholdings of each director and of all
officers and directors as a group.
Except as otherwise indicated, the persons named in the table have sole
voting and investment power with respect to all shares beneficially owned,
subject to community property laws, where applicable. Unless other indicated,
the address of each beneficial owner listed below is c/o Consolidated Energy, 76
George Road, Betsy Layne, Kentucky 41605.
52
Percentage of
Name of Beneficial Owner Number of Shares Shares Beneficially Owned (1)
- ------------------------------------------------ ------------------------- ----------------------------------
Executive Officers and Directors:
David Guthrie 750,000 3.4%
President, Director
Robert Chmiel 312,553 1.4%
Interim CFO, Director
Joseph G. Jacobs 351,000 1.6%
Secretary, Director
Edward H. Jennings 25,000 *
Director
Carl G. Baker 25,000 *
Director
Barry W. Tackett 350,000 1.6%
Director
Timothy M. Stobaugh 0 0%
Director
Jesse Shelmire 176,609 *
Director
Scott Griffith 426,609 1.9%
Director
All Directors and Executive Officers as a 2,416,771 10.9%
Group (9 persons)
Other 5% Shareholders:
Gryphon Master Fund, L.P. (2) 1,927,942 8.7%
100 Crescent Court, Suite 490
Dallas, Texas 75201
GSSF Master Fund, LP (3) 1,868,147 8.4%
100 Crescent Court, Suite 490
Dallas, Texas 75201
Diatom Energy, LLC (4) 1,182,502 5.3%
1030 Coral Ridge Dr.
Coral Springs, FL 33071
Jeff Miller 994,977 4.5%
1876 Monte Carlo
Coral Springs, FL 33071
____________________________
* less than 1%
(1) Applicable percentage ownership as of August 7, 2006 is based upon
22,175,374 shares of common stock outstanding. Beneficial ownership is
determined in accordance with Rule 13d-3 of the Securities Exchange Act of
1934, as amended. Under Rule 13d-3, shares issuable within 60 days upon
exercise of outstanding options, warrants, rights or conversion privileges
("Purchase Rights") are deemed outstanding for the purpose of calculating
the number and percentage owned by the holder of such Purchase Rights, but
53
not deemed outstanding for the purpose of calculating the percentage owned
by any other person. "Beneficial ownership" under Rule 13d-3 includes all
shares over which a person has sole or shared dispositive or voting power.
(2) Includes: (a) 604,442 shares of common stock; and (b) 1,323,500 shares
issuable upon the conversion of $1,191,150 principal amount of 6% senior
secured convertible notes. E. B. Leon makes the investment decisions on
behalf of Gryphon Master Fund, L.P. and has voting control over the
securities beneficially owned by Gryphon Master Fund, L.P.
(3) Includes: (a) 201,480 shares of common stock; and (b) 1,666,667 shares
issuable upon the conversion of $1,500,000 principal amount of 6% senior
secured convertible notes. Tom C. Davis makes the investment decisions on
behalf of GSSF Master Fund, LP and has voting control over the securities
beneficially owned by GSSF Master Fund, LP.
(4) Jay Lasner, a principal of Diatom Energy, LLC, is an indirect beneficial
owner of such shares.
SELLING SHAREHOLDERS
The following table lists certain information with respect to the selling
shareholders as follows: (i) each selling shareholder's name, (ii) the number of
outstanding shares of common stock beneficially owned by the selling
shareholders prior to this offering; (iii) the number of shares of common stock
to be beneficially owned by each selling shareholder after the completion of
this offering assuming the sale of all of the shares of the common stock offered
by each selling shareholder; and (iv) if one percent or more, the percentage of
outstanding shares of common stock to be beneficially owned by each selling
shareholder after the completion of this offering assuming the sale of all of
the shares of common stock offered by each selling shareholder. Except as noted,
none of the selling shareholders have had any position, office, or other
material relationship with us or any of our predecessors or affiliates within
the past three years.
The selling shareholders may sell all, or none of their shares in this
offering. See "Plan of Distribution."
Shares Beneficially Owned
After the Offering
------------------------
Shares Beneficially Shares Being Offered
Owned Prior to Offering Pursuant to this Prospectus
Name (1) Number Percent
- ------------------------------------------------------------------------------------------------------------------------------------
Gryphon Master Fund, L.P. 9,201,376 9,201,376 (2) 0 *
100 Crescent Court
Suite 490
Dallas, Texas 75201
GSSF Master Fund, LP 3,233,792 3,233,792 (3) 0 *
100 Crescent Court
Suite 475
Dallas, Texas 75201
Lonestar Partners, L.P. 6,699,262 6,699,262 (4) 0 *
c/o Lonestar Capital Management, LLC
One Maritime Plaza, Suite 2555
San Francisco, California 94111
WS Opportunity International Fund Ltd. 170,893 170,893 (5) 0 *
300 Crescent Court, Suite 1111
Dallas, Texas 75201
127,668 127,668 (6) 0 *
WS Opportunity Fund (QP), L.P.
300 Crescent Court, Suite 1111
Dallas, Texas 75201
54
WS Opportunity Fund, L.P. 118,657 118,657 (7) 0 *
300 Crescent Court, Suite 1111
Dallas, Texas 75201
Renaissance US Growth Investment Trust PLC 1,276,912 1,276,912 (8) 0 *
c/o RENN Capital Group, Inc.
8080 N. Central Expressway
Suite 210, LB-59
Dallas, Texas 75206
BFS US Special Opportunities Trust PLC 1,276,912 1,276,912 (9) 0 *
c/o RENN Capital Group, Inc.
8080 N. Central Expressway
Suite 210, LB-59
Dallas, Texas 75206
Scott R. Griffith 376,609 376,609 (10) 0 *
Stonegate Securities, Inc.
5940 Sherry Lane, Suite 410
Dallas, Texas 75225
Jesse B. Shelmire IV 126,609 126,609 (11) 0 *
Stonegate Securities, Inc.
5940 Sherry Lane, Suite 410
Dallas, Texas 75225
Enable Growth Partners, LP 2,865,119 2,865,119 (12) 0 *
One Ferry Building, Suite 255
San Francisco, CA 94111
Enable Opportunity Partners, LP 608,964 608,964 (13) 0 *
One Ferry Building, Suite 255
San Francisco, CA 94111
Gamma Opportunity Capital Partners L.P. 1,164,701 1,164,701 (14) 0 *
275 Seventh Avenue, Suite 2000
New York, NY 10001
Bushido Capital Master Fund L.P. 1,890,191 1,890,191 (15) 0 *
275 Seventh Avenue, Suite 2000
New York, NY 10001
Cordillera Fund, LP 2,211,480 2,211,480 (16) 0 *
8201 Preston Road, Suite 400
Dallas, TX 75225
Newgrange Partners, LP 85,854 85,854 (17) 0 *
8201 Preston Road, Suite 400
Dallas, TX 75225
Whalehaven Capital Fund Limited 1,666,667 1,666,667 (18) 0 *
3rd Floor, 14 Par-La-Ville Road
Hamilton HM08
Bermuda
55
ABS SOS-Plus Partners Ltd. 208,333 208,333 (19) 0 *
1967 Longwood - Lake Mary Road
Longwood, FL 32750
Regenmacher Holdings, Ltd. 208,333 208,333 (20) 0 *
1967 Longwood - Lake Mary Road
Longwood, FL 32750
Iroquois Master Fund Ltd. 1,201,111 1,201,111 (21) 0 *
641 Lexington Avenue, 26th Floor
New York, NY 10022
Robert Blakely 50,000 50,000 (22) 0 *
c/o Stonegate Securities, Inc.
5940 Sherry Lane, Suite 410
Dallas, Texas 75225
Jeff Nash 100,000 100,000 (23) 0 *
11550 East F.M. 917
Alverado, Texas 76009
Stan Graff 100,000 100,000 (24) 0 *
8901 Governors Row
Dallas, Texas 75247
RC Financial Group, LLC 112,553 112,553 (25) 0 *
650 Hampshire Rd., suite 200
Westlake Village, CA 91361
TOTAL SHARES OFFERED 35,081,996 (1)
===============
* less than 1%.
(1) Includes: (a) 15,277,778 shares issuable upon conversion of $13,750,000
principal amount of 6% senior secured convertible notes; (b) 2,093,306
presently outstanding shares of common stock issued pursuant to the
cashless exercise of warrants which were issued in connection with the 6%
senior secured convertible notes; (c) 1,058,822 presently outstanding
shares of common stock issued as payment of accrued interest pursuant to
the terms of $1,800,000 principal amount of promissory notes originally
issued on September 23, 2005, as amended on November 24, 2005 to increase
the principal amount from $1,500,000 to $1,800,000; (d) 6,933,256 shares
issuable upon conversion of $6,239,930 principal amount of 8% senior
secured convertible notes; (e) 9,046,694 shares issuable upon exercise of
warrants issued in connection with the 8% senior secured convertible note
financing; and (f) 672,140 presently outstanding shares of common stock
issued upon exercise of warrants which were issued as consideration for
financial consulting services and placement agent fees. Except for RC
Financial Group, LLC, the selling shareholders have contractually agreed to
restrict their ability to convert their senior secured convertible notes or
exercise their warrants and receive shares of our common stock such that
the number of shares of common stock held by them in the aggregate and
their affiliates after such conversion or exercise does not exceed 4.99% of
the then issued and outstanding shares of common stock as determined in
accordance with Section 13(d) of the Exchange Act. Accordingly, the number
of shares of common stock set forth in the table for the selling
shareholders exceeds the number of shares of common stock that the selling
shareholders could beneficially own at any given time through their
ownership of the senior secured convertible notes and warrants.
(2) Includes: (a) 5,000,000 shares issuable upon conversion of $4,500,000
principal amount of 6% senior secured convertible notes; (b) 604,442
presently outstanding shares of common stock issued pursuant to the
cashless exercise of warrants which were issued in connection with the 6%
senior secured convertible notes;(c)1,172,466 shares issuable upon
conversion of $1,055,219 principal amount of 8% senior secured convertible
56
notes; and (d) 2,424,468 shares issuable upon exercise of warrants issued
in connection with the 8% senior secured convertible note financing. E.B.
Leon makes the investment decisions on behalf of Gryphon Master Fund, L.P.
and has voting control over the securities beneficially owned by Gryphon
Master Fund, L.P.
(3) Includes: (a) 1,666,667 shares issuable upon conversion of $1,500,000
principal amount of 6% senior secured convertible notes; (b) 201,480
presently outstanding shares of common stock issued pursuant to the
cashless exercise of warrants which were issued in connection with the 6%
senior secured convertible notes (c) 501,933 shares issuable upon
conversion of $451,740 principal amount of 8% senior secured convertible
notes; and (d) 863,712 shares issuable upon exercise of warrants issued in
connection with the 8% senior secured convertible note financing. Tom C.
Davis makes the investment decisions on behalf of GSSF Master Fund, LP and
has voting control over the securities beneficially owned by GSSF Master
Fund, LP.
(4) Includes: (a) 4,444,444 shares issuable upon conversion of $4,000,000
principal amount of 6% senior secured convertible notes; (b) 603,715
presently outstanding shares of common stock issued pursuant to the
cashless exercise of warrants which were issued in connection with the 6%
senior secured convertible notes; (c) 207,489 shares issuable upon
conversion of $186,740 principal amount of 8% senior secured convertible
notes; and (d) 1,443,614 shares issuable upon exercise of warrants issued
in connection with the 8% senior secured convertible note financing. Jerome
L. Simon makes the investment decisions on behalf of Lonestar Partners,
L.P. and has voting control over the securities beneficially owned by
Lonestar Partners, L.P.
(5) Includes: (a) 113,778 shares issuable upon conversion of $102,400 principal
amount of 6% senior secured convertible notes; (b) 21,647 presently
outstanding shares of common stock issued pursuant to the cashless exercise
of warrants which were issued in connection with the 6% senior secured
convertible notes; (c) 5,798 shares issuable upon conversion of $5,218
principal amount of 8% senior secured convertible notes; and (d) 29,670
shares issuable upon exercise of warrants issued in connection with the 8%
senior secured convertible note financing. Patrick P. Walker, G. Stacy
Smith and Reid S. Walker make the investment decisions on behalf of WS
Opportunity International Fund Ltd. and have voting control over the
securities beneficially owned by WS Opportunity International Fund Ltd.
(6) Includes: (a) 85,000 shares issuable upon conversion of $76,500 principal
amount of 6% senior secured convertible notes; (b) 16,171 presently
outstanding shares of common stock issued pursuant to the cashless exercise
of warrants which were issued in connection with the 6% senior secured
convertible notes; (c) 4,331 shares issuable upon conversion of $3,898
principal amount of 8% senior secured convertible notes; and (d) 22,166
shares issuable upon exercise of warrants issued in connection with the 8%
senior secured convertible note financing. Patrick P. Walker, G. Stacy
Smith and Reid S. Walker make the investment decisions on behalf of WS
Opportunity Fund (QP), L.P. and have voting control over the securities
beneficially owned by WS Opportunity Fund (QP), L.P.
(7) Includes: (a) 79,000 shares issuable upon conversion of $71,100 principal
amount of 6% senior secured convertible notes; (b) 15,030 presently
outstanding shares of common stock issued pursuant to the cashless exercise
of warrants which were issued in connection with the 6% senior secured
convertible notes; (c) 4,026 shares issuable upon conversion of $3,623
principal amount of 8% senior secured convertible notes; and (d) 20,601
shares issuable upon exercise of warrants issued in connection with the 8%
senior secured convertible note financing. Patrick P. Walker, G. Stacy
Smith and Reid S. Walker make the investment decisions on behalf of WS
Opportunity Fund, L.P. and have voting control over the securities
beneficially owned by WS Opportunity Fund, L.P.
(8) Includes: (a) 833,333 shares issuable upon conversion of $750,000 principal
amount of 6% senior secured convertible notes; (b) 77,206 presently
outstanding shares of common stock issued pursuant to the cashless exercise
of warrants which were issued in connection with the 6% senior secured
convertible notes; (c) 40,000 shares issuable upon conversion of $36,000
principal amount of 8% senior secured convertible notes; and (d) 326,373
shares issuable upon exercise of warrants issued in connection with the 8%
senior secured convertible note financing. G. Russell Cleveland makes the
investment decisions on behalf of Renaissance US Growth Investment Trust
PLC and has voting control over the securities beneficially owned by
Renaissance US Growth Investment Trust PLC.
57
(9) Includes: (a) 833,333 shares issuable upon conversion of $750,000 principal
amount of 6% senior secured convertible notes; (b) 77,206 presently
outstanding shares of common stock issued pursuant to the cashless exercise
of warrants which were issued in connection with the 6% senior secured
convertible notes; (c) 40,000 shares issuable upon conversion of $36,000
principal amount of 8% senior secured convertible notes; and (d) 326,373
shares issuable upon exercise of warrants issued in connection with the 8%
senior secured convertible note financing. G. Russell Cleveland makes the
investment decisions on behalf of BFS US Special Opportunities Trust PLC
and has voting control over the securities beneficially owned by BFS US
Special Opportunities Trust PLC.
(10) Includes: (a) 367,998 shares of common stock acquired upon exercise of
placement agent warrants issued in connection with the sale of our 6%
senior secured convertible notes and related warrants; and (b) 8,611 shares
of common stock issuable upon conversion of placement agent warrants. Scott
R. Griffith is a registered representative of Stonegate Securities, Inc., a
registered broker-dealer, and is an "underwriter" within the meaning of the
Securities Act of 1933 in connection with the sale of common stock under
this prospectus. Mr. Griffith received his securities as compensation for
placement agent services in connection with the sale of our 6% senior
secured convertible notes, 8% senior secured convertible notes and the
related common stock purchase warrants. Mr. Griffith is a member of our
Board of Directors.
(11) Includes: (a) 117,998 shares of common stock acquired upon exercise of
placement agent warrants issued in connection with the sale of our 6%
senior secured convertible notes and related warrants; and (b) 8,611 shares
of common stock issuable upon conversion of placement agent warrants. Jesse
B. Shelmire IV is a registered representative of Stonegate Securities,
Inc., a registered broker-dealer, and is an "underwriter" within the
meaning of the Securities Act of 1933 in connection with the sale of common
stock under this prospectus. Mr. Shelmire received his securities as
compensation for placement agent services in connection with the sale of
our 6% senior secured convertible notes, 8% senior secured convertible
notes and the related common stock purchase warrants. Mr. Shelmire is a
member of our Board of Directors.
(12) Includes: (a) 282,353 shares of common stock acquired as payment of
interest on previously outstanding Bridge Notes issued in November 2005;
(b) 722,222 shares issuable upon conversion of $650,000 principal amount of
6% senior secured convertible notes; (c) 999,622 shares issuable upon
conversion of $899,660 principal amount of 8% senior secured convertible
notes; and (d) 860,922 shares issuable upon exercise of warrants issued in
connection with the 8% senior secured convertible note financing. Mitch
Leveine makes the investment decisions on behalf of Enable Growth Partners,
LP and has voting control over the securities beneficially owned by Enable
Growth Partners, LP.
(13) Includes: (a) 70,588 shares of common stock acquired as payment of interest
on previously outstanding Bridge Notes issued in November 2005; (b) 111,111
shares issuable upon conversion of $100,000 principal amount of 6% senior
secured convertible notes; (c) 247,806 shares issuable upon conversion of
$223,025 principal amount of 8% senior secured convertible notes; and (d)
179,459 shares issuable upon exercise of warrants issued in connection with
the 8% senior secured convertible note financing. Mitch Leveine makes the
investment decisions on behalf of Enable Opportunity Partners, LP and has
voting control over the securities beneficially owned by Enable Opportunity
Partners, LP.
(14) Includes: (a) 147,058 shares of common stock acquired as payment of
interest on previously outstanding Bridge Notes issued in November 2005;
(b) 388,889 shares issuable upon conversion of $350,000 principal amount of
6% senior secured convertible notes; (c) 289,540 shares issuable upon
conversion of $260,586 principal amount of 8% senior secured convertible
notes; and (d) 339,214 shares issuable upon exercise of warrants issued in
connection with the 8% senior secured convertible note financing.
Christopher Rossman makes the investment decisions on behalf of Gamma
Opportunity Capital Partners L.P. and has voting control over the
securities beneficially owned by Gamma Opportunity Capital Partners L.P.
(15) Includes: (a) 205,882 shares of common stock acquired as payment of
interest on previously outstanding Bridge Notes issued in November 2005;
(b) 388,889 shares issuable upon conversion of $350,000 principal amount of
6% senior secured convertible notes; (c) 733,984 shares issuable upon
58
conversion of $660,586 principal amount of 8% senior secured convertible
notes; and (d) 561,436 shares issuable upon exercise of warrants issued in
connection with the 8% senior secured convertible note financing.
Christopher Rossman makes the investment decisions on behalf of Bushido
Capital Master Fund L.P. and has voting control over the securities
beneficially owned by Bushido Capital Master Fund L.P.
(16) Includes: (a) 352,941 shares of common stock acquired as payment of
interest on previously outstanding Bridge Notes issued in November 2005;
(b) 555,556 shares issuable upon conversion of $500,000 principal amount of
6% senior secured convertible notes; (c) 683,470 shares issuable upon
conversion of $615,123 principal amount of 8% senior secured convertible
notes; and (d) 619,513 shares issuable upon exercise of warrants issued in
connection with the 8% senior secured convertible note financing. Stephen
J. Carter and James P. Andrew make the investment decisions on behalf of
Cordillera Fund, LP and have voting control over the securities
beneficially owned by Cordillera Fund, LP.
(17) Includes: (a) 55,556 shares issuable upon conversion of $50,000 principal
amount of 6% senior secured convertible notes; (b) 1,680 shares issuable
upon conversion of $1,512 principal amount of 8% senior secured convertible
notes; and (c) 28,618 shares issuable upon exercise of warrants issued in
connection with the 8% senior secured convertible note financing. Michael
H. Scholten makes the investment decisions on behalf of Newgrange Partners,
LP and has voting control over the securities beneficially owned by
Newgrange Partners, LP.
(18) Includes: (a) 1,111,111 shares issuable upon conversion of $1,000,000
principal amount of 8% senior secured convertible notes; and (b) 555,556
shares issuable upon exercise of warrants issued in connection with the 8%
senior secured convertible note financing. Evan Schemenauer makes the
investment decisions on behalf of Whalehaven Capital Fund Limited and has
voting control over the securities beneficially owned by Whalehaven Capital
Fund Limited.
(19) Includes: (a) 138,889 shares issuable upon conversion of $125,000 principal
amount of 8% senior secured convertible notes; and (b) 69,444 shares
issuable upon exercise of warrants issued in connection with the 8% senior
secured convertible note financing. Jonathan Knight makes the investment
decisions on behalf of ABS SOS-Plus Partners Ltd. and has voting control
over the securities beneficially owned by ABS SOS-Plus Partners Ltd.
(20) Includes: (a) 138,889 shares issuable upon conversion of $125,000 principal
amount of 8% senior secured convertible notes; and (b) 69,444 shares
issuable upon exercise of warrants issued in connection with the 8% senior
secured convertible note financing. Jonathan Knight makes the investment
decisions on behalf of Regenmacher Holdings, Ltd. and has voting control
over the securities beneficially owned by Regenmacher Holdings, Ltd.
(21) Includes: (a) 277,778 shares issuable upon conversion of $250,000 principal
amount of 8% senior secured convertible notes; (b) 334,444 shares of common
stock issuable upon conversion of $301,000 principal amount of 8% senior
secured convertible notes and 300,000 shares of common stock all acquired
in a private transaction between Iroquois and Messrs. Griffith and
Shelmire; and (c) 288,889 shares issuable upon exercise of warrants issued
in connection with the 8% senior secured convertible note financing. Josh
Silverman makes the investment decisions on behalf of Iroquois Master Fund
Ltd. and has voting control over the securities beneficially owned by
Iroquois Master Fund Ltd.
(22) Represents presently outstanding shares of common stock which were acquired
in a private transaction from Jesse Shelmire of Stonegate Securities, Inc.
Robert Blakely purchased these shares for investment purposes and was not
related to placement agent services. Mr. Blakely informed us that he
purchased his shares from Mr. Shelmire in the normal course of business and
that at the time of purchase of the shares to be resold he had no agreement
or understanding with any party to distribute the securities. Mr. Blakely
is a registered representative of Stonegate Securities, Inc., a registered
broker-dealer, and may be considered an "underwriter" within the meaning of
the Securities Act of 1933 in connection with the sale of common stock
under this prospectus.
(23) Represents presently outstanding shares of common stock which were acquired
in a private transaction from Jesse B. Shelmire IV.
59
(24) Represents presently outstanding shares of common stock which were acquired
in a private transaction from Jesse B. Shelmire IV.
(25) Represents presently outstanding shares of common stock. Robert Chmiel
makes the investment decisions on behalf of RC Financial Group, LLC and has
voting control over the securities beneficially owned by RC Financial
Group, LLC. Mr. Chmiel is our interim Chief Financial Officer and one of
our directors.
6% Senior Secured Convertible Notes Due 2008
On February 24, 2005, we executed a financing transaction for aggregate
gross proceeds of $7,000,000, with additional investment rights of up to an
additional $7,000,000, such financing to be used for the purchase of equipment
and to fund expenditures for the consummation of mining activities at the
Warfield Mine. The financing is in the form of 6% senior secured convertible
notes for an aggregate total face amount of $7,000,000 and a term of three
years. The 6% senior secured convertible notes initially had a conversion price
of $1.70 per share which was subsequently amended to $0.90 per share on January
13, 2006. Holders of the 6% senior secured convertible notes are Gryphon Master
Fund, L.P. and GSSF Master Fund, LP, Lonestar Partners, L.P., WS Opportunity
International Fund, Ltd., WS Opportunity Fund (QP), L.P., WS Opportunity Fund,
L.P., Renaissance US Growth Investment Trust PLC, and BFS US Special
Opportunities Trust PLC. As additional consideration, we have issued to the 6%
note holders warrants to purchase an aggregate of 2,058,824 shares of common
stock. Such warrants initially had an exercise price of $1.70 per share which
was subsequently amended to $0.90 per share on January 13, 2006. The warrants
are exercisable for a term of five years. The conversion price of the 6% senior
secured convertible notes, and the exercise price of the related warrants, are
subject to certain normal and customary anti-dilution adjustment provisions and
also include a one-time reset provision.
Additionally, during March and June 2005 we received additional investments
totaling $6,750,000 of 6% senior secured convertible notes from the following
investors who exercised Additional Investment Rights: Gryphon Master Fund, L.P.,
GSSF Master Fund, L.P., Lonestar Partners, L.P., Renaissance US Growth, BFS US
Special Opportunities Trust PLC, Enable Capital, Bushido Capital, AC Capital,
and Newgrange Advisors, LLC.
The 6% senior secured convertible notes bear interest at 6%, mature in
February, 2008, and are convertible into our common stock, at the selling
shareholder's option. The 6% senior secured convertible notes were initially
convertible into shares of common stock at a conversion price of $1.70 per
share, which was subsequently amended on January 13, 2006 to $0.90 per share.
The conversion price of the 6% senior secured convertible notes is subject to
adjustment in the event we issue additional stock below the then current market
price or declare a stock split or stock dividend. In addition, the conversion
price is subject to a one time adjustment.
In addition, we issued to the selling shareholders warrants to purchase up
to 2,573,529 shares of our common stock at an initial exercise price of $1.70
per share. The exercise price was amended to $0.90 per share on January 13,
2006. The exercise price of the warrants is subject to the same adjustments and
reset provisions as the 6% senior secured convertible notes.
Pursuant to the terms of the 6% senior secured convertible notes and the
warrants, the selling shareholders have contractually agreed to restrict their
ability to convert or exercise their warrants and receive shares of our common
stock such that the number of shares of common stock held by them and their
affiliates after such conversion or exercise does not exceed 4.99% of the then
issued and outstanding shares of common stock.
On January 13, 2006, in connection with the sale of 8% senior secured
convertible notes described below, the terms of the 6% senior secured
convertible notes and related warrants were materially amended. A complete
description of the material terms of the amendments is included under
"Forbearance Agreement" beginning on page 12 of this prospectus.
8% Senior Secured Convertible Notes Due June 30, 2008
On January 13, 2006, we sold approximately $6.24 million principal amount
of 8% senior secured convertible notes due June 30, 2008 to 18 accredited
investors. In connection with the sale of the 8% senior secured convertible
notes, we issued investors warrants to purchase an aggregate of approximately
60
3.3 million shares of common stock, calculated as 50% of each investor's
subscription amount divided by $0.90. Of the $6.24 million principal amount of
8% senior secured convertible notes, we received gross proceeds of $3.4 million.
The remaining approximate $2.84 million principal amount of 8% senior secured
convertible notes was paid by investors as follows: (a) $1.8 million was paid by
the cancellation of promissory notes sold by us on September 23, 2005; (b)
$102,000 represents a management fee owed to the lead investor, Gryphon Master
Fund, L.P.; (c) $586,000 represents interest accrued on our 6% senior secured
convertible notes sold February 24, 2005 and pursuant to certain Additional
Investment Rights sold February 24, 2005; and (d) $352,000 represents placement
agent fees in connection with the sale of the 8% senior secured convertible
notes.
The 8% senior secured convertible notes have a final maturity date of June
30, 2008, accrue interest at the rate of 8% per annum, are secured by all of our
properties and assets and the properties and assets of each of our subsidiaries,
and are guaranteed by each of our subsidiaries. The 8% senior secured
convertible notes rank pari passu with our outstanding 6% senior secured
convertible notes. Interest may be paid either in cash or with shares of common
stock in our sole discretion. Holders of the 8% senior secured convertible notes
have the right to convert the outstanding principal amount into shares of our
common stock from time to time based on a conversion price of $0.90, subject to
adjustment. Beginning July 1, 2006, on the first day of each month we are
required to redeem 1/24th of the outstanding principal of the 8% senior secured
convertible notes (the "Monthly Redemption Amount"). If the transaction is
registered on an effective registration statement and certain other conditions
are satisfied, we may pay the Monthly Redemption Amount with shares of common
stock based on a conversion price equal to the lesser of (a) the then conversion
price and (b) 80% of the daily volume weighted average price of the common stock
for the 10 consecutive trading days prior to the applicable monthly redemption
date. In the event our annualized EBITDA for the two fiscal quarters ending
December 31, 2006 (the "Annualized EBITDA") is less than $17 million, the
conversion price of the 8% senior secured convertible notes will be reset to
equal the greater of (a) $0.30 or (b) a price determined by the following
formula: [3 * X/Y], where X equals the Annualized EBITDA and Y equals the number
of shares of common stock outstanding on a fully diluted basis on December 31,
2006. In addition, if we issue or commit to issue or distribute new securities
at a price per share less than the current market price or the current
conversion price, then the conversion price will be adjusted to reflect such
lower price. The conversion price is also subject to adjustment for stock
dividends, stock splits, stock combinations and similar dilutive transactions.
The warrants issued in connection with the 8% senior secured convertible
notes have an exercise price of $0.90 per share and are exercisable until
January 14, 2011. Holders may exercise the warrants on a cashless basis after
the first anniversary of the initial issuance date and then only in the event
that a registration statement covering the resale of the warrant shares is not
then effective. In the event our annualized EBITDA for the two fiscal quarters
ending December 31, 2006 (the "Annualized EBITDA") is less than $17 million, the
exercise price of the warrants will be reset to equal the greater of (a) $0.30
or (b) a price determined by the following formula: [3 * X/Y], where X equals
the Annualized EBITDA and Y equals the number of shares of common stock
outstanding on a fully diluted basis on December 31, 2006. In addition, if we
issue or commit to issue or distribute new securities at a price per share less
than the current market price or the current exercise price, then the exercise
price will be adjusted to reflect such lower price. The exercise price is also
subject to adjustment for stock dividends, stock splits, stock combinations and
similar dilutive transactions.
The investors have agreed to restrict their ability to convert the 8%
senior secured convertible notes and exercise the warrants such that the number
of shares of common stock held by them in the aggregate and their affiliates
after such conversion or exercise does not exceed 4.99% of our then issued and
outstanding shares of common stock.
We agreed to file a registration statement with the SEC registering the
resale of the shares of common stock issuable upon conversion of the 8% senior
secured convertible notes and related warrants on or before February 12, 2006
and cause such registration statement to be declared effective no later than May
31, 2006. We filed the required registration statement on February 13, 2006.
Pursuant to the terms of the July 12, 2006 financing, our requirement to cause
such registration statement to be declared effective was extended to no later
than November 30, 2006 without incurring liquidated damages.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Other than the transactions listed below, during the past three years there
were no material transactions, or series of similar transactions, or any
currently proposed transaction, or series of similar transactions, to which we
61
were or are to be party, in which the amount involved exceeds $60,000, and in
which any of our directors or executive officers, or any security holders who is
known by us to own of record or beneficially more than 5% of any class of our
common stock, or any member of the immediate family of any of the foregoing
persons, has an interest.
Our principal executive office is currently located at 76 George Road,
Betsy Layne, KY 41605. Starting January 1, 2005 we entered into a verbal lease
for $2,000 per month plus utilities averaging approximately $300 per month,
which approximates market rates. The property is leased from Jacobs Risk
Management, a company owned by Mr. Joe Jacobs, our Chief Operating Officer.
During the year ended December 31, 2004, we issued 700,000 shares of common
stock to Eastern Land Development Company, Inc., a company controlled by Larry
Hunt a related party due to the fact that during the time of the transactions,
Mr. Hunt beneficially owned more than 10% of our outstanding common stock, in
exchange for the Copley coal lease. The 700,000 shares of stock were valued at
fair market value of $1,085,000, which represents the closing quoted market
value of the stock on the date of acquisition.
In February 2005, we issued 2,500,000 shares of common stock to Eastern
Land Development Company, Inc. and acquired the right to mine an additional
approximately 26.0 million tons of proven and probable coal in the Alma, Pond
Creek, Coalburg, Taylor, Richardson, and Broas seams. The acquisition was booked
at $4,875,000, the fair market value of the stock on the date issued.
On January 6, 2004, we received $275,000 from a related party, Eastern
Consolidated Mining, Inc. ("Mining"), a company controlled by Larry Hunt and CJ
Douglas, each a related party at the time of the transaction, as a prepayment
for future coal sales. Mining has a coal sales contract between Mining and a
customer. We invoice Mining for coal delivered on a weekly basis. During the
years ended December 31, 2004 and December 31, 2005, $751,450 and $341,415,
respectively, of coal sales were recorded as a result of this agreement. At
December 31, 2004, payable to a related party includes $110,450 due Mining,
which represents the balance due on the advance payment of $275,000. At December
31, 2005 and March 31, 2006, this payable was $0. Mining is considered a related
party due to the fact that during the time of the transactions, the principals
of Mining, when taken as a whole, beneficially owned more than 10% of our
outstanding common stock. Coal sales receipts were not transferred to is, we
invoiced Mining for coal shipped to Mining's customer. We were reducing our
$275,000 obligation to Mining on a per ton basis. When we suspended coal
shipments to Mining's customer on February 7, 2005, $110,450 was the remaining
balance due.
Barry Tackett, appointed as a director and CFO in February 2004, was paid a
total of $10,610 for accounting services in fiscal 2003, and $37,509 in fiscal
2004. In January 2005, Mr. Tackett also received a total of 225,000 shares for
consulting services in fiscal 2004 valued at $438,750. In January 2006, Mr.
Tackett resigned as CFO and agreed to serve as our Controller. We currently have
an oral agreement with Mr. Tackett. Mr. Tackett provides services relating to
all aspects of the Company's accounting needs, including payroll services and
general day to day accounting functions.
Jacobs Risk Management, a risk management consulting company operated as a
sole proprietorship by one of our directors and our Secretary, Joseph G. Jacobs,
provides preventative and ongoing compliance support to help insure that Eastern
remains in compliance with all state and federal mandates. Through Jacobs Risk
Management, Mr. Jacobs was paid a total of $7,146 in fiscal 2003, $25,543 in
fiscal 2004 and $7,146 in fiscal 2005. Mr. Jacobs was paid $7,597 in the quarter
ended March 31, 2006 pursuant to this arrangement. In January 2005, Mr. Jacobs
also received 225,000 shares for consulting services in fiscal 2004 valued at
$438,750. We currently have an oral agreement with Mr. Jacobs in connection with
Jacobs Risk Management's services.
Steven Hicks, appointed as a director in February 2004, is the owner of
CVS, Inc., a coal consulting company. CVS was paid a total of $15,000 for
consulting services in fiscal 2003. Mr. Hicks resigned as a director in October
2004.
Clear Focus, Inc., one of our major shareholders, was paid $15,500 for
business and management consulting services in fiscal 2004, and $37,800 in
fiscal 2003.
62
In anticipation of the completion of our planned acquisition, we paid a
total $15,000 in patent fees for Saudi American in fiscal 2004. We paid $24,146
in expenses for Saudi American during fiscal 2003, including $16,595 for
advertising and promotional materials for the clean coal technology, $751 for
freight delivery on coal to be tested, and $6,800 for laboratory testing.
We paid $2,814 to Kentucky Energy Consultants for services and accrued an
additional $29,666 for services through December 31, 2003. The Company accrued
an additional $133,092 for services through December 31, 2004. Principals of
Kentucky Energy Consultants are minority shareholders of us and major
shareholders of Saudi American.
In fiscal 2003, we paid $55,344.29 to Midwest Energy Transport for
services. In fiscal 2004, we paid $35,875 to Midwest Energy Transport.
Principals of Midwest Energy are minority shareholders of us and major
shareholders of Saudi American.
In 2004, Eastern Consolidated Oil & Gas engaged in a series of transactions
related to oil and gas leases with Buckeye Energy Development, LLC. Principals
of Buckeye Energy Development are minority shareholders of us and major
shareholders of Saudi American.
In 2004, we engaged in a series of transactions related to coal sales
with Eastern Consolidated Mining, Inc. Principals of Eastern Consolidated Mining
are minority shareholders of us and major shareholders of Saudi American.
On January 13, 2006, Scott Griffith and Jesse Shelmire were appointed to
our Board of Directors. Messrs. Griffith and Shelmire are both registered
representatives of Stonegate Securities, Inc., the placement agent engaged by us
in connection with our January 13, 2006 private placement. We paid Stonegate
Securities, Inc. a 7% placement agent fee for services rendered in connection
with the January 13, 2006 private placement, which Stonegate elected to be paid
in the same securities as the institutional investors who participated in the
January 13, 2006 transaction. We also paid Stonegate Securities, Inc. a
placement agent fee of $825,000 in association with placement of our sale of 6%
senior secured convertible notes and related warrants in February 2005 and the
exercise of Additional Investment Rights during 2005. Also in connection with
these placements, we issued Messrs. Griffith and Shelmire warrants to purchase
1,110,290 shares (555,145 shares each) of common stock with term of five years
and an exercise price of $1.70 per share. These warrants were exercised on a
cashless basis and we thereby issued an aggregate of 652,144 shares (326,072
shares each) of common stock to Messrs. Griffith and Shelmire. Messrs. Griffith
and Shelmire were also issued warrants to purchase 577,778 shares (288,889
shares each) of common stock with a term of five years and an exercise price of
$0.90 per share as additional compensation for their placement agent efforts
pursuant to the successful closing of the January 13, 2006 transaction. These
warrants were exercised on a cashless basis in February 2006 and we thereby
issued an aggregate of 383,856 shares (191,928 shares each) of common stock to
Messrs. Griffith and Shelmire.
RC Financial Group LLC was issued 20,000 shares of common stock during the
year ended December 31, 2005 and the first calendar quarter of 2006 for
financial consulting services. On January 13, 2006 Mr. Robert Chmiel, a
principal of RC Financial Group, LLC, was appointed to our Board of Directors
and interim Chief Financial Officer. Mr. Chmiel's agreement with the company is
for an annual salary of $150,000 and warrants to purchase 150,000 shares of
common stock with a term of five years and an exercise price of $0.90 per share.
These warrants were exercised on a cashless basis in February 2006 and the
Company thereby issued an aggregate of 92,553 shares of common stock to RC
Financial Group, LLC. In June, we amended our agreement with Mr. Chmiel pursuant
to which his annual salary was increased to $225,000 and we issued 200,000
additional shares of restricted common stock.
On July 12, 2006, we completed a private placement transaction consisting
of $4,444,444 in face amount of Variable Rate Original Issue Discount
Convertible Secured Debentures and $1,750,000 in Unsecured Debt Securities. In
connection with the transactions contemplated under the Agreement, we paid a
placement agent fee of $262,500 in cash and issued five-year warrants to
purchase 100,000 shares of common stock at $0.01 per share to Stonegate
Securities and its principals Jesse Shelmire and Scott Griffith, each a director
of the Company.
DESCRIPTION OF SECURITIES
The following description of our capital stock and provisions of our
articles of incorporation and bylaws, each as amended, is only a summary. Our
authorized capital stock consists of 50,000,000 shares of common stock, par
value $0.001 per share. As of August 7, 2006, there were 22,175,374 shares of
common stock issued and outstanding.
Common Stock
Holders of our common stock are entitled to one vote for each share held on
all matters submitted to a vote of our shareholders. Holders of our common stock
63
are entitled to receive dividends ratably, if any, as may be declared by the
board of directors out of legally available funds, subject to any preferential
dividend rights of any outstanding preferred stock. Upon our liquidation,
dissolution or winding up, the holders of our common stock are entitled to
receive ratably our net assets available after the payment of all debts and
other liabilities and subject to the prior rights of any outstanding preferred
stock. Holders of our common stock have no preemptive, subscription, redemption
or conversion rights. The outstanding shares of common stock are fully paid and
non-assessable. The rights, preferences and privileges of holders of our common
stock are subject to, and may be adversely affected by, the rights of holders of
shares of any series of preferred stock which we may designate and issue in the
future without further shareholder approval.
Transfer Agent and Registrar
We were notified that our stock transfer agent, Pacific Stock Transfer, has
resigned effective as of March 31, 2006. We retained InterWest Transfer Co.,
based in Salt Lake City, Utah, as our new transfer agent.
PLAN OF DISTRIBUTION
The selling shareholders, or their pledgees, donees, transferees, or any of
their successors in interest selling shares received from a named selling
shareholder as a gift, partnership distribution or other non-sale-related
transfer after the date of this prospectus (all of whom may be selling
shareholders) may sell the common stock offered by this prospectus from time to
time on any stock exchange or automated interdealer quotation system on which
the common stock is listed or quoted at the time of sale, in the
over-the-counter market, in privately negotiated transactions or otherwise, at
fixed prices that may be changed, at market prices prevailing at the time of
sale, at prices related to prevailing market prices or at prices otherwise
negotiated. The selling shareholders may sell the common stock by one or more of
the following methods, without limitation:
o Block trades in which the broker or dealer so engaged will attempt to
sell the common stock as agent but may position and resell a portion
of the block as principal to facilitate the transaction;
o An exchange distribution in accordance with the rules of any stock
exchange on which the common stock is listed;
o Ordinary brokerage transactions and transactions in which the broker
solicits purchases;
o Privately negotiated transactions;
o In connection with short sales of company shares;
o Through the distribution of common stock by any selling shareholder to
its partners, members or shareholders;
o By pledge to secure debts of other obligations;
o In connection with the writing of non-traded and exchange-traded call
options, in hedge transactions and in settlement of other transactions
in standardized or over-the-counter options;
o Purchases by a broker-dealer as principal and resale by the
broker-dealer for its account; or
o In a combination of any of the above.
These transactions may include crosses, which are transactions in which the
same broker acts as an agent on both sides of the trade. The selling
shareholders may also transfer the common stock by gift. We do not know of any
arrangements by the selling shareholders for the sale of any of the common
stock.
64
The selling shareholders may engage brokers and dealers, and any brokers or
dealers may arrange for other brokers or dealers to participate in effecting
sales of the common stock. These brokers or dealers may act as principals, or as
an agent of a selling shareholder. Broker-dealers may agree with a selling
shareholder to sell a specified number of the stocks at a stipulated price per
share. If the broker-dealer is unable to sell common stock acting as agent for a
selling shareholder, it may purchase as principal any unsold shares at the
stipulated price. Broker-dealers who acquire common stock as principals may
thereafter resell the shares from time to time in transactions in any stock
exchange or automated interdealer quotation system on which the common stock is
then listed, at prices and on terms then prevailing at the time of sale, at
prices related to the then-current market price or in negotiated transactions.
Broker-dealers may use block transactions and sales to and through
broker-dealers, including transactions of the nature described above. The
selling shareholders may also sell the common stock in accordance with Rule 144
or Rule 144A under the Securities Act, rather than pursuant to this prospectus.
In order to comply with the securities laws of some states, if applicable, the
shares of common stock may be sold in these jurisdictions only through
registered or licensed brokers or dealers.
From time to time, one or more of the selling shareholders may pledge,
hypothecate or grant a security interest in some or all of the shares owned by
them. The pledgees, secured parties or person to whom the shares have been
hypothecated will, upon foreclosure in the event of default, be deemed to be
selling shareholders. The number of a selling shareholder's shares offered under
this prospectus will decrease as and when it takes such actions. The plan of
distribution for that selling shareholder's shares will otherwise remain
unchanged. In addition, a selling shareholder may, from time to time, sell the
shares short, and, in those instances, this prospectus may be delivered in
connection with the short sales and the shares offered under this prospectus may
be used to cover short sales.
To the extent required under the Securities Act, the aggregate amount of
selling shareholders' shares being offered and the terms of the offering, the
names of any agents, brokers, dealers or underwriters, any applicable commission
and other material facts with respect to a particular offer will be set forth in
an accompanying prospectus supplement or a post-effective amendment to the
registration statement of which this prospectus is a part, as appropriate. Any
underwriters, dealers, brokers or agents participating in the distribution of
the common stock may receive compensation in the form of underwriting discounts,
concessions, commissions or fees from a selling shareholder and/or purchasers of
selling shareholders' shares, for whom they may act (which compensation as to a
particular broker-dealer might be less than or in excess of customary
commissions). Neither we nor any selling shareholder can presently estimate the
amount of any such compensation.
Scott R. Griffith and Jesse B. Shelmire IV are both registered
representatives of Stonegate Securities, Inc., a registered broker-dealer, and
are "underwriters" within the meaning of the Securities Act, and any discounts,
concessions, commissions or fees received by them and any profit on the resale
of the securities sold by them may be deemed to be underwriting discounts and
commissions. The other selling shareholders and any other underwriters, brokers,
dealers or agents that participate in the distribution of the common stock may
also be deemed to be "underwriters" within the meaning of the Securities Act,
and any discounts, concessions, commissions or fees received by them and any
profit on the resale of the securities sold by them may be deemed to be
underwriting discounts and commissions. If a selling shareholder is deemed to be
an underwriter, the selling shareholder may be subject to certain statutory
liabilities including, but not limited to Sections 11, 12 and 17 of the
Securities Act and Rule 10b-5 under the Exchange Act. Selling shareholders who
are deemed underwriters within the meaning of the Securities Act will be subject
to the prospectus delivery requirements of the Securities Act. The SEC staff is
of a view that selling shareholders who are registered broker-dealers or
affiliates of registered broker-dealers may be underwriters under the Securities
Act. We will not pay any compensation or give any discounts or commissions to
any underwriter in connection with the securities being offered by this
prospectus.
A selling shareholder may enter into hedging transactions with
broker-dealers and the broker-dealers may engage in short sales of the common
stock in the course of hedging the positions they assume with that selling
shareholder, including, without limitation, in connection with distributions of
the common stock by those broker-dealers. A selling shareholder may enter into
option or other transactions with broker-dealers, who may then resell or
otherwise transfer those common stock. A selling shareholder may also loan or
pledge the common stock offered hereby to a broker-dealer and the broker-dealer
may sell the common stock offered by this prospectus so loaned or upon a default
may sell or otherwise transfer the pledged common stock offered by this
prospectus.
65
The selling shareholders and other persons participating in the sale or
distribution of the common stock will be subject to applicable provisions of the
Exchange Act, and the rules and regulations under the Exchange Act, including
Regulation M. This regulation may limit the timing of purchases and sales of any
of the common stock by the selling shareholders and any other person. The
anti-manipulation rules under the Exchange Act may apply to sales of common
stock in the market and to the activities of the selling shareholders and their
affiliates. Regulation M may restrict the ability of any person engaged in the
distribution of the common stock to engage in market-making activities with
respect to the particular common stock being distributed for a period of up to
five business days before the distribution. These restrictions may affect the
marketability of the common stock and the ability of any person or entity to
engage in market-making activities with respect to the common stock.
We cannot assure you that the selling shareholders will sell all or any
portion of the common stock offered by this prospectus. In addition, we cannot
assure you that a selling shareholder will not transfer the shares of our common
stock by other means not described in this prospectus.
LEGAL MATTERS
The validity of the common stock has been passed upon by Sichenzia Ross
Friedman Ference LLP, New York, New York.
EXPERTS
The financial statements included in the Prospectus have been audited by
Killman, Murell & Company, P.C., independent certified public accountants to the
extent and for the periods set forth in their report appearing elsewhere herein
and are included in reliance upon such report given upon the authority of said
firm as experts in auditing and accounting.
References in this prospectus to Summit Engineering Inc. and its analysis
relating to our coal reserves are made in reliance on Summit Engineering's
authority as an expert in engineering consulting.
WHERE YOU CAN FIND MORE INFORMATION
We filed with the SEC a registration statement on Form SB-2 under the
Securities Act for the common stock to be sold in this offering. This prospectus
does not contain all of the information in the registration statement and the
exhibits and schedules that were filed with the registration statement. For
further information with respect to the common stock and us, we refer you to the
registration statement and the exhibits and schedules that were filed with the
registration statement. Statements made in this prospectus regarding the
contents of any contract, agreement or other document that is filed as an
exhibit to the registration statement are not necessarily complete, and we refer
you to the full text of the contract or other document filed as an exhibit to
the registration statement. A copy of the registration statement and the
exhibits and schedules that were filed with the registration statement may be
inspected without charge at the public reference facilities maintained by the
SEC at 100 F Street, N.E., Washington, D.C. 20549. Copies of all or any part of
the registration statement may be obtained from the SEC upon payment of the
prescribed fee. Information regarding the operation of the public reference
rooms may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a
web site that contains reports, proxy and information statements and other
information regarding registrants that file electronically with the SEC. The
address of the site is http://www.sec.gov.
DISCLOSURE OF COMMISSION POSITION ON
INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
Our Articles of Incorporation provide that, to the fullest extent permitted
by law, none of our directors or officers shall be personally liable to us or
our shareholders for damages for breach of any duty owed to our shareholders or
us.
In addition, we have the power, by our by-laws or in any resolution of our
shareholders or directors, to undertake to indemnify the officers and directors
of ours against any contingency or peril as may be determined to be in our best
interest and in conjunction therewith, to procure, at our expense, policies of
insurance. At this time, no statute or provision of the by-laws, any contract or
other arrangement provides for insurance or indemnification of any of our
controlling persons, directors or officers that would affect his or her
liability in that capacity.
66
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the "Act") may be permitted to directors, officers and controlling
persons of the small business issuer pursuant to the foregoing provisions, or
otherwise, the small business issuer has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities, other than the payment by us
of expenses incurred or paid by our directors, officers or controlling persons
in the successful defense of any action, suit or proceedings, is asserted by
such director, officer, or controlling person in connection with any securities
being registered, we will, unless in the opinion of our counsel the matter has
been settled by controlling precedent, submit to court of appropriate
jurisdiction the question whether such indemnification by us is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issues.
67
CONSOLIDATED ENERGY, INC.
CONSOLIDATED FINANCIAL STATEMENTS
INDEX
Page
Three Months Ended March 31, 2006 and 2005 (Unaudited)
Condensed Consolidated Balance Sheets.......................................... F-2
Condensed Consolidated Statements of Operations................................ F-3
Condensed Consolidated Statements of Cash Flows................................ F-4
Notes to Condensed Consolidated Financial Statements........................... F-6
Fiscal Years Ended December 31, 2005 and 2004
Report of Independent Registered Public Accounting Firm........................ F-17
Consolidated Balance Sheets.................................................... F-18
Consolidated Statement of Operations........................................... F-19
Consolidated Statement of Cash Flows .......................................... F-20
Consolidated Statement of Changes in Stockholders' Equity (Deficit) ........... F-22
Notes to Consolidated Financial Statements..................................... F-23
F-1
CONSOLIDATED ENERGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31,2006 December 31,2005
-------------------- --------------------
(unaudited) (Restated)
(Restated)
ASSETS
CURRENT ASSETS
Cash $ 9,426 $ 1,031
Accounts receivable 126,771 1,754
Accounts receivable - other 71,417 71,417
Prepaid and other 72,813 7,754
-------------------- --------------------
Total current assets 280,427 81,956
-------------------- --------------------
BUILDING, EQUIPMENT AND COAL LEASES
Building and equipment, net of $849,503 and $791,027
Depreciation 9,924,672 11,073,058
Coal Leases, net of $22,697 and $17,829 Amortization 15,895,252 15,157,721
-------------------- --------------------
Total building, equipment and coal leases, net 25,819,924 26,230,779
-------------------- --------------------
OTHER ASSETS
Restricted cash 121,700 70,800
Prepaid royalty 141,039 70,857
Other assets 25,000 55,800
-------------------- --------------------
Total other assets 287,739 197,457
-------------------- --------------------
Total Assets $ 26,388,090 $ 26,510,192
==================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Cash overdrafts $ -- $ 23,532
Convertible debentures 707,960 707,959
Accounts payable 1,833,917 1,453,350
Accrued liabilities 1,933,523 6,917,796
Royalties payable 507,674 476,638
Current portion of capital lease -- 1,295,322
Notes payable 126,025 2,172,191
Derivative liability - warrants 25,964,012 3,551,471
Derivative liability - convertible shares 10,993,846 7,602,941
Payable to related parties 590,659 590,659
-------------------- --------------------
Total current liabilities 42,657,616 24,791,859
-------------------- --------------------
Deferred royalties payable 154,227 157,541
Asset retirement obligations 52,291 34,629
Notes payable - long term portion 3,223,213 1,478,931
-------------------- --------------------
Total long-term liabilities 3,429,731 1,671,101
-------------------- --------------------
Total Liabilities 46,087,347 26,462,960
-------------------- --------------------
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock, $0.001 per value; 50 million shares
authorized; 17,975,374 and 14,823,246 shares issued and
outstanding 17,975 14,824
Additional paid-in capital 19,071,795 14,266,314
Accumulated deficit (38,789,027) (14,233,906)
-------------------- --------------------
Total Stockholders' Equity (Deficit) (19,699,257) 47,232
-------------------- --------------------
Total Liabilities and Stockholder's Equity (Deficit) $ 26,388,090 $ 26,510,192
==================== ====================
See Notes to Condensed Consolidated Financial Statements.
F-2
CONSOLIDATED ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended March 31,
----------------------------------------------
2005 2006
(restated) (restated)
-------------------- --------------------
REVENUES
Coal Sales $ 433,033 $ 277,040
Other revenue -- 1,800
-------------------- --------------------
Total revenue 433,033 278,840
EXPENSES
Cost of sales, excluding depreciation of mine equipment
of $113,000 and $203,209, and amortization of coal
leases of $2,829and $4,868 for the three months ended
March 31, 2005 and 2006, respectively 385,499 1,126,383
Operating expenses 555,899 911,545
Depreciation and amortization 115,829 208,137
-------------------- --------------------
Total costs and expenses 1,057,227 2,246,065
-------------------- --------------------
LOSS FROM OPERATIONS (624,194) (1,967,225)
OTHER INCOME (EXPENSE)
Interest income - 3,747
Change in fair value of warrant liability (12,501,691) (10,140,675)
Change in fair value of convertible share liability (1,276,470) 1,362,690
Loss on sale of assets -- (506,894)
Interest expense including amortization of debt
discount of $2,875 and $663,915 and excluding
$1,098,868 of capitalized interest in 2005 (6,411) (13,306,764)
-------------------- --------------------
Total other income (expense) (13,784,572) (22,587,896)
-------------------- --------------------
NET (LOSS) $ (14,408,766) $ (24,555,121)
-------------------- --------------------
BASIC AND DILUTED
NET (LOSS) PER COMMON SHARE $ (1.14) $ (1.55)
-------------------- --------------------
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES 12,686,939 15,875,984
==================== ====================
See Notes to Condensed Consolidated Financial Statements.
F-3
CONSOLIDATED ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
2005 2006
---------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Loss $ (14,408,766) $ (24,555,121)
Adjustments to reconcile net loss to net cash provided by operating
activities Depreciation and Amortization 115,829 208,137
Stock Issued for Services - 228,000
Accretion of debt discount 2,875 663,915
Change in fair value of warrant and convertible share liabilities 13,778,161 21,063,669
Asset Retirement Obligation accretion - 1,151
Loss on Sale of Assets - 506,894
Changes in Operating assets and Liabilities
Prepaid Expenses (93) (65,059)
Accounts Receivable - (125,017)
Prepaid Royalties (34,501) (70,184)
Other Assets 5,500 30,800
Cash Overdrafts (400,623) (23,532)
Accounts Payable 273,267 17,315
Accrued Liabilities 37,615 409,320
Royalties Payable (18,476) 31,036
Deferred Royalties Payable (2,461) (3,314)
Purchase of Restricted Cash (1,300) (50,900)
---------------- ---------------
NET CASH USED BY OPERATING ACTIVITIES (652,973) (1,732,890)
---------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of Equipment (1,933,883) (493,845)
Interest Capitalized (100,093)
Lease Cost Capitalized (925,690) (725,888)
---------------- ---------------
NET CASH USED BY INVESTING ACTIVITIES (2,959,666) (1,219,733)
---------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from Secured Notes - 3,402,502
Proceeds From Convertible Debentures 7,097,500 -
Advances from (Payment) to Related Parties (304,195) -
Payments on Capital Leases (137,470) -
Payments on Notes Payable (182,737) (441,484)
Proceeds From Stock Sales - -
---------------- ---------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 6,473,098 2,961,018
---------------- ---------------
NET INCREASE IN CASH 2,860,459 8,395
CASH BALANCE, BEGINNING OF YEAR 4,392 1,031
---------------- ---------------
CASH BALANCE, END OF YEAR $ 2,864,851 $ 9,426
================ ===============
(continued)
F-4
NON-CASH INVESTING AND FINANCING ACTIVITIES
Accrued interest converted into Convertible Debenture $ - $ (2,640,000)
Convertible debenture from interest addition - 2,640,000
Accrued Liabilities settled by issuance of common stock (2,082,500) (2,166,662)
Common stock issued for accrued interest 750 1,059
Additional paid-in capital from stock issued 2,081,750 2,165,603
Additions to equipment from capital leases (1,674,500) -
Capital leases issued for equipment 1,674,500 -
Common stock issued for debenture conversion 30 -
Additional paid-in capital from debenture conversions 53,854 -
Leases acquired for stock (4,875,000) -
Common stock issued for leases 2,500 -
Reduction in Debt Discount 947,887 -
Additional paid-in capital from lease acquisitions 4,872,500 -
Accretion of Debt Discount capitalized (947,887) (15,143,903)
Additional paid-in capital from issuance of senior notes - 6,147,498
Beneficial conversion feature on issuance of convertible
debentures
capitalized as interest cost - -
Additional paid-in capital from beneficial conversion feature - 8,996,405
Accrued interest converted to note payable - (586,932)
Note payable from accrued interest - 586,932
Capitalized mine closure costs - (16,511)
Asset retirement obligation - 16,511
Addition Paid-In-Capital for Issue of Stock for Warrants - (2,093)
Common Stock Issued for Warrants - 2,093
Debt discount on Issuance of Convertible Debentures (5,502,720) -
Derivative Liability from Debt Discount 5,502,720 -
Debenture converted to common stock (50,000) -
Accrued interest converted to common stock (3,884) -
Reduction in equipment - 1,076,860
Reduction in Accounts Payable from Sale of Equipment - (1,747)
Reduction in Capital Leases from Sale of Equipment - (930,322)
Reduction in Accumulated Depreciation from Sale of Equipment - (144,791)
Increase in Accounts Payable - 365,000
Reduction in Capital Leases - (365,000)
-------------------- --------------------
$ - $ -
==================== ====================
Supplemental Cash Flow Disclosures
Interest paid in cash $ 100,093 $ 2,970
==================== ====================
Income Taxes $ - $ -
==================== ====================
See Notes to Condensed Consolidated Financial Statements.
F-5
CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles in the
United States for interim financial information and with the instructions to
Form 10-QSB and Item 310 of Regulation S-B. Accordingly, they do not include all
of the information and footnotes required by generally accepted accounting
principles in the United States for complete financial statements. The
accompanying unaudited condensed consolidated financial statements reflect all
adjustments that, in the opinion of management, are considered necessary for a
fair presentation of the financial position, results of operations, and cash
flows for the periods presented. The results of operations for such periods are
not necessarily indicative of the results expected for the full fiscal year or
for any future period. The accompanying financial statements should be read in
conjunction with the audited consolidated financial statements of Consolidated
Energy, Inc. and consolidated subsidiaries (the "Company") included in the
Company's Form 10-KSB for the fiscal year ended December 31, 2005.
The discussion and analysis of the Company's financial condition and
results of operations are based upon its consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, the Company evaluates
its estimates, including those related to reserves for bad debts and those
related to the possible impairment of long-lived assets. The Company bases its
estimates on historical experience and on various other assumptions that are
believed 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.
The Company was incorporated in Nevada on December 18, 1996, under the name
Barbeque Capital Corp., and engages principally in the business of mining coal
in Eastern Kentucky. The Company's main business focus is the operation of
profitable coal mines and its main customer is American Electric Power, Co.
The Company's financial statements have been presented on the basis that it
is a going concern, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company has
not established revenues sufficient to cover its operating costs, has incurred
significant outstanding current obligations and has incurred substantial net
losses, thereby raising substantial doubts about its ability to continue as a
going concern. The Company is in the process of raising additional funds to
complete the mine development and cover its overhead costs until such time as
enough revenue is generated to cover all operating costs. If additional funds
are raised through the issuance of equity securities, the current stockholders
may experience dilution. Furthermore, there can be no assurance that additional
financings will be available when needed or that if available, such financings
will include terms favorable to the Company's stockholders. If such financings
are not available when required or are not available on acceptable terms, the
Company may be unable to take advantage of business opportunities or respond to
competitive pressures, any of which could have a material adverse effect on its
business, financial condition and results of operations.
2. Notes Payable
The January 2005 Bridge Notes
On January 11, 2005, the Company closed a financing transaction for
$2,500,000 in bridge financing to be used exclusively for the purchase of
equipment and to fund expenditures for the consummation of mining activities at
its Warfield Mine operations. The financing consisted of a senior secured
promissory note for the face amount of $2,500,000 with an interest rate of 9%
per annum and a payment date (principal and interest) of March 31, 2005. Gryphon
Master Fund, LP and GSSF Master Fund, LP, both Bermuda limited partnerships,
were collectively the payees on the note. The note was repaid with the proceeds
from the Company's February 2005 financing - see below.
F-6
CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
In consideration for the above note, the Company paid a commitment fee of
$50,000 to the Gryphon Master Fund and GSSF Master Fund, and a flat fee of
$10,000 as reimbursement for fees and expenses incurred in connection with the
negotiation, preparation and delivery of the note, all deducted from the
proceeds of funding the note. As additional consideration, the Company issued to
Gryphon Master Fund and GSSF Master Fund a warrant for the purchase of an
aggregate of 514,706 shares of the Company's common stock at an exercise price
of $1.70 per share, exercisable for five years. The warrant also contains
so-called "piggyback" registration provisions under which the warrant holder may
request that the shares underlying the warrant be included in a registration
with respect to an offering of the Company's securities.
In addition to the above bridge note fees and warrants, the Company paid
Stonegate Securities, Inc., a Texas corporation, which the Company refer to as
Stonegate, a placement agent fee for a total of $200,000 cash and issued
warrants for the purchase of an aggregate of 51,470 shares of the Company's
common stock on the same terms as the warrants issued to Gryphon Master Fund and
GSSF Master Fund. The warrant issuances were in the form of a warrant issued to
Scott R. Griffith and a warrant issued to Jesse B. Shelmire IV, each for the
purchase of 25,735 shares. The cash paid and warrants issued were per the terms
of a non-exclusive Placement Agency Agreement between the Company and Stonegate.
6% Senior Secured Convertible Notes
On February 24, 2005, the Company entered into a financing transaction for
aggregate gross proceeds of $7,000,000, with additional investment rights of up
to an additional $7,000,000 (hereinafter, the "6% Notes"), such financing to be
used for the purchase of equipment and to fund expenditures for the consummation
of mining activities at the Company's Warfield Mine. The financing is in the
form of 6% senior secured convertible notes for an aggregate total face amount
of $7,000,000 and a term of three years. The 6% senior secured notes may be
converted to common stock at a conversion price of $1.70 per share. Holders of
such notes are Gryphon Master Fund, L.P., GSSF Master Fund, LP, Lonestar
Partners, L.P., WS Opportunity International Fund, Ltd., WS Opportunity Fund
(QP), L.P., WS Opportunity Fund, L.P., Renaissance US Growth Investment Trust
PLC, and BFS US Special Opportunities Trust PLC (collectively, the "Holders").
As additional consideration, the Company issued to each of such holders warrants
for the purchase of an aggregate of 2,058,824 shares of the Company's common
stock at an exercise price of $1.70 per share, exercisable for five years. The
conversion price of such notes, and the exercise price of such warrants, are
subject to certain normal and customary anti-dilution adjustment provisions and
also include a one-time reset date provision with a floor price of $0.90 per
share.
In February 2005, simultaneous with the closing of the 6% Note offering,
the Company used approximately $2,527,000 of the proceeds of the above offering
to repay the January 2005 bridge loan (principal and interest) from Gryphon
Master Fund and GSSF Master Fund. The Company also paid a flat fee of $30,000 to
Gryphon Master Fund and GSSF Master Fund as reimbursement for fees and expenses
incurred in connection with the negotiation, preparation and delivery of the 6%
Notes and related investment documents. In addition to the above fees related to
the issuance of the 6% Notes, the Company paid Stonegate a total of $340,000
cash and issued warrants for the purchase of an aggregate of 617,647 shares of
the Company's common stock on the same terms as the warrants issued to the
Holders.
During March 2005, two investors in the Company's February 2005 private
placement exercised their additional investment rights for an aggregate of
$750,000 in the same 6% senior secured convertible notes that may be convertible
into 441,176 shares of the Company's common stock at an exercise price of $1.70
upon the occurrence of certain events. In connection with the additional
investment, the Company issued warrants for the purchase of 44,116 shares of the
Company's common stock at an exercise price of $1.70 to Stonegate. In April
2005, Stonegate exercised all of the 713,223 warrants issued through a cashless
exercise provision in exchange for the issuance of 485,850 shares of the
Company's common stock. During June 2005, seven investors exercised their
additional investment rights for an aggregate of $6,000,000 in the same 6%
senior secured convertible notes that may be convertible into 3,529,411 shares
of the Company's common stock at an exercise price of $1.70 upon the occurrence
of certain events. In July, placement agent warrants issued to Stonegate for the
purchase of 352,994 shares issued in connection with the exercise of the
additional investment rights were exercised pursuant to cashless exercise
provisions for the issuance of 166,290 shares.
F-7
CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
In connection with the above transactions, the Company executed a security
agreement (the "Security Agreement") giving the Holders a security interest in
and to any and all of the Company's assets and properties ("Collateral" as
defined in the Security Agreement). Each of the Company's subsidiaries has also
executed a Guaranty for the Company's obligations under the 6% Notes.
On July 1, 2005, the Company failed to pay interest as required pursuant
the terms of certain 6% senior secured convertible notes and Additional
Investment Rights first executed on February 24, 2005 for an aggregate total
face amount of $13,750,000, and thereby caused a default under the terms of the
notes.
The September and November 2005 Bridge Notes
Subsequently, and in order to secure additional financing for continuing
operations, on September 23, 2005, the Company executed a promissory note (the
"September Bridge Note") payable to Cordillera Fund L.P. for an aggregate
principal amount of up to $1,500,000. On November 24, 2005 the existing
September Bridge Note holders and the Company agreed to increase the amount of
debt by $300,000 to a total of $1,800,000. The September Bridge Note was
subsequently cancelled on January 13, 2006 and exchanged for an investment in
the Company's 8% senior secured convertible notes and warrants. See below for a
description of the material terms of this transaction. In connection with the
September Bridge Note, the Company entered into a Consent and Waiver with the
holders of the 6% Notes, whereby they consented to the September Bridge Note
transactions and waived, until resolution of the September Bridge Note
transactions, the application of any of the provisions of the 6% Notes and
related transaction documents. The Company also entered into a Subordination
Agreement in connection with the September Bridge Note, whereby Cordillera Fund
L.P. agreed to subordinate the September Bridge Note to the prior payment in
full in cash of the 6% Notes. In addition, the holders of the 6% Notes entered
into a Bridge Forbearance with the Company whereby they agreed to forebear from
exercising any of their rights or remedies under the 6% Notes and the related
securities purchase agreement, security agreement and any other related
transaction documents for a period of ten business days.
On October 6, 2005, the holders of the 6% Notes signed an extension to the
Bridge Forbearance until the earliest to occur of the following: (i) November
18, 2005, (ii) the expiration and termination of the September Bridge Note, or
(iii) the completion by the Company of a new financing. On January 13, 2006, the
6% Note holders signed another forbearance agreement pursuant to which, among
other things, they agreed to waive the Company's prior defaults on the 6% Notes,
and the holders of the $1.8 million bridge notes agreed to cancelled their notes
in exchange for the 8% notes issued in January 2006 - See January 13, 2006
Private Placement below.
January 13, 2006 Private Placement
On January 13, 2006, the Company sold approximately $6.24 million principal
amount of 8% senior secured convertible notes due June 30, 2008 to 18 accredited
investors (the "8% Notes"). In connection with the sale of the 8% Notes, the
Company issued investors warrants to purchase an aggregate of approximately 3.3
million shares of common stock, calculated as 50% of each investor's
subscription amount divided by $0.90. Of the $6.24 million principal amount of
8% Notes, the Company received gross proceeds of $3.3 million. The remaining
approximate $2.94 million principal amount was paid by investors as follows: (a)
$1.8 million was paid by the cancellation of the September Bridge Notes; (b)
$102,000 represents a management fee owed to the lead investor, Gryphon Master
Fund, L.P.; (c) $586,000 represents interest accrued on the Company's 6% Notes
and pursuant to certain Additional Investment Rights sold February 24, 2005 and
$452,000 as placement agent fees.
The 8% Notes have a final maturity date of June 30, 2008, accrue interest
at the rate of 8% per annum, are secured by all of the Company's properties and
assets and the properties and assets of each of the Company's subsidiaries, and
are guaranteed by each of the Company's subsidiaries. The 8% Notes rank pari
passu with the Company's outstanding 6% Notes. Interest may be paid either in
cash or with shares of common stock in the Company's sole discretion. Holders of
the 8% Notes have the right to convert the outstanding principal amount into
shares of the Company's common stock from time to time based on a conversion
price of $0.90, subject to adjustment. Beginning July 1, 2006, on the first day
of each month the Company is required to redeem 1/24th of the outstanding
principal of the 8% Notes (the "Monthly Redemption Amount"). If the transaction
is registered on an effective registration statement and certain other
conditions are satisfied, the Company may pay the Monthly Redemption Amount with
shares of common stock based on a conversion price equal to the lesser of (a)
F-8
CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
the then conversion price and (b) 80% of the daily volume weighted average price
of the common stock for the 10 consecutive trading days prior to the applicable
monthly redemption date. In the event the Company's annualized EBITDA for the
two fiscal quarters ending December 31, 2006 (the "Annualized EBITDA") is less
than $17 million, the conversion price of the 8% Notes will be reset to equal
the greater of (a) $0.30 or (b) a price determined by the following formula: [3
* X/Y], where X equals the Annualized EBITDA and Y equals the number of shares
of common stock outstanding on a fully diluted basis on December 31, 2006. In
addition, if the Company issues or commits to issue or distribute new securities
at a price per share less than the current market price or the current
conversion price, then the conversion price will be adjusted to reflect such
lower price. The conversion price is also subject to adjustment for stock
dividends, stock splits, stock combinations and similar dilutive transactions.
The warrants issued in connection with the 8% Notes have an exercise price
of $0.90 per share and are exercisable until January 14, 2011. Holders may
exercise the warrants on a cashless basis after the first anniversary of the
initial issuance date and then only in the event that a registration statement
covering the resale of the warrant shares is not then effective. In the event
the Company's annualized EBITDA for the two fiscal quarters ending December 31,
2006 (the "Annualized EBITDA") is less than $17 million, the exercise price of
the warrants will be reset to equal the greater of (a) $0.30 or (b) a price
determined by the following formula: [3 * X/Y], where X equals the Annualized
EBITDA and Y equals the number of shares of common stock outstanding on a fully
diluted basis on December 31, 2006. In addition, if the Company issues or
commits to issue or distribute new securities at a price per share less than the
current market price or the current exercise price, then the exercise price will
be adjusted to reflect such lower price. The exercise price is also subject to
adjustment for stock dividends, stock splits, stock combinations and similar
dilutive transactions.
The investors have agreed to restrict their ability to convert the 8% Notes
and exercise the warrants such that the number of shares of common stock held by
them in the aggregate and their affiliates after such conversion or exercise
does not exceed 4.99% of the Company's then issued and outstanding shares of
common stock.
The Company agreed to file a registration statement with the SEC
registering the resale of the shares of common stock issuable upon conversion of
the 6% Notes and the 8% Notes and related warrants on or before February 12,
2006 and cause such registration statement to be declared effective no later
than May 31, 2006. The Company has filed such registration statement, as
amended, on Form SB-2 but has not yet been informed by the SEC regarding its
effectiveness.
Forbearance Agreement
On January 13, 2006, the Company entered into a forbearance agreement with
the holders of the Company's 6% Notes. In connection with the January 13, 2006
private placement described above, holders of the 6% Notes waived certain events
of default (the "Existing Defaults") by the Company including: (a) the Company's
failure to pay accrued but unpaid interest on the 6% Notes when due; (2) the
Company's failure to comply with certain negative and financial covenants of the
securities purchase agreement dated February 22, 2005; (3) the Company's failure
to comply with certain registration requirements of the registration rights
agreement dated February 24, 2005; and (4) the Company's failure to comply with
certain other provisions of the 6% Notes, the February 22, 2005 securities
purchase agreement and the February 24, 2005 registration rights agreement to
the extent that completion of the January 13, 2006 private placement may cause
any processing delay of the Company's prior registration statement (SEC File No.
333-127261) with the SEC.
In connection with the forbearance agreement, the Company agreed to release
and discharge each of the parties thereto and each of their affiliates from any
and all claims that the Company has or ever had against such parties through
January 13, 2006. Solely for the purpose of completing the January 13, 2006
private placement, the parties waived the anti-dilution provisions of the 6%
Notes and the related warrants, any existing rights associated with Additional
Investment Rights and the right to liquidated damages and other remedies under
the February 24, 2005 registration rights agreement. The parties also agreed to
forbear from enforcing certain remedies as a result of the Existing Defaults
through December 30, 2005.
F-9
CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
Pursuant to the terms of the forbearance agreement, the following
substantive amendments were made to the February 22, 2005 securities purchase
agreement; the 6% Notes, the related warrants and the February 24, 2005
registration rights agreement:
o The minimum EBITDA financial covenants required by the February 22,
2005 securities purchase agreement through March 31, 2006 were
deleted;
o The maximum capital expenditures required by the February 22, 2005
securities purchase agreement were deleted in their entirety;
o The minimum cash level requirements of the February 22, 2005
securities purchase agreement through June 30, 3006 were deleted;
o The minimum cash level requirement of the February 22, 2005 securities
purchase agreement for the period from July 1, 2006 through September
30, 2006 was changed from $2 million to $1 million;
o The definition of "Conversion Price" in the 6% Notes and "Exercise
Price" in the related warrants was changed from $1.70 to $0.90;
o The interest requirement of the 6% Notes was changed to require
interest payments beginning July 1, 2006; o A provision was added to
the 6% Notes and the related warrants requiring an adjustment to the
conversion price and exercise price in the event the Company's
annualized EBITDA for the two fiscal quarters ending December 31, 2006
(the "Annualized EBITDA") is less than $17 million. In such event, the
conversion price and exercise price will be reset to equal the greater
of (a) $0.30 or (b) a price determined by the following formula: [3 *
X/Y], where X equals the Annualized EBITDA and Y equals the number of
shares of common stock outstanding on a fully diluted basis on
December 31, 2006;
o A provision was added to the 6% Notes and the related warrants
requiring an adjustment to the conversion price and exercise price in
the event the Company issue or commits to issue or distribute new
securities at a price per share less than the current conversion or
exercise price;
o The "Events of Default" provision of the 6% Notes was amended
replacing the event of default for failure to have an effective
registration statement within 270 days of the closing date with an
event of default for failure to have an effective registration
statement within 270 days of the closing date for the January 13, 2006
private placement;
o An event of default was added to the 6% Notes for a breach of any of
the Company's representations, warranties or covenants contained in
any agreement or document executed in connection with the January 13,
2006 private placement; and
o The required filing date and earliest required effectiveness date of
the February 24, 2005 registration rights agreement was changed to
February 12, 2006 and May 31, 2006, respectively.
Notwithstanding the availability of Rule 144, each investor agreed not to
sell, offer or otherwise transfer any shares of the Company's common stock
beneficially owned by them until the earlier of: (a) May 31, 2006, or (b) the
date the required registration statement is declared effective by the SEC.
The parties also entered into an amended and restated security agreement
reflecting the pari passu nature of the 6% Notes with the 8% Notes.
In lieu of cash payment of accrued but unpaid interest due pursuant to the
6% Notes, the Company issued holders notes and warrants pursuant to the terms of
the January 13, 2006 private placement.
In addition, the Company issued non-convertible promissory notes to holders
of the 6% Notes in the aggregate principal amount of $2,640,000 which represents
liquidated damages which had accrued and is payable pursuant to the February 24,
2005 registration rights agreement. The promissory notes bear interest at the
rate of 3% per annum, compounded annually. The full amount of principal and
interest is due on June 30, 2008. The Company's obligations pursuant to the
promissory notes are secured by all of the Company's properties and assets and
the properties and assets of each of the Company's subsidiaries pari passu with
the 6% Notes and 8% Notes.
F-10
CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
As additional incentive to enter into the forbearance agreement, the
Company issued to all 6% Note holders additional warrants to purchase an
aggregate of 5,580,065 shares of common stock calculated pursuant to the
following formula: X = [((Y/$0.90) * 0.50 - Z)], where: X = the number of shares
of common stock underlying the warrant certificate; Y = the stated aggregate
principal amount of all 6% Notes; and Z = the number of shares of common stock
underlying all warrants previously issued to such party in connection with the
6% Notes. The additional warrants issued have identical terms to the warrants
sold by the Company pursuant to the January 13, 2006 private placement.
Other Agreements Executed in Connection with the January 13, 2006 Private
Placement
Also in connection with the January 13, 2006 private placement:
(a) the Company secured a directors and officers liability insurance policy
which provides $10,000,000 of total coverage;
(b) each of the Company's then-current officers and directors entered into
an agreement to vote all shares of common stock owned by them to increase the
Company's authorized shares of common stock from 50 million shares to 100
million shares;
(c) each of the Company's then-current officers and directors entered into
an agreement to vote for Timothy M. Stobaugh, Robert Chmiel, Jesse Shelmire and
Scott Griffith as additional directors and for a fifth additional director
designated by Gryphon Master Fund, L.P. within 60 days of closing;
(d) each of the Company's officers and directors entered into lock-up
agreements agreeing not to offer, sell, contract to sell, pledge or otherwise
dispose of any shares of common stock or other of the Company's equity
securities for the period ending on January 13, 2007;
(e) the Company's subsidiary, Eastern Consolidated Energy, Inc., entered
into an agreement with Kentucky Energy Consultants, Inc. whereby Kentucky Energy
Consultants, Inc. agreed to: (i) change its coal sales commission to 2.5% of the
gross sales price received by Eastern Consolidated Energy, Inc. on any purchase
orders and/or contracts on either spot or contract arrangements, and (ii)
forfeit its coal sales commission of 2.5% of gross revenues less trucking costs
until such time that the Company reach $20 million in aggregate EBITDA
production;
(f) the Company's subsidiary, Eastern Consolidated Energy, Inc., entered
into an agreement with New River Energy Sales Company, Inc. whereby, among other
things, New River Energy Sales Company, Inc. agreed to reduce its coal sales
commission from 5% to 2.5% of gross coal sales until such time that the Company
reach $20 million in aggregate EBITDA production;
(g) together with the Company's subsidiary CEI Holdings, Inc., the Company
entered into an agreement with Saudi American Minerals, Inc. whereby, among
other things: (i) the parties terminated that certain Agreement and Plan of
Acquisition and Merger dated May 30, 2003 and all subsequent amendments to such
agreement; and (ii) the Company agreed to pay $750,000 cash and issue 3,000,000
shares of common stock to Saudi American Minerals, Inc. in exchange for the
assignment by Saudi American Minerals, Inc. of a 25% interest in its patented
clean coal technology (Patent No. 6,447,559) including any subsequent
improvements thereto; and
(h) the Company entered into a consulting agreement with RC Financial
Group, LLC, pursuant to which Robert Chmiel was retained as a non-exclusive
financial advisor for a term of 24 months in exchange for the following
compensation: (i) $17,500 each month from January 1, 2006 through June 30, 2006;
(ii) $12,500 each month thereafter; and (iii) issuance of a warrant to purchase
150,000 shares of common stock with an exercise price of $0.90 per share and an
expiration date of December 31, 2011.
Bank Notes
On October 27, 2005, the Company borrowed $329,190 from Community Trust
Bank, Pikeville, KY to purchase mining equipment. The note had a maturity date
of January 27, 2006 and an annual interest rate of the Prime Rate plus one
percent (1%), calculated on the basis of an assumed 360-day year for the actual
number of days elapsed. The note plus all accrued interest was paid in full on
January 20, 2006.
F-11
CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
Convertible Debentures
The Company has issued a total of $707,959 in convertible debentures, which
are convertible into shares of the Company's common stock at 60% to 70% of the
asking price quoted on the OTCBB on the date of conversion. .
The Company's notes payable at March 31, 2006 consisted of the following:
Amount Due at
March 31,
Promissory Notes 2006
- ------------------------------------------------------------------------------------------------ -------------------
Senior secured convertible Note dated February 14, 2005; interest rate of 6% per annum from $ 7,000,000
original issue. Interest due semi-annually with six month anniversary date. Principal and
interest can be converted into shares of the Company's common stock at $0.90 per share.
Principal due 36 months from the date of issue.
Senior secured convertible Note dated June 30, 2005; interest rate of 6% per
annum from original issue. Interest due semi-annually with six month
anniversary date. Principal and interest can be converted into shares of the
Company's common stock at $0.90per share.
Principal due 36 months from the date of issue. 6,750,000
Senior secured convertible note dated January 13, 2006; interest rate of 8%. Principal and
interest are due monthly commencing with June 30, 2006. Principal and interest can be
converted into shares of the company's common stock at $0.90 per share. 6,239,932
Senior secured non-convertible promissory note dated January 13, 2006; Interest rate of 3%
per annum compounded annually with principal and interest due upon final maturity date of
June 30, 2008. 2,640,000
Bank Note Dated June 25, 2005; Interest rate 5.99% payable monthly 14,100
Bank Note Dated July 15, 2005; Interest rate 5.0%, payable monthly 27,358
Bank Note Dated June 25, 2005; Interest rate of 5.99%, payable monthly 27,614
Bank Note Dated June 25, 2005; Interest rate of 5.99%, payable monthly 28,202
-------------------
TOTAL PROMISSORY NOTES $ 22,727,206
Less: debt discount (19,377,968)
Less: current portion of notes payable (126,025)
-------------------
TOTAL LONG-TERM PORTION OF PROMISSORY NOTES $ 3,223,213
- ------------------------------------------------------------------------------------------------ -------------------
3. Equity Transactions
Issuance of Stock upon the Conversion of Notes Payable and Accrued Interest
During the first quarter of 2005, the Company issued 29,348 shares of
common stock upon the conversion debt principal and interest totaling $53,884.
During the second quarter of 2005, the Company issued 29,330 shares of common
stock upon the conversion of debt principal and interest totaling $52,529.
Issuance of Stock Pursuant to the Exercise of Warrants
In January 2005, the Company issued warrants for the purchase of an
aggregate of 51,470 shares of the Company's common stock with a term of five
years and an exercise price of $1.70 per share to Stonegate Securities, Inc., as
additional placement agent compensation related to the January 2005 bridge
financing. In February 2005, the Company issued to Stonegate warrants to
purchase 1,110,290 shares of common stock with term of five years and an
exercise price of $1.70 per share as additional compensation for the placement
of the Company's sale of 6% senior secured convertible notes and related
warrants in February 2005 and the exercise of Additional Investment Rights
during 2005. These warrants were exercised on a cashless basis at $4.09, the
price of the stock on the date the holders exercised the warrants, and the
Company thereby issued an aggregate of 652,144 and cancelled warrants to
purchase 509,616 shares.
F-12
CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
In February and March 2006, the Company issued 2,093,306 shares of common
stock and cancelled warrants to purchase 1,208,000 shares of common stock
pursuant to the cashless exercise of warrants. The warrants had an exercise
price between $0.90 and $1.70 per share and were cashlessly exercised between
$2.35 and $3.20, the price of the stock on the date the holders exercised the
warrants.
Issuance of Stock for Services
On March 23, 2005, the Company authorized the issuance of 200,000 shares of
its common stock for services, which were performed during the year that ended
December 31, 2002. The value of the stock issued was $1,010,000, which was the
fair market value quoted in the Over The Counter Electronic Bulletin Board
trading exchange ("OTCBB"), and has been recorded as an expense in the year that
ended December 31, 2004, with a corresponding increase in accrued liabilities.
During 2005, the Company issued 110,000 shares of common stock in exchange
for consulting services valued at $269,976, the fair market value on the OTCBB
on the date the stock was issued.
Issuance of Stock for Mining Lease
In February 2005, the Company issued 2,500,000 shares of its common stock
to Eastern Land Development Company, Inc. and acquired the lease right to mine
an additional approximately 13.0 million tons of recoverable coal in the Alma,
Pond Creek, Coalburg, Taylor, Richardson, and Broas seams. The acquisition was
booked at $4,875,000, the fair market value of the stock on the date issued.
Issuance of Stock for Compensation
On January 3, 2005, the Company issued 550,000 shares of its common stock
to the Officers and Directors for services rendered during the year that ended
December 31, 2004. The Company recognized a $1,072,500 compensation expense
during 2004, which represents the fair market value of the stock on the OTCBB on
the date the stock was issued.
Registration Statement
The Company entered into a Registration Rights Agreement with the investors
in the Company's 6% Senior Secured Convertible Notes described in Note 2. The
Company was required to file a registration statement by April 10, 2005,
registering the resale of the shares of common stock issuable upon conversion of
the 6% Senior Secured Convertible Notes and the common stock issuable upon
exercise of the warrants attached to such 6% Senior Secured Convertible Notes.
The Company also was required to cause such registration statement to be
declared effective by June 24, 2005 (or July 24, 2005 if reviewed by the SEC).
The Company is required to pay the investors liquidated damages equal to 2% of
the purchase price of the securities for each 30 day period (prorated for any
period less than 30 days) that such deadlines are not met. The Company filed the
initial registration statement on May 16, 2005 and the registration statement
has not yet been declared effective. As of January 13, 2006, the Company
incurred $2.64 million in liquidated damages, and the Company paid such damages
by issuing 3% notes on January 13, 2006. As part of the Company's January 13,
2006 private placement described under Note 2, the Company will not incur
further liquidated damages if the registration statement is declared effective
by May 31, 2006. If the Company does not cause the registration statement to be
declared effective by May 31, 2006, it will continue to incur liquidated damages
as described above.
4. Related Party Transactions
Barry Tackett, appointed as a director and CFO in February 2004, was paid a
total of $10,610 for accounting services in fiscal 2005. In January 2005, Mr.
Tackett also received a total of 225,000 shares for consulting services in
fiscal 2004 valued at $438,750. In January 2006, Mr. Tackett resigned as CFO and
agreed to serve as the Company's Controller. The Company currently has an oral
agreement with Mr. Tackett. Mr. Tackett provides services relating to all
aspects of the Company's accounting needs, including payroll services and
general day to day accounting functions.
F-13
CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
Jacobs Risk Management, a risk management consulting company operated as a
sole proprietorship by one of the Company's directors and the Company's
Secretary, Joseph G. Jacobs, provides preventative and ongoing compliance
support to help insure that the Company remains in compliance with all state and
federal regulatory coal mining matters. Through Jacobs Risk Management, Mr.
Jacobs was paid a total of $7,146 in fiscal 2005. In January 2005, Mr. Jacobs
also received 225,000 shares for consulting services in fiscal 2004 valued at
$438,750. The Company currently has an oral agreement with Mr. Jacobs in
connection with Jacobs Risk Management's services. Additionally, the Company
leases its executive offices at 76 George Rd. Betsy Layne, KY from Jacobs Risk
Management. The office is leased for $2,000 per month plus utilities, which
approximates market rates.
During the calendar fourth quarter 2005 and the calendar first quarter of
2006, the Company issued 20,000 shares to RC Financial Group, LLC for consulting
services rendered. As a result, the Company recognized a $25,200 consulting
expense in 2005 and has booked a $10,500 consulting expense in 2006. Robert
Chmiel is the sole owner of RC Financial Group, LLC and is the Company's current
interim chief financial officer.
5. Events Subsequent to March 31, 2006
Accounts Receivable Leveraging Agreement
On April 24, 2006, the Company signed an agreement for a Line of Credit
with Community Trust Bank, Inc., Pikeville, KY pursuant to which the Company may
borrow 80% of its accounts receivable, up to $5 million. The Company will be
required to make monthly payments of interest-only, calculated by multiplying
the then principal balance outstanding by an interest rate determined to be
Prime Rate plus 1%.
Stock Transfer Agent
In early April, 2006, the Company retained InterWest Transfer Co., based in
Salt Lake City, Utah, as its new transfer agent, replacing Pacific Stock
Transfer, which resigned its account as of March 31, 2006.
Coal Deliveries to American Electric Power
On April 18, 2006, the Company commenced delivery coal to American Electric
Power Co. pursuant to its 36-month coal supply contract for wherein the Company
will be supplying 40,000 tons per month to AEP.
Registration Statement on Form SB-2 Filed with the SEC
On April 12, 2006, the Company filed a Registration Statement on Form SB-2,
as amended, with the Securities and Exchange Commission (the "SEC"). The Company
received comments from the SEC on April 26, 2006 and filed a second amendment on
Form SB-2 on May 8, 2006. The Registration Statement is seeking to register
35,081,996 shares of common stock for resale by the selling shareholders. The
shares, once registered, include shares which may be issued pursuant to the
conversion of notes payable and the exercise of stock purchase warrants.
Proxy Statement
On April 24, 2006, the Company filed and subsequently mailed to
shareholders a proxy statement on Schedule 14A with the SEC pursuant to which
the Company will conduct its annual shareholders meeting, tentatively scheduled
to occur on May 25, 2006. At the annual meeting, shareholders will be asked to
consider and act upon the following matters:
1. Elect nine (9) existing directors;
2. Approve an amendment to the Company's Articles of Incorporation to
increase the number of its authorized shares of common stock from
50,000,000 to 100,000,000;
F-14
CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
3. Ratify Killman Murrell & Co., P.C. as the Company's auditors; and
4. Approve the 2006 Stock Award Plan pursuant to which the Company can
issue up to 2,000,000 shares. The Company intends to use the Award
Plan to (a) attract competent directors, executive personnel, and
other employees, (b) aid in the retention of the services of existing
directors, executive personnel, and employees, and (c) provide
incentives to all of such personnel.
The annual meeting was held on May 25, 2006, and all of the four matters
noted above put forth for shareholder vote passed.
Cancellation of the Agreement between Saudi American Minerals Inc. and
the Company
On May 1, 2006, the Company received a letter from Saudi American Minerals
Inc. ("SAMI") informing it that SAMI was exercising its sole right to
immediately terminate the December 30, 2005 agreement between the SAMI and the
Company. The Company accepted SAMI's termination of the agreement, thus
completely eliminating all obligations of SAMI to the Company and/or its
subsidiaries, and reciprocally eliminating any obligations of the Company and/or
its subsidiaries to SAMI.
Cancellation of the Agreement between Kentucky Energy Consultants Inc. and
the Company
On May 1, 2006, the Company received a letter from Kentucky Energy
Consultants Inc. ("KECI") informing it that KECI was canceling the agreement
between KECI and the Company dated July 21, 2003. The Company accepted KECI's
cancellation of the agreement thus completely terminating all future obligations
of KECI to the Company and its subsidiary, Eastern Consolidated Energy, Inc.
("ECEI"), and reciprocally terminating all future obligations of the Company and
ECEI to KECI.
July 12, 2006 Financing
On July 12, 2006 (the "Closing Date"), the Company completed the
transactions contemplated by a Securities Purchase Agreement, effective as of
June 30, 2006 (the "Purchase Agreement"). Under the terms of the Purchase
Agreement, the Company issued to four institutional investors (the "Senior
Investors") $4,444,444 in face amount of Variable Rate Original Issue Discount
Convertible Secured Debentures (the "Secured Debentures") due June 2008. The
Company realized gross proceeds of $4,000,000 from the issuance. The Secured
Debentures bear interest at the annual rate of the higher of 12% or prime rate
plus 4%, and may be convertible into common stock of the Company at a fixed
conversion price of $1.36. The Secured Debentures are secured by a first
priority security interest in equipment to be purchased with the proceeds from
the Secured Debentures (the "Equipment") and a subordinated security interest in
all assets of the Company as well as certain of the Company's real estate
located in Martin County, Kentucky. In addition, the Secured Debentures are
guaranteed by the Company's subsidiaries.
Of the amount raised, $3,750,000 was deposited into a blocked account and
will be released upon the purchase by the Company of the Equipment. The balance
of the funds was deposited into a control account and will be released when the
Company issues one or more widely disseminated press releases reporting that it
has produced and sold at least 70,000 tons of coal during each of three
consecutive calendar months.
F-15
CONSOLIDATED ENERGY, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
On the same date, pursuant to an Unsecured Debt Securities Purchase
Agreement, effective as of June 30, 2006 (the "Unsecured Purchase Agreement,"
together with the Purchase Agreement, the "Agreements"), the Company also issued
to six institutional investors (the "Junior Investors," together with the Senior
Investors, the "Investors") unsecured convertible debentures in the principal
amount of $1,750,000 (the "Unsecured Debentures"). The Unsecured Debentures are
due in July 2008, accrue interest at the annual rate of 15% and may be converted
into shares of common stock at a fixed conversion price of $0.90.
Under the terms of the Agreements, the Company also issued to the Investors
an aggregate of 4,000,000 shares of common stock (the "Investor Shares") and
five-year warrants to purchase up to 5,875,000 shares of the Company's common
stock at $0.01 per share (the "Warrants"). The sale and issuance of all
securities pursuant to the Agreements was exempt from registration requirements
pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Rule 506
promulgated thereunder.
Pursuant to the terms of a registration rights agreement, the Company
agreed to file a registration statement with the Securities and Exchange
Commission (the "Commission") registering the resale of (i) the shares of common
stock issuable upon conversion of the Secured Debentures and the Unsecured
Debentures, (ii) the Investor Shares, and (iii) the shares of common stock
issuable upon the exercise of the Warrants on the earlier of (a) the 60th
calendar day following the Closing Date, or (b) the 20th calendar day following
the date on which the Company's registration statement currently on file with
the Commission is declared effective and cause such registration statement to be
declared effective no later than 60 days after the filing thereof.
In connection with the execution of the Agreements and as a condition to
the completion thereof, the holders of (i) an aggregate of $7,000,000 in
principal amount of the Company's 6% Senior Secured Convertible Notes due 2008
dated February 24, 2005, (ii) an aggregate of $6,750,000 in principal amount of
the Company's 6% Senior Secured Convertible Notes due 2008 dated March 18, 2005,
June 8, 2005 and June 30, 2005, and (iii) an aggregate of $6,239,930 in
principal amount of the Company's 8% Senior Secured Convertible Notes due 2008
dated January 13, 2006 have agreed to subordinate their security interests in
the Company's assets to liens granted to the holders of the Secured Debentures
in the Equipment. They also agreed to waive, until November 30, 2006, certain
penalties due to them and agreed to allow the Company to pay some of the accrued
interest on their existing notes in shares of common stock.
As a further condition to the completion of the Agreements, approximately
$708,000 of outstanding debentures and approximately $497,000 of accrued
salaries were converted into shares of common stock at a $0.90 conversion price.
In connection with the transactions contemplated under the Agreement, the
Company paid (i) a placement agent fee of $140,000 in cash and issued five-year
warrants to purchase 400,000 shares of common stock at $0.01 per share to
Ascendiant Securities, LLC, and (ii) a placement agent fee of $262,500 in cash
and issued five-year warrants to purchase 100,000 shares of common stock at
$0.01 per share to Stonegate Securities and its principals Jesse Shelmire and
Scott Griffith, each a director of the Company.
As an inducement to one of the Junior Investors to purchase the Unsecured
Debentures, Messrs. Shelmire and Griffith sold to that Junior Investor Company
securities owned by them, consisting of $300,000 face amount of promissory notes
issued by the Company, warrants to purchase 150,000 of the Company's common
stock, and 300,000 shares of the Company's common stock for a total purchase
price of $300,000.
F-16
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Consolidated Energy, Inc.
Betsy Layne, KY
We have audited the accompanying consolidated balance sheets of Consolidated
Energy, Inc. as of December 31, 2005 and 2004, and the related consolidated
statements of operations, changes in stockholders' equity (deficit) and cash
flows for the years then ended. 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 consolidated financial position of
Consolidated Energy, Inc. as of December 31, 2005 and 2004, and the consolidated
results of its operations and its cash flows for the years then ended in
conformity with United States generally accepted accounting principles.
As discussed in Note 8 to the financial statements, certain errors resulting in
an understatement of previously reported investment in coal leases and
additional paid-in capital as of December 31, 2004, were discovered by
management of the Company during the current year. Accordingly, the amounts
recorded in the 2004 financial statements for coal leases and additional paid-in
capital have been restated to correct the error. Also as discussed in Note 8,
management of the Company determined that the warrants and the shares into which
the senior secured notes can be converted, should be accounted for as
derivatives, with the initial value of the derivative recorded as a liability
and the corresponding debit being recorded as a reduction in the related senior
secured note payable as debt discount and the changes in the fair value of the
derivative liability reported in earnings. Accordingly, the amounts recorded in
the 2005 financial statements for the derivatives have been restated to correct
the error.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 9 to the
consolidated financial statements, the Company has suffered recurring losses
from operations and its limited capital resources raise substantial doubt about
its ability to continue as a going concern. Management's plans in regard to
these matters are described in Note 9. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
/s/Killman, Murrell & Company, P.C.
- -----------------------------------------
KILLMAN, MURRELL & COMPANY, P.C.
March 29, 2006, except for Note 8, as to
which the date is August 10, 2006
Houston, Texas
F-17
CONSOLIDATED ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2005 2004
------------------ --------------------
ASSETS (Restated) (Restated)
CURRENT ASSETS
Cash $ 1,031 $ 4,392
Accounts Receivable 1,754 -
Accounts Receivable - Other 71,417 75,000
Prepaid Expenses 7,754 400
------------------ --------------------
TOTAL CURRENT ASSETS
81,956 79,792
------------------ --------------------
BUILDING, EQUIPMENT AND COAL LEASES
Building and Equipment, Net of $791,027 and $246,306 Depreciation 11,073,058
at December 31, 2005 and 2004 respectively 1,515,677
Coal Leases, Net of $17,829 and $15,000 Amortization at December 15,157,721 1,182,457
31, 2005 and 2004 respectively
------------------ --------------------
TOTAL BUILDING, EQUIPMENT AND COAL LEASES, NET 26,230,779 2,698,134
------------------ --------------------
OTHER ASSETS
Restricted Cash 70,800 49,900
Prepaid Royalty 70,857 11,666
Other Assets 55,800 32,500
------------------ --------------------
TOTAL OTHER ASSETS
197,457 94,066
------------------ --------------------
TOTAL ASSETS $ 26,510,192 $ 2,871,992
================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Cash Overdrafts $ 23,532 $ 400,623
Accounts Payable 1,453,350 426,427
6,917,796
Accrued Liabilities 2,550,574
Royalties Payable 476,638 369,374
Notes Payable 2,172,191 182,737
Convertible Debentures 707,959 588,010
Current Portion of Capital Lease 1,295,322 -
Derivative liability - warrants 3,551,471 -
Derivative liability - convertible shares 7,602,941 -
Payable to Related Parties 590,659 1,220,245
------------------ --------------------
TOTAL CURRENT LIABILITIES 24,791,859
5,737,990
------------------ --------------------
LONG TERM LIABILITIES
Deferred Royalties Payable 157,541 168,962
Asset Retirement Obligation 34,629 -
1,478,931
Long Term Note Payable -
------------------ --------------------
TOTAL LONG-TERM LIABILITIES 1,671,101
168,962
------------------ --------------------
STOCKHOLDERS' EQUITY (DEFICIT)
Common Stock, $0.001 Par Value, 50,000,000 Shares Authorized;
14,823,246 and 10,327,428 shares issued and outstanding at
December 31, 2005 and 2004 respectively 14,824 10,327
14,266,314
Additional Paid-In-Capital 4,770,335
Retained Deficit (14,233,906) (7,815,622)
------------------ --------------------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) 47,232 (3,034,960)
------------------ --------------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT) $ 26,510,192 $ 2,871,992
------------------ --------------------
The accompanying notes are an integral part of these consolidated
financial statements.
F-18
CONSOLIDATED ENERGY, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
Years Ended December 31,
2005 2004
------------------ --------------------
REVENUES
Coal Sales $ 2,048,152 $ 2,746,983
Other income 4,596 -
------------------ --------------------
TOTAL REVENUES 2,052,748 2,746,983
------------------ --------------------
EXPENSES
Cost of Revenue, Excluding
Depreciation of mine equipment of $681,833 and $256,880 and
Amortization of coal leases of $2,879 and $8,514 for the year ended
December
31, 2005 and 2004, respectively 3,267,578 3,727,162
Operating Expenses 3,105,265 4,205,518
Liquidated Damages 2,520,833 -
Depreciation and Amortization 684,712 265,394
------------------ --------------------
TOTAL COSTS AND EXPENSES 9,578,388 8,198,074
------------------ --------------------
OTHER INCOME (EXPENSE)
Interest Income 15,922 -
Loss on Sale of Assets (63,667) (83,861)
Change in fair value of convertible share
liability 2,464,707 -
Change in fair value of warrant liability (1,137,498) -
Interest Expense net of $4,714,961
capitalized interest in 2005 (172,108) (878,948)
------------------ --------------------
TOTAL OTHER INCOME (EXPENSE) 1,107,356 (962,809)
------------------ --------------------
LOSS BEFORE INCOME TAXES (6,418,284) (6,413,900)
------------------ --------------------
PROVISION FOR INCOME TAXES - -
------------------ --------------------
NET LOSS $ (6,418,284) $ 6,413,900)
================== ====================
BASIC AND DILUTED NET (LOSS) PER
COMMON SHARE $ (0.46) $ (0.67)
================== ====================
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES
Basic and Diluted 13,934,322 9,529,560
================== ====================
The accompanying notes are an integral part of these consolidated
financial statements.
F-19
CONSOLIDATED ENERGY, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
Years Ended December 31,
2005 2004
------------------- ------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Loss $ (6,418,284) $ (6,413,900)
Adjustments to reconcile net loss to net cash provided by operating
activities
Depreciation and Amortization 684,712 265,394
Stock Issued for Services 269,976 1,254,499
Interest Due to Beneficial Conversion Feature - 485,001
Change in fair value of warrant and convertible share liabilities (1,327,209) -
Loss on Sale of Assets 63,667 83,861
Changes in Operating assets and Liabilities
Prepaid Expenses (7,354) 18,741
Accounts Receivable 1,829 -
Prepaid Royalties (59,191) 32,446
Other Assets (23,300) 12,304
Cash Overdrafts (377,091) 343,739
Accounts Payable 1,026,923 85,731
Accrued Liabilities 3,601,847 2,509,370
Royalties Payable 107,264 303,602
Deferred Royalties Payable (11,421) 185,948
Purchase of Restricted Cash (20,900) (49,900)
------------------- ------------------
NET CASH USED BY OPERATING ACTIVITIES (2,488,532) (883,164)
------------------- ------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of Equipment (4,856,111) (1,075,132)
Lease Cost Capitalized (7,581,532) -
Proceeds from disposal of Equipment 60,460 -
------------------- ------------------
NET CASH USED BY INVESTING ACTIVITIES (12,377,183) (1,075,132)
------------------- ------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds From Notes Payable 4,529,190 182,737
Proceeds from Secured Notes 13,750,000 -
Proceeds From Convertible Debentures 190,875 325,000
Advances from (Payment) to Related Parties (629,586) 1,173,635
Payments on Capital Leases (379,178) -
Payments on Notes Payable (2,598,947) -
Proceeds From Stock Sales - 275,000
------------------- ------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 14,862,354 1,956,372
------------------- ------------------
NET (DECREASE) INCREASE IN CASH (3,361) (1,924)
CASH BALANCE, BEGINNING OF YEAR 4,392 6,316
------------------- ------------------
CASH BALANCE, END OF YEAR $ 1,031 $ 4,392
=================== ==================
(continued)
The accompanying notes are an integral part of these consolidated
financial statements.
F-20
CONSOLIDATED ENERGY, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(CONTINUED)
Years Ended December 31,
2005 2004
------------------- ------------------
NON-CASH INVESTING AND FINANCING ACTIVITIES
Increase in Accounts Receivable Other $ - $ (75,000)
Reduction in equipment - 589,017
Reduction in note payable - (514,017)
Accrued interest converted to debenture - (82,684)
Convertible debenture from interest addition - 82,684
Accrued Liabilities settled by issuance of common stock (2,082,500) -
Common stock issued for accrued liabilities 750 -
Additional paid-in capital from stock issued 2,081,750 -
Additions to equipment from capital leases (1,674,500) -
Capital leases issued for equipment 1,674,500 -
Common stock issued for debenture conversion 59 1,205
Additional paid-in capital from debenture conversions 106,619 1,084,635
Debenture converted to common stock (100,000) (1,057,000)
Accrued interest converted to common stock (6,678) (28,840)
Leases acquired for stock (5,945,000) (1,085,000)
Common stock issued for leases 2,925 700
Additional paid-in capital from lease acquisitions 5,942,075 1,084,300
Debt Discount acquired on issuance of senior notes 13,450,957 -
Additional derivative liability from issuance of
warrants with senior notes (13,450,957) -
Beneficial conversion feature on issuance of convertible
debentures capitalized as interest cost (127,250) -
Additional paid-in capital from beneficial conversion feature 127,250 -
Amortization of debt discount 1,113,057 -
1,113,057
Amortization of debt discount capitalized as interest cost -
Capitalized mine closure costs (34,629) -
Asset retirement obligation 34,629 -
Equipment acquired by issuance of notes payable (125,777) -
Notes payable issued for equipment 125,777 -
Interest costs capitalized (2,854,554) -
Accrued interest expense capitalized 2,854,554 -
------------------- ------------------
$ 0 $ 0
=================== ==================
Supplemental Cash Flow Disclosures
Interest paid in cash $ 12,653 $ 67,845
=================== ==================
Income Taxes $ - $ -
=================== ==================
The accompanying notes are an integral part of these consolidated
financial statements.
F-21
CONSOLIDATED ENERGY, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
Common Stock Additional Retained
----------------------------- Paid-In Earnings
Shares Par Value Capital (Deficit) Total
------------ ------------ -------------- --------------- -------------
(Restated) (Restated)
Balance January 1, 2004 7,358,000 $ 7,358 $ 558,890 $ (1,401,722) $ (835,474)
Shares Issued for Settlement of
Accrued Liabilities 670,000 670 1,253,829 - 1,254,499
Shares Sold For Cash 394,118 394 274,606 - 275,000
Shares Issued Upon Conversion
of Convertible Debentures and
Accrued Interest 1,205,310 1,205 1,084,635 - 1,085,840
Interest Cost Associated With
Beneficial Conversion Features
of Debentures - - 514,075 - 514,075
Shares Issued for Copley Lease 700,000 700 1,084,300 - 1,085,000
Net Loss - - - (6,413,900) (6,413,900)
------------ ------------ -------------- --------------- -------------
Balance, December 31, 2004 (7,815,622) (3,034,960)
10,327,428 10,327 4,770,335
Shares Issued for Settlement of
Accrued Liabilities 750,000 750 2,081,750 2,082,500
Shares Issued for Consulting Fees 110,000 110 269,866 269,976
Shares Issued In Connection with
Repurchase of 20% Working Interest 425,000 425 1,069,575 1,070,000
Shares Issued for Dempsey Lease 2,500,000 2,500 4,872,500 4,875,000
Shares Issued Upon Conversion
of Convertible Debentures and
Accrued Interest 58,678 59 106,355 106,414
Shares Issued in Connection with
Cashless Exercise of Warrants 652,140 653 (653) -
Additional Paid-in capital from
exercise of warrants 969,336 969,336
Value of Beneficial Conversion Feature
of Debentures 127,250 127,250
Net Loss (6,418,284) (6,418,284)
------------ ------------ -------------- --------------- -------------
Balance, December 31, 2005 14,823,246 $ 14,824 $ 14,266,314 $ (14,233,906) $ 47,232
============ ============ ============== =============== =============
The accompanying notes are an integral part of these consolidated
financial statements.
F-22
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
Business Overview
Consolidated Energy, Inc. (the "Company") was incorporated in Nevada on
December 18, 1996, under the name Barbeque Capital Corp., and engages
principally in the business of mining coal in Eastern Kentucky. The Company's
main business focus is the operation of profitable coal mines and its main
customer is American Electric Power, Co.
The Company ceased operating in the barbeque business after two seasonal
business cycles and began looking for alternative businesses. In early October
2002, the Company entered into an agreement and plan of reincorporation and
merger with Consolidated Energy, Inc., a privately-held Wyoming corporation
which was incorporated for the sole purpose of merging with Barbeque Capital
Corp. On October 4, 2002 the secretary of state Wyoming issued a certificate of
merger acknowledging that Barbeque Capital Corp. (Nevada) had merged into
Consolidated Energy Inc. (Wyoming), which became the surviving entity. On
October 14, 2002, the reincorporation was deemed effective and the Company
affected a change in its domicile from Nevada to Wyoming and changed its name
from Barbeque Capital Corp. to Consolidated Energy, Inc. The Company changed its
corporate name to Consolidated Energy, Inc. in order to better reflect its
changing business operations. Management believed changing domicile to Wyoming
was in the Company's and its shareholders' best interest because Wyoming is one
of the leading coal producing states in the United States and was appropriate
since the business focus changed to coal production. In addition, the new chosen
corporate name Consolidated Energy, Inc. was not available in Nevada. In August
2003, the Company entered the coal mining business by issuing 3,000,000 shares
of its common stock in exchange for all of the issued and outstanding stock of
Eastern Consolidated Energy, Inc., a privately-held Kentucky coal mining
corporation (the "Eastern Reverse Merger").
As part of Eastern Reverse Merger, the Company acquired the lease rights to
mine approximately 4.17 million recoverable tons of proven and probable coal in
the Alma coal seam and other seams above drainage in Martin County, Kentucky. In
December 2004, the Company issued 700,000 shares of its common stock, valued at
approximately $1.1 million, to Eastern Land Development Company, Inc., a
privately-held Kentucky corporation, and acquired the right to mine
approximately 3.74 million recoverable tons of proven and probable coal located
within the Alma, Pond Creek, Coalburg, Taylor, Richardson, and Broas seams above
and below drainage. This lease is commonly referred to as the "Copley Lease". In
February 2005, the Company issued 2,500,000 additional shares of its common
stock, valued at $4.9 million, to Eastern Land Development Company, Inc. and
acquired the right to mine an additional approximately 12.33 million recoverable
tons of proven and probable coal in the Alma, Pond Creek, Coalburg, Taylor,
Richardson, and Broas seams. This lease is commonly referred to as the "Dempsey
Heir Lease". All of the mine seams are sometimes referred herein as the "Martin
County Property". The leases above were acquired from related parties.
1. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying financial statements include the accounts of the Company
and its wholly-owned subsidiaries; Morgan Mining Inc., Warfield Processing Inc.,
CEI Holdings Inc., Consolidated Energy Inc., Eastern Consolidated Oil and Gas
Inc., Eastern Coal Energies Inc. and Eastern Consolidated Energy, Inc. All
inter-company transactions and balances have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States requires management to make
estimates and assumptions that materially affect the amounts reported in the
financial statements and accompanying notes. Actual results could materially
differ from those estimates.
F-23
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
Revenue Recognition
Under SEC Staff Accounting Bulletin No. 104, "Revenue Recognition," the
Company recognizes revenue when all of the following criteria are met: (1)
persuasive evidence of an arrangement exists, (2) delivery has occurred or
services have been rendered, (3) the seller's price to the buyer is fixed or
determinable, and (4) collectibility is reasonably assured.
Mined Coal. In the case of coal mined and sold, the Company negotiates a
specific sales contract with each customer, which includes a fixed price per
ton, a delivery schedule, and terms for payment. The Company recognizes revenue
from sales made pursuant to these contracts at the time of delivery.
Accounts Receivable. Unless cash is paid in advance, accounts receivable
are recorded as revenue is earned and are evaluated for collectibility on a
continual basis. Allowances, if necessary, are provided for potentially
uncollectible accounts based on management's estimate of the collectibility of
customer accounts. If the financial condition of a customer were to deteriorate,
resulting in an impairment of its ability to make payments, an additional
allowance may be required. Allowance adjustments, if any, are charged to
operations in the period in which the facts that give rise to the adjustments
become known. To date, the Company has not had any customer whose payment was
considered past due, and as such, has not recorded any reserves for doubtful
collectibility.
Cost of Mining Operations and Selling Expenses
Cost of mining operations and selling expenses consists primarily of direct
compensation and benefits costs for miners, as well as direct costs such as
equipment leases and maintenance, payments to third parties for coal purchases,
parts and supplies, blasting, fuel, parts, hauling costs, royalties and taxes,
and commissions paid to third party brokers.
Exploration Costs
Costs related to locating coal deposits and determining the economic
mineability of such deposits are expensed as incurred.
Reclamation and Asset Retirement Obligations
The Surface Mining Control and Reclamation Act of 1977 and similar state
statutes require that mine properties be restored in accordance with specified
standards and an approved reclamation plan. Significant reclamation activities
include reclaiming refuse and slurry ponds, reclaiming the pit and support
acreage at surface mines, and sealing portals at deep mines. Reclamation
activities that are performed outside of the normal mining process are accounted
for as asset retirement obligations in accordance with the provisions of
Statement of Financial Accounting Standards, or SFAS, No. 143, "Accounting For
Asset Retirement Obligations". The Company records its reclamation obligations
on a mine-by-mine basis based upon current permit requirements and estimated
reclamation obligations for such mines as determined by the U.S. Department of
the Interior, Office of Surface Mining ("OSM") when a predetermined amount of
reclamation bonds are posted prior to commencing mining operations. The OSM's
estimates of disturbed acreage are determined based on approved mining plans and
related engineering data. Cost estimates are based upon estimates approved by
OSM based on historical costs. In accordance with SFAS No. 143, the Company
determines the fair value of its asset retirement obligation ("ARO") using a
discounted cash flow methodology based on a discount rate related to U.S.
treasury bonds with maturities similar to the expected life of a mine, adjusted
for the Company's credit standing.
On at least an annual basis, the Company reviews its entire reclamation
liability and makes necessary adjustments for permit changes granted by state
authorities, additional costs resulting from accelerated mine closures, and
revisions to cost estimates and productivity assumptions, to reflect current
experience. At December 31, 2005, the Company had recorded asset retirement
obligation liabilities of approximately $34,629. While the precise amount of
these future costs cannot be determined with certainty, as of December 31, 2005,
the Company estimates that the aggregate undiscounted cost of final mine closure
is approximately $60,000.
F-24
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
SFAS No. 143 requires recognition of expenses for eventual reclamation of
disturbed acreage remaining after mining production has been completed. A
liability is recorded for the present value of reclamation and mine closing
costs with a corresponding increase in the asset carrying value of coal and
mineral rights at the time a mine is permitted and commences operations. The ARO
asset is amortized proportionate to the estimated total tonnage mined and the
ARO liability is accreted to its present value based on the projected spending
date.
Beneficial Conversion Feature of Convertible Debentures
In accordance with Emerging Issues Task Force No. 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios," and No. 00-27, "Application of Issue No. 98-5 to
Certain Convertible Instruments," the Company recognizes the value of conversion
rights of convertible debt instruments. These rights give the instrument holder
the immediate ability to convert debt into common stock at a price per share
that is less than the trading price of the common stock to the public. The
beneficial conversion value is calculated based on the market price of the stock
at the commitment date in excess of the conversion rate of the debt and related
accruing interest and is recorded as a discount to the related debt and an
addition to Additional Paid-in Capital. The debt discount is amortized and
recorded as interest expense over the remaining outstanding period of related
debt.
During 2005 and 2004, the Company recorded beneficial conversion debt
discount associated with the convertible debentures of $127,250 and $514,075
respectively.
Convertible Debt Issued with Warrants
Convertible Debt Issued with Warrants Accounted for as Derivative Financial
Instruments. In accordance with Emerging Issues Task Force No. 00-19,
"Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company's Own Stock", we recognize the value of convertible debt
issued with warrants as a derivative financial instrument. Our senior secured
convertible debt was accounted for as an embedded derivative and valued on the
transaction date using a Binomial Lattice pricing model. The warrants were
accounted for separately and also as a derivative and were valued on the
transaction date using a Binomial Lattice pricing model also in accordance with
EITF 00-19. At every reporting balance sheet date, the values of the derivatives
are evaluated and any change to fair market value is recorded as a gain or loss
in our statement of operations. The notice conversion feature and the warrants
may be exercised at any time and, therefore, have been reported as current
liabilities.
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 Statement of Financial Standards ("SFAS") No. 130, "Reporting
Comprehensive Income."
Segment Reporting
In June 1997, SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information," was issued. 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 management in
deciding how to allocate resources and assess performance. During the periods
presented, the Company had one operating segment, coal mining, however the
Company did recognize $4,596 of other income during the twelve months ended
December 31, 2005 pursuant to receipts from oil & gas sales. The Company did not
invest any financial capital towards the advancement of its oil & gas interests
during 2004 and 2005, and does not intend to invest any financial or human
capital for the foreseeable future, and as such has not classified its oil & gas
interests as an operating segment.
Cash and Cash Equivalents
Cash and cash equivalents are stated at cost. Cash equivalents consist of
all highly liquid investments with maturities of three months or less when
acquired.
F-25
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
Inventory
Inventory consists of extracted coal that is both available for delivery to
customers, as well as extracted coal which has been removed from the ground but
not yet processed through a wash plant. Coal inventory is valued at the lower of
average cost or market. Coal inventory costs include labor and benefits, and all
expenditures directly related to the removal of coal. At December 31, 2005 and
2004, the Company did not have any coal inventory.
Building, Equipment and Coal Leases
Property and equipment are stated at cost. Expenditures for significant
renewals and improvements that extend estimated lives are capitalized.
Replacements costs, and maintenance and repairs which do not improve or extend
the life of the respective asset, are expensed as incurred. The Company removes
the cost and the related accumulated depreciation from the accounts for assets
sold or retired, and the resulting gains or losses are included in the results
of operations.
Leased property and equipment meeting certain criteria is capitalized and
the present value of the related lease payments is recorded as a liability.
During 2005, the Company continued construction on one coal processing
facility costing a total of approximately $6,300,000. Since the construction
project is not complete, the Company has not yet begun to depreciate this asset.
Depreciation is provided using the straight-line method over the estimated
useful lives or lease life of the assets, ranging from five to ten years.
Depreciation expense recorded for 2005 and 2004 was approximately $681,883 and
$256,880 respectively.
The following chart lists the Company's major depreciable assets along
with accumulated depreciation amounts at December 31, 2005 and 2004:
December, 31
2005 2004
----------------- ---------------
Automobiles $ 189,693 $ 15,000
39,269
Buildings 38,098
Mine Equipment 11,636,294 1,678,431
----------------- ---------------
Total Building and Equipment $ 11,864,085 $ 1,732,700
Less: Total Accumulated Depreciation 791,027 217,023
----------------- ---------------
Net Building and Equipment $ 11,073,058 $ 1,515,677
================= ===============
Coal and Mineral Rights
Significant expenditures incurred to acquire coal and mineral rights are
capitalized at cost. These costs represent the investment in mineral rights,
including capitalized mine development costs, which are costs incurred in
preparation of opening a mine. Amortization is computed using the units of
production method based on total proven and probable reserves on a mine-by-mine
basis.
Loan Acquisition
Loan acquisition costs related to notes payable are amortized over the life
of the debt using the interest method.
F-26
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
Asset Impairment
If facts and circumstances suggest that a long-lived asset may be impaired,
the carrying value is reviewed. If this review indicates that the value of the
asset will not be recoverable, as determined based on projected undiscounted
cash flows related to the asset over its remaining life, then the carrying value
of the asset is reduced to its estimated fair value based on discounted cash
flows.
Fair Value of Financial Instruments
The carrying amounts for cash, accounts receivable, accounts payable and
accrued liabilities approximate fair value because of their immediate or
short-term maturities. The fair value of notes payable approximates fair value
because of the market rate of interest on the debt.
Income Taxes
Deferred income taxes are based on temporary differences between the
financial statement and tax basis of assets and liabilities existing at each
balance sheet date using enacted tax rates for years during which taxes are
expected to be paid or recovered.
Net Loss Per Common Share
The Company computes and presents loss per share in accordance with SFAS
No. 128, "Earnings Per Share". Basic earnings per share are computed based upon
the weighted average number of common shares outstanding during the period.
Warrants and convertible debt representing common shares of 11,217,985 and
471,540 for 2005 and 2004 respectively were excluded from the average number of
common shares outstanding in the calculation because the effect of inclusion
would be anti-dilutive.
Concentration of Credit Risk and Major Customers
SFAS No. 105, "Disclosure of Information about Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk" requires disclosure of significant concentrations of credit risk
regardless of the degree of such risk.
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash and accounts receivable.
Accounts receivable are from purchasers of the Company's coal with payment terms
that typically do not exceed 20 days. The Company routinely performs credit
evaluations of customers purchasing on account and generally does not require
collateral.
The Company maintains the majority of its cash deposits in an international
and a local bank. The deposits are guaranteed by the Federal Deposit Insurance
Corporation ("FDIC") up to $100,000. At December 31, 2005, the Company's
combined cash balance at these banks did not exceed the FDIC insurance limit.
During the twelve months ended December 31, 2005, the Company derived
revenue from three customers, one of which was an electric utility company, and
two of which were coal resellers. The Company derived revenue in excess of
ten-percent (10%) of total coal sales from major customers as follows:
Customer
A B C D
----- ----- ---- -------
Year ended December 31:
2005 41% 45% 13% *
2004 37% 35% * 24% * = Less than 10%.
At December 31, 2005, the Company had two contracts of one year or longer.
The following table summarizes, as of December 31, 2005, the tons of coal that
the Company is committed to deliver at prices determined under existing
long-term contracts, which prices are subject to change pursuant to the terms of
the contracts, during the calendar years 2006 through 2008:
F-27
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
------------- ------------- ---------------
Calendar Year Tons Avg. $/ Ton Dollar Value
------------- ------------- ---------------
2006.............................. 660,000 $53.86 $ 35,547,600
2007.............................. 600,000 $53.40 $ 32,040,000
2008.............................. 120,000 $51.00 $ 6,120,000
------------- ------------- ---------------
Total......................... 1,380,000 $ 53.41 $ 73,707,600
------------------------------------ ============= ============= ---------------
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board, or FASB, issued
SFAS No. 123R "Share-Based Payment," a revision to FASB No. 123. SFAS No. 123R
replaces existing requirements under SFAS No. 123 and APB Opinion No. 25, and
requires public companies to recognize the cost of employee services received in
exchange for equity instruments, based on the grant-date fair value of those
instruments, with limited exceptions. SFAS No. 123R also affects the pattern in
which compensation cost is recognized, the accounting for employee share
purchase plans, and the accounting for income tax effects of share-based payment
transactions. For small business filers, SFAS No. 123R will be effective for
interim periods beginning after December 15, 2005. The Company does not have any
current exposure to SFAS No. 123R however it will apply this accounting
principle if in the future the Company issued stock options to employees.
In December 2004, the FASB issued FASB Statement No. 153. This Statement
addresses the measurement of exchanges of nonmonetary assets. The guidance in
APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the
principle that exchanges of nonmonetary assets should be measured based on the
fair value of the assets exchanged. The guidance in that Opinion, however,
included certain exceptions to that principle. This Statement amends Opinion 29
to eliminate the exception for nonmonetary exchanges of similar productive
assets and replaces it with a general exception for exchanges of nonmonetary
assets that do not have commercial substance. A nonmonetary exchange has
commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. This Statement is effective
for financial statements for fiscal years beginning after June 15, 2005. Earlier
application is permitted for nonmonetary asset exchanges incurred during fiscal
years beginning after the date of this Statement is issued. Management believes
this Statement will have no impact on the financial statements of the Company
once adopted.
2. Lease Commitments
During the first calendar quarter of 2005, the Company entered into a
capital lease agreement with a regional reseller for various mining equipment
with a combined estimated fair value of $1,674,500, which approximates the
present value of the minimum lease payments. Payments are made monthly pursuant
to the lease agreement and amortization is included in depreciation expense.
The Company rents other mining equipment pursuant to an operating lease
agreement, and made lease payments totaling approximately $10,420 and $61,692
during 2004 and 2005 respectively.
A summary of future minimum payments under non-cancelable capital and
operating lease agreements as of December 31, 2005 follows:
Capital Operating
Year Ending December 31, Leases Leases Total
- ----------------------------------------- ------------- ---------------- ---------------
2006 $ 1,295,322 $ 65,803 $ 1,361,125
2007
- 59,495 59,495
------------- ---------------- ---------------
Total Minimum lease payments $ 1,295,322 $ 125,298 $ 1,420,620
============= ================ ===============
F-28
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
The Company has not recorded any imputed interest on its capital leases
payments due to the immateriality of these amounts attributed to the short term
nature of these obligations.
As of December 31, 2005, the cost of equipment held under capital lease was
$1,674,500, and accumulated depreciation on such equipment was $153,496.
3. Notes Payable
The January 2005 Bridge Notes
On January 11, 2005, the Company obtained a $2,500,000 bridge loan (the
"January Bridge Loan") to be used exclusively for the purchase of equipment and
to fund expenditures for the consummation of mining activities at the Company's
Martin County Property. The financing consisted of a senior secured promissory
note for the face amount of $2,500,000 with an interest rate of 9% per annum and
a payment date (principal and interest) of March 31, 2005. Gryphon Master Fund,
LP and GSSF Master Fund, LP, both Bermuda limited partnerships, are collectively
the payees on the note. The note was repaid with the proceeds from the Company's
February 2005 6% senior secured notes.
In consideration for the above bridge financing, the Company paid a
commitment fee of $50,000 to the Gryphon Master Fund and GSSF Master Fund and a
flat fee of $10,000 as reimbursement for fees and expenses incurred in
connection with the negotiation, preparation and delivery of the note, all
deducted from the proceeds of funding the note. As additional consideration, the
Company issued to Gryphon Master Fund and GSSF Master Fund a warrant for the
purchase of an aggregate of 514,706 shares of the Company's common stock at an
exercise price of $1.70 per share, exercisable for five years. The warrant also
contains so-called "piggyback" registration provisions under which the warrant
holder may request that the shares underlying the warrant be included in a
registration with respect to an offering of the Company's securities.
In addition to the above bridge note fees and warrants, the Company paid
Stonegate Securities, Inc., a Texas corporation, which the Company refers to as
Stonegate, a placement agent fee for a total of $200,000 cash and issued
warrants for the purchase of an aggregate of 51,470 shares of the Company's
common stock on the same terms as the warrants issued to Gryphon Master Fund and
GSSF Master Fund. The warrant issuances were in the form of a warrant issued to
Scott R. Griffith and a warrant issued to Jesse B. Shelmire IV, each for the
purchase of 25,735 shares. The cash paid and warrants issued were per the terms
of a non-exclusive Placement Agency Agreement between the Company and Stonegate.
6% Senior Secured Convertible Notes
On February 24, 2005, the Company entered into a financing transaction for
aggregate gross proceeds of $7,000,000, with additional investment rights of up
to an additional $7,000,000, such financing to be used for the purchase of
equipment and to fund expenditures for the consummation of mining activities at
the Company's Warfield Mine. The financing is in the form of 6% senior secured
convertible notes for an aggregate total face amount of $7,000,000 and a term of
three years. The 6% senior secured notes may be converted to common stock at a
conversion price of $1.70 per share. Holders of such notes are Gryphon Master
Fund, L.P., GSSF Master Fund, LP, Lonestar Partners, L.P., WS Opportunity
International Fund, Ltd., WS Opportunity Fund (QP), L.P., WS Opportunity Fund,
L.P., Renaissance US Growth Investment Trust PLC, and BFS US Special
Opportunities Trust PLC. As additional consideration, the Company issued to each
of such holders warrants for the purchase of an aggregate of 2,058,824 shares of
the Company's common stock at an exercise price of $1.70 per share, exercisable
for five years. The conversion price of such notes, and the exercise price of
such warrants, are subject to certain normal and customary anti-dilution
adjustment provisions and also include a one-time reset date provision with a
floor price of $1.00 per share.
F-29
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
In February 2005, simultaneous with the closing of the Company's 6% senior
secured convertible note offering, the Company used approximately $2,527,000 of
the proceeds of the above offering to repay the January 2005 bridge loan
(principal and interest) from Gryphon Master Fund and GSSF Master Fund. The
Company also paid a flat fee of $30,000 to Gryphon Master Fund and GSSF Master
Fund as reimbursement for fees and expenses incurred in connection with the
negotiation, preparation and delivery of the 6% senior secured convertible notes
and related investment documents. In addition to the above fees related to the
issuance of the 6% senior secured convertible notes, the Company paid Stonegate
a total of $340,000 cash and issued warrants for the purchase of an aggregate of
617,647 shares of the Company's common stock on the same terms as the Warrants
issued to the Holders above. The cash fee paid and warrants issued were pursuant
to the terms of a non-exclusive Placement Agency Agreement between the Company
and Stonegate referenced above.
During March 2005, two investors in the Company's February 2005 private
placement exercised their additional investment rights for an aggregate of
$750,000 in 6% senior secured convertible notes that may be convertible into
441,176 shares of the Company's common stock at an exercise price of $1.70 upon
the occurrence of certain events. In connection with the additional investment,
the Company issued warrants for the purchase of 44,116 shares of the Company's
common stock at an exercise price of $1.70 to the placement agent. In April
2005, Stonegate exercised all of the 713,223 warrants issued through a cashless
exercise provision in exchange for the issuance of 485,850 shares of the
Company's common stock. During June 2005, seven investors exercised their
additional investment rights for an aggregate of $6,000,000 in 6% senior secured
convertible notes that may be convertible into 3,529,411 shares of the Company's
common stock at an exercise price of $1.70 upon the occurrence of certain
events. In July, placement agent warrants issued to Stonegate for the purchase
of 352,994 shares issued in connection with the exercise of the additional
investment rights were exercised pursuant to cashless exercise provisions for
the issuance of 166,290 shares.
In connection with the above transaction, the Company executed a security
agreement (the "Security Agreement") giving the Holders a security interest in
and to any and all of the Company's assets and properties ("Collateral" as
defined in the Security Agreement). Each of the Company's subsidiaries has also
executed a Guaranty for the Company's obligations under the Notes.
On July 1, 2005, the Company failed to pay interest as required pursuant
the terms of certain 6% senior secured convertible notes and Additional
Investment Rights first executed on February 24, 2005 for an aggregate total
face amount of $13,750,000 (the "6% Notes"), and thereby caused a default under
the terms of the notes.
The September and November 2005 Bridge Notes
Subsequently, and in order to secure additional financing for continuing
operations, on September 23, 2005, the Company executed a promissory note (the
"September Bridge Note") payable to Cordillera Fund L.P. for an aggregate
principal amount of up to $1,500,000. On November 24, 2005 the existing
September Bridge Note holders and the Company agreed to increase the amount of
debt by $300,000 to a total of $1,800,000. The September Bridge Note was
subsequently cancelled on January 13, 2006 and exchanged for an investment in
the Company's 8% senior secured convertible notes and warrants. See below for a
description of the material terms of this transaction.
In connection with the September Bridge Note, the Company entered into a
Consent and Waiver with the holders of the 6% Notes, whereby they consented to
the September Bridge Note transactions and waived, until resolution of the
September Bridge Note transactions, the application of any of the provisions of
the 6% Notes and related transaction documents. The Company also entered into a
Subordination Agreement in connection with the September Bridge Note, whereby
Cordillera Fund L.P. agreed to subordinate the September Bridge Note to the
prior payment in full in cash of the 6% Notes. In addition, the holders of the
6% Notes entered into a Bridge Forbearance with the Company whereby they agreed
to forebear from exercising any of their rights or remedies under the 6% Notes
and the related securities purchase agreement, security agreement and any other
related transaction documents for a period of ten business days.
F-30
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
On October 6, 2005, the holders of the 6% Notes signed an extension to the
Bridge Forbearance until the earliest to occur of the following: (i) November
18, 2005, (ii) the expiration and termination of the September Bridge Note, or
(iii) the completion by the Company of a new financing. On January 13, 2006, the
6% Note holders signed another forbearance agreement pursuant to which, among
other things, they agreed to waive the Company's prior defaults on the 6% Notes,
and the holders of the $1.8 million bridge notes agreed to cancelled their notes
in exchange for the 8% notes issued in January 2006 - See January 13, 2006
Private Placement below.
Bank Notes
On October 27, 2005, the Company borrowed $329,190 from Community Trust
Bank, Pikeville, KY to purchase mining equipment. The note had a maturity date
of January 27, 2006 and an annual interest rate of the Prime Rate plus one
percent (1%), calculated on the basis of an assumed 360-day year for the actual
number of days elapsed. The note plus all accrued interest was paid in full on
January 20, 2006.
Convertible Debentures
The Company has issued a total of $707,959 in convertible debentures, which
are convertible into shares of the Company's common stock at 60% to 70% of the
asking price quoted on the OTCBB on the date of conversion. Debt discount in the
amount of $127,250 and $514,075 has been recognized during the years ended
December 31, 2005 and 2004, respectively, as the cost of this beneficial
conversion feature. Amortization of the debt discount was $156,324 and $485,001
during the years ended December 31, 2005 and 2004, respectively. The $156,324 in
2005 was capitalized as mine costs.
The Company's notes payable at December 31, 2005 consisted of the
following:
Amount Due at
December 31,
Promissory Notes 2005
- ----------------------------------------------------------------------------------------------- -------------------
Senior secured convertible Note dated February 14, 2005; interest rate of 6% per annum from
original issue. Interest due semi-annually with six month anniversary date. Principal
and interest can be converted into shares of the Company's common stock at $1.70 per
share. Principal due 36 months from the date of issue. $ 7,000,000
Senior secured convertible Note dated June 30, 2005; interest rate of 6% per annum from
original issue. Interest due semi-annually with six month anniversary date. Principal
and interest can be converted into shares of the Company's common stock at $1.70 per 6,750,000
share. Principal due 36 months from the date of issue.
Senior secured note dated September 23, 2005; interest rate of 15% or 1,058,822 shares of the
Company's common stock, at the election of the lender. Principal and interest are due
upon the earliest of January 15, 2006, the first Business Day following Maker's receipt
of $2,500,000 or more in proceeds from its issuance or sale of any promissory note,
capital stock, or other security of an nature, or the occurrence of an Event of Default. 1,800,000
Ninety day Bank Note Dated October 27, 2005; Interest rate - Prime rate + 1% 329,190
Bank Note Dated June 25, 2005; Interest rate 5.99% payable monthly 16,026
Bank Note Dated July 15, 2005; Interest rate 5.0%, payable monthly 31,037
Bank Note Dated June 25, 2005; Interest rate of 5.99%, payable monthly 31,397
Bank Note Dated June 25, 2005; Interest rate of 5.99%, payable monthly 31,106
-------------------
TOTAL PROMISSORY NOTES $ 15,988,756
Less: debt discount (12,337,634)
Less: current portion of notes payable (2,172,191)
-------------------
TOTAL LONG-TERM PORTION OF PROMISSORY NOTES $ 1,478,931
- ----------------------------------------------------------------------------------------------- -------------------
F-31
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
4. Income Taxes
At December 31, 2005, the Company had a net operating loss carry forward of
approximately $17.2 million that may be offset against future taxable income.
These carry forwards are subject to review by the Internal Revenue Service and
begin to expire in 2012.
The Company has fully reserved the approximately $4.43 million tax benefit
of the operating loss carry forward by a valuation allowance of the same amount
because the likelihood of realization of the tax benefit cannot be determined.
There was an increase of approximately $1.24 million in 2005.
Temporary differences between the time of reporting certain items for
financial statement and tax reporting purposes consists primarily of beneficial
conversion feature interest expense, stock-based compensation, depreciation,
depletion and accrued reclamation expenses.
Deferred tax assets (liabilities) are comprised of the following:
December, 31
2005 2004
------------------- ----------------
Net Operating Loss Carryforward $ 3,940,717 $ 2,657,397
Other 39,440 6,800
Derivative gains (losses) 451,251 -
Valuation Allowance (4,431,408) (2,664,197)
------------------- ----------------
Total $ - $ -
=================== ================
The income tax benefit differs from the amount computed at federal statutory
rates of approximately 34% as follows:
For the Years Ended
December, 31
2005 2004
------------------- ----------------
Income tax Benefit at Statutory Rate of 34% $ 2,182,217 $ 2,180,726
5,489
Other 36,245
Derivative gains (losses) (451,251) -
Change in Valuation Allowance (1,767,211) (2,186,215)
------------------- ----------------
Total $ - $ -
=================== ================
F-32
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
Due to the change in ownership provisions of the Tax Reform Act of 1986,
net operating loss carryforwards for Federal income tax reporting purposes are
subject to annual limitations. If a change in ownership should occur, net
operating loss carryforwards may be limited as to use in the future.
5. Equity Transactions
Issuance of stock for cash
During the year ended December 31, 2004, the Company sold 394,118 shares of
its common stock for $275,000 in cash.
Issuance of Stock upon the Conversion of Notes Payable and Accrued Interest
During the year ended December 31, 2004, the Company issued 1,205,310
shares of its common stock upon the conversion of $1,057,000 in debentures and
$28,840 of accrued interest.
During the first quarter of 2005, the Company issued 29,348 shares of
common stock upon the conversion debt principal and interest totaling $53,884.
During the second quarter of 2005, the Company issued 29,330 shares of common
stock upon the conversion of debt principal and interest totaling $52,529.
Issuance of Stock Pursuant to the Exercise of Warrants
During the twelve months ended December 31, 2005, the Company issued
652,140 shares of common stock pursuant to the cashless exercise of warrants to
the placement agent as fees associated with the January 14, and June 30, 2005
senior secured convertible debt.
Issuance of Stock for Services
During the year ended December 31, 2004, the Company issued a total of
670,000 shares of its common stock in exchange for services received. The stock
was valued at $1,254,449, which was approximately the value quoted in the Over
The Counter Electronic Bulletin Board trading exchange ("OTCBB") and was
expensed in the statement of operations.
On March 23, 2005, the Company authorized the issuance of 200,000 shares of
its common stock for services, which were performed during the year that ended
December 31, 2002. The value of the stock issued was $1,010,000, which was the
fair market value quoted in the OTCBB, and has been recorded as an expense in
the year that ended December 31, 2004, with a corresponding increase in accrued
liabilities.
During 2005, the Company issued 110,000 shares of common stock in exchange
for consulting services valued at $269,976, the fair market value on the OTCBB
on the date the stock was issued.
Issuance of Stock for Mining Lease
In 2004, the Company issued 700,000 shares of its common stock to certain
controlling shareholders for the Copley coal lease. The 700,000 shares of stock
were valued at fair market value of $1,085,000, which represents the closing
quoted market value of the stock on the date acquisition date.
In February 2005, the Company issued 2,500,000 shares of its common stock
to Eastern Land Development Company, Inc. and acquired the lease right to mine
an additional approximately 12.33 million recoverable tons of proven and
probable coal in the Alma, Pond Creek, Coalburg, Taylor, Richardson, and Broas
seams. The acquisition was booked at $4,875,000, the fair market value of the
stock on the date issued.
Issuance of Stock for Compensation
On January 3, 2005, the Company issued 550,000 shares of its common stock
to the Officers and Directors for services rendered during the year that ended
December 31, 2004. The Company recognized a $1,072,500 compensation expense
during 2004, which represents the fair market value of the stock on the OTCBB on
the date the stock was issued.
F-33
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
Registration Statement
The Company entered into a Registration Rights Agreement with the investors
in the Company's 6% Senior Secured Convertible Notes described in Note 3. The
Company was required to file a registration statement by April 10, 2005,
registering the resale of the shares of common stock issuable upon conversion of
the 6% Senior Secured Convertible Notes and the common stock issuable upon
exercise of the warrants attached to such 6% Senior Secured Convertible Notes.
The Company also was required to cause such registration statement to be
declared effective by June 24, 2005 (or July 24, 2005 if reviewed by the SEC).
The Company is required to pay the investors liquidated damages equal to 2% of
the purchase price of the securities for each 30 day period (prorated for any
period less than 30 days) that such deadlines are not met. The Company filed the
required registration statement on May 16, 2005 and the registration statement
has not yet been declared effective. As of January 13, 2006, the Company
incurred $2.64 million in liquidated damages, and the Company paid such damages
by issuing 3% notes on January 13, 2006. As part of the Company's January 13,
2006 private placement described under Note 10, the Company will not incur
further liquidated damages if the registration statement is declared effective
by May 31, 2006. If the Company does not cause the registration statement to be
declared effective by May 31, 2006, it will continue to incur liquidated damages
as described above. As of December 31, 2005, the Company had accrued
approximately $2.5 million in liquidated damages, and included these accrued
fees in the Statement of Operations and the accrual is recorded in the Balance
Sheet under Accrued Liabilities.
6. Related Party Transactions
During the year ended December, 31, 2004, the Company issued 700,000 shares
of its common stock to related parties in exchange for the Copley coal lease.
The 700,000 shares of stock were valued at fair market value of $1,085,000,
which represents the closing quoted market value of the stock on the date of
acquisition.
On January 6, 2004, the Company received $275,000 from a related party,
Eastern Consolidated Mining, Inc. ("Mining") as a prepayment for future coal
sales. Mining has a coal sales contract between Mining and a customer. The
Company invoices Mining for coal delivered on a weekly basis. During the year
ended December 31, 2004, $751,450 of coal sales were recorded as a result of
this agreement. At December 31, 2004, payable to a related party includes
$110,450 due Mining, which represents the balance due on the advance payment of
$275,000. Mining is considered a related party due to the fact that during the
time of the transactions, the principals of Mining, when taken as a whole,
beneficially owned more than 10% of the common stock of the Company. Coal sales
receipts were not transferred to the Company, the Company invoiced Mining for
coal shipped to Mining's customer. The Company was reducing its $275,000
obligation to Mining on a per ton basis. When the Company suspended coal
shipments to Mining's customer, $110,450 was the remaining balance due.
Barry Tackett, appointed as a director and CFO in February 2004, was paid a
total of $10,610 for accounting services in fiscal 2005, and $37,509 in fiscal
2004. In January 2005, Mr. Tackett also received a total of 225,000 shares for
consulting services in fiscal 2004 valued at $438,750. In January 2006, Mr.
Tackett resigned as CFO and agreed to serve as the Company's Controller. The
Company currently has an oral agreement with Mr. Tackett. Mr. Tackett provides
services relating to all aspects of the Company's accounting needs, including
payroll services and general day to day accounting functions.
Jacobs Risk Management, a risk management consulting company operated as a
sole proprietorship by one of the Company's directors and the Company's
Secretary, Joseph G. Jacobs, provides preventative and ongoing compliance
support to help insure that the Company remains in compliance with all state and
federal regulatory coal mining matters. Through Jacobs Risk Management, Mr.
Jacobs was paid a total of $7,146 in fiscal 2005, and $25,543 in fiscal 2004. In
January 2005, Mr. Jacobs also received 225,000 shares for consulting services in
fiscal 2004 valued at $438,750. The Company currently has an oral agreement with
Mr. Jacobs in connection with Jacobs Risk Management's services. Additionally,
the Company leases its executive offices in at 76 George Rd. Betsy Layne, KY
from Jacobs Risk Management. The office is leased for $2,000 per month plus
utilities, which approximates market rates.
F-34
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
Clear Focus, Inc., one of the Company's major shareholders, was paid
$15,500 for business and management consulting services in fiscal 2004.
In anticipation of the completion of the Company's planned acquisition, the
Company paid a total $15,000 in patent fees for Saudi American in fiscal 2004.
The Company accrued $162,757 for services through December 31, 2004, and an
additional $15,243 for services in 2005 of Kentucky Energy Consultants.
Principals of Kentucky Energy Consultants are minority shareholders of the
Company and major shareholders of Saudi American.
In 2004, the Company engaged in a series of transactions related to coal
sales with Eastern Consolidated Mining, Inc. Principals of Eastern Consolidated
Mining are minority shareholders of the Company and major shareholders of Saudi
American.
During the calendar fourth quarter 2005 and the calendar first quarter of
2006, the Company issued 20,000 shares to RC Financial Group, LLC for consulting
services rendered. As a result, the Company recognized a $25,200 consulting
expense in 2005 and has booked a $10,500 consulting expense in 2006. Robert
Chmiel is the sole owner of RC Financial Group, LLC and is the Company's current
interim chief financial officer.
7. Asset Retirement Obligations
Since commencing mining activities, the Company has received 2 permits, has
deposited $70,800 in cash with a local bank in the form of a certificate of
deposit, and has provided bank letters of credit for $70,800 for reclamation
bonding with OSM. These letters of credit are secured by certificates of deposit
totaling $70,800.
The following table describes the changes to the Company's asset retirement
obligations for 2005:
2005
---------------
Balance at beginning of period......................... $ --
Accretion expense...................................... 2,859
Additions resulting from property additions............ 70,800
Adjustments and revisions from annual re-costing....... --
Obligations settled.................................... (39,030)
---------------
Balance at December 31................................. 34,629
Current portion included in accrued expenses........... --
---------------
Long-term liability.................................... $ 34,629
===============
8. Restatement of 2004 and 2005 Balances
During the year ended December 31, 2004 the Company issued 700,000 shares
of its common stock to certain controlling shareholders for the Copley coal
lease. The 700,000 shares of stock were valued and originally booked at par
value of $700 which approximated the cost basis of the Copley lease in the hands
of the controlling shareholders. In November 2005, the Company discovered the
error and amended its financial statements to record the 700,000 shares of stock
at fair market value of $1,085,000 which represents the closing quoted market
value of its stock on the date of acquisition. As summarized below, the
restatements only affected the value of certain balance sheet items and
accordingly, did not result in a change to earnings.
F-35
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
The following sets forth the balance sheet items affected by these changes:
As As
Reported Restatement Restated
12/31/2004 Adjustment 12/31/2004
---------------- ---------------- -----------------
Coal Leases, Net of Amortization $ 98,157 $ 1,084,300 $ 1,182,457
Additional Paid-in-Capital $ 3,686,035 $ 1,084,300 $ 4,770,335
Also, on January 3, 2005, the Company issued 2,500,000 shares of its common
stock to certain controlling shareholders for additional coal seams on the
Dempsey Lease. The 2,500,000 shares of stock were valued and originally booked
at par value of $2,500 which approximated the cost basis of the Lease in the
hands of the controlling shareholders. In November 2005, the Company discovered
the error and the correction is reflected in the Company's financial statements
for the fiscal year ended December 31, 2005 which reflect the 2,500,000 shares
of stock at fair market value of $4,875,000 which represents the closing quoted
market value of its stock on the date of acquisition. As summarized below, the
restatements only affected the value of certain balance sheet items and
accordingly, did not result in a change to earnings.
The following sets forth the balance sheet items affected by these changes
for the errors discovered in November 2005:
As As
Reported Restatement Restated
3/31/05 Adjustment 3/31/05
---------------- ---------------- -----------------
Coal Leases, Net of Amortization $ 1,343,226 $ 5,956,800 $ 7,300,026
Additional Paid-in-Capital $ 8,315,536 $ 5,956,800 $ 14,272,336
As As
Reported Restatement Restated
6/30/05 Adjustment 6/30/05
---------------- ---------------- -----------------
Coal Leases, Net of Amortization $ 3,253,462 $ 5,956,800 $ 9,210,262
Additional Paid-in-Capital $ 9,375,487 $ 5,956,800 $ 15,332,287
As As
Reported Restatement Restated
9/30/05 Adjustment 9/30/05
---------------- ---------------- -----------------
Coal Leases, Net of Amortization $ 6,020,708 $ 5,956,800 $ 11,977,508
Additional Paid-in-Capital $ 10,571,052 $ 5,956,800 $ 16,527,852
In July 2006, the Company determined that the warrants issued in
conjunction with the senior secured notes and the shares into which the senior
secured notes can be converted into, should have been accounted for as
derivatives, with the initial fair value of the derivatives being recorded as a
liability and the corresponding debit being recorded as a reduction in the
related senior secured note payable as debt discount. Changes in the fair value
of the derivative from the initial fair value calculation to the balance sheet
date are recorded in earnings.
The following table sets forth the financial statement items affected by
changes to the financial statements caused by recording the warrants issued in
conjunction with the senior secured notes and the shares into which the senior
secured notes can be converted into, as derivatives.
F-36
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
As Reported and
Restated for
the November July 2006
2005 Errors Restatement As Restated
3/31/05 Adjustments 3/31/05
----------------- ----------------- -----------------
Coal leases, net of amortization 7,300,026 (30,245) (5) 7,269,781
Derivative liability warrants (2,493,897) (1)
(12,501,691) (3) (14,995,588)
Derivative liability conversion shares (3,008,824) (2)
(1,276,470) (4) (4,285,294)
Long term notes payable (5,581,735) 3,008,824 (2)
30,245 (5) (2,542,666)
Additional Paid-in-Capital (14,272,336) 2,493,897 (1)
12,090,000 (3) (11,778,439)
Retained deficit 8,446,128 13,778,161 (4) 22,224,289
Changes in fair value derivative liability warrants (12,501,691) (3) (12,501,691)
Changes in fair value derivative liability conversion shares (1,276,470) (4) (1,276,470)
Net Loss (630,605) (13,778,161) (14,408,766)
(1) Represents the initial fair value of the warrant liability. The fair value
was calculated using the Binomial Lattice pricing model with the following
assumptions: (i) risk free interest rate of 3.91%; (ii) expected life of
5.0 years; (iii) expected volatility of 83.24%; (iv) expected dividend
yield of 0.00%; and (v) stock valuation of $4.00.
(2) Represents the initial fair value of the conversion share liability. The
fair value was calculated using the Binomial Lattice pricing model with the
following assumptions: (i) risk free interest rate of 3.67%; (ii) expected
life of 3.0 years; (iii) expected volatility of 83.24%; (iv) expected
dividend yield of 0.00%; and (v) stock valuation of $1.70.
(3) Represents the change in the fair of the warrant derivative liability
between the initial commitment date and March 31, 2005. The fair value was
calculated using the Binomial Lattice pricing model with the following
assumptions: (i) risk free interest rate of 4.18%; (ii) expected life of
4.92 years; (iii) expected volatility of 83.28%; (iv) expected dividend
yield of 0.00%; and (v) stock valuation of $4.95.
(4) Represents the change in the fair of the conversion share derivative
liability between the initial commitment date and March 31, 2005. The fair
value was calculated using the Binomial Lattice pricing model with the
following assumptions: (i) risk free interest rate of 3.96%; (ii) expected
life of 2.92 years; (iii) expected volatility of 83.28%; (iv) expected
dividend yield of 0.00%; and (v) stock trading price of $1.70.
(5) Represents the change in the amortization of the debt discount. During this
period the Company was capitalizing all interest charges.
F-37
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
As Reported and
Restated for
the November July 2006
2005 Errors Restatement As Restated
6/30/05 Adjustments 6/30/05
----------------- ----------------- -----------------
Coal leases, net of amortization 9,210,262 70,447 (5) 9,280,709
Derivative liability warrants (3,383,309) (1)
611,984 (6)
(4,061,027) (3) (6,832,352)
Derivative liability conversion shares (10,067,648) (2)
(2,545,589) (4) (7,522,059)
Long term notes payable (10,500,378) 10,067,648 (2)
(70,447) (5) (503,177)
Additional Paid-in-Capital (15,332,287) 3,383,309 (1)
(611,984) (6) (12,560,962)
Retained deficit 9,800,135 (4,061,027) (3)
2,545,589 (4) 11,315,573
Changes in fair value derivative liability warrants (4,061,027) (3) (4,061,027)
Changes in fair value derivative liability conversion shares 2,545,589 (4) 2,545,589
Net Loss (1,984,513) (1,515,438) (3,499,951)
(1) Represents the initial fair value of the warrant liability. The fair value
was calculated using the Binomial Lattice pricing model with the following
assumptions: (i) risk free interest rate of 3.91%; (ii) expected life of
5.0 years; (iii) expected volatility of 83.24%; (iv) expected dividend
yield of 0.00%; and (v) stock valuation of $4.00.
(2) Represents the initial fair value of the conversion share liability. The
fair value was calculated using the Binomial Lattice pricing model with the
following assumptions: (i) risk free interest rate of 3.67%; (ii) expected
life of 3.0 years; (iii) expected volatility of 83.24%; (iv) expected
dividend yield of 0.00%; and (v) stock valuation of $1.70.
(3) Represents the change in the fair of the warrant derivative liability
between the initial commitment date and June 30, 2005. The fair value was
calculated using the Binomial Lattice pricing model with the following
assumptions: (i) risk free interest rate of 3.72%; (ii) expected life of
2.98 years; (iii) expected volatility of 87.47%; (iv) expected dividend
yield of 0.00%; and (v) stock valuation of $2.98.
(4) Represents the change in the fair of the conversion share derivative
liability between the initial commitment date and June 30, 2005. The fair
value was calculated using the Binomial Lattice pricing model with the
following assumptions: (i) risk free interest rate of 3.67%; (ii) expected
life of 2.67 years; (iii) expected volatility of 87.47%; (iv) expected
dividend yield of 0.00%; and (v) stock valuation of $1.70.
(5) Represents the change in the amortization of the debt discount. During this
period the Company was capitalizing all interest charges.
(6) Represents the value associated with the settlement of 669,118 warrants
through a cashless exercise.
F-38
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
As Reported and
Restated for
the November July 2006
2005 Errors Restatement As Restated
9/30/05 Adjustments 9/30/05
----------------- ----------------- -----------------
Coal leases, net of amortization 11,977,508 385,557 (5) 12,363,065
Derivative liability warrants (3,383,309) (1)
969,336 (6)
(1,909,557) (3) (4,323,530)
Derivative liability conversion shares (10,067,648) (2)
2,950,001 (4) (7,117,647)
Long term notes payable (10,669,221) 10,067,648 (2)
(385,557) (5) (987,130)
Additional Paid-in-Capital (16,527,852) 3,383,309 (1)
(969,336) (6) (14,113,879)
Retained deficit 11,457,704 (1,909,557) (3)
2,950,001 (4) 10,417,260
Changes in fair value derivative liability warrants (1,909,557) (3) (1,909,557)
Changes in fair value derivative liability conversion shares 2,950,001 (4) 2,950,001
Net Loss (3,642,082) (1,040,444) (2,601,638)
(1) Represents the initial fair value of the warrant liability. The fair value
was calculated using the Binomial Lattice pricing model with the following
assumptions: (i) risk free interest rate of 3.91%; (ii) expected life of
5.0 years; (iii) expected volatility of 83.24%; (iv) expected dividend
yield of 0.00%; and (v) stock valuation of $4.00.
(2) Represents the initial fair value of the conversion share liability. The
fair value was calculated using the Binomial Lattice pricing model with the
following assumptions: (i) risk free interest rate of 3.67%; (ii) expected
life of 3.0 years; (iii) expected volatility of 83.24%; (iv) expected
dividend yield of 0.00%; and (v) stock valuation of $1.70.
(3) Represents the change in the fair of the warrant derivative liability
between the initial commitment date and September 30, 2005. The fair value
was calculated using the Binomial Lattice pricing model with the following
assumptions: (i) risk free interest rate of 4.18%; (ii) expected life of
4.42 years; (iii) expected volatility of 84.56%; (iv) expected dividend
yield of 0.00%; and (v) stock valuation of $2.35.
(4) Represents the change in the fair of the conversion share derivative
liability between the initial commitment date and September 30, 2005. The
fair value was calculated using the Binomial Lattice pricing model with the
following assumptions: (i) risk free interest rate of 4.18%; (ii) expected
life of 2.42 years; (iii) expected volatility of 84.56%; (iv) expected
dividend yield of 0.00%; and (v) stock trading price of $1.70.
(5) Represents the change in the amortization of the debt discount. During this
period the Company was capitalizing all interest charges.
(6) Represents the value associated with the settlement of 1,066,176 warrants
through a cashless exercise.
F-39
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
As Reported and
Restated for
the November June 2006
2005 Errors Restatement As Restated
12/30/05 Adjustments 12/30/05
----------------- ----------------- -----------------
Coal leases, net of amortization 14,717,350 440,371 (5) 15,157,721
Derivative liability warrants (3,383,309) (1)
969,336 (6)
(1,137,498) (3) (3,551,471)
Derivative liability conversion shares (10,067,648) (2)
2,464,707 (4) (7,602,941)
Long term notes payable (11,106,208) 10,067,648 (2)
(440,371) (5) (1,478,931)
Additional Paid-in-Capital (16,680,287) 3,383,309 (1)
(969,336) (6) (14,266,314)
Retained deficit 15,561,115 1,137,498 (3)
(2,464,707) (4) 14,233,906
Changes in fair value derivative liability warrants 1,137,498 (3) 1,137,498
Changes in fair value derivative liability conversion shares (2,464,707) (4) (2,464,707)
Net Loss (7,745,493) 1,327,209 (6,418,284)
(1) Represents the initial fair value of the warrant liability. The fair value
was calculated using the Binomial Lattice pricing model with the following
assumptions: (i) risk free interest rate of 3.91%; (ii) expected life of
5.0 years; (iii) expected volatility of 83.24%; (iv) expected dividend
yield of 0.00%; and (v) stock valuation of $4.00.
(2) Represents the initial fair value of the conversion share liability. The
fair value was calculated using the Binomial Lattice pricing model with the
following assumptions: (i) risk free interest rate of 3.67%; (ii) expected
life of 3.0 years; (iii) expected volatility of 83.24%; (iv) expected
dividend yield of 0.00%; and (v) stock valuation of $1.70.
(3) Represents the change in the fair of the warrant derivative liability
between the initial commitment date and December 31, 2005. The fair value
was calculated using the Binomial Lattice pricing model with the following
assumptions: (i) risk free interest rate of 4.35%; (ii) expected life of
4.17 years; (iii) expected volatility of 97.87%; (iv) expected dividend
yield of 0.00%; and (v) stock valuation of $1.90.
(4) Represents the change in the fair of the conversion share derivative
liability between the initial commitment date and December 31, 2005. The
fair value was calculated using the Binomial Lattice pricing model with the
following assumptions: (i) risk free interest rate of 4.41%; (ii) expected
life of 2.17 years; (iii) expected volatility of 97.87%; (iv) expected
dividend yield of 0.00%; and (v) stock trading price of $1.70.
(5) Represents the change in the amortization of the debt discount. During this
period the Company was capitalizing all interest charges.
(6) Represents the value associated with the settlement of 1,066,176 warrants
through a cashless exercise.
F-40
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
9. Going Concern
The Company's consolidated financial statements are prepared using
generally accepted accounting principles applicable to a going concern, which
contemplates the realization of assets and liquidation of liabilities in the
normal course of business. The Company has not established revenues sufficient
to cover its operating costs, thereby raising substantial doubts about its
ability to continue as a going concern. The Company is in the process of raising
additional funds to complete the mine development and cover its overhead costs
until such time as enough revenue is generated to cover all operating costs. If
additional funds are raised through the issuance of equity securities, the
current stockholders may experience dilution. Furthermore, there can be no
assurance that additional financings will be available when needed or that if
available, such financings will include terms favorable to the Company's
stockholders. If such financings are not available when required or are not
available on acceptable terms, the Company may be unable to take advantage of
business opportunities or respond to competitive pressures, any of which could
have a material adverse effect on its business, financial condition and results
of operations.
10. Events Subsequent to December 31, 2005
January 13, 2006 Private Placement
On January 13, 2006, the Company sold approximately $6.24 million principal
amount of 8% senior secured convertible notes due June 30, 2008 to 18 accredited
investors (the "8% Notes"). In connection with the sale of the 8% Notes, the
Company issued investors warrants to purchase an aggregate of approximately 3.3
million shares of common stock, calculated as 50% of each investor's
subscription amount divided by $0.90. Of the $6.24 million principal amount of
8% Notes, the Company received gross proceeds of $3.4 million. The remaining
approximate $2.84 million principal amount was paid by investors as follows: (a)
$1.8 million was paid by the cancellation of the September Bridge Notes; (b)
$102,000 represents a management fee owed to the lead investor, Gryphon Master
Fund, L.P.; (c) $586,000 represents interest accrued on the Company's 6% Notes
and pursuant to certain Additional Investment Rights sold February 24, 2005 and
$352,000 as placement agent fees.
The 8% Notes have a final maturity date of June 30, 2008, accrue interest
at the rate of 8% per annum, are secured by all of the Company's properties and
assets and the properties and assets of each of the Company's subsidiaries, and
are guaranteed by each of the Company's subsidiaries. The 8% Notes rank pari
passu with the Company's outstanding 6% Notes. Interest may be paid either in
cash or with shares of common stock in the Company's sole discretion. Holders of
the 8% Notes have the right to convert the outstanding principal amount into
shares of the Company's common stock from time to time based on a conversion
price of $0.90, subject to adjustment. Beginning July 1, 2006, on the first day
of each month the Company is required to redeem 1/24th of the outstanding
principal of the 8% Notes (the "Monthly Redemption Amount"). If the transaction
is registered on an effective registration statement and certain other
conditions are satisfied, the Company may pay the Monthly Redemption Amount with
shares of common stock based on a conversion price equal to the lesser of (a)
the then conversion price and (b) 80% of the daily volume weighted average price
F-40
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
of the common stock for the 10 consecutive trading days prior to the applicable
monthly redemption date. In the event the Company's annualized EBITDA for the
two fiscal quarters ending December 31, 2006 (the "Annualized EBITDA") is less
than $17 million, the conversion price of the 8% Notes will be reset to equal
the greater of (a) $0.30 or (b) a price determined by the following formula: [3
* X/Y], where X equals the Annualized EBITDA and Y equals the number of shares
of common stock outstanding on a fully diluted basis on December 31, 2006. In
addition, if the Company issues or commits to issue or distribute new securities
at a price per share less than the current market price or the current
conversion price, then the conversion price will be adjusted to reflect such
lower price. The conversion price is also subject to adjustment for stock
dividends, stock splits, stock combinations and similar dilutive transactions.
The warrants issued in connection with the 8% Notes have an exercise price
of $0.90 per share and are exercisable until January 14, 2011. Holders may
exercise the warrants on a cashless basis after the first anniversary of the
initial issuance date and then only in the event that a registration statement
covering the resale of the warrant shares is not then effective. In the event
the Company's annualized EBITDA for the two fiscal quarters ending December 31,
2006 (the "Annualized EBITDA") is less than $17 million, the exercise price of
the warrants will be reset to equal the greater of (a) $0.30 or (b) a price
determined by the following formula: [3 * X/Y], where X equals the Annualized
EBITDA and Y equals the number of shares of common stock outstanding on a fully
diluted basis on December 31, 2006. In addition, if the Company issues or
commits to issue or distribute new securities at a price per share less than the
current market price or the current exercise price, then the exercise price will
be adjusted to reflect such lower price. The exercise price is also subject to
adjustment for stock dividends, stock splits, stock combinations and similar
dilutive transactions.
The investors have agreed to restrict their ability to convert the 8% Notes
and exercise the warrants such that the number of shares of common stock held by
them in the aggregate and their affiliates after such conversion or exercise
does not exceed 4.99% of the Company's then issued and outstanding shares of
common stock.
The Company agreed to file a registration statement with the SEC
registering the resale of the shares of common stock issuable upon conversion of
the 6% Notes and the 8% Notes and related warrants on or before February 12,
2006 and cause such registration statement to be declared effective no later
than May 31, 2006. The Company timely filed such registration statement on
February 13, 2006. If the registration statement is not declared effective by
May 31, 2006, the Company is required to pay investors liquidated damages equal
to 2% of the purchase price of the securities for each 30 day period (prorated
for any period less than 30 days) that such deadline is not met.
Forbearance Agreement
On January 13, 2006, the Company entered into a forbearance agreement with
the holders of the Company's 6% Notes. In connection with the January 13, 2006
private placement described above, holders of the 6% Notes waived certain events
of default (the "Existing Defaults") by the Company including: (a) the Company's
failure to pay accrued but unpaid interest on the 6% Notes when due; (2) the
Company's failure to comply with certain negative and financial covenants of the
securities purchase agreement dated February 22, 2005; (3) the Company's failure
to comply with certain registration requirements of the registration rights
agreement dated February 24, 2005; and (4) the Company's failure to comply with
certain other provisions of the 6% Notes, the February 22, 2005 securities
purchase agreement and the February 24, 2005 registration rights agreement to
the extent that completion of the January 13, 2006 private placement may cause
any processing delay of the Company's prior registration statement (SEC File No.
333-127261) with the SEC.
In connection with the forbearance agreement, the Company agreed to release
and discharge each of the parties thereto and each of their affiliates from any
and all claims that the Company has or ever had against such parties through
January 13, 2006. Solely for the purpose of completing the January 13, 2006
private placement, the parties waived the anti-dilution provisions of the 6%
Notes and the related warrants, any existing rights associated with Additional
Investment Rights and the right to liquidated damages and other remedies under
the February 24, 2005 registration rights agreement. The parties also agreed to
forbear from enforcing certain remedies as a result of the Existing Defaults
through December 30, 2005.
F-41
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
Pursuant to the terms of the forbearance agreement, the following
substantive amendments were made to the February 22, 2005 securities purchase
agreement; the 6% Notes, the related warrants and the February 24, 2005
registration rights agreement:
o The minimum EBITDA financial covenants required by the February 22,
2005 securities purchase agreement through March 31, 2006 were
deleted;
o The maximum capital expenditures required by the February 22, 2005
securities purchase agreement were deleted in their entirety;
o The minimum cash level requirements of the February 22, 2005
securities purchase agreement through June 30, 3006 were deleted;
o The minimum cash level requirement of the February 22, 2005 securities
purchase agreement for the period from July 1, 2006 through September
30, 2006 was changed from $2 million to $1 million;
o The definition of "Conversion Price" in the 6% Notes and "Exercise
Price" in the related warrants was changed from $1.70 to $0.90;
o The interest requirement of the 6% Notes was changed to require
interest payments beginning July 1, 2006;
o A provision was added to the 6% Notes and the related warrants
requiring an adjustment to the conversion price and exercise price in
the event the Company's annualized EBITDA for the two fiscal quarters
ending December 31, 2006 (the "Annualized EBITDA") is less than $17
million. In such event, the conversion price and exercise price will
be reset to equal the greater of (a) $0.30 or (b) a price determined
by the following formula: [3 * X/Y], where X equals the Annualized
EBITDA and Y equals the number of shares of common stock outstanding
on a fully diluted basis on December 31, 2006;
o A provision was added to the 6% Notes and the related warrants
requiring an adjustment to the conversion price and exercise price in
the event the Company issue or commits to issue or distribute new
securities at a price per share less than the current conversion or
exercise price;
o The "Events of Default" provision of the 6% Notes was amended
replacing the event of default for failure to have an effective
registration statement within 270 days of the closing date with an
event of default for failure to have an effective registration
statement within 270 days of the closing date for the January 13, 2006
private placement;
o An event of default was added to the 6% Notes for a breach of any of
the Company's representations, warranties or covenants contained in
any agreement or document executed in connection with the January 13,
2006 private placement; and
o The required filing date and earliest required effectiveness date of
the February 24, 2005 registration rights agreement was changed to
February 12, 2006 and May 31, 2006, respectively.
Notwithstanding the availability of Rule 144, each investor agreed not to
sell, offer or otherwise transfer any shares of the Company's common stock
beneficially owned by them until the earlier of: (a) May 31, 2006 or (b) the
date the required registration statement is declared effective by the SEC.
The parties also entered into an amended and restated security agreement
reflecting the pari passu nature of the 6% Notes with the 8% Notes.
In lieu of cash payment of accrued but unpaid interest due pursuant to the
6% Notes, the Company issued holders notes and warrants pursuant to the terms of
the January 13, 2006 private placement.
In addition, the Company issued non-convertible promissory notes to holders
of the 6% Notes in the aggregate principal amount of $2,640,000 which represents
liquidated damages which had accrued and is payable pursuant to the February 24,
2005 registration rights agreement. The promissory notes bear interest at the
F-42
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
rate of 3% per annum, compounded annually. The full amount of principal and
interest is due on June 30, 2008. The Company's obligations pursuant to the
promissory notes are secured by all of the Company's properties and assets and
the properties and assets of each of the Company's subsidiaries pari passu with
the 6% Notes and 8% Notes.
As additional incentive to enter into the forbearance agreement, the
Company issued to all 6% Note holders additional warrants to purchase an
aggregate of 5,580,065 shares of common stock calculated pursuant to the
following formula: X = [((Y/$0.90) * 0.50) - Z)], where: X = the number of
shares of common stock underlying the warrant certificate; Y = the stated
aggregate principal amount of all 6% Notes; and Z = the number of shares of
common stock underlying all warrants previously issued to such party in
connection with the 6% Notes. The additional warrants issued have identical
terms to the warrants sold by the Company pursuant to the January 13, 2006
private placement.
Other Agreements Executed in Connection with the January 13, 2006 Private
Placement
Also in connection with the January 13, 2006 private placement:
(a) the Company secured a directors and officers liability insurance policy
which provides $10,000,000 of total coverage;
(b) each of the Company's then-current officers and directors entered into
an agreement to vote all shares of common stock owned by them to increase the
Company's authorized shares of common stock from 50 million shares to 100
million shares;
(c) each of the Company's then-current officers and directors entered into
an agreement to vote for Timothy M. Stobaugh, Robert Chmiel, Jesse Shelmire and
Scott Griffith as additional directors and for a fifth additional director
designated by Gryphon Master Fund, L.P. within 60 days of closing;
(d) each of the Company's officers and directors entered into lock-up
agreements agreeing not to offer, sell, contract to sell, pledge or otherwise
dispose of any shares of common stock or other of the Company's equity
securities for the period ending on January 13, 2007;
(e) the Company's subsidiary, Eastern Consolidated Energy, Inc., entered
into an agreement with Kentucky Energy Consultants, Inc. whereby Kentucky Energy
Consultants, Inc. agreed to: (i) change its coal sales commission to 2.5% of the
gross sales price received by Eastern Consolidated Energy, Inc. on any purchase
orders and/or contracts on either spot or contract arrangements, and (ii)
forfeit its coal sales commission of 2.5% of gross revenues less trucking costs
until such time that the Company reach $20 million in aggregate EBITDA
production;
(f) the Company's subsidiary, Eastern Consolidated Energy, Inc., entered
into an agreement with New River Energy Sales Company, Inc. whereby, among other
things, New River Energy Sales Company, Inc. agreed to reduce its coal sales
commission from 5% to 2.5% of gross coal sales until such time that the Company
reach $20 million in aggregate EBITDA production;
(g) together with the Company's subsidiary CEI Holdings, Inc., the Company
entered into an agreement with Saudi American Minerals, Inc. whereby, among
other things: (i) the parties terminated that certain Agreement and Plan of
Acquisition and Merger dated May 30, 2003 and all subsequent amendments to such
agreement; and (ii) the Company agreed to pay $750,000 cash and issue 3,000,000
shares of common stock to Saudi American Minerals, Inc. in exchange for the
assignment by Saudi American Minerals, Inc. of a 25% interest in its patented
clean coal technology (Patent No. 6,447,559) including any subsequent
improvements thereto; and
(h) the Company entered into a consulting agreement with RC Financial
Group, LLC, pursuant to which Robert Chmiel was retained as a non-exclusive
financial advisor for a term of 24 months in exchange for the following
F-43
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
compensation: (i) $17,500 each month from January 1, 2006 through June 30, 2006;
(ii) $12,500 each month thereafter; and (iii) issuance of a warrant to purchase
150,000 shares of common stock with an exercise price of $0.90 per share and an
expiration date of December 31, 2011.
Registration Statement on Form SB-2 Filed with the SEC
On February 13, 2006, the Company filed a Registration Statement on Form
SB-2, as amended, with the Securities and Exchange Commission (the "SEC"). The
Registration Statement was seeking to register 35,636,148 shares of common stock
for resale by the selling shareholders. On March 15, 2006, the Company received
a letter form the SEC, seeking further clarification on 14 items pursuant to the
document filed in February. The Company intends to address the concerns of the
SEC by responding to their letter and filing an amended Registration Statement
before the end of April 2006. The shares, once registered, include shares which
may be issued pursuant to the conversion of notes payable and the exercise of
stock purchase warrants.
Board Appointments
Pursuant to the terms of the January 13, 2006 financing, each of the
Company's then-current officers and directors entered into an agreement to vote
for Timothy M. Stobaugh, Robert Chmiel, Jesse Shelmire and Scott Griffith as
additional directors and for a fifth additional director designated by Gryphon
Master Fund, L.P. within 60 days of closing. As of the date of this filing,
Gryphon Master Fund, L.P. has not made this selection for a fifth director.
Issuance of Common Stock Pursuant to the Cashless Exercise of Warrants
In February and March 2006, the Company issued 2,093,306 shares of common
stock and cancelled warrants to purchase 1,208,000 shares of common stock
pursuant to the cashless exercise of warrants. The warrants had an exercise
price between $0.90 and $1.70 per share and were cashlessly exercised between
$2.35 and $3.20, the price of the stock on the date the holders exercised the
warrants.
Accounts Receivable Leveraging Agreement
In March 2006, the Company entered into a Memorandum of Understanding for a
Line of Credit with Community Trust Bank, Inc., Pikeville, KY pursuant to which
the Company may borrow 80% of its accounts receivable, up to $5 million. The
Company will be required to make monthly payments of interest-only, calculated
by multiplying the then principal balance outstanding by an interest rate
determined to be Prime Rate plus 1%. Approval from all of the Company's
outstanding note holders is required prior to this Line of Credit being
implemented. The Company expects to receive such approval in early April 2006.
Legal Proceeding
In March 2006, the Company engaged outside Kentucky counsel to secure a
temporary restraining order or take other legal means, the purpose of which is
to restrict the Company's stock transfer agent from allowing the transfer and/or
sale of an aggregate of 1,500,000 certain stock certificates which the Company
believes may have been inappropriately issued. The Company intends to fully
explore the transactions and activity related to the certificates in question.
The Company, upon completing its investigation, will respond in accordance to
its findings. If the findings of such investigation result in the cancellation
of these certificates, the registered shares of common stock outstanding shall
be reduced by 1,500,000.
Stock Transfer Agent
In early April, 2006, the Company retained InterWest Transfer Co., based in
Salt Lake City, Utah, as its new transfer agent, replacing Pacific Stock
Transfer, which resigned its account as of March 31, 2006.
F-44
CONSOLIDATED ENERGY, INC.
Notes to Financial Statements
December 31, 2005
July 12, 2006 Financing
On July 12, 2006 (the "Closing Date"), the Company completed the
transactions contemplated by a Securities Purchase Agreement, effective as of
June 30, 2006 (the "Purchase Agreement"). Under the terms of the Purchase
Agreement, the Company issued to four institutional investors (the "Senior
Investors") $4,444,444 in face amount of Variable Rate Original Issue Discount
Convertible Secured Debentures (the "Secured Debentures") due June 2008. The
Company realized gross proceeds of $4,000,000 from the issuance. The Secured
Debentures bear interest at the annual rate of the higher of 12% or prime rate
plus 4%, and may be convertible into common stock of the Company at a fixed
conversion price of $1.36. The Secured Debentures are secured by a first
priority security interest in equipment to be purchased with the proceeds from
the Secured Debentures (the "Equipment") and a subordinated security interest in
all assets of the Company as well as certain of the Company's real estate
located in Martin County, Kentucky. In addition, the Secured Debentures are
guaranteed by the Company's subsidiaries.
Of the amount raised, $3,750,000 was deposited into a blocked account and
will be released upon the purchase by the Company of the Equipment. The balance
of the funds was deposited into a control account and will be released when the
Company issues one or more widely disseminated press releases reporting that it
has produced and sold at least 70,000 tons of coal during each of three
consecutive calendar months.
On the same date, pursuant to an Unsecured Debt Securities Purchase
Agreement, effective as of June 30, 2006 (the "Unsecured Purchase Agreement,"
together with the Purchase Agreement, the "Agreements"), the Company also issued
to six institutional investors (the "Junior Investors," together with the Senior
Investors, the "Investors") unsecured convertible debentures in the principal
amount of $1,750,000 (the "Unsecured Debentures"). The Unsecured Debentures are
due in July 2008, accrue interest at the annual rate of 15% and may be converted
into shares of common stock at a fixed conversion price of $0.90.
Under the terms of the Agreements, the Company also issued to the Investors
an aggregate of 4,000,000 shares of common stock (the "Investor Shares") and
five-year warrants to purchase up to 5,875,000 shares of the Company's common
stock at $0.01 per share (the "Warrants"). The sale and issuance of all
securities pursuant to the Agreements was exempt from registration requirements
pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Rule 506
promulgated thereunder.
Pursuant to the terms of a registration rights agreement, the Company
agreed to file a registration statement with the Securities and Exchange
Commission (the "Commission") registering the resale of (i) the shares of common
stock issuable upon conversion of the Secured Debentures and the Unsecured
Debentures, (ii) the Investor Shares, and (iii) the shares of common stock
issuable upon the exercise of the Warrants on the earlier of (a) the 60th
calendar day following the Closing Date, or (b) the 20th calendar day following
the date on which the Company's registration statement currently on file with
the Commission is declared effective and cause such registration statement to be
declared effective no later than 60 days after the filing thereof.
In connection with the execution of the Agreements and as a condition to
the completion thereof, the holders of (i) an aggregate of $7,000,000 in
principal amount of the Company's 6% Senior Secured Convertible Notes due 2008
dated February 24, 2005, (ii) an aggregate of $6,750,000 in principal amount of
the Company's 6% Senior Secured Convertible Notes due 2008 dated March 18, 2005,
June 8, 2005 and June 30, 2005, and (iii) an aggregate of $6,239,930 in
principal amount of the Company's 8% Senior Secured Convertible Notes due 2008
dated January 13, 2006 have agreed to subordinate their security interests in
the Company's assets to liens granted to the holders of the Secured Debentures
in the Equipment. They also agreed to waive, until November 30, 2006, certain
penalties due to them and agreed to allow the Company to pay some of the accrued
interest on their existing notes in shares of common stock.
As a further condition to the completion of the Agreements, approximately
$708,000 of outstanding debentures and approximately $497,000 of accrued
salaries were converted into shares of common stock at a $0.90 conversion price.
In connection with the transactions contemplated under the Agreement, the
Company paid (i) a placement agent fee of $140,000 in cash and issued five-year
warrants to purchase 400,000 shares of common stock at $0.01 per share to
Ascendiant Securities, LLC, and (ii) a placement agent fee of $262,500 in cash
and issued five-year warrants to purchase 100,000 shares of common stock at
$0.01 per share to Stonegate Securities and its principals Jesse Shelmire and
Scott Griffith, each a director of the Company.
As an inducement to one of the Junior Investors to purchase the Unsecured
Debentures, Messrs. Shelmire and Griffith sold to that Junior Investor Company
securities owned by them, consisting of $300,000 face amount of promissory notes
issued by the Company, warrants to purchase 150,000 of the Company's common
stock, and 300,000 shares of the Company's common stock for a total purchase
price of $300,000.
F-45
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 24. INDEMNIFICATION OF OFFICERS AND DIRECTORS
Wyoming law permits a corporation, under specified circumstances, to
indemnify its directors, officers, employees or agents against expenses
(including attorney's fees), judgments, fines and amounts paid in settlements
actually and reasonably incurred by them in connection with any action, suit or
proceeding brought by third parties by reason of the fact that they were or are
directors, officers, employees or agents of the corporation, if these directors,
officers, employees or agents acted in good faith and in a manner they
reasonably believed to be in or not opposed to the best interests of the
corporation and, with respect to any criminal action or proceedings, had no
reason to believe their conduct was unlawful. In a derivative action, i.e., one
by or in the right of the corporation, indemnification may be made only for
expenses actually and reasonably incurred by directors, officers, employees or
agent in connection with the defense or settlement of an action or suit, and
only with respect to a matter as to which they shall have acted in good faith
and in a manner they reasonably believed to be in or not opposed to the best
interests of the corporation, except that no indemnification shall be made if
such person shall have been adjudged liable to the corporation, unless and only
to the extent that the court in which the action or suit was brought shall
determine upon application that the defendant directors, officers, employees or
agents are fairly and reasonably entitled to indemnify for such expenses despite
such adjudication of liability.
Our Articles of Incorporation provide that, none of our directors shall be
liable to us or our stockholders for damages for breach of fiduciary duty,
unless such breach involves a breach of duty of loyalty, acts or omissions not
in good faith or which involve intentional misconduct or a knowing violation of
law or involve unlawful payment of dividends or unlawful stock purchases or
redemptions, or involves a transaction from which the director derived an
improper personal benefit.
In addition, our by-laws provide that we shall indemnify our officers,
directors and agents to the fullest extent permissible under Wyoming law, and in
conjunction therewith, to procure, at our expense, policies of insurance. In
addition, our by-laws provide that our directors shall have no liability for
monetary damages to the fullest extent permitted under Wyoming law.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to our directors, officers, and controlling persons
pursuant to the foregoing provisions or otherwise, we have been advised that in
the opinion of the Securities Exchange Commission, such indemnification is
against public policy as expressed in the Securities Act of 1933, and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by us of expenses incurred or paid by
our director, officer, or controlling person in the successful defense of any
action, suit or proceeding) is asserted by such director, officer, or
controlling person in connection with the securities being registered hereunder,
we will, unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Securities Act of 1933 and will be governed by the final
adjudication of such issue.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth an estimate of the costs and expenses
payable by Consolidated Energy, Inc. in connection with the offering described
in this registration statement. All of the amounts shown are estimates except
the Securities and Exchange Commission registration fee:
SEC Registration Fee $ 9,102.90
Accounting fees and expenses 10,000.00*
Legal fees and expenses 50,000.00*
Miscellaneous 5,000.00*
-----------
Total $ 74,102.90*
===========
*Estimated
II-1
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES
In March of 2003, a total of 1,515,000 shares of the Company's common stock
were issued for services to various individuals. The stock was valued at
$212,100 which was approximately the value quoted in the Over the Counter
Bulletin Board Exchange ("OTCBB") and was expensed in the statement of
operations. Such issuances were considered exempt from registration by reason of
Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act").
In September and October of 2003, a total of 175,000 shares of common stock
was issued for legal services. The stock was valued at $183,750 (which was
approximately the value quoted in the OTCBB) and was expensed in the statement
of operations. Such issuances were considered exempt from registration by reason
of Section 4(2) of the Securities Act.
During the year ended December 31, 2004, the Company issued a total of
670,000 shares of its common stock in exchange for services received. The stock
was valued at $1,254,449, which was approximately the value quoted in the OTCBB
and was expensed in the statement of operations. Such issuances were considered
exempt from registration by reason of Section 4(2) of the Securities Act.
During the year ended December 31, 2004, the Company sold 394,118 shares of
its common stock for $275,000 in cash. Such issuances were considered exempt
from registration by reason of Section 4(2) of the Securities Act and Rule 506
promulgated under the Securities Act.
The Company issued 1,205,310 shares of it common stock upon the conversion
of $1,057,000 in debentures and $28,840 of accrued interest. Such issuances were
considered exempt from registration by reason of Section 4(2) of the Securities
Act and Rule 506 promulgated under the Securities Act.
In March of 2004, the Company issued 700,000 shares of its common stock to
certain controlling shareholders for an option to lease the Copley Lease for a
term of two years. The 700,000 shares of stock were valued at par value of $700,
which approximated the cost basis of the Copley Lease in the hands of the
shareholders. Such issuances were considered exempt from registration by reason
of Section 4(2) of the Securities Act and/or Rule 506 promulgated under the
Securities Act.
During the quarter ended December 31, 2004, the Company issued a total of
552,819 shares of its restricted common stock for the conversion of outstanding
debentures totaling $542,911 (principal and interest). Such issuances were
considered exempt from registration by reason of Section 4(2) of the Securities
Act and Rule 506 promulgated under the Securities Act. Also during the quarter,
the Company issued 210,000 shares to consultants for services rendered valued at
$378,000. Such issuances were considered exempt from registration by reason of
Section 4(2) of the Securities Act.
In January 2005, the Company issued Stonegate Securities, Inc., warrants
for the purchase of an aggregate of 51,470 shares of its common stock on the
same terms as the warrants issued to Gryphon Master Fund and GSSF Master Fund.
The warrant issuances are in the form of a warrant issued to Scott R. Griffith
and a warrant issued to Jesse B. Shelmire IV, each for the purchase of 25,735
shares. Additionally, in connection with a financing transaction for $2,500,000
in bridge financing, which consisted of a 9% senior secured promissory note, the
Company issued warrants for the purchase of an aggregate of 514,706 shares of
the Company's common stock. Such issuances were considered exempt from
registration by reason of Section 4(2) of the Securities Act.
In February 2005, the Company issued 2,500,000 shares of its restricted
common stock to Eastern Land Development, LLC, a private corporation in exchange
for the acquisition of rights to certain coal reserves in eastern Kentucky. In
connection with such acquisition, the Company issued warrants for the purchase
of an aggregate of 2,058,824 shares of the Company's common stock at an exercise
price of $1.70 per share, exercisable for five years, and 6% senior secured
convertible notes convertible into 4,117,647 shares of the Company's common
stock at conversion price of $1.70 per share upon the occurrence of certain
events, to accredited investors. The Company has also issued warrants for the
purchase of an aggregate of 102,941 shares to Scott R. Griffith and 102,941
shares to Jesse B. Shelmire IV. The securities issued in the foregoing
transaction were issued in reliance on the exemption from registration and
prospectus delivery requirements set forth in Section 3(b) and/or Section 4(2)
of the Securities Act and/or Rule 506 promulgated under the Securities Act and
the regulations promulgated thereunder.
II-2
In March 2005, two investors in the Company's February 2005 private
placement exercised their additional investment rights for an aggregate of
$750,000 in 6% senior secured convertible notes that may be convertible into
441,176 shares of the Company's common stock at an exercise price of $1.70 upon
the occurrence of certain events. In connection with the additional investment,
the Company issued warrants for the purchase of 44,116 shares of its common
stock at an exercise price of $1.70 to the placement agent. Such issuances were
considered exempt from registration by reason of Section 4(2) of the Securities
Act and/or Rule 506 promulgated under the Securities Act.
In April 2005, the placement agent exercised all of the 713,223 warrants
issued to date to the placement agent through a cashless exercise provision in
exchange for the issuance of 485,850 shares of the Company's common stock. Such
issuances were considered exempt from registration by reason of Section 4(2) of
the Securities Act and/or Rule 506 promulgated under the Securities Act.
In June 2005, the Company issued 6% senior secured convertible notes
convertible into an additional 2,794,117.6 shares of the Company's common stock
at conversion price of $1.70 per share upon the occurrence of certain events, to
accredited investors. Such issuances were considered exempt from registration by
reason of Section 4(2) of the Securities Act and Rule 506 promulgated under the
Securities Act.
Additionally, investors in the Company's February 2005 private placement
exercised their additional investment rights for an aggregate of $6,000,000 in
6% senior secured convertible notes that may be convertible into 3,529,942
shares of the Company's common stock at an exercise price of $1.70 upon the
occurrence of certain events. In connection with the additional investment, the
Company issued warrants for the purchase of 352,994 shares of its common stock
at an exercise price of $1.70 to the placement agent. Such issuances were
considered exempt from registration by reason of Section 4(2) of the Securities
Act and/or Rule 506 promulgated under the Securities Act.
Moreover, the Company issued 29,330 shares of its common stock pursuant to
the conversion of an outstanding debenture. The Company also issued to an
aggregate of 40,000 shares of its common stock to two consultants for services
performed during the quarter. Such issuances were considered exempt from
registration by reason of Section 4(2) of the Securities Act and/or Rule 506
promulgated under the Securities Act.
In July 2005, the placement agent exercised all of the remaining warrants
issued to date through a cashless exercise provision in exchange for the
issuance of 166,290 shares of the Company's common stock. This transaction was
considered exempt from registration by reason of Section 4(2) of the Securities
Act and/or Rule 506 promulgated under the Securities Act.
In the second quarter of 2005, the Company approved the issuance of 200,000
shares of its common stock pursuant to a repurchase agreement with the holder of
a 20% working interest in the Warfield Mine. The shares were issued in July
2005. This transaction was considered exempt from registration by reason of
Section 4(2) of the Securities Act and/or Rule 506 promulgated under the
Securities Act.
In the nine months ended September 30, 2005, the Company issued an
aggregate of 58,678 shares of its common stock pursuant to the conversion of
outstanding debentures. The Company also issued to an aggregate of 95,000 shares
of its common stock to consultants for services performed during the period.
These transactions were considered exempt from registration by reason of Section
4(2) of the Securities Act and/or Rule 506 promulgated under the Securities Act.
During the quarter ended December 31, 2005, the Company issued a total of
20,000 shares of its common stock for financial consulting services particularly
related to the Company's financing transactions in the calendar fourth quarter
2005. The Company recognized a $35,700 consulting expense which was the value of
the common stock on the OTCBB on the dates issued. This issuance was considered
exempt from registration by reason of Section 4(2) of the Securities Act.
During the quarter ended March 31, 2006, the Company has issued 3,152,128
shares of common stock: 2,093,306 pursuant to the cashless exercise of warrants,
and 1,058,822 in lieu of cash for interest due to holders of the Company's
September Bridge Loan. These transactions were considered exempt from
registration by reason of Section 4(2) of the Securities Act and/or Rule 506
promulgated under the Securities Act.
II-3
On January 13, 2006, the Company sold approximately $6.24 million principal
amount of 8% senior secured convertible notes due June 30, 2008 to 18 accredited
investors (the "8% Notes"). In connection with the sale of the 8% Notes, the
Company issued investors warrants to purchase an aggregate of approximately 3.3
million shares of common stock, calculated as 50% of each investor's
subscription amount divided by $0.90. Of the $6.24 million principal amount of
8% Notes, the Company received gross proceeds of $3.4 million. The remaining
approximate $2.84 million principal amount was paid by investors as follows: (a)
$1.8 million was paid by the cancellation of the September Bridge Notes; (b)
$102,000 represents a management fee owed to the lead investor, Gryphon Master
Fund, L.P.; (c) $586,000 represents interest accrued on the Company's 6% Notes
and pursuant to certain Additional Investment Rights sold February 24, 2005 and
$352,000 as placement agent fees. The sale and issuance of securities pursuant
to the Securities Purchase Agreement was exempt from registration requirements
pursuant to Section 4(2) of the Securities Act and Rule 506 promulgated
thereunder.
In connection with the sale of 8% senior secured convertible notes and
warrants on January 13, 2006, the Company amended the terms of its 6% senior
secured convertible notes and related warrants changing the conversion and
exercise prices from $1.70 per share to $0.90 per share.
On July 12, 2006, the Company sold to four institutional investors (the
"Senior Investors") $4,444,444 in face amount of 2-year Variable Rate Original
Issue Discount Convertible Secured Debentures which bear interest at the annual
rate of the higher of 12% or prime rate plus 4%, and may be convertible into
common stock of the Company at a fixed conversion price of $1.36 (the "Secured
Debentures"). The Company realized gross proceeds of $4,000,000 from the
issuance of the Secured Debentures. On the same date, the Company also issued to
six institutional investors (the "Junior Investors," together with the Senior
Investors, the "Investors") unsecured convertible 2-year debentures in the
principal amount of $1,750,000 (the "Unsecured Debentures"). The Unsecured
Debentures accrue interest at the annual rate of 15% and may be converted into
shares of common stock at a fixed conversion price of $0.90.
Under the terms of these July 2006 agreements, the Company also issued to
the Investors an aggregate of 4,000,000 shares of common stock and five-year
warrants to purchase up to 5,875,000 shares of the Company's common stock at
$0.01 per share. The sale and issuance of all securities pursuant to these
agreements was exempt from registration requirements pursuant to Section 4(2) of
the Securities Act of 1933, as amended, and Rule 506 promulgated thereunder.
In connection with the July 2006 transactions, the Company paid (i) a
placement agent fee of $140,000 in cash and issued five-year warrants to
purchase 400,000 shares of common stock at $0.01 per share to Ascendiant
Securities, LLC, and (ii) a placement agent fee of $262,500 in cash and issued
five-year warrants to purchase 100,000 shares of common stock at $0.01 per share
to Stonegate Securities and its principals Jesse Shelmire and Scott Griffith,
each a director of the Company.
Except as expressly set forth above, for transactions exempt from
registration under Rule 506, the individuals and entities to whom we issued
securities are unaffiliated with us. For each of such sales, no advertising or
general solicitation was employed in offering the securities. The offerings and
sales were made to a limited number of persons, all of whom were accredited
investors, business associates of ours or our executive officers, and transfer
was restricted by us in accordance with the requirements of the Securities Act.
Each of the above security holders who were not our executive officers
represented that they are accredited and sophisticated investors, that they are
capable of analyzing the merits and risks of their investment, and that they
understand the speculative nature of their investment. Furthermore, all of the
above-referenced persons had access to our Securities and Exchange Commission
filings.
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ITEM 27. EXHIBITS
Exhibit Number
Description
- --------------------------------------------------------------------------------
3.1 Articles of Incorporation of the Company (incorporated by reference to
Exhibit 3.1 to the Company's registration statement on Form SB-2/A (File
No. 333-127261), filed with the SEC on December 16, 2005).
3.2 Certificate of Merger (incorporated by reference to Exhibit 3.2 to the
Company's registration statement on Form SB-2/A (File No. 333-127261),
filed with the SEC on December 16, 2005).
3.3 By-Laws of the Company (incorporated by reference to Exhibit 3.3 to the
Company's registration statement on Form SB-2/A (File No. 333-127261),
filed with the SEC on December 16, 2005).
4.1 Form of Stock Certificate (incorporated by reference to Exhibit 4.1 to
the Company's registration statement on Form SB-2/A (File No.
333-127261), filed with the SEC on December 16, 2005).
4.2 Form of Warrant (incorporated by reference to Exhibit 10.6 to the
Company's Current Report on Form 8-K, filed with the SEC on February 24,
2005).
4.3 Form of 6% Senior Secured Convertible Note (incorporated by reference to
Exhibit 10.3 to the Company's Current Report on Form 8-K, filed with the
SEC on February 24, 2005).
4.4 Form of 8% Senior Secured Convertible Note Due June 30, 2008
(incorporated by reference to Exhibit 4.1 to the Company's Current
Report on Form 8-K, filed with the SEC on January 17, 2006). 4.5 Form of
Warrant Issued January 13, 2006 (incorporated by reference to Exhibit
4.2 to the Company's Current Report on Form 8-K, filed with the SEC on
January 17, 2006).
4.6 Form of Secured Promissory Note Issued January 13, 2006 (incorporated by
reference to Exhibit 4.3 to the Company's Current Report on Form 8-K,
filed with the SEC on January 17, 2006).
4.7 Form Variable Rate Original Issue Discount Convertible Secured
Debentures (incorporated by reference to the Company's Current Report on
Form 8-K, filed with the SEC on July 17, 2006).
4.8 Form of Unsecured Convertible Debenture (incorporated by reference to
the Company's Current Report on Form 8-K, filed with the SEC on July 17,
2006).
4.9 Form of Warrant (incorporated by reference to the Company's Current
Report on Form 8-K, filed with the SEC on July 17, 2006).
5.1 Opinion and Consent of Sichenzia Ross Friedman Ference LLP
10.1 Lease Agreement, dated March 2002, between Eastern Consolidated Energy,
Inc. as Lessee and the Lessors signatory thereto (incorporated by
reference to Exhibit 10.1 to the Company's Annual Report on Form 10-KSB,
filed with the SEC on March 30, 2004).
10.2 Surface Coal Lease Agreement, dated August 12, 2002, between Eastern
Consolidated Energy, Inc. as Lessee and the Lessors signatory thereto
(incorporated by reference to Exhibit 10.2 to the Company's Annual
Report on Form 10-KSB, filed with the SEC on March 30, 2004).
10.3 Lease Agreement, dated October 3, 2003, between Eastern Land
Development, LLC as Lessee and the Lessors signatory thereto
(incorporated by reference to Exhibit 10.3 to the Company's Annual
Report on Form 10-KSB, filed with the SEC on March 30, 2004).
10.4 Sub-Lease Agreement, entered into on October 20, 2003, by and between
Eastern Consolidated Energy, Inc. and Eastern Consolidated Mining, Inc.
(incorporated by reference to Exhibit 10.4 to the Company's Annual
Report on Form 10-KSB, filed with the SEC on March 30, 2004).
10.5 Assignment Agreement, effective April 1, 2003, by and between Eastern
Consolidated Energy, Inc. and James Buchanan (incorporated by reference
to Exhibit 10.5 to the Company's Annual Report on Form 10-KSB, filed
with the SEC on March 30, 2004).
10.6 Lease Assignment entered into and effective July 1, 2003, by and between
Eastern Consolidated Energy, Inc. and Eastern Consolidated Coal Corp
(incorporated by reference to Exhibit 10.6 to the Company's Annual
Report on Form 10-KSB, filed with the SEC on March 30, 2004).
10.7 Coal Sales Agreement entered into July 21, 2003 by and between Eastern
Consolidated Energy, Inc. and Kentucky Energy Consultants, Inc.
(incorporated by reference to Exhibit 10.7 to the Company's Annual
Report on Form 10-KSB, filed with the SEC on March 30, 2004).
10.8 Amendment to Coal Purchase and Sale Agreement (incorporated by reference
to Exhibit 10.15a to the Company's Annual Report on form 10-KSB, filed
with the SEC on April 15, 2005).
II-5
10.9 Option to Lease Agreement, dated October 9, 2003, by and between James
Harris, Ronnie Harris, Gary R. Copley, Luella McDaniel, Romane Conley,
Eula Faye Copley, Howard D. Copley, and Joyce G. Conn, as Lessor and
Eastern Land Development, LLC., as Lessee (incorporated by reference to
Exhibit 10.8 to the Company's Annual Report on Form 10-KSB, filed with
the SEC on March 30, 2004).
10.10 Memorandum of Agreement, dated October 10, 2003, by and between James
Harris and the other Lessors party thereto and Eastern Land Development,
LLC (incorporated by reference to Exhibit 10.9 to the Company's Annual
Report on Form 10-KSB, filed with the SEC on March 30, 2004).
10.11 Assignment of Lease, dated January 12, 2004, between Eastern Land
Development LLC and Eastern Consolidated Energy, Inc. (incorporated by
reference to Exhibit 10.10 to the Company's Annual Report on Form
10-KSB, filed with the SEC on March 30, 2004).
10.12 Lease Agreement, dated October 3, 2003, by and between Eastern Land
Development, LLC as Lessee and the Lessors signatory thereto
(incorporated by reference to Exhibit 10.11 to the Company's Annual
Report on Form 10-KSB, filed with the SEC on March 30, 2004).
10.13 Assignment of Lease, dated as of October 15, 2003, from Eastern Land
Development LLC to Eastern Consolidated Energy, Inc. (incorporated by
reference to Exhibit 10.12 to the Company's Annual Report on Form
10-KSB, filed with the SEC on March 30, 2004).
10.14 Coal Purchase and Sale Agreement entered into as of September 25, 2004
by and between Kentucky Power Company and Eastern Consolidated Energy,
Inc. (incorporated by reference to Exhibit 10.15 to the Company's
Quarterly Report on form 10-QSB, filed with the SEC on November 12,
2004).
10.15 Securities Purchase Agreement (incorporated by reference to Exhibit 10.1
to the Company's Current Report on Form 8-K, filed with the SEC on
February 24, 2005).
10.16 Registration Rights Agreement (incorporated by reference to Exhibit 10.2
to the Company's Current Report on Form 8-K, filed with the SEC on
February 24, 2005).
10.17 Security Agreement (incorporated by reference to Exhibit 10.4 to the
Company's Current Report on Form 8-K, filed with the SEC on February 24,
2005).
10.18 Form of Guaranty (incorporated by reference to Exhibit 10.5 to the
Company's Current Report on Form 8-K, filed with the SEC on February 24,
2005).
10.19 Form of Additional Investment Rights (incorporated by reference to
Exhibit 10.7 to the Company's Current Report on Form 8-K, filed with the
SEC on February 24, 2005).
10.20 Form of Lockup Agreement (incorporated by reference to Exhibit 10.8 to
the Company's Current Report on Form 8-K, filed with the SEC on February
24, 2005).
10.21 Promissory Note dated September 23, 2005 issued to Cordillera Fund L.P.
(incorporated by reference to Exhibit 10.5 to the Company's Current
Report on Form 8-K, filed with the SEC on September 29, 2005).
10.22 Consent and Waiver dated September 23, 2005 (incorporated by reference
to Exhibit 10.6 to the Company's Current Report on Form 8-K, filed with
the SEC on September 29, 2005).
10.23 Bridge Forbearance dated September 23, 2005 (incorporated by reference
to Exhibit 10.7 to the Company's Current Report on Form 8-K, filed with
the SEC on September 29, 2005).
10.24 Subordination Agreement entered into as of September 23, 2005
(incorporated by reference to Exhibit 10.8 to the Company's Current
Report on Form 8-K, filed with the SEC on September 29, 2005).
10.25 Additional Financing Forbearance Agreement entered into as of October 6,
2005 (incorporated by reference to Exhibit 10.71 to the Company's
Current Report on Form 8-K, filed with the SEC on October 13, 2005).
10.26 Securities Purchase Agreement dated January 13, 2006 by and among
Consolidated Energy, Inc. and the investors signatory thereto
(incorporated by reference to Exhibit 10.1 to the Company's Current
Report on Form 8-K, filed with the SEC on January 17, 2006).
10.27 Escrow Agreement dated January 13, 2006 by and between Stonegate
Securities, Inc., Consolidated Energy, Inc. and Signature Bank
(incorporated by reference to Exhibit 10.2 to the Company's Current
Report on Form 8-K, filed with the SEC on January 17, 2006).
10.28 Registration Rights Agreement dated January 13, 2006 by and among
Consolidated Energy, Inc. and the Purchasers signatory thereto
(incorporated by reference to Exhibit 10.3 to the Company's Current
Report on Form 8-K, filed with the SEC on January 17, 2006).
II-6
10.29 Security Agreement dated January 13, 2006 by and among Consolidated
Energy, Inc., Eastern Consolidated Energy, Inc., Eastern Consolidated
Oil and Gas, Inc., CEI Holdings, Inc., Morgan Mining, Inc., Warfield
Processing, Inc., Eastern Coal Energies, Inc. and Gryphon Master Fund,
L.P. (incorporated by reference to Exhibit 10.4 to the Company's Current
Report on Form 8-K, filed with the SEC on January 17, 2006).
10.30 Guaranty dated January 13, 2006 by Eastern Consolidated Energy, Inc.,
Eastern Consolidated Oil and Gas, Inc., CEI Holdings, Inc., Morgan
Mining, Inc., Warfield Processing, Inc. and Eastern Coal Energies, Inc.
(incorporated by reference to Exhibit 10.5 to the Company's Current
Report on Form 8-K, filed with the SEC on January 17, 2006).
10.31 Lock-Up Agreements of Officers and Directors of Consolidated Energy,
Inc. (incorporated by reference to Exhibit 10.6 to the Company's Current
Report on Form 8-K, filed with the SEC on January 17, 2006).
10.32 Director Voting Agreement of Officers and Directors of Consolidated
Energy, Inc. (incorporated by reference to Exhibit 10.7 to the Company's
Current Report on Form 8-K, filed with the SEC on January 17, 2006).
10.33 Charter Amendment Voting Agreement of Officers and Directors of
Consolidated Energy, Inc. (incorporated by reference to Exhibit 10.8 to
the Company's Current Report on Form 8-K, filed with the SEC on January
17, 2006).
10.34 Forbearance Agreement dated January 13, 2006 by and between Consolidated
Energy, Inc. and the noteholders signatory thereto (incorporated by
reference to Exhibit 10.9 to the Company's Current Report on Form 8-K,
filed with the SEC on January 17, 2006).
10.35 Amended and Restated Security Agreement dated January 13, 2006 by and
among Consolidated Energy, Inc., Eastern Consolidated Energy, Inc.,
Eastern Consolidated Oil and Gas, Inc., CEI Holdings, Inc., Morgan
Mining, Inc., Warfield Processing, Inc., Eastern Coal Energies, Inc. and
Gryphon Master Fund, L.P. (incorporated by reference to Exhibit 10.10 to
the Company's Current Report on Form 8-K, filed with the SEC on January
17, 2006).
10.36 Amendment among Eastern Consolidated Energy, Inc. and Kentucky Energy
Consultants, Inc. (incorporated by reference to Exhibit 10.11 to the
Company's Current Report on Form 8-K, filed with the SEC on January 17,
2006).
10.37 Amendment among Eastern Consolidated Energy, Inc. and New River Energy
Sales Company, Inc. (incorporated by reference to Exhibit 10.12 to the
Company's Current Report on Form 8-K, filed with the SEC on January 17,
2006).
10.38 Agreement among Consolidated Energy, Inc., CEI Holdings, Inc. and Saudi
American Minerals, Inc. (incorporated by reference to Exhibit 10.13 to
the Company's Current Report on Form 8-K, filed with the SEC on January
17, 2006).
10.39 Consultant Agreement dated January 1, 2006 by and between Consolidated
Energy, inc. and RC Financial Group, LLC (incorporated by reference to
Exhibit 10.14 to the Company's Current Report on Form 8-K, filed with
the SEC on January 17, 2006).
10.40 Placement Agent Agreement (incorporated by reference to Exhibit 10.4 to
the Company's Current Report on Form 8-K, filed with the SEC on January
14, 2005).
10.41 Amendment to Coal Purchase and Sale Agreement between Kentucky Power
Company and Eastern Consolidated Energy, Inc. dated March 8, 2006
(incorporated by reference to Exhibit 10.28 to the Company's Annual
Report on Form 10-KSB, filed with the SEC on March 31, 2006).
10.42 Cancellation of the agreement between Saudi American Minerals Inc. and
the Company (incorporated by reference to Exhibit 10.5 to the Company's
Quarterly Report on Form 10-QSB, filed with the SEC on May 19, 2006).
II-6
10.43 Cancellation of the agreement between Kentucky Energy Consultants Inc.
and the Company (incorporated by reference to Exhibit 10.5 to the
Company's Quarterly Report on Form 10-QSB, filed with the SEC on May 19,
2006).
10.44 Securities Purchase Agreement dated as of June 30, 2006 by and among
Consolidated Energy, Inc. and the investors signatory thereto
(incorporated by reference to the Company's Current Report on Form 8-K,
filed with the SEC on July 17, 2006).
10.45 Unsecured Debt Securities Purchase Agreement dated as of June 30, 2006
by and among Consolidated Energy, Inc. and the investors signatory
thereto (incorporated by reference to the Company's Current Report on
Form 8-K, filed with the SEC on July 17, 2006).
10.46 Registration Rights Agreement dated as of June 30, 2006 by and among
Consolidated Energy, Inc. and the Purchasers signatory thereto
(incorporated by reference to the Company's Current Report on Form 8-K,
filed with the SEC on July 17, 2006). (incorporated by reference to the
Company's Current Report on Form 8-K, filed with the SEC on July 17,
2006).
10.47 Security Agreement dated as of June 30, 2006 by and among Consolidated
Energy, Inc., and the Senior Investors. (incorporated by reference to
the Company's Current Report on Form 8-K, filed with the SEC on July 17,
2006).
10.48 Subsidiary Guaranty dated as of June 30, 2006 by and among Eastern
Consolidated Energy, Inc., CEI Holdings, Inc., Morgan Mining, Inc.,
Warfield Processing, Inc. and Eastern Coal Energies, Inc. (incorporated
by reference to the Company's Current Report on Form 8-K, filed with the
SEC on July 17, 2006).
10.49 Intercreditor Agreement dated as of June 30, 2006, among Consolidated
Energy, Inc. and the parties listed on the signature page thereto
(incorporated by reference to the Company's Current Report on Form 8-K,
filed with the SEC on July 17, 2006).
10.50 Subordination Agreement dated as of June 30, 2006, among Consolidated
Energy, Inc. and the parties listed on the signature page thereto
(incorporated by reference to the Company's Current Report on Form 8-K,
filed with the SEC on July 17, 2006).
10.51 Blocked Account Agreement dated as of June 30, 2006, by and among
Consolidated Energy, Inc. and Community Trust and Investment Company
(incorporated by reference to the Company's Current Report on Form 8-K,
filed with the SEC on July 17, 2006).
10.52 Control Account Agreement dated as of June 30, 2006, by and among
Consolidated Energy, Inc. Atoll Asset Management, LLC, Community Trust
and Investment Company and the purchasers set forth on the signature
page thereto (incorporated by reference to the Company's Current Report
on Form 8-K, filed with the SEC on July 17, 2006).
16.1 Letter of concurrence from Clyde Bailey, PC (incorporated by reference
to Exhibit 16.1 to the Company's Current Report on Form 8-K, filed with
the SEC on April 5, 2005)
21.1 List of Subsidiaries (incorporated by reference to Exhibit 21.1 to the
Company's registration statement on Form SB-2 (File No. 333-131802),
filed with the SEC on February 13, 2006).
23.1 Consent of Sichenzia Ross Friedman Ference LLP (included in exhibit 5.1)
23.2* Consent of Killman, Murell & Company, P.C.
23.3 Consent of Summit Engineering Inc. (incorporated by reference to Exhibit
21.1 to the Company's registration statement on Form SB-2 (File No.
333-131802), filed with the SEC on February 13, 2006).
___________________________
* Filed herewith
II-7
ITEM 28. UNDERTAKINGS
The undersigned registrant hereby undertakes to:
(1) File, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement to:
(i) Include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933, as amended (the "Securities Act");
(ii) Reflect in the prospectus any facts or events which, individually
or together, represent a fundamental change in the information in the
registration statement. Notwithstanding the foregoing, any increase or decrease
in volume of securities offered (if the total dollar value of the securities
offered would not exceed that which was registered) and any deviation from the
low or high end of the estimated maximum offering range may be reflected in the
form of a prospectus filed with the Commission pursuant to Rule 424(b) under the
Securities Act if, in the aggregate, the changes in volume and price represent
no more than a 20% change in the maximum aggregate offering price set forth in
the "Calculation of Registration Fee" table in the effective registration
statement, and
(iii) Include any additional or changed material information on the plan
of distribution.
(2) For determining liability under the Securities Act, treat each
post-effective amendment as a new registration statement of the securities
offered, and the offering of the securities at that time to be the initial bona
fide offering.
(3) File a post-effective amendment to remove from registration any of the
securities that remain unsold at the end of the offering.
(4) For determining liability of the undersigned small business issuer
under the Securities Act to any purchaser in the initial distribution of the
securities, the undersigned undertakes that in a primary offering of securities
of the undersigned small business issuer pursuant to this registration
statement, regardless of the underwriting method used to sell the securities to
the purchaser, if the securities are offered or sold to such purchaser by means
of any of the following communications, the undersigned small business issuer
will be a seller to the purchaser and will be considered to offer or sell such
securities to such purchaser:
(i) Any preliminary prospectus or prospectus of the undersigned small
business issuer relating to the offering required to be filed pursuant to Rule
424;
(ii) Any free writing prospectus relating to the offering prepared by or
on behalf of the undersigned small business issuer or used or referred to by the
undersigned small business issuer;
(iii) The portion of any other free writing prospectus relating to the
offering containing material information about the undersigned small business
issuer or its securities provided by or on behalf of the undersigned small
business issuer; and
(iv) Any other communication that is an offer in the offering made by
the undersigned small business issuer to the purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities
(other than the payment by the registrant of expenses incurred or paid by a
director, officer or controlling person of the registrant in the successful
defense of any action, suit or proceeding) is asserted by such director, officer
or controlling person in connection with the securities being registered, the
registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of such issue.
II-8
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all the
requirements for filing on Form SB-2 and has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Betsy Layne, State of Kentucky, on this 11 day of
August 2006.
CONSOLIDATED ENERGY, INC.
By:/s/ David Guthrie
---------------------------------------
David Guthrie
President, Principal Executive Officer
and Director
By:/s/ Robert Chmiel
---------------------------------------
Robert Chmiel
Interim Chief Financial Officer, Principal
Accounting Officer and Director
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
Signature Title Date
- --------------------------- --------------------------------- ---------------
/s/ David Guthrie President, Principal Executive
- --------------------------- Officer and Director August 11, 2006
David Guthrie
/s/ Robert Chmiel
- --------------------------- Interim Chief Financial August 11, 2006
Robert Chmiel Officer, Principal Accounting
Officer and Director
/s/ Joseph Jacobs
- --------------------------- Director August 11, 2006
Joseph Jacobs
/s/ Edward Jennings
- --------------------------- Director August 11, 2006
Edward Jennings
/s/ Barry Tackett
- --------------------------- Director August 11, 2006
Barry Tackett
/s/ Timothy M. Stobaugh
- --------------------------- Director August 11, 2006
Timothy M. Stobaugh
/s/ Jesse Shelmire
- --------------------------- Director August 11, 2006
Jesse Shelmire
/s/ Scott Griffith
- --------------------------- Director August 11, 2006
Scott Griffith
- --------------------------- Director August 11, 2006
Carl Baker
II-9