BENZ ENERGY INC.
OFFER TO EXCHANGE
UP TO 354,250 SHARES OF CLASS A, SERIES II CONVERTIBLE
PREFERRED STOCK FOR ANY AND ALL 9% CONVERTIBLE DEBENTURES,
SERIES 1 DUE MARCH 31, 2003
and
OFFER TO SELL
UP TO 121,000 SHARES OF CLASS A, SERIES II CONVERTIBLE PREFERRED STOCK
The Offering will expire at 5:00 p.m., London, England time, on June 30,
1999, unless extended or earlier terminated by the Company.
Benz Energy Inc. (the "Company" or "Benz") hereby offers, upon the terms and
subject to the conditions set forth in this Offering Circular (the "Offering
Circular") and in the related Letter of Transmittal (the "Letter of
Transmittal") and Subscription Agreement ("Subscription Agreement") (which
together constitute the "Offering"), to (a) exchange up to 354,250 shares of
the Company's Class A, Series II Convertible Preferred Stock, par value $1.00
per share (the "Preferred Stock") for up to $27,250,000 aggregate principal
amount of the Company's 9% Convertible Debentures, Series 1 due March 31,
2003 (the "Notes") and (b) sell up to 121,000 shares of Preferred Stock. The
Company will exchange (i) 65 shares of the Preferred Stock for each $5,000
principal amount of the Notes plus $1,500 cash payment tendered ("Option 1")
or (ii) 45 shares of Preferred Stock for each $5,000 principal amount of the
Notes tendered ("Option 2"). The Notes may be offered for exchange in minimum
denominations of $5,000 each and integral multiples thereof. In addition, the
Company has initially agreed to offer up to 121,000 shares of Preferred Stock
for $5,000 for each 55 shares of Preferred Stock purchased, in minimum
purchases of $5,000. As part of the Offering, holders of Notes accepted for
exchange in the Offering will cease to accrue interest under the Notes from
and after March 31, 1999 and instead will accrue dividends under the
Preferred Stock on and after March 31, 1999. The first payment of dividends,
which will be made on September 30, 1999, will be in respect of the period
from (and including) March 31, 1999 to (but excluding) September 30, 1999 and
will equal $4 per $100 nominal amount of the Preferred Stock. Dividends will
be payable in arrears semi-annually on September 30 and March 31 of each
year. The shares of Preferred Stock will have a liquidation preference of
$105 per share.
Pursuant to the terms and subject to the conditions of the Offering, the
Company will accept for exchange any and all Notes validly tendered and not
properly withdrawn prior to 5:00 p.m., London, England time, on June 30, 1999
or, if the Offering is extended, the latest time and date to which it is
extended (the "Expiration Date"). Tenders of Notes pursuant to the Offering
may be withdrawn at any time prior to the Expiration Date unless otherwise
agreed by a holder tendering Notes.
Each share of Preferred Stock will be convertible into shares of the
Company's common stock, par value $0.01 per share (the "Common Stock"), at an
initial conversion price of Cdn. $0.35 (the "Preferred Conversion Price"), as
compared to a conversion price of Cdn. $1.40 for the Notes (the "Note
Conversion Price").
CERTAIN RISKS ARE INHERENT IN AN INVESTMENT IN THE PREFERRED STOCK AND
INVESTORS ARE URGED TO CONSULT WITH A PROFESSIONAL ADVISOR BEFORE INVESTING
IN THE PREFERRED STOCK. THE PREFERRED STOCK AND COMMON STOCK ARE SUBJECT TO A
HIGH DEGREE OF RISK. AN INVESTMENT IN THE PREFERRED STOCK SHOULD BE
CONSIDERED HIGHLY SPECULATIVE. SEE "RISK FACTORS".
The Common Stock is listed on the Vancouver Stock Exchange ("VSE") and traded
under the symbol "BZG". On June 14, 1999, the closing sale price of the
Common Stock on the VSE was Cdn. $0.31. See "Common Stock Price Range and
Dividend Policy."
June 15, 1999
THE OFFERING IS NOT CONDITIONAL UPON A MINIMUM AGGREGATE PRINCIPAL AMOUNT OF
NOTES BEING TENDERED.
NONE OF THE PREFERRED STOCK OFFERED HEREBY OR THE COMMON STOCK ISSUABLE IN
RESPECT OF THE PREFERRED STOCK HAVE BEEN REGISTERED UNDER THE SECURITIES ACT
OF 1933, AS AMENDED (THE "SECURITIES ACT") AND NONE OF SUCH SECURITIES MAY BE
OFFERED, SOLD, TRANSFERRED, PLEDGED, EXCHANGED OR OTHERWISE DISPOSED OF IN
THE UNITED STATES OR TO, OR FOR THE ACCOUNT OR BENEFIT OF, ANY "U.S. PERSON"
(AS DEFINED IN REGULATION S UNDER THE SECURITIES ACT) BY THE COMPANY OR ANY
PURCHASER IN THIS OFFERING EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION UNDER
THE SECURITIES ACT OR TO EXEMPTIONS FROM THE REGISTRATION REQUIREMENTS OF
SUCH LAWS. NONE OF THE PREFERRED STOCK OR THE COMMON STOCK ISSUABLE ON
CONVERSION OF THE PREFERRED STOCK HAVE BEEN OR WILL BE QUALIFIED FOR
DISTRIBUTION UNDER THE SECURITIES LEGISLATION OF ANY PROVINCE OF CANADA AND
CANNOT BE OFFERED OR SOLD IN CANADA, DIRECTLY OR INDIRECTLY, EXCEPT IN
CERTAIN TRANSACTIONS EXEMPT FROM PROSPECTUS AND REGISTRATION REQUIREMENTS.
THE COMPANY AND THE AGENT HAVE AGREED IN WRITING THAT THEY WILL NOT, AS
PRINCIPAL OR AGENTS, MAKE ANY OFFERS OR SALES OF ANY OF THE PREFERRED STOCK
TO, OR FOR THE ACCOUNT OR BENEFIT OF, ANY U.S. PERSON OR CANADIAN PERSON.
HEDGING TRANSACTIONS IN THE PREFERRED STOCK MAY NOT BE CONDUCTED UNLESS IN
COMPLIANCE WITH THE SECURITIES ACT. THIS OFFERING IS NOT BEING MADE TO
PERSONS IN THE UNITED STATES OR CANADA AND AT THE TIME AN ELECTION TO
EXCHANGE IS MADE OR A BUY ORDER IS ORIGINATED, THE HOLDER OF THE NOTES OR THE
BUYER MUST BE OUTSIDE THE UNITED STATES AND CANADA.
NO SECURITIES COMMISSION OR SIMILAR REGULATORY AUTHORITY IN CANADA OR THE
UNITED STATES HAS PASSED ON THE MERITS OF THE SECURITIES OFFERED NOR HAS IT
REVIEWED THIS OFFERING CIRCULAR AND ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENCE. NO PREFERRED STOCK MAY BE SOLD IN CONNECTION WITH THIS
OFFERING WITHOUT DELIVERY TO THE PURCHASER OF THIS OFFERING CIRCULAR.
ANY BENEFICIAL HOLDER OF NOTES DESIRING TO TENDER ALL OR ANY PORTION OF THE
AGGREGATE PRINCIPAL AMOUNT OF HIS OR HER NOTES MUST COMPLETE, SIGN AND
DELIVER THE LETTER OF TRANSMITTAL OR A FACSIMILE THEREOF IN ACCORDANCE WITH
THE INSTRUCTIONS IN THE LETTER OF TRANSMITTAL AND ANY OTHER REQUIRED
DOCUMENTS TO MIDLAND BANK PLC, THE COMPANY'S EXCHANGE AGENT (THE "EXCHANGE
AGENT"), AND TENDER SUCH NOTES PURSUANT TO THE PROCEDURE FOR GUARANTEED
DELIVERY OR BOOK-ENTRY TRANSFER SET FORTH IN THIS OFFERING CIRCULAR UNDER THE
HEADING "THE OFFERING--HOW TO TENDER" AND IN THE LETTER OF TRANSMITTAL. A
BENEFICIAL HOLDER OF NOTES WHOSE NOTES ARE HELD BY A BROKER, DEALER,
COMMERCIAL BANK, TRUST COMPANY OR OTHER NOMINEE MUST CONTACT SUCH BROKER,
DEALER, COMMERCIAL BANK, TRUST COMPANY OR OTHER NOMINEE TO TENDER SUCH NOTES.
THE COMPANY WOULD REQUEST THAT ALL HOLDERS EFFECTUATE DELIVERY OF THE NOTES
FOR EXCHANGE THROUGH THE GUARANTEED DELIVERY PROCEDURE OR BOOK-ENTRY TRANSFER
PROCEDURE, AS DESCRIBED IN THE LETTER OF TRANSMITTAL AND UNDER "THE
OFFERING--HOW TO TENDER."
QUESTIONS AND REQUESTS FOR ASSISTANCE MAY BE DIRECTED TO THE COMPANY AT THE
ADDRESS AND TELEPHONE NUMBER SET FORTH ON THE LAST PAGE OF THIS OFFERING
CIRCULAR. REQUESTS FOR ADDITIONAL COPIES OF THIS OFFERING CIRCULAR MAY BE
DIRECTED TO THE COMPANY OR TO BROKERS, DEALERS, COMMERCIAL BANKS OR TRUST
COMPANIES.
The Preferred Stock will be offered to a limited number of investors who are
not Canadian residents or "U.S. persons" (as defined in Regulation S under
the Securities Act) in reliance upon an exemption from the registration
requirements of the Securities Act pursuant to Regulation S under the
Securities Act and exemptions from the registration and prospectus
requirements of applicable securities legislation in Canada. The Preferred
Stock will have restrictions on its resale. Regulation S, the safe harbor
pursuant to which the Preferred Stock is being offered, prohibits the
Preferred Stock from coming into the hands of U.S. persons for a period of
one year (unless registered under the Securities Act or sold pursuant to an
exemption from such registration requirements), deems the Preferred Stock
"restricted securities" as defined in Rule 144 of the Securities Act, and
imposes legend requirements. Hedging transactions involving the Preferred
Stock may not be conducted unless in compliance with the Securities Act.
Certain provisions have been included in the terms and conditions of the
Preferred Stock in order to assure compliance with Regulation S. The Company
may, in its discretion, revise the selling restrictions on the Preferred
Stock if the Securities and Exchange Commission (the "Commission") or any
other regulatory authority should, subsequent to the date of this Offering
Circular, amend or give advice or interpretations respecting the selling
restrictions applicable to the Preferred Stock. If the Company so revises the
selling restrictions, it will give notice to the holders of the Preferred
Stock addressed to each holder of record at his or her address appearing on
the books of the Company and it shall cause a copy of such notice (or a
reasonable summary thereof) to be published in THE FINANCIAL TIMES (EUROPEAN
EDITION) of London, England.
The Preferred Stock will bear a legend indicating that it has not been
qualified for distribution in British Columbia or in any other Province of
Canada and may not be offered, sold, transferred, pledged, converted or
otherwise disposed of in British Columbia or in any other Province of Canada
or to or for the benefit of any resident of British Columbia or in any other
Province of Canada except in accordance with applicable resale restrictions
which include
2
in British Columbia a hold period of four months from the Closing Date. The
Company will use its reasonable best efforts to ensure that neither the
Preferred Stock nor any Common Stock issued as dividends or on conversion of
the Preferred Stock will be subject to a period of restriction in trading in
British Columbia in excess of four months following the Closing Date, save
that as otherwise provided herein such Common Stock will be Freely Tradable.
The Company, having made all reasonable inquiries, confirms that this
Offering Circular contains all information which is material in the context
of the Offering, that the information contained herein is true and accurate
in all material respects and is not misleading in any material respect, that
the opinions and intentions expressed herein are honestly held and that there
are no other facts the omission of which would make any of such information
or the expression of any such opinions or intentions misleading in any
material respect. The Company accepts responsibility accordingly.
No person has been authorized to give any information or to make any
representation with respect to the Company or the Preferred Stock being
offered hereby, except for the information contained in this Offering
Circular, the Letter of Transmittal and the Subscription Agreement and if
given or made, any other information or representation must not be relied
upon as having been authorized by the Company, the Agent or any other person.
Neither the delivery of this Offering Circular at any time nor any sale made
pursuant to the Offering shall, under any circumstances, constitute a
representation that there has been no change in the affairs of the Company or
any of its subsidiaries since the date hereof or create any implication that
the information contained herein is correct as of any time subsequent to the
date hereof.
No action is being taken to permit a public offering of the Preferred Stock
or the distribution of this Offering Circular in any jurisdiction where
action would be required for such purposes. Applicable laws may restrict the
distribution of this Offering Circular and the Offering related to the
Preferred Stock in certain jurisdictions. Persons into whose possession this
Offering Circular may come are required by the Company to inform themselves
about and to observe any such restrictions. This Offering Circular does not
relate to any securities other than the Preferred Stock and the Common Stock
that may be delivered in connection with the payment of dividends or into
which the Preferred Stock is convertible and does not constitute an offer to
sell or a solicitation of an offer to buy any of the Preferred Stock in any
jurisdiction where, or to any person to whom, it is unlawful to make such
offer of solicitation.
Purchase of the Preferred Stock may result in tax or other legal consequences
not discussed herein. Prospective investors are not to construe this Offering
Circular or any prior or subsequent communication from the Company or the
Agent or any of their respective directors, officers, agents or employees as
legal, tax or investment advice. Each prospective investor should consult
with and rely on the investor's own professional advisers, including legal
counsel and tax advisers, as to the consequences of any investment by the
prospective investor in the Preferred Stock.
The Preferred Stock is being offered when, as and if issued, subject to prior
sale or withdrawal, cancellation or modification of the Offering without
notice, and subject to the approval of certain legal matters by counsel and
certain other conditions.
The Agent has no obligation to make a market in the Preferred Stock and there
is no assurance that a market in the Preferred Stock will ever develop.
In this Offering Circular, all references to "dollars", "$" or "cents" are to
U.S. dollars and cents unless an indication to Canadian dollars or cents is
made.
3
TABLE OF CONTENTS
PAGE NO.
--------
CONVERSIONS.........................................................................................4
SUMMARY.............................................................................................5
COMPARISON OF THE NOTES AND THE PREFERRED STOCK.....................................................9
GLOSSARY...........................................................................................13
THE OFFERING.......................................................................................16
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS..........................................20
RISK FACTORS.......................................................................................20
USE OF PROCEEDS....................................................................................29
CONSOLIDATED CAPITALIZATION........................................................................30
COMMON STOCK PRICE RANGE AND DIVIDEND POLICY.......................................................31
SELECTED CONSOLIDATED FINANCIAL INFORMATION........................................................32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.............33
BUSINESS AND PROPERTIES............................................................................42
MANAGEMENT.........................................................................................57
PRINCIPAL SHAREHOLDERS.............................................................................61
INTERESTS OF MANAGEMENT AND OTHERS IN MATERIAL TRANSACTIONS........................................62
DESCRIPTION OF CAPITAL STOCK.......................................................................65
SUBSCRIPTION AND SALE..............................................................................68
SELLING RESTRICTIONS...............................................................................68
TAX CONSIDERATIONS.................................................................................74
LEGAL OPINIONS OF COMPANY COUNSEL..................................................................81
ADDITIONAL INFORMATION.............................................................................81
CERTIFICATE OF DESIGNATION.......................................................................APPENDIX A
AUDITED FINANCIAL STATEMENTS.....................................................................APPENDIX B
FIRST QUARTER FINANCIAL STATEMENTS..............................................................APPENDIX C
CONVERSIONS
The following table sets forth certain standard conversions from
standard imperial units to the international system of units (or metric
units).
TO CONVERT FROM TO MULTIPLY BY
---------------------------- --------------------------- ------------
MCF......................... Cubic.meters................ 28.174
Cubic meters................ Cubic.feet.................. 35.494
Bbls........................ Cubic.meters................ 0.159
Cubic meters................ Bbls.oil.................... 6.29
Feet........................ Meters...................... 0.305
Meters...................... Feet........................ 3.281
Miles....................... Kilometers.................. 1.609
Kilometers.................. Miles....................... 0.621
Acres....................... Hectares.................... 0.405
Hectares.................... Acres....................... 2.471
4
SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHALL BE READ
IN CONJUNCTION WITH, THE MORE DETAILED INFORMATION AND CONSOLIDATED FINANCIAL
STATEMENTS, INCLUDING THE NOTES THERETO, APPEARING OR INCORPORATED BY
REFERENCE ELSEWHERE IN THIS OFFERING CIRCULAR.
THE COMPANY
The Company is a Delaware corporation engaged in the acquisition,
exploration and development of oil and gas properties, primarily in the Gulf
Coast area of the United States. The Company's interests in its United States
properties are held primarily through its wholly owned Texas subsidiary,
Texstar Petroleum Inc. ("Texstar").
Through Texstar, the Company holds various oil and gas interests in
Mississippi, Louisiana and Texas. The Company's principal activity is
acquisition, drilling and production from prospects in those states including
its existing major projects and prospects of Lahinch, Rayburn and Old Ocean
and others in Texas and subsequent development of commercial wells in Texas,
Oakvale Dome, Morgantown, Wausau and other prospects in Mississippi. See
"Business and Properties".
The following table summarizes the Company's proved oil and gas reserve
quantities as estimated by the Company's independent petroleum engineers as
of January 1, 1999.
PROVED RESERVES (1)
--------------------
Gas, MMCF 36,405
Oil, Condensate & NGL, MBO 584
---------------------------
(1) Includes reserves in Louisiana that were sold in May 1999
as part of the sale of the Lisbon Field. See "Business and
Properties-Recent Developments"
The Company's senior management is highly experienced in the oil and
gas industry and has participated in the development of various oil and gas
prospects throughout the United States. The Company's policy is to attract
and retain senior management with proven oil and gas expertise to conduct its
operations. Mr. Prentis B. Tomlinson, Jr., the Chairman and Chief Executive
Officer, has been involved in the oil and gas industry for the past 30 years.
THE OFFERING
The principal purposes of the Offering are to raise new capital,
reduce the Company's debt service requirements and to improve the Company's
debt to equity ratio. Noteholders who elect to exchange for Preferred Stock
will also receive the benefit of a reduction in the effective rate into which
the Notes convert into Common Stock. The Certificate of Designation
establishing the Preferred Stock is attached hereto as Appendix A.
TERMS OF EXCHANGE:
Option 1 65 shares of Preferred Stock for each $5,000
principal amount of the Notes plus $1,500
in cash.
Option 2 45 shares of Preferred Stock for each $5,000
principal amount of the Notes.
TERMS OF SALE: 55 shares of Preferred Stock for each $5,000
in cash.
AGENT: RP&C International Inc.
RP&C International Limited.
EXPIRATION DATE: The Company will accept for exchange Notes,
validly tendered prior to 5:00 p.m., London,
England time, on the Expiration Date. The
Offering will expire on the Expiration Date.
Tenders received prior to the Expiration
Date may be withdrawn at any time prior to
the Expiration Date unless otherwise agreed
by the holder. See "The Offering-Withdrawal
Rights."
5
DIVIDENDS: Through March 31, 2003, each share of
Preferred Stock will accrue an $8 annual
dividend (equivalent to 8% annually or $800
per $10,000 of Preferred Stock). After March
31, 2003 each share of Preferred Stock will
accrue a $15 annual dividend (equivalent to
15% annually or $1,500 per $10,000 of
Preferred Stock). If dividends are not
timely paid, annual dividends will be
increased by $3.00 per share until such
dividends have been paid. Dividends will be
payable semi-annually in arrears in cash or,
at the option of the Company, in Freely
Tradable (as defined in the Glossary) Common
Stock valued at the average of the Market
Price thereof for the 20 consecutive Stock
Exchange Business Days ending five Stock
Exchange Business Days prior to the dividend
payment date. "Market Price" is defined as
the weighted average price of the Common
Stock on the principal stock exchange on
which the Common Stock is traded on any
Stock Exchange Business Day. Dividends will
be paid free of withholding taxes. The
Preferred Stock will have a liquidation
value of $105 per share and will not be
subject to any sinking fund requirements.
Additionally, the Preferred Stock will have
greatly limited voting rights. See
"Comparison of the Notes and the Preferred
Stock" below and "Description of Share
Capital."
CONVERSION: Through March 31, 2000, the Preferred Stock
will be convertible, at the option of the
holder thereof, into Common Stock at an
initial conversion rate (the "Preferred
Conversion Price") equal to Cdn. $0.35. If
on March 31, 2000, the average of the Market
Prices during the preceding 20 consecutive
Stock Exchange Business Days is lower than
the Preferred Conversion Price, then the
Preferred Conversion Price will be adjusted
downward to such average price. The Company
will use its best efforts to ensure that
within four months after the Closing Date,
the Preferred Stock and any Common Stock
issuable as dividends or on conversion are
Freely Tradable. If such securities are not
Freely Tradable within that time period, the
Preferred Conversion Price shall be reduced
thereafter by 5% for each six month period
or portion thereof until such securities are
Freely Tradable. Upon the conversion of any
Preferred Stock, payment will be made by the
Company within 60 days following conversion
for dividends accrued during the period from
the most recent dividend payment date to the
conversion date.
REQUIRED CONVERSION: The Company may cause all of the Preferred
Stock to be converted into Common Stock at
the then Preferred Conversion Price at any
time after March 31, 2000, if the average
Market Price for 20 consecutive Stock
Exchange Business Days ending not more than
five days prior to the giving of such notice
is equal to or in excess of 140% of the
Preferred Conversion Price then in effect
and the Common Stock to be received in
connection with such conversion is Freely
Tradable. The Company is required to give 30
days notice in writing to the holders of the
Preferred Stock that it has elected a
mandatory conversion. Upon any mandatory
conversion of any Preferred Stock by the
Company, the Company will make payment for
dividends accrued during the period from the
most recent dividend payment date to the
conversion date.
REDEMPTION: The Preferred Stock is redeemable in whole
or in part by the Company at any time on the
giving of 30 days written notice at 105% of
the nominal amount thereof, together with
any accrued but unpaid dividends, payable in
cash ("Redemption Value"). Commencing April
1, 2003, at the option of the Company the
Preferred Stock may also be redeemed for
Freely Tradable Common Stock (i) at 115% of
the nominal amount if the market
capitalization of the Company is $300
million or more on such date, or (ii) at
120% of the nominal amount if the market
capitalization is less than $300 million on
such date. The Common Stock issued will be
valued at the average Market Price for the
20 Stock Exchange Business Days ending five
Stock Exchange Business
6
Days prior to the payment date. During the
30 day notice period, holders retain the
ability to convert their Preferred Stock
into Common Stock.
RANKING: The Preferred Stock will rank PARI PASSU
with the $9.5 million of Class A, Series I
Preferred Stock held by Lasco Energy
Partners, LP (the "Lasco Preferred") and any
new issue of preferred stock that stipulates
a liquidation preference PARI PASSU with the
Preferred Stock, and senior to all other
present and future equity of the Company.
The Preferred Stock will be subordinate to
claims of creditors, including holders of
the Company's outstanding debt instruments
(including the Notes, all production
financings and other creditors).
COVENANTS: During the period that any of the Preferred
Stock is outstanding, the Company will
maintain Tangible Assets equal to or greater
than 100% (rising to 140% in respect of the
years ending 31 December 2000 and thereafter)
of Long Term Debt (which includes the
Preferred Stock and other preferred stock
ranking PARI PASSU with the Preferred Stock).
A breach of this covenant by the Company or
a breach by the Company of certain other
covenants specified in the Certification of
Designation shall entitle the holder of the
Preferred Stock to cause a redemption
thereof by the Company.
VOTING RIGHTS: None prior to conversion except as
provided by law.
MINIMUM TENDER AMOUNT: Subject to the terms and conditions of the
Offering, all Notes will be accepted if duly
tendered and not withdrawn prior to the
Expiration Date. The Offering is not
conditioned upon a minimum aggregate
principal amount of Notes being tendered.
DENOMINATIONS AND FORM: The Preferred Stock will be registered and
issued in a non-certificated form that will
be eligible for clearing through the
Depository Trust Company ("DTC"), New York,
New York. The Preferred Stock will have a
nominal value of $100 and a liquidation
value of $105.
RESTRICTIONS ON RESALES: The Preferred Stock will have restrictions
on their resale. The Preferred Stock will
bear a legend indicating that it has not
been registered under the Securities Act and
that resales will be restricted for the
first two years after issuance in accordance
with Regulation S under the Securities Act
unless an exemption applies. The Preferred
Stock will bear a legend indicating that
they have not been qualified for
distribution in Canada and may not be
offered, sold, transferred, pledged,
converted or otherwise disposed of in Canada
or to or for the benefit of any resident of
Canada except in accordance with applicable
resale restrictions which include a hold
period of four months from the Closing Date.
EXTENSIONS: Subject to the approval of the Agent, the
Company expressly reserves the right to
extend the Expiration Date. See "The
Expiration Date-Expiration and Extension of
Tender Period".
HOW TO TENDER: Tendering holders of Notes must complete and
sign a Letter of Transmittal, forward the
Letter of Transmittal and any other required
documents to the Exchange Agent and tender
such Notes pursuant to the procedures for
guaranteed delivery or book-entry transfer,
and if choosing option 1 and the holder is a
member of the ICSD system, instruct Cedel or
Euroclear to debit such holder's ICSD
account by the required amount on the
instructions of the Exchange Agent and
thereafter deliver such amount to the
Exchange Agent's account, or if the holder
of Notes is not a member of the ICSD system,
then such holder must contact the Agent to
arrange for the delivery of the required
cash payment. Physical delivery of Notes is
not recommended due to the fact that the
Notes are in bearer form. Confirmation of a
book-entry transfer of such Notes to the
Exchange Agent's account at the Book-Entry
Facility (as defined below) will
7
effectuate delivery in a timely fashion.
Questions regarding how to tender and
requests for information should be directed
to the Company. See "The Offering - How
to Tender".
ACCEPTANCE OF TENDERS: Subject to the terms and conditions of the
Offering and unless otherwise agreed with a
holder, Notes validly tendered will be
accepted on or promptly after the Expiration
Date. Subject to such terms and conditions,
DTC accounts designated by the holders will
be credited with the appropriate number of
shares of Preferred Stock promptly after
acceptance of the tendered Notes. See "The
Offering - Acceptance of Tenders."
UNTENDERED NOTES: Holders of Notes who do not tender their
Notes in the Offering or whose Notes are not
accepted for exchange will continue to hold
such Notes and will be entitled to all the
rights and preferences and will be subject
to all of the limitations applicable
thereto, including the possible delisting of
the Notes from the Luxembourg Stock
Exchange. See "Risk Factors."
HOW TO PURCHASE: Any investor electing to purchase Preferred
Stock must complete and sign a Subscription
Agreement and forward the Subscription
Agreement and any other required documents
to the Agent and forward the cash payment to
the account referenced in the Subscription
Agreement, all in accordance with the
procedures set out in the Subscription
Agreement.
USE OF PROCEEDS: The net proceeds of the Offering will be
used by the Company to repay a portion of
its trade payables, to repay a portion of
amounts due under its senior debt facilities
and for general corporate purposes. See "Use
of Proceeds".
CLOSING: On the Expiration Date; however, the Company
may sell Preferred Stock or with the written
consent of a holder accept tenders prior to
the Expiration Date. Any sales or exchanges
completed prior to the Expiration Date shall
be final and binding regardless of whether
the Closing is further delayed or never
occurs.
RISK FACTORS: Certain risks are inherent in an investment
in the Preferred Stock and investors are
urged to consult with a professional advisor
before investing in the Preferred Stock. The
Preferred Stock and Common Stock are subject
to a high degree of risk. Risk factors
include, but are not limited to, variation
in commodity prices, actual success in
drilling and commercial completions and
availability and cost of services. See "Risk
Factors".
CUSIP NUMBER: 083453209
SWISS SECURITIES NUMBER
FOR THE PREFERRED STOCK: CH804491
SWISS SECURITIES NUMBER
FOR THE COMMON STOCK: CH679175
8
COMPARISON OF THE NOTES AND THE PREFERRED STOCK
The following is a brief summary comparison of certain of the principal terms
of the Notes and the Preferred Stock. Holders are encouraged to review in
detail the terms of the Preferred Stock as set forth in the Certificate of
Designation attached hereto as Appendix A, the Trust Indenture and Notes they
hold for a more complete description of each.
NOTES PREFERRED STOCK
----- ---------------
MATURITY: March 31, 2003 The Preferred Stock will not be
subject to redemption except upon
the occurrence of certain specified
events. However, on March 31,
2003, the dividends payable on the
Preferred Stock increase to 15% per
annum.
INTEREST/DIVIDEND RATE: 9% annual interest (equivalent to Through March 31, 2003, $800 annual dividend
$900 annually per $10,000 principal per $10,000 of Preferred Stock (8% annual
amount of Notes) payable in cash dividend) and after March 31, 2003, $1,500
semi-annually in arrears on March 31 annual dividend per $10,000 of Preferred
and September 30 equally each year. Stock (15% annual dividend equivalent),
which dividends will be payable
semi-annually in arrears in cash or, at the
Company's option, in Common Stock on March
31 and September 30 of each year, when, as
and if declared by the Company's board of
directors. The Common Stock issued to pay
dividends will be Freely Tradable and
valued based on the average Market
Price for the 20 consecutive Stock Exchange
Business Days ending five Stock Exchange
Business Days prior to the relevant
dividend payment date.
INTEREST/DIVIDENDS RECEIVED: Interest paid on the Notes to holders Dividends paid on the Preferred
not connected with the United States Stock to holders not connected with
or Canada is adjusted upward to the United States will be adjusted
include applicable withholding taxes, upward to include applicable
subject to certain exceptions. withholding taxes, subject to
certain exceptions.
9
NOTES PREFERRED STOCK
----- ---------------
RESTRICTIONS ON PAYMENT OF None The Company may only pay dividends out of
INTEREST/DIVIDENDS: surplus, as defined in the Delaware General
Corporation Law, or, if no surplus is
available, out of its net profits for the
fiscal year which the dividend or
distribution is declared and the preceding
fiscal year. No dividends or distributions
may be declared or paid if the Company is or
would be rendered insolvent by virtue of the
dividend distribution. In addition, the
EnCap Credit Facility and the BOCP Credit
Facility currently contain restrictions on
the payment of dividends.
CONVERSION: Convertible at the option of the Convertible at the option of the holder
holder at any time prior to maturity at any time into Common Stock at a
into Common Stock at a conversion conversion price of Cdn. $0.35. Subject to
price of Cdn. $1.40. further downward repricing on March 31,
2000, if the average 20 day Market Price
is lower than the Preferred Conversion
Price. If the Common Stock that would be
received in connection with conversion is
not Freely Tradable within four months
after the Closing Date, the Preferred
Conversion Price shall thereafter be
reduced by 5% for each 6 month period or
portion thereof until such Common Stock
becomes Freely Tradable.
CASH REDEMPTION OPTION: The Company may at any time after The Company may at any time redeem the
March 31, 2002, redeem the Notes for Preferred Stock for a cash price equal to
a cash price equal to the principal 105% of the nominal value of the Preferred
amount of the Notes together with Stock plus accumulated and unpaid dividends.
accrued and unpaid interest.
10
NOTES PREFERRED STOCK
----- ---------------
MANDATORY CONVERSION: The Company may, at its option, cause The Company may, at its option, cause the
the Notes to be converted into shares Preferred Stock to be converted into shares
of Common Stock, at any time after of Common Stock at the Preferred Conversion
September 30, 1999 and prior to March Price at any time and from time to time
31, 2003, if the weighted average after March 31, 2000, if the average Market
trading price of the Common Stock on Price during 20 consecutive Stock Exchange
the principal stock exchange on which Business Days ending not more than five days
the Common Stock is traded during a prior to the giving of notice is equal to or
20 consecutive trading day period is in excess of 140% of the Preferred
not less than 140% of the conversion Conversion Price then in effect. The Company
price then in effect. The Company is is required to give 30 days notice in
required to give notice that it has writing to the holders thereof that it has
elected mandatory conversion. elected mandatory conversion. Upon any
mandatory conversion of any Preferred Stock
by the Company, payment will be made by the
Company for dividends accrued during the
period from the most recent dividend payment
date to the conversion date.
CONVERSION PRICE ADJUSTMENT: The conversion price will be adjusted The Preferred Conversion Price will be
upon the occurrence of certain events adjusted upon the occurrence of certain
including (i) on the subdivision or events including (i) on the subdivision or
consolidation of the outstanding consolidation of the outstanding Common
Common Stock; (ii) on the issue of Stock; (ii) on the issue of any Common Stock
any Common Stock to holders of Common to holders of Common Stock by way of stock
Stock by way of stock dividends (with dividends (with certain exceptions); (iii)
certain exceptions); (iii) on the on the issue of rights, options or warrants
issue of rights, options or warrants to substantially all of the holders of
to substantially all of the holders Common Stock entitling them to acquire
of Common Stock entitling them to Common Stock or securities convertible into
acquire Common Stock or securities Common Stock (with certain exceptions); or
convertible into Common Stock (with (iv) on the distribution to substantially
certain exceptions); or (iv) on the all of the holders of Common Stock of class
distribution to substantially all of or of rights, options or warrants or of
the holders of Common Stock of any evidences of indebtedness or of assets.
other class or of rights, options or
warrants or of evidences of any other
indebtedness or of assets.
VOTING RIGHTS: None. Non-voting, except as otherwise required
by law.
LISTING: The Notes are listed on the The Preferred Stock is not currently
Luxembourg Stock Exchange. The Common listed on an exchange.
Stock is currently listed on the VSE.
11
NOTES PREFERRED STOCK
----- ---------------
RANKING: The Notes rank equally amongst The Preferred Stock will rank PARI PASSU to the
themselves and at least equally with Lasco Preferred and any new issue of
all other unsecured obligations (other preferred stock stipulates a liquidation
than in respect of statutorily that preference PARI PASSU with the Preferred
preferred creditors) of the Company. Stock, and senior to all other present and
At April 30, 1999, the Company had future equity of the Company. The Preferred
outstanding $27,200,000 of secured Stock will be subordinate to claims of
obligations. creditors, including holders of the
Company's outstanding debt securities
(including the Notes, all production
financings and other creditors). The
Preferred Stock will also be effectively
subordinated to all debt obligations of the
Company's subsidiaries.
DEBT COVENANT: The Noteholders are entitled to the Holders of the Preferred Stock will the
protection of numerous covenants have right to require redemption of their
provided in the Trust Indenture Preferred Stock if the Company fails to
including a covenant that the Company maintain Tangible Assets equal to or greater
must maintain tangible assets equal to than 100% (rising to 140% in respect of the
or greater than 100% (rising to 140% years ending 31 December 2000 and
in respect of the years ending 31 thereafter) of Long Term Debt.
December 2000 and thereafter) of long
term debt and any preferred stock of
the Company.
RESALE RESTRICTIONS: None The Preferred Stock will bear legends
indicating that they have not been (i)
registered under the Securities Act and that
resales will be restricted for the first two
years after issuance in accordance with
Regulation S under the Securities Act unless
an exemption applies and (ii) qualified for
distribution in Canada and may not be
offered, sold, transferred, pledged,
converted or otherwise disposed of in Canada
or to or for the benefit of any resident of
Canada except in accordance with applicable
resale restrictions which include a hold
period of four months from the Closing Date.
SETTLEMENT: Notes are settled in the Euroclear/ Preferred Stock will be eligible for
Cedel System. settlement in the DTC system.
FORM: The Notes are in bearer form. The Preferred Stock will be issued in
registered form as non-certificated shares.
12
GLOSSARY
In this Offering Circular (including the Summary), the following words and
phrases shall have the meaning set forth below, unless the context otherwise
requires:
"Alternative Stock Exchange" means any national or regional stock exchange,
or if not available, a U.S. national or regional stock quotation service such
as the Nasdaq National Market System or the quotation service maintained by
the National Quotation Bureau (the pink sheets) or any successor thereto,
which in any such case is acceptable to the Agent. The Agent has agreed that
the bulletin board trading system operated by Nasdaq is acceptable and will
constitute an "Alternative Stock Exchange".
"Agency Agreement" means the Agency Agreement entered into between the
Company and the Agent.
"Agent" means RP&C International Inc. and RP&C International Limited.
"BCFG" means billion cubic feet of gas.
"BCPD" means barrels of condensate per day.
"BO" means barrels of oil.
"BOCP" means BOCP Energy Partners, L.P.
"BOCP Credit Facility" means Texstar's Credit Facility with BOCP in effect at
the date hereof and as it may be increased, decreased, supplemented or
amended from time to time hereafter.
"BOPD" means barrels of oil per day.
"BPO" means the designated interest held before payout occurs.
"Calibre" means Calibre Energy, L.L.C.
"Certificate of Designation" means the Certificate of Designation adopted by
the board of directors of the Company establishing the Preferred Stock and
substantially in the form attached hereto as Appendix A.
"Certificate of Incorporation" means the Company's Certificate of
Incorporation on file with the Secretary of State of Delaware.
"Closing Date" means the date the Company accepts the Notes in exchange for
the Preferred Stock.
"Common Stock" means the common stock, par value $0.01 per share of the
Company.
"Company" means Benz Energy Inc.
"Convertible Debentures" means the Notes and if converted, the resulting
Series 2 Debentures and the Series 3 Debentures.
"EnCap" means EnCap Investments, L.C.
"EnCap Credit Facility" means Texstar's credit facility with EnCap Energy in
effect at the date hereof and as it may be increased, decreased, supplanted
or amended from time to time hereafter.
"EnCap Energy" means EnCap Energy Capital Fund III, L.P.
"Exchange Agent" means Midland Bank plc.
"Expiration Date" means June 30, 1999, or such later date as is designated by
the Company with the approval of the Agent.
13
"Farmout" means the exchange of a working interest for a smaller net profits
interest or royalty interest.
"Freely Tradable" means with respect to the Preferred Stock and the Common
Stock, that such stock has been registered pursuant to a registration
statement that has been declared effective pursuant to the Securities Act or
that such stock can be resold without restrictions under an exemption from
registration under the Securities Act applicable to all holders of such
Preferred Stock or the Common Stock, is listed on the VSE or on an
Alternative Stock Exchange and is tradable on such exchange without further
restrictions.
"Lasco Transaction" means the acquisition by the Company of reserves in east
Texas and northwest Louisiana.
"Lenser & Associates" means R.A. Lenser and Associates, Inc., petroleum
engineers.
"Letter of Transmittal" means the Letter of Transmittal forwarded along with
the Offering Circular to the Noteholders.
"LOE" means lease operating expenses.
"Long Term Debt" as defined in the Certificate of Designation attached hereto
as Appendix A.
"MB" means thousand barrels.
"MBO" means thousand barrels of oil.
"MCF" means thousand cubic feet.
"MCFGPD" means a thousand cubic feet of gas per day.
"MCFPD" means a thousand cubic feet per day.
"MMBO" means a million barrels of oil.
"MMCFG" means a million cubic feet of gas.
"nominal amount" means as to each share of Preferred Stock, $100.
"Noteholder" means the beneficial holders of the Notes.
"NPI" means net profit interest, which is revenues less royalty burden,
operating expenses, excise taxes, gathering and treating expenses and capital
costs of drilling and completing the producing well, provided that the excess
of such deductions over revenues is recouped solely through future revenues
to the owner of the net profits interest.
"Offering" means the offering of Preferred Stock pursuant to the Offering
Circular, the Letter of Transmittal and the Subscription Agreement.
"Old Ocean Loan" means the $2,200,000 of indebtedness outstanding pursuant to
the terms of the Letter Loan Agreement dated December 31, 1998 among Texstar,
as borrower, and the Agent and the other lenders signatory thereto.
"Preferred Conversion Price" means on the Closing Date Cdn. $0.35 per
Common Share, as subsequently may be adjusted.
"Preferred Stock" means the Class A, Series II Convertible Preferred Stock,
par value $1.00 per share, of the Company with a nominal value of $100 per
share and a liquidation value of $105 per share, which Preferred Stock was
established pursuant to the Certificate of Designation substantially in the
form attached hereto as Appendix A.
"psi" means pounds of pressure per square inch.
14
"Series 2 Debentures" means the Special Notes, Series A issued in April of
1998 to Canadian investors and any Debentures into which such Special Notes
may be converted.
"Series 3 Debentures" means the Special Notes, Series B issued in April of
1998 to United States investors and the Debentures into which such Special
Notes have been converted.
"Stock Exchange Business Day" means any day (other than a Saturday or Sunday)
on which the principal exchange on which the Common Stock is traded or the
Alternative Stock Exchange, as the case may be, is open for business.
"Subscription Agreement" means those certain Subscription Agreements executed
by persons interested in purchasing Preferred Stock.
"Subsidiary" of any person means any corporation of which at least a majority
of the shares of stock having by the terms thereof ordinary voting power to
elect a majority of the board of directors of such corporation (irrespective
of whether or not at the time stock of any other class of such corporation
shall have voting power by reason of the happening of any contingency) is
directly or indirectly owned or controlled by any one of or any combinations
of the Company or one or more of its Subsidiaries.
"Trust Indenture" means that certain Trust Indenture dated as of March 25,
1998 between the Corporation and Montreal Trust Company of Canada, as amended
by the First Supplemental Trust Indenture and the Second Supplemental Trust
Indenture.
"Tangible Assets" as defined in the Certificate of Designation attached
hereto as Appendix A.
"Trustee" means Montreal Trust Company of Canada.
"VSE" means The Vancouver Stock Exchange.
15
THE OFFERING
EXCHANGE OFFER; OFFERING OF PREFERRED STOCK
The Company hereby offers, upon the terms and conditions set forth
herein and in the related Letter of Transmittal, to exchange up to 354,250
shares of the Company's Class A, Series II Convertible Preferred Stock, $1.00
par value for the Notes. Noteholders have the following exchange options: (i)
65 shares of Preferred Stock for each $5,000 principal amount of the Notes
plus $1,500 cash payment tendered or (ii) 45 shares of Preferred Stock for
each $5,000 principal amount of the Notes tendered. In addition, the Company
is offering a total of 121,000 shares of Preferred Stock in units of 55
shares of Preferred Stock for $5,000. On March 31, 1999, there was
$27,250,000 in aggregate principal amount of Notes outstanding. The Offering
is not conditioned upon any minimum number or principal amount of Notes being
tendered.
The Offering will expire at 5:00 p.m., London, England time, on the
Expiration Date. See "The Offering - Expiration and Extension of Tender
Period."
Holders of Notes who wish to exchange Notes for Preferred Stock must
validly tender certificates for Notes to the Company or validly tender Notes
by complying with the book-entry transfer procedures described below and, in
each case, must furnish the Letter of Transmittal and other required
documents to the Exchange Agent. If choosing Option 1 and the holder is a
member of the ICSD system, holders of Notes must also instruct Cedel or
Euroclear to debit such holder's ICSD account by the required amount on the
instructions of the Exchange Agent and thereafter deliver such amount to the
Exchange Agent's account, or if the holder of Notes is not a member of the
ICSD system then such holder must contact the Agent to arrange for the
delivery of the required cash payment. Thereafter, the holders will have
designated DTC accounts credited with the appropriate number of shares of
Preferred Stock, promptly after the tender is accepted by the Company.
Subject to the terms and conditions of the Offering and unless otherwise
agreed by a holder, properly tendered Notes will be accepted on or promptly
after the Expiration Date.
The Letter of Transmittal and Offering Circular will be forwarded to
Morgan Guaranty Trust Company of New York, Brussels office, as operator of
the Euroclear System and Cedelbank for distribution to holders who are listed
as participants in a clearing agency's position listing for subsequent
transmittal to beneficial owners of Notes. Such beneficial owners may also
obtain a copy of this Offering Circular and Letter of Transmittal from the
Company, the Agent and the Exchange Agent.
EXPIRATION AND EXTENSION OF TENDER PERIOD
The Offering will expire at 5:00 p.m., London, England time, on the
Expiration Date, subject to the right of the Company to (i) extend the
Expiration Date with the consent of the Agent and (ii) elect to sell
Preferred Stock or with the consent of a holder accept tenders of Notes prior
to the Expiration Date.
CERTAIN CONDITIONS OF THE OFFERING
Notwithstanding any other provisions of the Offering, the Company
will not be required to issue Preferred Stock in respect of any properly
tendered Notes not accepted and may delay the acceptance of the tendered
Notes but only if one or more of the following events shall have occurred (or
shall have been determined by the Company to have occurred) and which in the
Company's reasonable judgment in any such case makes it inadvisable to
proceed with the Offering:
(a) Any action or proceeding, order, decree or injunction
shall have been taken or threatened, instituted or pending, or any
statute, rule, regulation, judgment, order, stay, decree or
injunction shall have been sought, promulgated, enacted, entered,
enforced or deemed applicable to the Offering or the Company taken
as a whole, by or before any court or governmental, regulatory or
administrative authority or agency or tribunal, which (i) challenges
the making of the Offering, the acquisition of the Notes or issuance
of the Preferred Stock pursuant to the Offering or might directly or
indirectly prohibit, prevent, restrict or delay consummation of the
Offering, or (ii) materially adversely affects the business,
operations, condition (financial or otherwise), results of
operations, prospects, assets, liabilities, working capital or
reserves of
16
the Company taken as a whole, or otherwise materially impairs in any
way the contemplated future conduct of the business of the Company
taken as a whole.
(b) There shall have occurred (i) the declaration of any
banking moratorium or suspension of payments in respect of banks in
Canada or the United States, (ii) any general suspension of trading
in, or limitation on prices for, securities on any Canadian or
United States national securities exchange or in the
over-the-counter market, (iii) any limitation (whether or not
mandatory) by any government or governmental, regulatory or
administrative agency or authority on, or any event which in the
Company's sole judgment might adversely affect, the extension of
credit by banks or other lending institutions in Canada or the
United States, or (iv) in the case of any of the foregoing existing
at the time of the commencement of the Offering, a material
acceleration or worsening thereof.
(c) There shall have occurred any event that has resulted,
or may in the reasonable judgment of the Company result, in an
actual or threatened material adverse change in the business,
operations, condition (financial or otherwise), results of
operations, prospects, assets, liabilities, working capital or
reserves of the Company.
The foregoing conditions are for the sole benefit of the Company and
may be asserted by the Company in its reasonable discretion regardless of the
circumstances (including any action or inaction by the Company) giving rise
to any such conditions, or may be waived by the Company, in its sole
discretion, in whole or in part at any time.
HOW TO TENDER
Tendering holders of Notes must complete and sign a Letter of
Transmittal or a facsimile thereof (all references in this Offering Circular
to the Letter of Transmittal shall be deemed to include a facsimile thereof),
forward the Letter of Transmittal and any other required documents to the
Exchange Agent at the address set forth in the Letter of Transmittal and
tender such Notes pursuant to the procedures for guaranteed delivery or
book-entry transfer. Physical delivery of Notes is not recommended due to the
fact that the Notes are in bearer form. Confirmation of a book-entry transfer
of such Notes to the Exchange Agent's account at the Book-Entry Facility (as
defined below) will effectuate delivery of the Notes in a timely fashion. If
electing Option 1 and if the holder of Notes has an ICSD account, then such
holder shall instruct Cedel or Euroclear to debit such holder's ICSD account
by the required cash payment on the instructions of the Exchange Agent and
thereafter deliver such amount to the Exchange Agent's account or if the
holder of Notes is not a member of the ICSD system, then such holder must
contact the Agent to arrange for payment. Questions regarding how to tender
and requests for information should be directed to the Company.
The Exchange Agent will establish an account with respect to the
Notes at Euroclear and Cedelbank (each individually, a "Book-Entry Facility")
as soon as practicable after the date of this Offering Circular, and any
financial institution which is a participant in the Book-Entry Facility may
make book-entry delivery of the Notes by causing the Book-Entry Facility to
transfer such Notes into the Exchange Agent's account in accordance with the
Book-Entry Facility's procedure for such transfer. Although delivery of Notes
may be effected through book-entry transfer into the Exchange Agent's account
at the Book-Entry Facility, the Letter of Transmittal, any required cash
payment (either through the ICSD account system or in readily available
funds) and any other required documents, must in any case be transmitted to
and received by the appropriate party on or prior to the Expiration Date.
Delivery of documents to the Book-Entry Facility does not constitute delivery
to the Exchange Agent. All references in this Offering Circular to deposit or
delivery of Notes shall be deemed to include the Book-Entry Facility's
book-entry delivery method.
THE METHOD OF DELIVERY OF NOTES AND ALL OTHER DOCUMENTS, INCLUDING
DELIVERY THROUGH THE BOOK-ENTRY FACILITY, IS AT THE ELECTION AND RISK OF THE
HOLDER OF NOTES.
The Notes will be offered for exchange in minimum denominations of
$5,000 each and integral multiples thereof. Tendering holders of Notes may
tender less than all of the Notes represented by the certificates they hold
provided they appropriately indicate this fact on the Letter of Transmittal
accompanying the tendered Note certificates.
17
With respect to tenders of Notes, the Company reserves full
discretion to determine whether the documentation is complete and generally
to determine all questions as to tenders, including the date of receipt of a
tender, the propriety of execution of any document, and other questions as to
the validity, form, eligibility or acceptability of any tender. The Company
reserves the right to reject any tender not in proper form or otherwise not
valid or the acceptance for exchange of which may, in the reasonable opinion
of the Company's counsel, be unlawful or to waive any irregularities or
conditions, and the Company's interpretation of the terms and conditions of
the Offering (including the instructions on the Letter of Transmittal) will
be final. The Company shall not be obligated to give notice of any defects or
irregularities in tenders and shall not incur any liability for failure to
give any such notice. Notes shall not be deemed to have been duly or validly
tendered unless and until all defects and irregularities have been cured or
waived.
TERMS AND CONDITIONS OF THE LETTER OF TRANSMITTAL
The Letter of Transmittal contains, among other things, certain
terms and conditions, which are summarised below and are part of the Offering.
On or prior to the Expiration Date, (i) a beneficial owner of the
Notes or an Agent Member Bank ("Agent Member Bank") of the Euroclear System
or Cedelbank must have effectuated the transaction on behalf of the tendering
beneficial owner(s) and (ii) the Letter of Transmittal, with other required
documents, must be transmitted to and received by the Exchange Agent at the
address as set forth in the Letter of Transmittal. If choosing Option 1 and a
member of the ICSD system, the holder must instruct Cedel or Euroclear to
debit such holder's ICSD account by the required amount on the instructions
of the Exchange Agent and thereafter deliver such amount to the Exchange
Agent's account, or if the holder of Notes is not a member of the ICSD
system, then such holder must contact the Agent to arrange for the delivery
of the required cash payment. The party tendering the Notes for exchange on
behalf of the beneficial owner(s) (the "Holder") by execution of the Letter
of Transmittal sells, assigns and transfers the Notes to the Exchange Agent
and irrevocably constitutes and appoints the Exchange Agent as the Holder's
agent and attorney-in-fact to cause the Notes to be transferred and
exchanged. The Holder warrants that it has full power and authority to
tender, exchange, sell, assign and transfer the Notes and to acquire shares
of Preferred Stock issuable upon the exchange of such tendered Notes and the
delivery of any required cash payment, that the Company will acquire good and
unencumbered title to the tendered Notes, free and clear of all liens,
restrictions, charges and encumbrances, and that the Notes tendered for
exchange are not subject to any adverse claims when accepted by the Company.
The Holder also warrants that it will, upon request, execute and deliver any
additional documents deemed by the Company to be necessary or desirable to
complete the exchange, sale, assignment and transfer of the tendered Notes.
All authority conferred or agreed to be conferred in the Letter of
Transmittal by the Holder will survive the death or incapacity of the Holder
and any obligation of the Holder shall be binding upon the heirs, personal
representatives, successors and assigns of such Holder.
All questions as to the validity, form, eligibility (including time
of receipt) and acceptability of any tender will be determined by the
Company, in its reasonable discretion, and such determination will be final
and binding. Unless waived by the Company, irregularities and defects must be
cured by the Expiration Date. The Company will pay all stock transfer taxes
applicable to the transfer and exchange of Notes tendered.
WITHDRAWAL RIGHTS
All tenders of Notes may be withdrawn at any time prior to the
Expiration Date unless otherwise agreed by a Holder. To be effective, a
notice of withdrawal must be timely received by the Exchange Agent at the
address as set forth in the Letter of Transmittal. Any notice of withdrawal
must specify the person named in the Letter of Transmittal as having tendered
the Notes, the number of Notes to be withdrawn and the name of the holder of
such Notes. If the Notes have been delivered pursuant to the book-entry
procedures set forth above under "The Offering - How to Tender," any notice
of withdrawal must specify the name and number of the participant's account
at the Book-Entry Facility to be credited with the withdrawn Notes. The
Exchange Agent will confirm to each Noteholder in writing as to any properly
withdrawn Notes as soon as practicable following receipt of notice of
withdrawal. All questions as to the validity, including time of receipt, of
notices of withdrawals will be determined in the Company's reasonable
judgement.
18
ACCEPTANCE OF TENDERS
Subject to the terms and conditions of the Offering, Notes tendered
(either physically or through book-entry delivery as described in "The
Offering - How to Tender") with a properly executed Letter of Transmittal,
appropriate provision for any required cash payment and all other required
documentation, and not withdrawn, will be accepted on or promptly after the
Expiration Date. The Company reserves the right to accept one or more tenders
of Notes prior to the Expiration Date with the written consent of a holder.
Subject to such terms and conditions, Preferred Stock to be issued in
exchange for properly tendered Notes will be credited to the DTC Account
specified by a holder promptly after acceptance of the tendered Notes.
Preferred Stock will be issued in the name specified in the Letter of
Transmittal. The Company, however, reserves the right to delay acceptance of
tendered Notes upon the occurrence of any of the conditions set forth above
under the caption "The Offering - Certain Conditions of the Offering."
The tender of Notes pursuant to any one of the procedures set forth
in "The Offering - How to Tender" will constitute an agreement between the
tendering holder and the Company upon the terms and subject to the conditions
of the Offering.
SOLICITATION OF TENDERS
No person has been authorized to give any information or to make any
representations in connection with the Offering other than those contained in
this Offering Circular. If given or made, such information or representations
should not be relied upon as having been authorized by the Company. Neither
the delivery of this Offering Circular nor any exchange made hereunder shall,
under any circumstances, create any implication that there has been no change
in the affairs of the Company since the respective dates as of which
information is given herein. This Offering Circular does not constitute an
offer to exchange, or a solicitation of an offer to exchange, any securities
other than the securities covered by the Offering Circular by the Company or
any other person, nor does it constitute an offer to exchange or a
solicitation of an offer to exchange such securities by the Company, or any
such other person in any jurisdiction in which or to any person to whom it is
unlawful to make any such offer or solicitation. In any jurisdiction the laws
of which require the offer to be made by a licensed broker or dealer, the
offer in order to be capable of acceptance must be made on behalf of the
Company by one or more registered brokers or dealers licensed under the laws
of such jurisdiction.
SALE OF PREFERRED STOCK
The Company is offering a total of 121,000 shares of Preferred Stock
in units of 55 shares of Preferred Stock for $5,000. An investor electing to
purchase Preferred Stock must complete and sign a Subscription Agreement and
forward the Subscription Agreement and any other required documents to the
Agent and forward the cash payment to the account referenced in the
Subscription Agreement, all in accordance with the procedures set out in the
Subscription Agreement. Unless otherwise agreed by a purchaser, an election
to purchase may be withdrawn at any time prior to the Expiration Date. To be
effective, a notice of withdrawal must be timely received by the Agent at the
address set forth in the Subscription Agreement. A properly executed
Subscription Agreement, which has not been withdrawn, and the appropriate
provision for any required cash payment will be accepted on or promptly after
the Expiration Date and the DTC account as specified by a purchaser will be
credited with the appropriate number of shares of Preferred Stock.
19
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Offering Circular includes "forward-looking statements." All
statements other than statements of historical facts included in this
Offering Circular, including without limitation statements under "Summary,"
"Risk Factors," "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Business and Properties" regarding planned
capital expenditures, the availability of capital resources to fund capital
expenditures, estimates of proved reserves, the number of anticipated wells
to be drilled in the future, the Company's financial position, business
strategy and other plans and objectives for future operations, are
forward-looking statements. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, it
can give no assurance that such expectations will prove to be correct. There
are numerous uncertainties inherent in estimating quantities of proved oil
and natural gas reserves and in projecting future rates of production and
timing of development expenditures, including many factors beyond the
Company's control. Reserve engineering is a subjective process of estimating
underground accumulations of oil and natural gas that cannot be measured in
an exact way, and the accuracy of any reserve estimate is a function of the
quality of available data and of engineering and geological interpretation
and judgement. As a result, estimates made by different engineers often vary
from one another. In addition, results of drilling, testing and production
after the date of an estimate may justify revisions of such estimate and such
revisions, if significant, would change the schedule of any further
production and development drilling. Accordingly, reserve estimates are
generally different from quantities of oil and natural gas that ultimately
are recovered. Additional important factors that could cause actual results
to differ materially from the Company's expectations are disclosed elsewhere
in this Offering Circular. All subsequent written and oral forward-looking
statements attributable to the Company or persons acting on its behalf are
expressly qualified in their entirety by such factors.
RISK FACTORS
LIMITED OPERATING HISTORY; HISTORY OF LOSSES; ACCUMULATED LOSSES AND WORKING
CAPITAL DEFICITS
The Company commenced operations in 1991 and acquired a substantial
portion of its operating assets through the acquisition of Texstar in October
1996. Potential purchasers, therefore, have limited historical financial and
operating information upon which to base an evaluation of the Company's
performance and whether to invest in the Company's securities. The Company
has incurred substantial operating and net losses to date. The following
table reflects total net losses and net losses per share of Common Stock for
the periods indicated:
PER SHARE
AMOUNT (BASIC)
--------------- -----------
Quarter Ended March 31, 1999 $ (2,665,782) $ (0.08)
Year Ended December 31, 1998 $ (11,915,191) $ (0.37)
Four Month Period Ended December 31, 1997 $ (2,739,322) $ (0.10)
Ten Month Period Ended August 31, 1997 $ (1,917,141) $ (0.09)
The Company has also had the following working capital surplus
(deficit) as at the dates indicated:
March 31, 1999 $(35,135,688)
December 31, 1998 $(27,360,635)
December 31, 1997 $(15,290,406)
August 31, 1997 $ 1,784,075
20
The Company will continue to require substantial expenditures to
develop and expand its business. The Company's future financial results will
depend primarily on the following:
- its ability to economically locate hydrocarbons in
commercial quantities;
- its ability to reduce drilling risks and costs through 3-D
seismic data and CAEX technologies in selecting site and
depth of wells;
- its ability to secure adequate financial resources to fund
activities; and
- externally, on oil and gas prices.
There can be no assurance that the Company will achieve or sustain
profitability or positive cash flows from operating activities in the future.
See "Risk Factors - Substantial Capital Requirements" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
SUBSTANTIAL CAPITAL REQUIREMENTS
The Company has experienced and expects to continue to experience
substantial working capital needs. Its ongoing capital requirements consist
primarily of the following items:
- funding the 1999 capital and exploration budget;
- payment for the recently completed 3-D survey at Old Ocean
Field in installments totaling approximately $6,700,000
beginning in June of 1999. The first scheduled payment is
past due. The Company has reached an oral agreement with
respect to payment terms described below under "Impending
Maturity Dates".
- payment of EnCap Credit Facility, the BOCP Credit Facility
and the Old Ocean Loan, all due June 30, 1999 in the
principal amounts of $12.0 million, $6.0 million and $2.2
million, plus accrued interest, respectively. The Company is
negotiating a production financing facility to fund the
repayment of the first two facilities and is negotiating to
use Preferred Stock to repay all but $100,000 of the Old
Ocean Loan;
- potential repurchase of the Shell Production Payment;
- payment of certain trade payables of which $11,360,000 is
past due as of June 10, 1999;
- payment of preferred dividends not otherwise paid in Common
Stock; and
- payment of interest on the Convertible Debentures and bank
obligations.
The Company's 1999 capital and exploration budget is $11.3 million
(excluding capitalized interest and overhead). The Company plans to finance
anticipated ongoing expenses and its 1999 capital and exploration budget with
funds generated from the following sources:
- available cash and cash investments;
- cash provided by operation activities;
- capital the Company believes it can raise through an
increase in the Shell Production Payment or the sale of a
term production payment, and sale of equity;
- non-core asset sales and sales of excess interests in core
assets;
- a $4.0 million capital infusion from an affiliate of EnCap;
and
- capital raised in connection with the Offering.
No assurance can be given as to the availability or terms of
additional financing that may be required. If such capital resources are not
available, the Company may be required to curtail its drilling, development
and other operations; may not be able to participate in operations proposed
by others with an interest in its properties and be subjected to applicable
non-consent penalties; and may not be able to meet certain of its existing
contractual
21
obligations, which as to any of the foregoing could have a material adverse
effect on the Company and its financial condition.
IMPENDING MATURITY DATES
The Company's EnCap, BOCP and Old Ocean Credit Facilities will come
due on June 30, 1999. The Company anticipates that as to the indebtedness
reflected by the Old Ocean Loan, that all lenders, other than affiliates of
EnCap that are owed $100,000, will elect to convert their respective
indebtedness and the mineral interests obtained in connection with the Old
Ocean Loan into Preferred Stock. The Company anticipates that it will pay off
the $100,000 owed to affiliates of EnCap under the Old Ocean Loan and the
indebtedness reflected by the EnCap Credit Facility and the BOCP Credit
Facility with funds obtained in connection with the Offering and new funds
anticipated to be received in connection with either an increase of the Shell
Production Payment or through funds received in connection with a new
production payment arrangement with a new lender. The Company is currently
engaged in negotiations as to both financing options, but does not have a
binding agreement with respect to either option. There can be no assurance
that either financing option will be consummated. The Company anticipates
that any such financing will not close until after June 30, 1999. The Company
currently does not have an extension of the maturity dates with respect to
the EnCap and BOCP Credit Facilities, but the lenders thereunder have in the
past granted maturity date extensions, and the Company believes that EnCap
Energy and BOCP will continue to extend the maturity dates to provide the
Company with sufficient time to obtain the new financings. If the maturity
dates under the EnCap and BOCP Credit Facilities are not extended or the
Company is unable to obtain sufficient new financings to pay off the EnCap
Credit Facility and the BOCP Credit Facility, then the Company will be in
default under the applicable Credit Facility and the applicable lenders will
have the right to seek immediate repayment of the entire indebtedness due
thereunder and enforce its other remedies, which include the right to
foreclose on substantially all of the properties of the Company. Such a
default will also cause defaults under other material contracts to which the
Company and its subsidiaries are parties. Any of the foregoing actions could
cause the Company to cease operations.
On June 10, 1999, the Company was obligated to pay one-half of the
$6.7 million cost of acquiring certain seismic materials relating to the Old
Ocean Prospect and was obligated to pay the remaining amounts 60 days after
delivery of the processed data. The Company failed to make the payment due on
June 10, 1999. The Company has, however, reached a verbal arrangement for the
extension of the date of the first required payment until the end of the week
of June 14, 1999, at which time the Company has agreed to pay a portion, but
not all, of the first payment. The verbal agreement requires that the balance
of the initial payment be paid by the end of July rather than the currently
scheduled payment date of 60 days following delivery of the processed data.
Funds for the payment are anticipated to come from a sale by the Company of
approximately 37.5% of its interest in the Old Ocean Prospect. The Company
currently is in negotiation for the sale of such interest, but has not
entered into a definitive agreement with any party with respect to the sale.
Although the Company believes the sale will be consummated in time for the
Company to meet its payment obligations, there can be no assurance that the
sale of the interest will be consummated by such time or at all. If the
Company is unable to complete such transaction and is unable to satisfy its
payment obligations by some other means, the Company will be in default with
respect to its obligations to the company that has completed the seismic
survey and with the other owner of an interest in the Old Ocean Prospect.
Such defaults would subject the Company to the possibility of losing its
rights in the seismic materials and in a substantial portion of its rights in
the Old Ocean Prospect. Such defaults will also cause defaults under other
material contracts to which the Company and its subsidiaries are parties. Any
of the foregoing actions would have a material adverse effect on the Company
and its financial condition.
TRADE PAYABLES
At June 10, 1999, the Company had outstanding approximately
$12,980,000 of accounts payable to industry partners and trade creditors.
Approximately $11,360,000 of this amount is past due. The Company intends to
request the holders of such accounts payable to accept payment over an
extended time and to accept a discount on the total payment due or accept a
further delay in the payment of such payables and receive payment in full.
There can be no assurance that any of the Company's creditors will accept the
proposed discounts or other payment terms. The Company anticipates funding
these payment obligations by using the proceeds to be received from either
the increase in the Shell Production Payment, the new production payment that
the Company is attempting to arrange, sale of assets and production revenue.
If a creditor is unwilling to participate in any such arrangement and the
Company does not have sufficient funds to pay such creditor, then a creditor
may declare the Company in default
22
and pursue its available remedies against the Company. Those remedies could
include, under certain circumstances, placing the Company into involuntary
bankruptcy.
ABILITY TO CONTINUE AS A GOING CONCERN
The report of the Company's independent public accountants in the
Company's financial statements includes an explanatory paragraph that states
that the Company's ability to continue as a going concern is in question.
Note 18 to the Company's consolidated financial statements states that the
financial statements were prepared assuming that the Company is able to
continue as a going concern assuming certain events, such as refinancing of
the Company's indebtedness and the anticipated success of certain of the
Company's oil and gas wells will occur. There can be no assurance that the
events described in the going concern note will occur, and if they do not
occur, the Company may be unable to continue as a going concern.
VOLATILITY OF OIL AND GAS MARKETS
MARKET PRICES ARE VOLATILE
The Company's profitability and cash flow depend greatly on the
market price of oil and natural gas. Prices for oil and natural gas are
subject to wide fluctuations in response to relatively minor changes in
supply and demand, market uncertainty and a variety of additional factors
that it cannot control. These factors include:
- the level of consumer product demand;
- weather conditions;
- domestic and foreign governmental regulations;
- the price and availability of alternative fuels;
- political conditions in the Middle East;
- the foreign supply of oil and natural gas;
- the price of oil and gas imports; and
- overall economic conditions.
The Company's ability to maintain or increase its borrowing capacity
and to obtain additional capital on attractive terms, or not at all, is also
substantially dependent upon oil and gas prices. Compared to 1997, the
average prices for the Company's production have generally declined.
Continued low prices could seriously effect the Company's cash flow,
financial condition and access to additional capital.
HEDGING TRANSACTIONS MAY MITIGATE FLUCTUATION IN PRICES
Substantially all of the Company's sales of oil and natural gas are
made in the spot market or pursuant to contracts based on spot market prices.
To reduce price risk, the Company sometimes executes contracts on a portion
of its production to hedge against market price changes. Hedging transactions
are intended to limit the negative effect of future price declines, but could
also limit the Company's participation in significant price increases for the
covered period. The Company cannot be certain that hedging transactions will
reduce the effect of any substantial declines in oil and natural gas prices.
As of December 31, 1998, the Company was not a party to any natural gas
futures contracts, crude oil swap agreements or other commodity hedging
agreement; however, the Company has agreed to backstop the limited gas hedges
entered into by Shell Capital covering gas dedicated to its term production
payment in the event such gas volumes delivered to Shell Capital are less
than the amounts hedged. In March, the Company entered into a forward sale of
ten contracts for delivery in May 1999 and twelve contracts for delivery in
June, July and August, of its anticipated gas production at an average price
of $2.07/MMBTU. Each contract equates to 10,000 million BTU of gas.
23
UNCERTAINTY OF ESTIMATES OF OIL AND GAS RESERVES
There is substantial uncertainty in estimating quantities of proved
reserves and projecting future production rates and the timing of development
expenditures. No one can measure underground accumulations of oil and natural
gas in an exact way. Accordingly, oil and gas reserve engineering requires
subjective estimations of those accumulations. Estimates of other engineers
might differ widely from those of the Company's internal engineers as well as
Lenser & Associates, the Company's independent engineers. Accuracy of reserve
estimates depends on the quality of available data and on engineering and
geological interpretation and judgment. Lenser & Associates may make material
changes to reserve estimates based on the results of actual drilling, testing
and production. As a result, the Company's reserve estimates often differ
from the quantities of oil and gas it ultimately recovers. Also, the Company
makes certain assumptions regarding future oil and gas prices, production
levels, and operating and development costs that may prove incorrect. Any
significant variance from these assumptions could greatly affect the
Company's estimates of reserves and future net revenues.
EXPLORATION RISKS; RELIANCE ON 3-D SEISMIC DATA AND CAEX TECHNOLOGY
The Company's strategy is to enhance the value of its prospects
through the use of 3-D seismic data and CAEX technology with emphasis on
direct hydrocarbon detection technologies. These technologies create computer
generated 3-D displays of subsurface geological formations that enable the
Company's explorationists to detect seismic anomalies and structural features
that are not apparent in 2-D seismic surveys. These technologies, however,
require greater pre-drilling expenditures than traditional drilling
strategies. Even when fully used and properly interpreted, 3-D seismic data
and CAEX visualization techniques only assist geo-scientists in identifying
subsurface structures and hydrocarbon indicators, and do not conclusively
allow the interpreter to know if hydrocarbons will in fact be present and
recoverable in such structures.
OPERATING AND UNINSURED RISKS
The Company must continually acquire or explore for and develop new
oil and natural gas reserves to replace those produced and sold. The
Company's hydrocarbon reserves and revenues will decline if it is not
successful in its drilling, acquisition or exploration activities. The
Company cannot be certain that its exploration and development projects will
result in significant additional reserves or that the Company will have
success drilling productive wells at economically viable costs. Casualty risk
and other operating risks could cause reserves and revenues to decline.
CASUALTY RISKS
The Company's operations are subject to the following inherent
casualty risks:
- fires;
- explosions and blow-outs;
- abnormally pressured formation;
- uncontrollable flows of oil, natural gas or well fluids;
- pollution and other environmental risks; and
- pipe failure.
The Company could suffer substantial financial losses due to any of
the following:
- injury or loss of life;
- severe damage to and destruction of property and equipment;
- pollution and other environmental damage;
- regulatory investigations and penalties; and
- suspension of operations.
24
UNINSURED RISKS
As is customary in the industry, the Company maintains insurance
against some, but not all, casualty risks incidental to its business.
OTHER OPERATING RISKS
Numerous risks affect the Company's drilling activities, including
the risk of drilling non-productive wells or dry holes. The cost of drilling,
completing and operating wells and of installing production facilities and
pipelines is often uncertain. Also, the Company's drilling operations could
diminish or cease because of any of the following:
- title problems;
- compliance with governmental regulations;
- shortages or delays in the delivery or availability of
drilling rigs and other equipment; and
- weather conditions.
Moreover, effective marketing of the Company's natural gas
production depends on a number of factors such as the following:
- existing market supply of and demand for natural gas;
- the proximity of its reserves to pipelines;
- the available capacity of such pipelines; and
- government regulations.
The marketing of oil and gas production similarly depends on the
availability of pipelines and other transportation, processing and refining
facilities, and the existence of adequate markets. As a result, even if
hydrocarbons are discovered in commercial quantities, a substantial period of
time may elapse before commercial production commences. If pipeline
facilities in an area are insufficient, the Company may have to wait for
construction or expansion of pipeline capacity before the Company can market
production from the area.
GOVERNMENTAL REGULATIONS AND ENVIRONMENTAL RISKS
LEGAL LIMITATIONS
The Company is subject to various United States federal, state and
local laws and regulations on taxation, exploration and development, and
environmental and safety matters. Many laws and regulations require drilling
permits and govern the spacing of wells, the prevention of waste, rates of
production and other matters. These statutes and regulations, and any others
that are passed by the jurisdictions where the Company has production, could
limit the total number of wells drilled or the total allowable production
from successful wells, which could limit revenues. Currently, the Company has
not curtailed production on any of its oil and gas wells.
ENVIRONMENTAL LIABILITIES
The Company could incur liability to the government or third parties
for any unlawful discharge of oil, gas or other pollutants into the air, soil
or water, including responsibility for remedial costs. The Company could
potentially discharge oil or natural gas into the environment in any of the
following ways:
- from a well or drilling equipment at a drill site;
- leakage from storage tanks, pipelines or other gathering and
transportation facilities;
- damage to oil or natural gas wells resulting from accidents
during normal operations; or
25
- blow-outs or explosions.
Environmental discharges may move through soil to water supplies or
adjoining properties giving rise to additional liabilities. Some laws and
regulations could impose liability for failure to notify the proper
authorities of a discharge and other failures to comply with those laws.
Environmental laws may also affect the costs of the Company's acquisitions of
properties. The Company does not believe that its environmental risks are
materially different from those of comparable companies in the oil and gas
industry. However, the Company cannot be certain that environmental laws will
not, in the future, result in decreased production, substantially increased
costs of operations or other adverse effects to its operations and financial
condition. Pollution and similar environmental risks generally are not fully
insurable.
COMPETITION
The oil and gas industry is highly competitive. The Company competes
with major oil and gas companies, other independent oil and gas concerns, and
individual producers and operators. Many of these competitors have financial
and other resources substantially greater than those available to the
Company. Moreover, the oil and gas industry competes with other industries in
supplying the energy and fuel needs of industrial, commercial and other
consumers. Increased competition causing over supply and depressed prices
could greatly affect the Company's operations revenues.
DEPENDENCE ON THE K.S. BYRD 31-1 #1 WELL AND HOWELL #1 WELL
For the first quarter of 1999, revenue from the K.S. Byrd 31-1#1
well totaled approximately $640,800, 47% of the Company's total revenue, on
net production of 4,290 MCFGED. The K.S. Byrd 31-1#1 well accounted for
approximately $2.4 million of the Company's revenue for the year ended
December 31, 1998, 49% of total revenue, on net production of 3,226 MCFGED.
After dedication of certain volumes to the Shell Production Payment or a
replacement production payment, the K.S. Byrd 31-1 #1 will continue to be a
major contributor to the Company's net production. Subsequent to year-end
1998, the Company put the Howell #1 on production at a high rate of gas flow.
The Howell well is expected to contribute greater net production than the
Byrd, and thus, should become the largest production source for the Company.
CONFLICTS OF INTEREST WITH RESPECT TO CERTAIN TRANSACTIONS
The Company has engaged in acquisitions, financings, and other
transactions with entities that are owned in part by certain of the Company's
officers, directors and affiliates. The Company believes that these
transactions were fair to the Company; however, the transactions did not
result from arms length negotiations. See "Interests in Management and Others
in Material Transactions".
CONTROL BY EXISTING MANAGEMENT AND STOCKHOLDERS
The Chairman and Chief Executive Officer, Prentis B. Tomlinson, Jr.
and his wife Heather Tomlinson, beneficially own approximately 35.8% and
6.6%, respectively, of the Company's outstanding Common Stock. Mr. and Mrs.
Tomlinson are able to exercise significant influence over the Company's
affairs, including election of the board of directors and other matters
submitted to a vote of the stockholders. Assuming full conversion of all
Convertible Debentures and the exercise of all warrants, Mr. and Mrs.
Tomlinson will beneficially own approximately 6% and 1.1%, respectively, of
the then outstanding shares of Common Stock.
SHARES ELIGIBLE FOR FUTURE SALE
As of March 31, 1999, the Company had 33,727,724 shares of Common
Stock outstanding. Of the outstanding Common Stock, 16,430,717 shares are
owned by affiliates, as defined in regulations under the Securities Act, and
will be considered "Restricted Stock" within the meaning of Rule 144 under
the Securities Act. Common Stock held by affiliates may not be sold in the
United States in the absence of registration under the Securities Act, unless
an exemption from registration is available. The remaining outstanding Common
Stock is freely transferable in the United States by persons other than
affiliates without restriction or further registration under the Securities
Act. Although the Company cannot predict the timing or amount of future sales
of Common Stock, if any, by selling shareholders or affiliates of the Company
or the effect that the availability of such Common Stock for sale
26
will have on the market price from time to time, sales of substantial amounts
of Common Stock could adversely affect the market price of the Common Stock.
See "Principal Shareholders" and "Description of Share Capital". In addition
to the Common Stock described above, 7,311,578 shares of Common Stock are
reserved for issuance or are issuable upon the exercise of outstanding
warrants, options and other convertible securities. Upon completion of the
Offering, an additional 216,903,158 shares of Common Stock will be issuable
upon conversion of the Preferred Stock, assuming 55,000 shares of Preferred
Stock are purchased in the Offering, all holders of Notes elect Option 1 in
the Exchange and the Series 2 Debentures are converted (or 157,963,678 shares
of Common Stock if all holders of Notes select Option 2 in the Exchange).
To the extent that outstanding options and warrants are exercised,
the percentage ownership of Common Stock of the Company's stockholders will
be diluted. Moreover, the terms upon which the Company will be able to obtain
additional equity capital may be adversely affected because the holders of
outstanding options and warrants can be expected to exercise them at a time
when the Company would, in all likelihood, be able to obtain any needed
capital on terms more favorable to the Company than the exercise terms
provided by such outstanding securities. In the event of the exercise of a
substantial number of stock options or warrants or the conversion of any
convertible securities, including the Notes and the Preferred Stock, within a
reasonably short period of time after the right to exercise commences, the
resulting increase in the amount of Common Stock of the Company in the
trading market could substantially affect the market price of the Common
Stock. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Overview - Capitalization."
ABSENCE OF UNITED STATES TRADING MARKET
The Common Stock is currently traded on the VSE. There is no
established trading market for the Common Stock in the United States. The
future value of the Common Stock and Preferred Stock will depend on many
factors including:
- prevailing foreign currency exchange rates,
- operating results, and
- the market for similar domestic securities.
The Company cannot assure purchasers that the Common Stock will be
listed on a U.S. exchange, that an active United States public market will
develop or that if a purchaser's Preferred Stock is converted into Common
Stock, that it will be able to resell such securities in the United States.
See "Summary - The Offering".
ABSENCE OF PUBLIC MARKET FOR THE PREFERRED STOCK; RESTRICTIONS ON TRANSFER
There is currently no existing market for the Preferred Stock. The
Company has agreed to a reduction in the Preferred Conversion Price if the
Preferred Stock and the Common Stock issuable on conversion is not Freely
Tradable within four months after the Closing Date. See "Summary - The
Offering." Prior to the registration of the Preferred Stock and the Common
Stock issuable thereunder, the Preferred Stock offered hereby and underlying
Common Stock may only be offered or sold pursuant to an exemption from the
registration requirements of the Securities Act or pursuant to an effective
registration statement. See "Restrictions on Transfer."
CERTAIN ANTI-TAKEOVER PROVISIONS
The Certificate of Incorporation authorizes the issuance of
preferred stock at the discretion of the Company's board of directors. The
board of directors can, without shareholder approval, issue preferred stock
with dividend, liquidation, conversion, voting or other rights that could
adversely affect the voting power or other rights of holders of the Company's
securities. In the event of issuance, the preferred stock could be used,
under certain circumstances, as a method of discouraging, delaying or
preventing a change in control of the Company. This could discourage bids for
the Company and, thereby, prevent shareholders from receiving the maximum
value for their shares. The board of directors may institute further
protections on behalf of shareholders to assure their fair consideration in
certain circumstances. The terms of the Preferred Stock prohibit the Company
from issuing additional preferred stock that would be senior to the Preferred
Stock without the consent of the holders of the Preferred Stock.
27
SUBORDINATION OF THE PREFERRED STOCK
The Preferred Stock will rank PARI PASSU with Lasco Preferred and
any new issue of preferred stock that stipulates a liquidation preference
PARI PASSU with the Preferred Stock, and senior to all other present and any
future equity of the Company that does not stipulate it will be PARI PASSU
with the Preferred Stock. The Preferred Stock will be subordinate to claims
of creditors, including holders of the Company's outstanding debt instruments
(including the Notes, all production financings and other creditors). As of
March 31, 1999, the Company had $61,871,600 of indebtedness outstanding,
including $27,250,000 of indebtedness outstanding under the Notes. In
addition, at March 31, 1999, the Company had approximately $12,300,000 of
trade payables outstanding.
Additional indebtedness will be incurred by the Company and its
subsidiaries from time to time subject to certain restrictions contained in
its credit arrangements, the Trust Indenture and the terms of the Preferred
Stock. In the event of a liquidation, dissolution or winding up of the
Company, lenders to and other creditors of the Company and its subsidiaries
would be entitled to payment in full before satisfaction of the liquidation
preference on the Preferred Stock.
EFFECT OF SUBSTANTIAL INDEBTEDNESS
The Company's indebtedness will have several important consequences
to the holders of Notes electing to exchange Notes for Preferred Stock,
including, but not limited to, the following: (i) the holders of Preferred
Stock will be subordinate to any such debt; (ii) the Company's ability to
obtain additional financing in the future, as needed, may be limited; (iii)
the Company's leverage position and the covenants contained in its existing
contractual arrangements may limit the Company's ability to expand its
business and take advantage of certain business opportunities; and (iv) the
Company's leverage may make it more vulnerable to economic downturns, limit
its ability to withstand competitive pressures, and reduce its flexibility in
responding to changing business and economic conditions.
NO DIVIDENDS
The Company may only pay dividends out of surplus, as defined in the
Delaware General Corporation Law, or, if no surplus is available, out of its
net profits for the fiscal year which the dividend or distribution is
declared and the preceding fiscal year. No dividends or distributions may be
declared or paid if the Company is or would be rendered insolvent by virtue
of the dividend distribution. The Company does not believe that these
restrictions will limit its ability to pay dividends on the Preferred Stock
in the future. The Company has not paid any cash dividends on its Common
Stock and does not expect to declare or pay any cash dividends on the Common
Stock or the Preferred Stock in the foreseeable future. See "Common Stock
Price Range and Dividend Policy." The Company currently intends to pay
dividends on the Preferred Stock with Common Stock. The EnCap Credit Facility
and the BOCP Credit Facility currently contain restrictions on the payment of
dividends; however, the Company intends to pay off these credit facilities
shortly after the Closing Date at which time the restriction will no longer
be applicable.
LIMITATION ON MONETARY LIABILITY OF OFFICERS AND DIRECTORS TO STOCKHOLDERS
Section 145 of the Delaware General Corporation Law contains
provisions entitling directors and officers of the Company to indemnification
from judgments, fines, amounts paid in settlement and reasonable expenses,
including attorney's fees, as the result of an action or proceeding in which
they may be involved by reason of being or having been a director or officer
of the Company provided the officers or directors acted in good faith. The
Certificate of Incorporation contains provisions indemnifying officers and
directors of the Company to the fullest extent permitted by Delaware law.
These provisions provide, among other things, that a director of the Company
shall not be liable either to the Company or its stockholders for monetary
damages for breach of fiduciary duty as a director. These provisions may
limit the ability of the Company's stockholders to collect on any monetary
liability owed to them by an officer or director of the Company.
28
POSSIBLE DE-LISTING OF SECURITIES FROM THE LUXEMBOURG STOCK EXCHANGE
If less than 100% of the holders of the Notes accept the Exchange
Offer, and if less than the equivalent of 10,000,000 Luxembourg Francs of
Notes (equal to $265,675 at the exchange rate as of April 15, 1999) remain
outstanding, the remaining holders of Notes will be subject to the risk of an
automatic delisting of the Notes from the Luxembourg Stock Exchange.
USE OF PROCEEDS
The net proceeds to the Company through the sale of Preferred Stock
vary depending upon how many Notes are tendered using each option and the
amount of Preferred Stock sold. Under Assumption 1, the Company has assumed
that all Notes (Series 1 Debentures totaling $27.25 million) are exchanged
under Option 1. Under Assumption 2, the Company has assumed that all Notes
are exchanged under Option 2. In both cases the Company assumes that 55,000
shares of Preferred Stock are sold. Such proceeds are anticipated to be used
as follows (all amounts are approximate and are subject to the discretion of
the board of directors):
ASSUMPTION 1 ASSUMPTION 2
ALL NOTES ALL NOTES
EXCHANGED - OPTION I EXCHANGED - OPTION II
-------------------- ---------------------
Drilling (1)............................ $2.4 Million $0.1 Million
Repayment of Old Ocean Loan (2)......... $0.3 Million $0.3 Million
Seismic Costs (3)....................... $3.2 Million $3.2 Million
Other general corporate needs (4)....... $5.9 Million $0.7 Million
Agent's Commission...................... $1.1 Million $0.4 Million
Estimated Expenses...................... $0.3 Million $0.3 Million
------------ ------------
Total Anticipated Uses.................. $13.2 Million $5.0 Million
============= ============
Notes:
(1) Anticipated to include completion of Fortenberry #1 and some or all of
additional wells at Oakvale Dome, LaHinch, Rayburn and such other prospects
deemed appropriate by the Company. Prospects selected are subject to change
at the sole election of the Company.
(2) Assumes that all lenders participating in the Old Ocean Loan other than
lenders affiliated with EnCap will convert their indebtedness into
Preferred Stock, and includes repurchase of the net profits interest held
by such Old Ocean lenders. Principal amount of the Old Ocean loan is
$2,200,000. The Old Ocean loans bears interest at the rate of 10 % per
annum and matures on June 30, 1999.
(3) Amount due as initial payment to Western Geophysical on 3-D seismic survey
with respect to the Old Ocean Prospect.
(4) Working capital needs including reduction of existing trade payables.
Pending their use, the Company intends to invest the net proceeds in short
term, high grade, interest bearing investments.
Even if the Company receives the maximum anticipated proceeds of
$13.2 million in this Offering, such proceeds will be insufficient for the
Company to satisfy all of its trade payables, pay Western Geophysical in full
for the 3-D seismic survey with respect to the Old Ocean prospect or fund the
Company's exploration budget for the balance of 1999. The Company will
require additional financing from its existing or new lenders to obtain the
funds for such purposes. If loans from these sources plus cash from
operations are insufficient for these purposes, the Company may be required
to curtail its exploration activities.
29
The actual allocation of the proceeds from this Offering will depend
on the amount of such proceeds and the Company's success in exploring for,
finding and developing oil and gas reserves. The board of directors may
reallocate the proceeds of this Offering, but currently does not intend to do
so.
CONSOLIDATED CAPITALIZATION
The following table sets forth (i) the capitalization of the Company at 31
March, 1999; (ii) the capitalization of the Company as adjusted to give
effect to the Offering assuming holders of Notes and Series III Debentures
elect Option 1 and 55,000 shares of Preferred Stock offered hereby are sold;
and (iii) the capitalization of the Company as adjusted to give effect to the
Offering assuming holders of Notes and Series III Debentures elect Option 2
and 55,000 shares of the Preferred Stock offered hereby are sold.
As at March 31, 1999
-----------------------------------------------------------------
As Adjusted As Adjusted
Historical Option 1 Option 2
------------------- -------------------- -------------------
Long-term debt, including current
maturities, net of unamortized discount
of $937,500 $ 61,871,586 $ 27,261,586 $ 27,261,586
Redeemable Preferred Stock, no par value,
unlimited shares authorized; 9,488,140
shares issued and outstanding; redemption
value of $9,488,140 9,488,140 9,488,140 9,488,140
Stockholders equity:
Preferred Stock, $1.00 par value,
100,000,000 shares authorized; no
shares issued or outstanding; (504,930
shares outstanding as adjusted Option
1; 366,490 shares outstanding as
adjusted Option 2)(a) -- 49,993,000 36,149,000
Common Stock; no par value, unlimited
shares authorized; 33,727,724 shares
issued and outstanding (a) 20,424,996 20,424,996 20,424,996
Common Stock reserved for issuance,
1,927,436 shares reserved (a) 2,496,030 2,496,030 2,496,030
Additional paid-in capital 878,067 878,067 878,067
Accumulated deficit (19,237,436) (19,237,436) (19,237,436)
Unrealized losses on available for sale
marketable securities (72,882) (72,882) (72,882)
Cumulative foreign currency translation
adjustment (94,455) (94,455) (94,455)
------------------- -------------------- -------------------
Total stockholders' equity 4,394,320 54,387,320 40,543,320
------------------- -------------------- -------------------
Total Capitalization $ 75,754,046 $ 91,137,046 $ 77,293,046
=================== ==================== ===================
30
(a) On May 18, 1999, the Company migrated from the Yukon Territory, Canada
and became a Delaware Corporation. Authorized capital stock is currently
400,000,000 shares consisting of 300,000,000 shares of common stock, $.01 par
value, and 100,000,000 shares of preferred stock, $1.00 par value.
COMMON STOCK PRICE RANGE AND DIVIDEND POLICY
The Common Stock is listed on the VSE under the symbol "BZG". At March 31,
1999, there were approximately 272 shareholders of record of Common Stock and
1,190 beneficial owners.
The following table sets forth, for the periods indicated, the high and
low sales prices per share, in Canadian Dollars and in U.S. Dollar equivalents,
for the Common Stock as reported on Canada Stockwatch. The Company commenced
operations on October 31, 1996.
COMMON SHARE PRICE RANGE COMMON SHARE PRICE RANGE
(CDN$) (US$) (1)
--------------------------- --------------------------
HIGH LOW HIGH LOW
------------- ------------- ------------ -------------
TEN MONTHS ENDED AUGUST 31, 1997
Month ended November 30, 1996......................... $2.50 $1.90 $1.88 $1.41
Second Quarter ended February 28, 1997................ $4.30 $2.00 $3.15 $1.48
Third Quarter ended May 31, 1997...................... $4.40 $3.00 $3.23 $2.19
Fourth Quarter ended August 31, 1997.................. $3.35 $2.50 $2.44 $1.82
FOUR MONTHS ENDED DECEMBER 31, 1997(2) $3.50 $1.55 $2.53 $1.08
1998
First Quarter ended March 31, 1998.................... $2.10 $1.10 $1.49 $0.77
Second Quarter ended June 30, 1998.................... $2.04 $1.30 $1.43 $0.89
Third Quarter ended September 30, 1998................ $1.80 $0.45 $1.24 $0.30
Fourth Quarter ended December 31, 1998................ $1.15 $0.32 $0.74 $0.21
1999
First Quarter $0.75 $0.28 $0.49 $0.18
Second Quarter (through June 9, 1999).................. $0.50 $0.29 $0.34 $0.20
- -------------------------------
(1) Share price was converted from Canadian dollars to U.S. dollars using
the average of the high and low exchange rate in effect during the
respective periods.
(2) In 1997, the Company changed its fiscal year-end from August 31 to
December 31.
DIVIDEND POLICY
To date, the Company has not paid any dividends on its Common Stock. The
Company intends to retain its earnings, if any, to provide funds for
reinvestment in the Company's exploration, development and production
activities, and, therefore, does not anticipate declaring or paying dividends
on its Common Stock in the foreseeable future. Furthermore, payment of
dividends, if any, in the future is within the discretion of the board of
directors and will depend on the Company's earnings, if any, its capital
requirements and financial condition and other relevant factors. Presently,
the payment of dividends in cash by the Company on its Common Stock is
restricted under the terms of certain of the Company's credit facilities. The
Company has the right through December 31, 1999 to pay dividends due on its
Class A, Series I Preferred Stock with Common Stock priced at a trailing
average closing price. To date the Company has elected this option with
respect to all dividends due on the Series I Preferred Shares. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation - Liquidity and Capital Resources."
31
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following selected financial data as of and for the ten month
period ended August 31, 1997, the four month period ended December 31, 1997,
and the year ended December 31, 1998, have been derived from the Company's
audited consolidated financial statements. The selected consolidated
financial data as of and for the three month period ended March 31, 1998 and
1999 have been derived from the Company's unaudited consolidated financial
statements. The unaudited consolidated financial statements include all
adjustments consisting of normal recurring accruals that the Company
considers necessary for a fair presentation of the Company's financial
position as of such dates and the results of operations and cash flows for
such periods. Operating results for the three months ended March 31, 1999 are
not necessarily indicative of the results that may be expected for the entire
year ending December 31, 1999. The selected financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the financial statements of the Company and
the related notes thereto included elsewhere in this Offering Circular.
Four Month Ten Month
Year Ended Period Ended Period Ended
For the Quarter Ended March 31, December 31, December 31, August 31,
1999 1998 1998 1997(1) 1997(2)
-------------------------------------------------------------------------------------------
(unaudited) (unaudited) (audited) (audited) (audited)
INCOME STATEMENT DATA
Petroleum revenues $ 1,370,957 $1,040,780 $4,947,457 $ 707,987 $444,203
Earnings (loss) before
DD&A, interest
amortization of
issuance costs income
tax and preferred
dividends 210,271 (465,790) (2,756,466) (1,479,769) (1,686,624)
Net loss applicable to
common stockholders (2,665,782) (2,365,163) (11,915,191) (2,739,322) (1,917,141)
As of As of As of
As of December 31, December 31, August 31,
March 31, 1998 1997 (1) 1997(2)
---------------------------------- ---------------- -- ----------------- -- ---------------
1999 1998 (audited) (audited) (audited)
---------------- -----------------
BALANCE SHEET DATA (unaudited) (unaudited)
Working Capital Surplus (Deficit) $(35,135,688) $2,538,902 $(27,360,635) $(15,290,406) $1,784,075
Properties and Equipment, net 85,463,843 45,109,137 79,412,241 25,319,771 11,916,817
Total Assets 97,890,925 75,339,380 95,240,247 36,216,129 21,520,880
Long-term Debt, including
current maturities 61,871,586 41,152,167 59,490,912 12,708,303 781,326
Redeemable Preferred Shares 9,488,140 12,000,000 9,488,140 -- --
Stockholders' Equity 4,394,320 12,547,544 6,990,828 11,806,496 14,089,948
- --------------------------------
(1) The Company changed its fiscal year end to December 31.
(2) Represents the period from inception to original year-end, August 31.
32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with information
provided above under "Cautionary Statement Regarding Forward-Looking Statements"
and "Risk Factors," and with the Company's Consolidated Financial Statements and
notes thereto attached as Appendix B and Appendix C to this Offering Circular.
OVERVIEW
The following matters had a significant impact on the Company's results of
operations and financial position for the three months ended March 31, 1999:
VOLUME AND PRICE INFORMATION
Revenue for the first quarter of 1999 was significantly impacted by low
average natural gas prices. Natural gas production accounts for 87% of the
Company's total production on an equivalent MCF basis. The Company's revenues
are therefore more sensitive to gas price fluctuations than to oil price
changes. For the first quarter of 1999 natural gas prices received by the
Company for its production averaged $1.70 per MCF compared to $2.27 for the
comparable period in 1998.
The following table summarizes volume and price information with
respect to the Company's oil and gas production for the three months ended March
31, 1999 and 1998:
Three Months Ended March 31,
-------------------------------
Increase
1999 1998 (Decrease)
------ ------ ----------
Gas Volume - MCFGD 7,913 4,570 3,343
Average Gas Price - per MCF $ 1.70 $ 2.27 $(0.57)
Oil Volume - BOD 191 99 92
Average Oil Price - per barrel $ 9.50 $12.08 $(2.58)
OUTSTANDING DEBT
At March 31, 1999, the Company had outstanding debt of $61.9 million.
The Company's EnCap, BOCP and Old Ocean Credit Facilities will come due on June
30, 1999. The Company anticipates that as to the indebtedness reflected by the
Old Ocean Loan, that all lenders, other than affiliates of EnCap that are owed
$100,000, will elect to convert their respective indebtedness and the mineral
interests obtained in connection with the Old Ocean Loan into Preferred Stock.
The Company anticipates that it will repay the $100,000 owed to affiliates of
EnCap under the Old Ocean Loan and the indebtedness reflected by the EnCap
Credit Facility and the BOCP Credit Facility in June with funds obtained in
connection with the Offering and new funds received in connection with either an
increase of the Shell Production Payment or through funds received in connection
with a new production payment arrangement with a new lender. The Company is
currently engaged in negotiations as to both financing options and believes such
new financing will be available in time to meet the current maturity dates. If
the Company is unable to obtain sufficient new financing to pay off the EnCap
Credit Facility and the BOCP Credit Facility, then the Company will be in
default under the applicable Credit Facility and the applicable lenders will
have the right to seek immediate repayment of the entire indebtedness due
thereunder and enforce its other remedies, which include the right to foreclose
on substantially all of the properties of the Company. Any of the foregoing
actions could cause the Company to cease operations.
The following had a significant impact on the Company's results of
operations and financial position for the year ended December 31, 1998:
CAPITALIZATION
The Company completed in March and April of 1998 the private placement
of $37.5 million principal amount of Convertible Debentures, which include the
Notes. After expenses and escrow of $1.056 million for the satisfaction of
certain put rights of holders of Convertible Debentures (of which approximately
$988,000 has been
33
put), $32.5 million of the proceeds remained available to the Company. In
April 1999, the Company and the holders of the Notes agreed to lower the
conversion price of their debentures from Cdn. $1.70 per common share to Cdn.
$1.40 per common share in exchange for certain changes to the indentures.
Series 3 Debentureholders and the Series A Special Noteholders have agreed to
the same changes by written consent. The Notes are convertible into
29,003,555 shares of Common Stock, based on a conversion price of Cdn.$1.40
and an exchange rate of $0.6711 per Cdn.$1.00 (the exchange rate as of April
15, 1999). The remaining Convertible Debentures are convertible into
10,551,121 shares of Common Stock based on a current conversion price of
Cdn.$1.40 adjusted for the 10% penalty on conversion due to delayed
registration.
DISCOVERY WELL
The K. S. Byrd Well, which began producing in September of 1997,
contributed an average of 2,402 MCF per day during 1998, before including 747
MCF per day for acquired interests. The Company's interest in this well
increased with the Calibre Acquisition and the Southern Gas Acquisition.
ACQUISITIONS
The Company acquired certain producing properties from Lasco Energy
Partners in January 1998, Calibre Energy, L.L.C. in April 1998 and Southern Gas
Company in May 1998 (together with the Starbucks Acquisition and the Mobil
Acquisition, (the "Acquisitions"). The assets acquired in these transactions
contributed an average of 2,982 MCF per day during 1998, of which 747 MCF per
day was additional production to the Company related to the K. S. Byrd well not
included in the discussion above.
VOLUME AND PRICE INFORMATION
The Company's average realized price for natural gas decreased $0.56
per MCF from $2.80 per MCF for the year ended December 31, 1997 to $2.24 per MCF
for the comparable period in 1998. Income in 1998 from hedging gains increased
gas realizations by $0.18 per Mcf. The average realized oil price decreased
$8.25 per barrel from $19.08 per barrel in 1997 to $10.83 per barrel in 1998.
The following table summarizes volume and price information with respect to
the Company's oil and gas production for the years ended December 31, 1998 and
1997, the four month period ended December 31, 1997 and the ten month period
ended August 31, 1997:
Four Months Ten Months
Year Ended December 31, Ended Ended
------------------------- Increase December 31, August 31,
1998 1997 (1) (Decrease) 1997 1997
-------- --------- ---------- ------------ ----------
Gas Volume - MCFGD 5,505.6 788.3 4,717.3 1,833.5 275.7
Average Gas Price - per MCF $ 2.24 $ 2.80 $ (0.56) $ 2.79 $ 3.05
Oil Volume - BOD 111.4 33.2 78.2 36.9 30.5
Average Oil Price - per barrel $ 10.83 $19.08 $ (8.25) $ 18.54 $20.28
- ------------------------------
(1) The amounts for the year ended December 31, 1997 were derived by adding the
audited four month period ended December 31, 1997 and the audited ten month
period ended August 31, 1997 and then subtracting the unaudited two month
period ended December 31, 1996.
34
OUTSTANDING DEBT
At December 31, 1998, the Company had outstanding debt of $59.5 million
compared to $12.7 million at December 31, 1997. The increase reflects the
issuance of $37.5 million of Convertible Debentures, proceeds from which were
used to fund oil and gas prospect drilling, leasing and seismic data acquisition
activities in the onshore Texas and Mississippi Gulf of Mexico region, repayment
of a portion of the Company's outstanding debt and other working capital uses.
In addition, the Company entered into a financing agreement with Shell Capital
whereby the Company sold a term production payment to Shell Capital for $7.0
million. The Company's debt-to-capitalization ratio at December 31, 1998 was
78.3%.
THREE MONTHS ENDED MARCH 31, 1999 VS. THREE MONTHS ENDED MARCH 31, 1998
For the three months ended March 31, 1999, revenue from crude oil and
natural gas production increased 32% over the same period in 1998. Natural gas
contributed 88% and crude oil contributed 12% of total oil and gas production
revenue.
Natural gas sales increased 30%, from $932,400 for the three months
ended March 31, 1998 to approximately $1.2 million for the same period in 1999;
however, the impact of increased production was significantly reduced by the
decline in natural gas prices. Production for the first quarter of 1999
increased significantly over the comparable prior year period due primarily to
production from the assets purchased in the second quarter of 1998 and
production from new wells drilled and completed. This increase in production
improved revenue from the 1999 period by $681,800. The average realized price
for natural gas sales declined from $2.27 per MCF in the first quarter of 1998
to $1.70 per MCF in the comparable 1999 period decreasing revenues by $406,700.
For the three months ended March 31, 1999, oil sales increased 51% to
$163,500, compared to $108,400 for the same period in 1998, due primarily to
sales of production from properties acquired in the second quarter of 1998 and
from new wells drilled and completed. This increase in production improved
revenue for the first quarter of 1999 by approximately $99,500. The Company's
average realized price for sales of crude oil in the first quarter of 1999
decreased by $2.58 per barrel, or 21%, decreasing revenue by $44,400 compared to
the same period in 1998.
The Company's depreciation, depletion and amortization ("DD&A") expense
for the first quarter of 1999 totaled $1.2 million compared to $676,600 in the
comparable period for 1998. Full cost DD&A totaled $1.1 million for the three
months ended March 31, 1999 compared to $621,600 for the same period in 1998.
The increase in DD&A is consistent with a higher amortizable asset base and an
increase in production for the 1999 period compared to the prior year period. On
an equivalent MCF basis, full cost DD&A decreased $0.04 per MCFE, from $1.34 per
MCFE for the three months ended March 31, 1998 to $1.30 per MCFE in the
comparable 1999 period. DD&A of other assets for the first quarter of 1999
totaled $102,500, an increase of $47,500 over the comparable period in 1998, due
primarily to an increase in the related asset base.
Operating costs, including lease operating expense ("LOE") and
production taxes, increased 30% from $129,200 in the first quarter of 1998 to
$168,200 for the same period in 1999. The increase was due primarily to
increased production from wells drilled or acquired since the prior year period.
For the three months ended March 31, 1999, LOE, excluding severance taxes,
totaled $138,000 compared to $111,100 for the comparable period in 1998. On an
equivalent MCF basis, average LOE for the first quarter of 1999 decreased from
$0.24 per MCFE in 1998 to $0.17 per MCFE in the same 1999 period.
General and administrative expense for the three months ended March 31,
1999 decreased $552,200, or 37%, compared to the same period in 1998. On an
equivalent MCF basis, general and administrative expenses declined 64% to $1.15
per MCFE for the three months ended March 31, 1999 compared to $3.19 per MCFE
for the same period in 1998. The decrease in G&A costs was due primarily to
lower compensation expense generated by staff reductions during the fourth
quarter of 1998 and the first quarter of 1999. These staff reductions, as well
as salary reductions for certain of the remaining employees, are expected to
significantly reduce G&A costs in 1999.
Interest expense for the three months ended March 31, 1999 totaled $1.0
million compared to $1.2 million in the comparable prior year period. Average
debt was approximately $59.8 million for the first quarter of 1999, resulting in
gross interest costs of $2.0 million. Other financing costs include the
amortization of discount of $77,800. Partially offsetting these costs was
capitalized interest of $1.0 million, which is based on the carrying value of
unproved properties. Financing costs also included amortization of debt issuance
costs totaling $582,030
35
for the first quarter of 1999. For the first quarter of 1998, average debt
was approximately $25.6 million, resulting in gross interest costs of
$857,000. Other financing costs included the amortization of the original
issue discount for the EnCap NPI and warrants of $512,400. Partially
offsetting these costs was capitalized interest of $171,400. Amortization of
debt issuance costs totaled $53,800 for the first quarter of 1998.
Other income (expense) for the three months ended March 31, 1999
included interest income of $88,200 partially offset by losses on the sale of
marketable securities totaling $58,600. For the comparable period in 1998 other
income included interest income of $29,000 and gains on the sale of marketable
securities totaling $108,800.
For the three months ended March 31, 1999, the Company reported a net
loss applicable to common stockholders of $2.7 million, or $0.08 per share,
compared to a net loss of $2.4 million, or $0.08 per share, in the comparable
1998 period. Weighted average shares outstanding increased from approximately
30.6 million in the first quarter of 1998 to over 33.7 million in the comparable
1999 period as a result of the issuance of Common Stock as dividend payment on
preferred shares as well as the exercise of warrants and options in the second
half of 1998.
YEAR ENDED DECEMBER 31, 1998 VS. YEAR ENDED DECEMBER 31, 1997
For the year ended December 31, 1998, the Company reported a net loss
applicable to common stockholders, of $11.9 million, or $0.37 per share,
compared to a net loss of $4.4 million, or $0.18 per share, in the comparable
1997 period. Weighted average shares outstanding increased from approximately
24.1 million in 1997 to over 32.4 million in 1998 as a result of the conversion
and exercise of warrants in late 1997 and the issuance of Common Stock to
acquire certain properties in 1998 and to pay interest and dividends on the
Lasco Acquisition note and subsequent preferred shares.
For the year ended December 31, 1998, revenue from crude oil and
natural gas production increased 378% over the same period in 1997. Natural gas
contributed 91% and crude oil contributed 9% of total oil and gas production
revenue.
Natural gas sales increased over 460%, from $804,700 for the year ended
December 31, 1997 to approximately $4.5 million for the same period in 1998, as
the impact of increased production more than offset the impact of the decline in
natural gas prices. Production for 1998 increased significantly over the
comparable prior year period due primarily to production from the assets
purchased in the Acquisitions and production from the K. S. Byrd Well. This
increase in production improved revenue for 1998 by $4.8 million. The average
realized price for natural gas sales declined from $2.80 per MCF in 1997 to
$2.24 per MCF in the comparable 1998 period, decreasing revenues by $1.1
million. Income in 1998 from hedging gains increased gas realizations by $0.18
per Mcf.
For the year ended December 31, 1998, oil sales increased 91% to
$440,500, compared to $231,100 for the same period in 1997, due primarily to
sales of production for properties acquired in the Acquisitions and production
from the Reedy Creek properties. This increase in production improved revenue
for 1998 by approximately $544,700. The Company's average realized price for
sales of crude oil in 1998 decreased by $8.25 per barrel, or 43%, decreasing
revenue by $335,300 compared to the same period in 1997.
The Company's depreciation, depletion and amortization ("DD&A") expense
for 1998 totaled $3.2 million compared to $854,100 in the comparable period for
1997. Full cost DD&A totaled $2.8 million for the year ended December 31, 1998
compared to $709,200 for the same period in 1997. The increase in DD&A is
consistent with the increased production for 1998 compared to the prior year
period. Included in DD&A for the year ended December 31, 1997, was $221,000 of
non-cash charges attributable to a price-related reduction in the book value of
the Company's oil and gas reserves. On an equivalent MCF basis, full cost DD&A
decreased $0.71 per MCFE, from $1.97 per MCFE for the year ended December 31,
1997 to $1.26 per MCFE in the comparable 1998 period. DD&A of other assets for
1998 totaled $305,700, an increase of $160,800 over the comparable period in
1997 due primarily to an increase in the related asset base.
Operating costs, including lease operating expense ("LOE") and
production taxes, increased 763% from $111,500 in 1997 to $962,700 for the same
period in 1998. The increase was due primarily to increased production from
wells drilled or acquired since the prior year period. For the year ended
December 31, 1998, LOE, excluding severance taxes, totaled $860,200 compared to
$86,500 for the comparable period in 1997. On an equivalent MCF basis, average
LOE for 1998 increased from $0.24 per MCFE in 1997 to $0.38 per MCFE in 1998.
This increase is primarily due to the Lasco Acquisition that was comprised of
older, lower rate wells.
36
General and administrative expense for the year ended December 31, 1998
increased over $1.9 million, or 52%, compared to the same period in 1997. On an
equivalent MCF basis, general and administrative costs declined 76% to $2.56 per
MCFE for the year ended December 31, 1998 compared to $10.51 per MCFE for the
same period in 1997. The increase in G&A costs was due primarily to higher
compensation expense generated by a larger staff. The Company began 1998 with 26
employees, increasing to 37 employees during the year. Staff reductions during
the fourth quarter of 1998 reduced total employees to 29 at year-end. Further
staff reductions during the first quarter of 1999 reduced total employees to 21
at March 31, 1999. These staff reductions, as well as salary reductions for the
majority of the remaining employees, are expected to significantly reduce G&A
costs in 1999. The overall high level of general and administrative expenses in
1997 was due to the initial costs associated with creating and managing the
Company's extensive capital program.
Interest expense for the year ended December 31, 1998 totaled $5.8
million compared to $689,219 in the comparable prior year period. The increase
is due primarily to the financing arrangements under the EnCap Credit Facility
entered into in December 1997 and interest on the $37.5 million principal amount
of Convertible Debentures issued in March and April of 1998. Average debt was
approximately $44.6 million for 1998, resulting in gross interest costs of $4.8
million. Other financing costs include the amortization of the original issue
discount for the EnCap NPI (defined below) of $1.7 million and the amortization
of deferred loan and issuance costs of $1.2 million. Partially offsetting these
costs were capitalized interest of $1.9 million, which is based on the carrying
value of unproved properties.
Other income (expense) for the year ended December 31, 1998 included a
charge of $1.0 million due to the termination of a key employee of the Company
recorded in December 1998 to reflect settlement of his employment contract. Such
settlement will be paid out through January 2001. Offsetting this expense were
interest income of $573,609 and gains on the sales of marketable securities
totaling $24,971. For the comparable period in 1997, interest income of $77,844
was offset by losses on the sales of marketable securities totaling $86,824.
FOUR MONTHS ENDED DECEMBER 31, 1997 AND TEN MONTHS ENDED AUGUST 31, 1997
The Company reported a net loss of $2,739,300, or $0.10 per share, for
the four months ended December 31, 1997 and $1,917,100 or $0.09 per share, for
the ten months ended August 31, 1997. Weighted average shares outstanding were
27.9 million for the four months ended December 31, 1997 and 21.9 million for
the ten months ended August 31, 1997.
Natural gas sales for the four months ended December 31, 1997 and the
ten months ended August 31, 1997 totaled $624,400 and $256,000, respectively.
Production averaged 1,833 MCFD for the four-month period ended December 31, 1997
at an average price of $2.79 per MCF and 276 MCFD for the ten-month period ended
August 31, 1997 at an average price of $3.05 per MCF. The K.S. Byrd Well began
production in September 1997 and averaged 1,605 MCFD for the four months ended
December 31, 1997.
The Company's crude oil sales for the four months ended December 31,
1997 and the ten months ended August 31, 1997 totaled $83,500 and $188,200,
respectively. Production averaged 36.9 barrels per day and 30.5 barrels per day,
respectively, for the four-month period ended December 31, 1997 and the
ten-month period ended August 31, 1997. The Company's average realized price for
sales of crude oil for the four month period ended December 31, 1997 and the
ten-month period ended August 31, 1997 were $18.54 per barrel and $20.28 per
barrel, respectively.
For the four months ended December 31, 1997, DD&A expense totaled
$634,500 and for the ten months ended August 31, 1997, DD&A expense was
$240,400. Full cost DD&A averaged $2.32 per MCFE for the four months ended
December 31, 1997 and $1.07 per MCFE for the ten months ended August 31, 1997,
due primarily to a ceiling test write-down of $221,000 at December 31, 1997.
Operating costs totaled $49,800 and $68,500, respectively, for the four
month period ended December 31, 1997 and the ten month period ended August 31,
1997. LOE, excluding severance taxes, totaled $42,700 and $45,600 for the same
periods, respectively. On an equivalent barrel basis, LOE for the four months
ended December 31, 1997 averaged $0.17 per MCFE and for the ten months ended
August 31, 1997 averaged $0.33 per MCFE.
37
General and administrative costs totaled $2,087,100 for the four months
ended December 31, 1997 and $2,026,400 for the ten months ended August 31, 1997.
On an equivalent MCF basis, general and administrative expenses were $8.32 per
MCFE for the four months ended December 31, 1997 and $14.53 per MCFE for the ten
months ended August 31, 1997. General and administrative costs were significant
during these periods and reflected establishment of the infrastructure necessary
to sustain the planned expansion of oil and gas operations and the Company's
desired position as operator of many of its prospects. Costs included signing
bonuses paid to professional and senior management staff as inducements to leave
their previous employment and join the Company, legal and accounting fees, and
the settlement of a lawsuit filed by a former employee.
Net financing costs for the four months ended December 31, 1997 were
$625,100, and consisted of gross interest expense of $286,700, the amortization
of the original issue discount for the EnCap NPI of $427,500 and amortization of
deferred loan costs of $42,900. Partially offsetting these costs was capitalized
interest of $108,200 and interest income of $23,800. For the ten months ended
August 31, 1997, gross interest expense of $49,300 was more than offset by
interest income of $59,200. The higher financing costs in the four month period
ended December 31, 1997 reflects the Company's increase in long-term debt from
$759,300 at August 31, 1997 to $14.7 million at December 31, 1997. This increase
in debt relates to the EnCap Credit Facility, entered into in late 1997, that
was used to finance the Oakvale Dome Field and Old Ocean acquisitions and
related development.
Other revenue for the four-month period ended December 31, 1997 and the
ten-month period ended August 31, 1997 represents losses on the sale of
marketable securities of $50,900 and $35,900, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary cash needs are for exploration, development and
acquisition of oil and gas properties, payment for the acquisition and
processing of seismic data, the repayment of trade payables and repayment of
principal and interest on outstanding debt. The Company has budgeted $11.3
million to fund planned capital expenditures on its prospects during 1999. The
Company's sources of financing include net proceeds from the Offering, a
tentative commitment of equity from an affiliate of EnCap, revenue generated
from operations, ongoing sales of non-core assets and proceeds from production
payment facilities. Based on the foregoing, the Company will require additional
capital from more than one of the sources identified above to fund its ongoing
activities and capital budget. If the Company is unable to obtain such
additional capital, the Company will either have to sell interests in its
prospects to fund its drilling program, curtail its exploration activities
and/or curtail ongoing activities. Such curtailing of activities could include
reducing the number of wells drilled, slowing activities on projects that the
Company operates, selling additional interests in the Company's prospect
inventory or a combination of the foregoing. In the absence of any new funding,
the Company will have inadequate liquidity to satisfy its existing contractual
obligations and to continue operations in its current form.
Many of the factors that may affect the Company's future operating
performance and long-term liquidity are beyond the Company's control, including,
but not limited to, oil and natural gas prices, governmental actions and taxes,
the availability and attractiveness of financing and its operational results.
The Company continues to examine alternative sources of long-term capital,
including bank borrowings, the issuance of debt instruments, the sale of Common
Stock or other equity securities, the issuance of net profits interests, sales
of promoted interests in its prospects, and various forms of joint venture
financing. In addition, the prices the Company receives for its future oil and
natural gas-production and the level of the Company's production will have a
significant impact on future operating cash flows.
LIQUIDITY
At March 31, 1999, the Company had cash and cash equivalents on hand of
$565,200 and working capital deficit of $35.1 million, as compared to a cash
balance of $2.3 million and a working capital deficit of $27.4 million as at
December 31, 1998 and a cash balance of $3.2 million and a working capital
deficit of $15.3 million at December 31, 1997. The Company's ratio of current
assets to current liabilities was 0.16:1 at March 31, 1999, 0.25:1 at December
31, 1998 and 0.37:1 at December 31, 1997. The working capital deficit and low
current ratio is primarily due to the EnCap Credit Facility discussed below,
repayment of which is due by June 30, 1999.
38
CASH FLOWS
Cash flows used in operations totaled $153,600 for the three months
ended March 31, 1999, compared to $4.1 million for the year ended December 31,
1998. Cash used in investing activities for the quarter ended March 31, 1999 and
year ended December 31, 1998 was $4.1 million and $35.4 million, respectively.
During the first quarter of 1999, costs incurred for exploration and development
expenditures totaled $4.1 million and capital expenditures for furniture and
equipment totaled $64,200. Partially offsetting these costs was proceeds of
$128,100 from the sale of marketable securities. Cash outlays for exploration
and development expenditures totaled approximately $36.3 million and capital
expenditures for furniture and equipment totaled $745,400 during the year ended
December 31, 1998. Partially offsetting these costs were $1.1 million in
proceeds from the sale of non-core properties and $1.1 million in proceeds from
the sale of marketable securities.
Cash provided by financing activities totaled $2.4 million for the
first quarter of 1999 and included borrowings under the BOCP Credit Facility of
approximately $2.7 million and repayments under the Shell Production Payment
totaling approximately $352,500. For the year ended December 31, 1998 cash
provided by financing activities totaled approximately $38.7 million and
consisted primarily of proceeds from the issuance of Convertible Debentures
including the Notes. The Company also borrowed $3.0 million under the EnCap
Credit Facility and repaid $5.0 million thereunder during the first quarter of
1998. In December 1998, the Company entered into a financing agreement with
Shell Capital whereby the Company sold a term production payment to Shell
Capital for $7.0 million. Also in December, the Company repaid $2.9 million on
Tranche A and Tranche B loans under its BOCP Credit Facility resulting in net
borrowings under that Facility of $2.3 million for the year ended December 31,
1998. The Company also borrowed $2.2 million for the acquisition of property
interests from Mobil through a short term, secured advance from investors
introduced by the Agent (referred to herein as the Old Ocean Loan).
CREDIT FACILITIES
ENCAP CREDIT FACILITY
In 1999, the Company entered into a $20 million credit agreement (the
"EnCap Credit Facility") with EnCap Capital Fund III, L.P. ("EnCap Energy")
consisting of a promissory note for $12,000,000 (the "Original Note") and a
promissory note for $8,000,000 (the "Supplemental Note"; collectively, the
"Notes"). The Original Note bears interest at 10% per annum through December 31,
1998 and at 18% per annum thereafter. The Note is due, with accrued interest, by
June 30, 1999. The Supplemental Note was repaid in full and is no longer
outstanding. Under the terms of the Convertible Debentures (other than the
Notes), the Company has agreed to limit borrowings under the EnCap Credit
Facility to $12,000,000, all of which is outstanding and due June 30, 1999
following an extension obtained by the Company. The proceeds from the facility
were applied to the acquisition of Oakvale Dome ($8,000,000), and Old Ocean
properties and the drilling and completion of certain development wells
($4,000,000). A first lien on certain properties and a second lien on certain
other properties secure the Original Note. Mr. Tomlinson, Calibre and certain
affiliates of Calibre guarantee the Original Note.
Under the terms of the Original Note, the Company agreed to convey to
EnCap Energy, on January 1, 1999, a 25% net profit interest (the "EnCap NPI")
from the properties acquired with the proceeds of the borrowing. In connection
with the original granting of the EnCap NPI, the Company recorded a discount on
the Original Note of $2,102,180 as of December 31, 1997. The discount has been
amortized over the term of the Original Note. The carrying amount of the oil and
gas interests has been reduced by the same amount.
Under the terms of the Supplemental Note, EnCap Energy was issued
warrants to purchase up to 1.5 million shares of Common Stock at an exercise
price of $1.28 per share. In connection with the issuance of these warrants, the
Company recorded a discount on the Supplemental Note of $367,881 as of December
31, 1997. This discount is being amortized over the term of the Supplemental
Note. Pursuant to a financing agreement dated November 4, 1998 with EnCap Energy
and as consideration for enabling additional funding through the BOCP Credit
Facility, the warrants were re-priced to $0.46475 per share.
BOCP CREDIT FACILITY
In December 1998, the Company's loan agreement with Bank One NA ("Bank
One") was purchased by BOCP Energy Partners, L.P. ("BOCP"), an affiliate of
EnCap. Pursuant to an assignment of note and liens dated
39
December 29, 1998, Bank One assigned the original loan agreement, together
with all loan documents referred to therein, to BOCP. In December 1998, the
principal amount then outstanding under Tranche A of $2.9 million plus
interest was repaid and, per amendments to the loan agreement, no further
advances will be requested or made under Tranche A. Interest accrued on
Tranche A at prime plus 2.0% and on Tranche B at a rate of 15% per annum,
payable monthly.
The amendments also modified the terms of Tranche B of the credit facility as
follows:
(1) Maximum availability of $6,000,000;
(2) No advances on Tranche B will be requested or made on or after April 30,
1999;
(3) Maturity date of June 30, 1999; and
(4) Interest rate of prime plus eight percent per annum through and including
December 31, 1998, and fifteen percent per annum from and after January 1,
1999.
The present outstanding balance of the BOCP Credit Facility is $6.0 million. All
interest accrued on Tranche B remains unpaid and owing and is due on June 30,
1999. The Company has reached a standstill agreement covering certain covenants
of which the Company is currently in violation and received an extension in the
maturity date to June 30, 1999.
SHELL FINANCING
In December 1998, the Company entered into a financing agreement with
Shell Capital, Inc. ("Shell Capital") whereby the Company sold a term production
payment ("Shell Production Payment") to Shell Capital for $7.0 million. The
production payment comprised a dedication of 42% of the net revenues from the
Wausau, Oak Hill and East Morgantown properties, 23.1% of Oakvale Dome's Howell
well, 12.2% of Oakvale Dome's Fortenberry well and 38.5% of Oakvale Dome's Byrd
well. The interests conveyed are subject to future adjustment. The Shell
Production Payment is secured solely by the properties and is non-recourse to
the Company. Following full pay-out ($7.0 million plus a 15% rate of return) of
the production payment, the dedicated revenue interest is returned to the
Company less a permanent royalty interest equal to 8.75% of the Company's net
revenue interest in Wausau, Oak Hill and East Morgantown; 4.8% of the Howell and
Byrd wells; and 2.5% of the Fortenberry well. The Company has the right to buy
back the production payment at a stated rate of return of 25% plus a payment of
$1.0 million. In connection with the right to buy back the permanent overriding
royalty interest conveyance, the Company recorded a discount on the financing of
$1.0 million. The carrying amount of the oil and gas interests has been reduced
by the same amount. Shell Capital further agreed to expand the Shell Production
Payment up to $25.0 million provided that the Company sell certain properties,
enter into a payment schedule for amounts owed to an industry partner, raise
additional capital and obtain certain minimum results from current development
drilling activity. The Company is currently negotiating with Shell Capital and
other parties to complete the expansion of the Shell Production Payment or the
creation of a new production payment.
This financing has been classified as debt on the balance sheet and
began being reduced in 1999 as production is delivered to Shell under the terms
of the contract. Volumes delivered to Shell are reported as revenue at prices
received by Shell. Interest expense is recorded based on a rate of 15% per
annum.
OLD OCEAN LOAN
On December 31, 1998, the Company obtained a $2.2 million loan from a
group of lenders led by the Agent, the proceeds being used to acquire additional
interests in the Old Ocean Project from Mobil. The loan is due, through
extension, on June 30, 1999, and is secured by the acquired interests and a
junior lien on certain other properties. The Company has proposed that it repay
the loan through the issuance of Preferred Stock. The Company also granted the
providers of the facility with an overriding royalty that is to be converted
into a participating net profits interest, which interest can be repurchased by
the Company for $1.1 million in cash or stock and $1.1 million principal amount
of warrants. The Company has proposed repurchasing the overriding interest and
participating net profits interest with Preferred Stock as well. One lender of
$100,000 has elected to accept cash for repayment of its portion of the loan and
purchase of the overriding interest.
40
CONVERTIBLE DEBENTURES
In April 1998, the Company issued the Series A Special Notes (which
Notes and the Debentures into which they are exchangeable are referred to herein
as the Series 2 Debentures) to Canadian investors and the Series 3 Debentures to
United States investors on substantially similar terms to the Notes. It is the
Company's intention to offer holders of the Series 3 Debenture the ability to
exchange their special notes or debentures into Preferred Stock on terms which
are not any more favorable, in whole or in part, than those attaching to the
Preferred Stock and to the terms set out in the Letter of Transmittal. The
holders of Series 2 Debentures (which amount to $1,652,000) are not being
offered the opportunity to exchange their Series 2 Debentures into Preferred
Stock.
CHANGES IN ISSUED SHARE CAPITAL
On March 31, 1999, the Company agreed to issue 1,057,000 shares of
Common Stock to certain holders of the Series 3 Debentures in exchange for
interest owed and due on March 31, 1999. Also on March 31, 1999, the Company
agreed to issue 541,700 shares of Common Stock to a holder of Series 3
Debentures to retire $250,000 principal amount of the debentures. The shares
will be issued following receipt of VSE acceptance.
YEAR 2000
The Company operates on an externally designed software package that is
compliant with the year 2000. The year 2000 problem is the result of software
that uses two digits (rather than four) to define the applicable year. Any
software or hardware that uses time-sensitive coding may recognize a day using
"00" as the year 1900 rather than the year 2000, which could result in
miscalculations or system failures. The Company is attempting to identify other
potential areas of risk and has begun addressing these in its planning,
purchasing and daily operations. Based on preliminary information, costs of
addressing potential problems are not currently expected to have a material
adverse impact on the Company's financial position, results of operations, or
cash flows in future periods. If, however, the Company, its customers, or
vendors are unable to adequately resolve such processing issues in a timely
manner, the Company's operations and financial results may be adversely
affected.
41
BUSINESS AND PROPERTIES
GENERAL
The Company is an independent energy company engaged in the exploration
for and development of oil and natural gas. The Company has interests in over 25
oil and gas prospects and projects primarily in the United States Gulf Coast
areas of Mississippi, Texas and Louisiana. Most of these prospects have been,
are being, or are expected to be, enhanced with 3-D seismic data and CAEX
technologies. The 3-D seismic data, including current surveys, will cover over
820 square miles. The Company's 1999 capital budget provides for a total of
$11.3 million for drilling and prospect development. Of such amount,
approximately $7.3 million is budgeted for development drilling, approximately
$1.0 million is budgeted for exploratory drilling, testing, and subsequent
completions, $2.3 million is budgeted for seismic data acquisitions and the
remainder is budgeted primarily for leasehold purchases. The Company believes
that its prospects represent a diverse array of technology enhanced, 3-D seismic
confirmed oil and gas exploration prospects.
A substantial portion of the Company's growth has been through
acquisitions, including the following 1998 acquisitions:
(i) in January 1998 the acquisition of certain oil and gas prospects from
Lasco Energy Partners, L.P. ("Lasco") (the "Lasco Acquisition");
(ii) the acquisition on April 22, 1998 of certain oil and gas property
interests of Calibre (the "Calibre Acquisition") (certain closing
matters to be completed);
(iii) the acquisition on May 1, 1998 of certain oil and gas properties from
Southern Gas Corporation (the "Southern Gas Acquisition");
(iv) the acquisition effective in July 1998 of certain oil and gas property
interests from Starbucks Trust (the "Starbucks Acquisition") (certain
closing matters to be completed); and
(v) the acquisition on December 29, 1998 of the Mobil interest in the Old
Ocean project (the "Mobil Acquisition", the Lasco Acquisition, the
Calibre Acquisition, Southern Gas Acquisition, Starbucks Acquisition
and Mobil Acquisition are referred to collectively herein as the
"Acquisitions").
The foregoing transactions, other than the Mobil Acquisition have
received regulatory acceptance by the VSE. Regulatory acceptance for the Mobil
Acquisition is pending and Company expects to receive this acceptance in due
course. If this acceptance is not received, the Company may be required to
modify certain aspects of these transactions, failing which the VSE may impose
regulatory sanctions, which could include delisting of the Company's Common
Stock from the VSE.
RECENT DEVELOPMENTS
In December 1998, the Company entered into a financing agreement with
Shell Capital, Inc. ("Shell Capital") whereby the Company sold a term production
payment to Shell Capital for $7.0 million. The Shell Production Payment
comprised a dedication of 42% of net revenues from the Wausau, Oak Hill and East
Morgantown Properties; 23.1% of Oakvale Dome's Howell well; 12.2% of Oakvale
Dome's Fortenberry well; and 38.5% of Oakvale Dome's Byrd well. The production
payment is secured solely by the properties and is non-recourse to the Company.
Following full payout of the production payment, the dedicated revenue interest
will be returned to the Company less a permanent royalty interest equal to 8.75%
of the Company's net revenue interest in Wausau, Oak Hill and East Morgantown;
4.8% of the interest in the Howell and Byrd wells; and 2.5% of the Fortenberry
interest. The Company has the right to buy back the production payment at a
stated rate of return of 25.0% plus $1 million. Shell Capital has agreed to
expand its term production payment up to $25.0 million provided that the Company
sell certain properties, enter into a payment schedule for amounts owed to an
industry partner, raise additional capital and obtain certain minimum results
from current development drilling activity. The Company is currently negotiating
with Shell Capital and other parties to complete the expansion of the term
production payment and believes that it will meet the specified requirements.
In December 1998, the Company acquired for $2.0 million all of Mobil's
right, title and interest in the deep rights below the existing production in
the Old Ocean Prospect. The Company has combined this interest with its
42
contractual rights and ownership in the immediate area and is currently
attempting to secure one or more industry partners to purchase 37.5% of the
Company's ownership in the Old Ocean Prospect. The Company paid for this
acquisition through the Old Ocean Loan.
In January 1999, the Company acquired, on behalf of the Company and its
partner in the Wausau prospect, a gas pipeline in Mississippi for approximately
$425,000 to provide access for gas sales. Included in the purchase were a 100%
and a 93.75% BPO working interest in two producing gas wells. The Company does
not anticipate these wells reaching pay-out. The Company owns a 53.8% interest
in the pipeline and the Fairchild #1 well and a 50.5% interest in the A. Foote
Estate #1 well. Gas reserves net to the Company are estimated to be in excess of
150 MMCFG and net production of over 150 MCFGPD.
In May 1999, the Company closed the sale of its interests in the Lisbon
Field, comprising essentially all of its proven reserves in Louisiana, for
$507,500 in gross proceeds to an unrelated party.
In June 1999, the Company completed the drilling of its Fortenberry #1
well to a depth of 16,126 feet at Oakvale Dome Field in Jefferson Davis County,
Mississippi. The Company elected to not drill deeper to the projected depth of
16,250 feet due to concerns that additional drilling difficulties could be
encountered in the side-track hole. Open hole electric and porosity logs which
run to a depth of 16,088 feet, indicate a total of 80 net feet of hydrocarbon
bearing sands in the primary objectives in the Hosston Formation at depths
between 15,792 feet and 15,992 feet. An additional four feet of net pay was
measured by electric and porosity logs in the lower Booth zone starting at a
depth of 16,075 feet based on mud logs from the original side-track hole. The
remainder of the zone could not be logged due to existing hole conditions. The
Company owns a 70% working interest in the well and an average 64% working
interest in the field. The Company is proceeding to complete the well for
production.
The Company plans to co-mingle the 42 net feet in the Harper and the 38
net feet in the Booth for production. Both of these zones are producing in the
adjacent fault block to the north out of the Company's first two wells in the
field, the K. S. Byrd #1 and the Howell #1. The top 22 feet of the
partially-logged lower Booth have been cased and are expected to be added to the
producing stream with the Harper and Booth.
STRATEGY
The Company's strategy is to expand its reserves, production and cash
flow through the implementation of an exploration and exploitation program that
focuses on:
(i) obtaining dominant positions in core areas of exploration and
development in under-exploited areas in or adjacent to fields and
trends that have historically produced hydrocarbons in significant
quantities;
(ii) enhancing the value of its prospects and reducing exploration
risks through the use of 3-D seismic data and CAEX technologies;
(iii) maintaining an experienced technical staff with the expertise
necessary to take advantage of the Company's proprietary 3-D seismic
data and CAEX technologies;
(iv) adding reserves and production using modern reservoir stimulation
methods; and
(v) retaining control over critical exploration decisions.
OBTAIN DOMINANT POSITION IN CORE AREAS
The Company has identified core areas for exploration and development
in geological trends with demonstrated histories of prolific natural gas
production from high porosity reservoir rocks with profiles suitable for seismic
evaluation. The Company believes that by obtaining substantial working
interests, related 3-D seismic data and significant acreage positions within its
core areas, it will be able to achieve a dominant position in focused portions
of those areas. With a dominant leasehold position, the Company believes it can
better control the core areas, drilling opportunities and future production and
can attempt to minimize costs through economies of scale and other efficiencies
inherent in its focused approach. Such cost savings and efficiencies include the
ability to use the Company's 3-D seismic data to reduce drilling risks and lower
its leasehold acquisition costs by identifying and purchasing leasehold
interests only in those focused areas in which the Company believes drilling is
most likely to be successful.
43
USE OF 3-D SEISMIC AND CAEX TECHNOLOGIES
The Company attempts to enhance the value of its prospects through the
use of 3-D seismic data and CAEX technologies, with an emphasis on direct
hydrocarbon detection technologies. These technologies create computer generated
3-dimensional displays of subsurface geological formations that enable the
Company's professional staff to detect seismic anomalies in structural features
that are not apparent in 2-D seismic surveys. The Company believes that 3-D
seismic data, if properly used, will reduce drilling risks and costs by reducing
the number of dry holes, optimizing well locations and reducing the number of
wells required to exploit a discovery.
EXPERIENCED TEAM
The Company maintains an experienced staff, including engineers,
geologists, geophysicists, a landman and other technical personnel. Such
professional staff has on average 18 years of experience in the oil and gas
industry.
USE OF MODERN RESERVOIR STIMULATION METHODS AND NEW DRILLING TECHNOLOGY
In addition to applying the latest in 3-D seismic and CAEX technology,
the Company uses the latest in industry reservoir stimulation and directional
drilling techniques. For example, many of the Company's development and
exploitation opportunities are "tight" reservoirs in which modern stimulation
practices may significantly increase production.
CONTROL OF DRILLING FUNCTIONS
The Company believes that controlling the most critical functions in
the drilling process will enhance its ability to develop successfully its
prospects. The Company has acquired a majority interest in many of its
prospects, including interests in most of the 3-D seismic data relating to those
prospects. In many cases where the Company does not own a majority interest in a
prospect the Company still owns a greater interest than that of any other
working interest owner. As a result, in many of its prospects, the Company will
be able to influence the areas to explore, manage the land permitting and option
process, determine seismic survey areas, oversee data acquisition and
processing, prepare, integrate and interpret the data and identify each prospect
drillsite. In addition, the Company will be the operator of many of the wells
drilled on these prospects.
BACKGROUND
The Company was originally formed on February 9, 1981 for the purpose
of conducting mineral exploration in Canada. In 1989, the Company changed its
focus and concentrated on investment and merchant banking activities. At that
time, the Company wrote off its mineral property costs and ceased all mineral
exploration activities. From 1991 to 1993, the Company diversified into the
acquisition and development of oil and gas properties. During 1996, the Company
sold substantially all of its investments outside of oil and gas and refocused
operations on oil and gas exploration and development in the United States.
Effective as of October 31, 1996, the Company acquired Texstar and as a result,
the Company focused its operations on oil and gas exploration and development in
the United States, specifically the Gulf Coast areas of Mississippi, Texas and
Louisiana. Former shareholders of Texstar acquired control of the Company and
Texstar became a wholly owned subsidiary of the Company. In July 1997, the
Company changed its name from Benz Equities Ltd. to Benz Energy Ltd. The Company
has migrated to the state of Delaware and is now a Delaware Corporation under
the name Benz Energy Inc.
THE PROSPECTS
The Company's prospects are located primarily in the Gulf Coast areas
of Mississippi, Texas and Louisiana. As of December 31, 1998, the Company owned
interests in 21 producing wells it operated and also owned non-operated
interests in 13 producing wells in Louisiana, Mississippi, and Texas. Daily
production from both operated and non-operated wells net to the Company's
interest averaged 5,506 MCFGD and 111.4 BOPD for the year ended December 31,
1998. Daily production as of March 31, 1999, was approximately 9,547 MCFGD and
219 BOPD. Each of the Company's prospects differs in scope and character and
consists of one or more types of assets, such as 3-D seismic data, working
interests in oil and gas leases, oil and gas lease options, contractual rights
to earn a working interest in oil and gas leases, royalty interests or other
mineral interests. Most of the Company's prospects
44
have been, are being, or are expected to be enhanced with 3-D seismic data
and CAEX technologies. The 3-D seismic data acquired will, when completed for
the existing prospects, cover over 820 square miles (gross). The table below
gives certain information regarding the location, objectives, and present
status of the Company's most significant prospects as of December 31, 1998:
Additional Gross
Prospect Leased Acreage Acreage (4) Square
------------------- ------------------ Miles of
Gross Net Gross Net 3-D Approx.
Acres Acres Acres Acres Seismic Formation Total
Prospect (1) (2) (1) (2) Data (5) Objective Depth
- -----------------------------------------------------------------------------------------------------------
MISSISSIPPI
Oakvale Dome (3,6,7) 4,853 2,675 N/A N/A 33 Hosston 16,700'
Hosston; Cotton
Glancy Re-entry (3,8) 5,175 4,692 N/A N/A N/A Valley 21,000'
Wausau (3) 1,240 471 N/A N/A 55 Cotton Valley 19,000'
Sardis Church Dome
(3,8) 4,000 2,835 N/A N/A N/A Hosston 16,500'
TEXAS
LaHinch (3,9) 1,382 1,036 N/A N/A 20 Wilcox 16,000'
Old Ocean
(8,10,11,12,13) 672 243 42,217 9,846 102 Frio 16,000'
Oak Hill Field (3) 793 698 N/A N/A N/A Cotton Valley 9,500'
Rayburn (3,8) 3,048 1,068 4,843 3,886 30 Yegua; Wilcox 15,000'
OTHER
Louisiana 13,176 2,222 N/A N/A 478
Mississippi 29,180 11,463 N/A N/A 73
New Mexico 160 12 N/A N/A N/A
Texas 8,408 3,557 N/A N/A 30
------ ------ ------ ------ ---
Total 72,087 30,972 47,060 13,732 821
====== ====== ====== ====== ===
- -------------------------------------
(1) "Gross Acres" means an acre in which the Company owns a working
interest. When used in conjunction with acreage under options it means
an acre in which the Company will acquire a working interest if and
when the option is exercised.
(2) "Net Acres" means the sum of the fractional working interest owned in
gross acres expressed as whole numbers and fractions thereof.
(3) Operated by the Company.
(4) "Additional Acreage" refers to the number of acres in which the Company
owns options for oil and gas leases from mineral owners and, with
respect to part of the acreage reported for the Old Ocean Prospect,
also has contractual rights to earn a working interest in the 21,784
acre Old Ocean Unit.
(5) Represents 3-D seismic data acquired, being acquired or expected to be
acquired.
(6) Drilling.
(7) Completing.
(8) Soliciting industry participant.
(9) Evaluating 3-D seismic data.
(10) Shooting 3-D seismic survey.
45
(11) Affiliates of EnCap own a overriding royalty interest that is
convertible into a participating net profits interest.
(12) The Company will earn an additional working interest in deep rights
upon completion and delivery of a 3-D survey over the unit and the
establishment of commercial production.
(13) Clients of the Agent and the Agent own an overriding royalty interest
that is convertible into a participating net profits interest. The
Company has the right to buy back the participating net profits
interest and is currently negotiating such purchase in exchange for
Preferred Stock.
Below are descriptions, as of December 31, 1998, unless otherwise
indicated, of the Company's most significant prospects.
OAKVALE DOME
The Oakvale Dome Prospect, located in Jefferson Davis County,
Mississippi, is the Company's most significant producing property. The Company
owns approximately 4,853 gross (2,675 net) acres in the Prospect. The Company is
the operator.
A 2-D seismic survey shot and processed originally in 1979 was
reprocessed in 1996 and confirmed the discovery well, which was the K.S. Byrd
Well. The K.S. Byrd Well was completed in June 1997 in the Harper formation from
15,964 feet to 15,988 feet, flowing 5.708 MMCFGD. Initial reserve estimates as
of August 1, 1997 conducted by an independent petroleum engineer gave the well
proved producing reserves of 8.7 BCFG and 34,800 barrels of condensate. Later
reserve estimates as of January 1, 1999 conducted by an independent petroleum
engineer revised the well's proved producing reserves to 12.1 BCFG and 41,500
barrels of condensate. The well began sales of production in September 1997 and,
as of December 31, 1998, was flowing at the rate of 10.4 MMCFGD and 42 BOPD. In
February of 1999 the Howell #1 well was completed and initial tests indicate a
commercial production rate of 21.1 MMCFGD and 19 barrels of condensate per day.
The Fortenberry #1 has just been drilled to total depth with promising
indications but due to mechanical problems is currently being sidetracked for
the lowest 500 feet and logged with 80 net feet of hydrocarbon bearing
reservoir. The well is being completed for production.
GLANCY
The Company owns approximately 5,175 gross (4,692 net) acres in the
Glancy Prospect in Copiah County, Mississippi. The Company is the operator.
Glancy Field has produced gas and condensate from the Lower Cretaceous Rodessa
formation on acreage not owned by the Company. The Glancy Prospect is
characterized as a simple anticline structure that formed as a result of a
deep-seated salt pillow. The presence of reservoir quality sandstones at both
the deeper Hosston and Cotton Valley levels has been demonstrated by two well
penetrations, both of which have produced gas and had multiple shows of
hydrocarbons. Early attempts (in 1971) to fracture stimulate one of the test
wells, having an initial production of 3.1 MMCFGD on an extended test from the
Cotton Valley, damaged the formation in the near-wellbore area. The Company
intends to re-enter a deep test well and to apply modern fracture stimulation to
establish commercial production.
WAUSAU
The Company owns approximately 1,240 gross (471 net) acres in the
Wausau Prospect in Wayne County, Mississippi (surface to 15,360 feet only). The
Company is the operator. The Company has rights in a 3-D survey acquired by
Compagnie Generale de Geophysiqe over this prospect area. This project is
located on two flanks of a large salt ridge trending northwest to southeast.
Based upon 3-D seismic data, the Cotton Valley appears to be trapped in both a
simple closure and an updip pinchout along the salt ridge flank. The Company
commenced drilling a test well in May 1998 and completed the well in November
1998 as a Cotton Valley discovery. Production commenced in November and was
increased to a rate of over 400 BOPD and 2,000 MCFD with the connection to a gas
sales pipeline in February 1999. The well has three additional shallower Cotton
Valley reservoirs behind pipe.
46
SARDIS CHURCH DOME
The Company owns approximately 4,000 gross (2,835 net) acres in the
Sardis Church Dome Prospect in Copiah County, Mississippi. The Company is the
operator. The Company's drilling objectives are the Paluxy, Hosston and Cotton
Valley sands. The Company anticipates it will sell at least 50% of the working
interest to an industry participant before spudding the test well. This prospect
is an analog to the Oakvale Dome discovery and is located along trend. A nearby
offstructure well has tested significant oil and gas shows in the Hosston
objective section.
LAHINCH
The Company owns deep rights under approximately 1,382 gross (1,036
net) acres in the LaHinch Prospect in Duval County, Texas. The Company is the
operator. The objectives for the prospect are sands in the Upper Wilcox
formation. The adjoining operator has drilled an Upper Wilcox test on the same
structure that, if successful, will confirm the Company's prospect and
reclassify it as a proven location. This well reached total depth in April 1999
and is currently being completed. Upon its successful test, the Company will
commence a development program on its acreage.
OLD OCEAN
The Company owns leases, options for oil and gas leases and has
contractual rights to earn working interests in approximately 42,889 gross
(10,089 net) acres in the Old Ocean Prospect in Brazoria and Matagorda Counties,
Texas. The Company owns a 37.02% working interest within the Old Ocean Unit and
a 69.23% working interest outside the unit, but within the 3-D area. A 3-D
seismic survey is underway and the Company is the operator of the seismic
survey. The Old Ocean Prospect is the largest Frio gas field in the Gulf Coast,
having produced more than five TCFGE since its discovery in 1934. In excess of
200 wells have been drilled in the Old Ocean field. These reserves have been
produced from four normally pressured reservoirs between 9,500 and 11,000 feet.
The Old Ocean Prospect actually consists of numerous prospects and the main
objective is in the overpressured Frio. Deep well information confirms reservoir
quality sands and scattered production of 45 BCFG in the immediate vicinity.
Precise structural mapping from the 3-D seismic survey will allow accurate
delineation of prospects. Affiliates of EnCap and the Agent and certain of its
clients own a 50% overriding royalty interest in certain of the Company's
properties that make up the Old Ocean Prospect, which interest is convertible
into a participating net profits interest. The Company has the right to buy back
the participating net profits interests and is negotiating such purchase in
exchange for a cash payment to affiliates of EnCap and using Preferred Stock for
the other Old Ocean Lenders.
OAK HILL FIELD
The Company owns approximately 793 gross (698 net) acres in the Oak
Hill Field in Gregg and Rusk Counties, Texas. The Company is the operator. This
prospect produces from the Lower Cotton Valley sands at depths of approximately
10,150 to 10,500 feet and from the Upper Cotton Valley sands at depths of
approximately 9,000 to 10,000 feet. The Company has completed a recompletion
program covering six wells and involving up to eleven distinct zones. Six
recompleted zones have been fracture stimulated and have increased the Company's
net production by over 1,100 MCFD. Additionally, the Company expects an increase
of approximately 800 MCFD net production when the original producing interval is
reactivated and the pressures across the zones equalize. There are currently six
producing wells in Oak Hill Field owned by the Company.
RAYBURN
The Company owns approximately 3,048 gross (1,068 net) acres and has
options for oil and gas leases on an additional 4,843 gross (3,886 net) acres in
the Rayburn Prospect in Liberty Co., Texas. The Company is the operator. This
prospect is within a 30 square mile 3-D survey acquired in 1998 of which the
Company intends to sell up to 60% to industry partners. The objectives are sands
primarily in the Wilcox, Cockfield and Miocene formations ranging in depth from
2,000 to 16,000 feet.
47
OIL AND GAS RESERVES
The following table sets forth information regarding estimated oil and
gas reserve quantities, reserve values and discounted future net revenues as
estimated by the Company's independent engineering consultant, Lenser &
Associates, as of January 1, 1999.
There are numerous uncertainties inherent in estimating quantities of
proven reserves and projecting future rates of production and timing of
development expenditures. The following reserve information represents estimates
only and should not be construed as being exact.
Present Value of
Estimated Future
Net Revenues
Gas Before Income
Equivalent Estimated Taxes
(MMCFE) Future Net (Discounted at
Gas (MMCF) Oil (MBO) (1) Revenue (2) 10 Percent)
------------ ---------- --------------- ----------------- ------------------
(in thousands)
Proved developed
reserves: (3)
Louisiana (5) 87 75 541 $ 349 $ 311
Mississippi 15,940 279 17,611 $ 30,772 $ 24,373
Texas 4,182 55 4,516 $ 5,292 $ 3,473
------------ ---------- --------------- ----------------- ------------------
20,209 409 22,668 $ 36,413 $ 28,157
------------ ---------- --------------- ----------------- ------------------
Proved undeveloped
reserves: (4)
Louisiana (5) 1,359 119 2,072 $ 1,093 $ 362
Mississippi 14,837 56 15,171 $ 25,816 $ 17,154
Texas -- -- -- $ -- $ --
------------ ---------- --------------- ----------------- ------------------
16,196 175 17,243 $ 26,909 $ 17,516
------------ ---------- --------------- ----------------- ------------------
Total proved
reserves 36,405 584 39,911 $ 63,323 $ 45,673
============ ========== =============== ================= ==================
- -----------------------------------
(1) Oil production is converted to MCFE at the rate of six MCF of natural gas
per Bbl of oil, based upon the approximate energy content of natural gas
and oil.
(2) Estimated future net revenue represents estimated future gross revenue to
be generated from the production of proved reserves, net of estimated
production and future development costs, using prices and costs in effect
as of January 1, 1999. The amounts shown do not give effect to expenses
unrelated to property, such as general and administrative expenses, debt
service and future income tax expense or to depreciation, depletion and
amortization. The estimates shown do not include amounts dedicated to Shell
Capital pursuant to the Shell Production Payment (see description of Shell
Production Payment above), but do include the effect of the EnCap NPI which
vested on January 1, 1999. The EnCap NPI comprises a 6.25% interest in the
producing Byrd #1and Howell #1.
(3) "Proved Developed Reserves" means those reserves estimated as recoverable
under current technology and projected economic conditions, from that
portion of a reservoir that can reasonably be evaluated as economically
productive on the basis of analysis of drilling, geological, geophysical
and to be obtained by enhanced recovery processes demonstrated to be
economic and technically successful in the subject reservoir.
48
(4) "Proved Undeveloped Reserves" mean those reserves estimated as recoverable
under current technology and projected economic conditions from that
portion of a reservoir that can reasonably be evaluated as technologically
productive, but which requires the drilling and completion of a well to
initiate production.
(5) In May 1999, the Company sold its interest in the Lisbon Field, which
accounted for all of the proved developed and undeveloped reserves in
Louisiana.
ACREAGE
The following table sets forth as of December 31, 1998, the gross and
net acres of developed and undeveloped oil and gas acreage that the Company
holds. Additionally, the data set forth below is based on the Company's before
pay-out working interests. In certain cases, the Company has a greater after
pay-out working interest. In certain other cases, the Company has only an after
pay-out working interest. As such, the amount of gross and net acreage will
increase when and if certain wells pay out.
DEVELOPED (1) UNDEVELOPED (2)
------------------------------------- ---------------------------------------
Gross Net Gross Net
Acres Acres Acres Acres
(3) (4) (3) (4)
---------------- ----------------- ----------------- ------------------
STATE
Louisiana(5)............ 6,254 1,839 6,922 383
Mississippi............. 2,080 833 42,368 21,303
New Mexico.............. 160 12 -- --
Texas................... 2,573 1,243 11,730 5,359
---------------- ----------------- ----------------- ------------------
Total................... 11,067 3,927 61,020 27,045
================ ================= ================= ==================
- -----------------------------
(1) "Developed acreage" is that acreage which is spaced or assignable to
productive wells.
(2) "Undeveloped acreage" is leased acreage on which wells have not been
drilled or completed to a point that would permit the production of
commercial quantities of oil and gas regardless of whether or not such
acreage contains proved reserves.
(3) "Gross acres" means an acre in which the Company owns a working
interest. When used in conjunction with acreage under options, it means
an acre in which the Company will acquire a working interest if and
when the option is executed.
(4) "Net acres" means the sum of the fractional working interest owned in
gross acres expressed as whole numbers and fractions thereof.
(5) The number of gross and net acres in Louisiana includes the acreage
associated with the Lisbon Field which the Company sold after December
31, 1998.
49
PRODUCTIVE OIL AND GAS WELLS
The following table sets forth certain information regarding the
Company's ownership as of December 31, 1998 of productive oil and gas wells,
operated and non-operated, in the areas indicated. Additionally, the data below
are based on the Company's before pay-out working interest. In some cases the
Company has only an after pay-out working interest. As such, the number of gross
and net wells will increase when and if certain wells pay-out.
GAS OIL
----------------------------- -----------------------------
Gross Net Gross Net
Wells Wells Wells Wells
(1) (2) (1) (2)
----------- -------------- ------------- ------------
STATE
Louisiana.......... 17 8.78354792 1 0.04770200
Mississippi........ 4 2.05204750 1 0.03730014
New Mexico......... 1 0.07500000 -- --
Texas.............. 10 6.09927790 1 0.50000000
----------- -------------- ------------- ------------
Total.............. 32 17.00987332 3 0.58500214
=========== ============== ============= ============
- --------------------------
(1) "Gross wells" means a well in which the Company owns a working
interest. The number of gross wells is the total number of wells in
which a working interest is owned.
(2) "Net wells" means the sum of the fractional working interest owned in
gross wells expressed as whole numbers and fractions thereof.
(3) The number of gross and net wells in Louisiana includes wells located
in the Lisbon Field which the Company sold after December 31, 1998.
DRILLING ACTIVITY
The Company participated in one Gross (0.14 Net) dry and three Gross
(1.8383 Net) productive exploratory wells and three Gross (0.25954 Net)
productive development wells during the year ended December 31, 1998. For the
four-month period ended December 31, 1997, the Company drilled one Gross
(0.48500 Net) productive exploratory well, two Gross (1.3575 Net) dry
exploratory wells and three Gross (0.342202 Net) productive development wells.
For the ten months ended August 31, 1997, the Company drilled one Gross (0.14725
Net) productive exploratory well and one Gross (0.20110 Net) dry exploratory
well. The Company is entitled to a working interest in certain additional wells
completed during these time periods when and if those wells pay-out.
Furthermore, the number of Net wells was calculated based-on the Company's
before pay-out working interest and in some cases the Company will have a
greater working interest or is entitled to a working interest in certain wells
completed during these time periods when and if these wells pay-out. In certain
cases, the Company, subsequent to completion, sold the prospect on which certain
of these wells were drilled. As such, while the Company did participate in the
drilling, it does not currently have an interest in all of the productive wells
mentioned above.
On December 31, 1998, the Company was drilling two Gross (1.2595076
Net) development wells. These wells are step out wells from the Byrd discovery
well at Oakvale Dome Field in Mississippi.
50
VOLUMES, PRICES AND PRODUCTION COSTS
The following table sets forth certain information regarding the
production volumes, average prices received and average production costs
associated with the Company's sale of oil and gas for the periods indicated.
Twelve Months Four Months Ten Months
Three Months Ended Ended Ended
Ended December 12, December 31, August 31,
March 31, 1999 1998 1997 1997
-------------- ------------- ------------ -----------
Net Production:
Oil (BBL) 17,213 40,662 4,506 9,281
Gas (MCF) 712,171 2,009,550 223,683 83,810
Gas equivalent (MCFE) 815,449 2,253,522 250,719 139,493
Average sales price:
Oil ($ per BBL) $ 1.70 $ 10.83 $ 18.54 $ 20.28
Gas ($ per MCF) $ 9.50 $ 2.24 $ 2.79 $ 3.05
Gas Equivalent ($ per MCFE) $ 1.68 $ 2.20 $ 2.82 $ 3.18
Average production expenses
($ per MCFE)(1) $ 0.17 $ 0.38 $ 0.17 $ 0.33
- --------------------------
(1) Average production costs, excluding severance taxes.
CAEX AND 3-D SEISMIC TECHNOLOGY
The Company, either directly or through other prospect participants,
uses 3-D seismic data and CAEX technology to collect and analyze geological,
geophysical, engineering, production and other data obtained about potential gas
or oil prospects. The Company uses this technology to correlate density and
sonic characteristics of subsurface formations obtained from 2-D seismic surveys
with like data from similar properties, and uses computer programs and modeling
techniques to determine the likely geological composition of a prospect and
potential locations of hydrocarbons.
Once all available data has been analyzed to determine the areas with
the highest potential within a prospect area, the Company may conduct 3-D
seismic surveys to enhance and verify the geological interpretation of the
structure, including its location and potential size. The 3-D seismic process
produces a three-dimensional image based upon seismic data obtained from
multiple horizontal and vertical points within a geological formation. The
calculations needed to process such data are made possible by computer programs
and advanced computer hardware.
While large oil companies have used 3-D seismic data and CAEX
technologies for approximately 20 years, these methods were not affordable by
smaller, independent oil and gas companies until more recently, when improved
data acquisition equipment and techniques and computer technology became
available at reduced costs. The Company believes that its use of 3-D seismic
data and CAEX technology may provide it with certain advantages in the
exploration process over those companies that do not use this technology. These
advantages include better delineation of the subsurface, which can reduce
exploration risks and help optimize well locations in productive reservoirs. The
Company believes these advantages can be readily validated based upon general
industry experience. Because computer modeling generally provides clearer and
more accurate projected images of geological formations, the Company believes it
is better able to identify potential locations of hydrocarbon accumulations and
the desirable locations for wellbores. However, the Company has not used the
technology extensively enough to arrive at any conclusion regarding the
Company's ability to interpret and use the information developed from the
technology.
51
CUSTOMERS
During the year ended December 31, 1998, H&N Gas Ltd. "H&N Gas" and
Tejas Gas Marketing Co. accounted for approximately 51% and 24%, respectively of
the Company's total revenue. For the four month period ended December 31, 1997,
H&N Gas and KCS Resources, Inc. ("KCS") accounted for 75% and 10%, respectively,
of the Company's total revenue. For the ten months ended August 31, 1997, KCS,
Samedan Oil Corporation and Energy Operating Limited Partnership accounted for
50%, 30% and 15%, respectively, of the Company's total revenue. No other
purchasers accounted for more than 10% of the Company's total revenue in the
periods indicated above. The Company does not believe the loss of any existing
purchaser would have a material adverse effect on the Company.
MARKETING
The Company markets its natural gas and oil through monthly spot sales.
Because sales made under spot sales contracts result in fluctuating revenues to
the Company depending upon the market price of oil and gas, the Company from
time to time enters into various forward contracts covering a portion of its
production to minimize the fluctuations and the effect of price declines. Under
the terms of the term production payment with Shell Capital, the Company markets
its natural gas through Coral Energy Resources, L.P. ("Coral") whereby Coral
markets at both fixed and floating prices.
COMPETITION
The oil and gas industry is highly competitive in all of its phases.
The Company encounters strong competition from other oil and gas companies in
all areas of its operations, including the acquisition of exploratory and
producing properties, the permitting and conducting of seismic surveys and the
marketing of oil and gas. Many of these competitors possess greater financial,
technical and other resources than the Company. Competition for the acquisition
of producing properties is affected by the amount of funds available to the
Company, information about producing properties available to the Company and any
standards the Company establishes from time to time for the minimum projected
return on investment. Competition also may be presented by alternative fuel
sources, including heating oil and other fossil fuels. There has been increased
competition for lower risk development opportunities and for available sources
of financing. In addition, the marketing and sale of natural gas and processed
gas are competitive. Because the primary markets for natural gas liquids are
refineries, petrochemical plants and fuel distributors, prices generally are set
by or in competition with the prices for refined products in the petrochemical,
fuel and motor gasoline markets.
REGULATION
GENERAL
The oil and gas industry is extensively regulated by federal, state and
local authorities. In particular, oil and gas production operations and
economics are affected by environmental protection statutes, tax statutes and
other laws, rules and regulations relating to the petroleum industry, as well as
changes in such laws, changing rules and regulations and the interpretations and
applications of such laws, rules and regulations. Oil and gas industry
legislation and agency regulation are under constant review for amendment and
expansion for a variety of political, economic and other reasons. Numerous
regulatory authorities, and federal, state and local governments issue rules and
regulations binding on the oil and gas industry, some of which carry substantial
penalties for failure to comply. The regulatory burden on the oil and gas
industry increases the Company's cost of doing business and, consequently,
affects its profitability. The Company believes it is in compliance with all
federal, state and local laws, regulations and orders applicable to the Company
and its properties and operations, the violation of which would have a material
adverse effect on the Company or its financial condition.
SEISMIC PERMITS
Current law in Louisiana requires permits from owners of at least an
undivided 80% interest in each tract over which the Company intends to conduct
seismic surveys. As a result, the Company may not be able to conduct seismic
surveys covering its entire area of interest in that state. Moreover, 3-D
seismic surveys typically are conducted from various locations both inside and
outside the area of interest to obtain the most detailed data of the
52
geological features within the area. To the extent that the Company is unable
to obtain permits to access locations to conduct the seismic surveys, the
data obtained may not be as detailed as might otherwise be available. In
addition, a recent decision of a federal court in Louisiana casts doubt on
traditional seismic permitting practices, which decision, in some instances,
could lead to the surface owner claiming ownership of the data.
EXPLORATION AND PRODUCTION
The Company's operations are subject to various regulations at the
federal, state and local levels. Such regulations include (i) requiring permits
for the drilling of wells; (ii) maintaining bonding requirements to drill or
operate wells; and (iii) regulating the location of wells, the method of
drilling and casing wells, the surface use and restoration of properties upon
which wells are drilled, the plugging and abandoning of wells and the disposal
of fluids used in connection with well operations. The Company's operations also
are subject to various conservation regulations. These include the regulation of
the size of drilling and spacing units, the density of wells that may be
drilled, and the unitization or pooling of oil and gas properties. In addition,
state conservation laws establish maximum rates of production from oil and gas
wells, generally prohibiting the venting or flaring of gas, and impose certain
requirements regarding the ratability of production. The effect of these
regulations is to limit the amount of oil and gas the Company can produce from
its wells and to limit the number of wells or the locations at which the Company
can drill.
NATURAL GAS MARKETING, GATHERING AND TRANSPORTATION
Federal legislation and regulatory controls in the United States have
historically affected the price of the natural gas produced by the Company and
the manner in which such production is marketed. The transportation and resale
of natural gas in interstate commerce are regulated by the Federal Energy
Regulatory Commission (the "FERC") pursuant to the Natural Gas Act and the
Natural Gas Policy Act of 1978 (the "NGPA"). Sales of the Company's natural gas
currently are made at market prices, subject to applicable contract provisions
and are not subject to federal or state price control. The FERC's jurisdiction
over natural gas transportation was unaffected by the Decontrol Act.
The FERC also regulates interstate natural gas transportation rates and
service conditions, which affect the marketing of natural gas produced by the
Company, as well as the revenues received by the Company for sales of such
natural gas. Since the latter part of 1985, the FERC has endeavored to make
interstate natural gas transportation more accessible to gas buyers and sellers
on an open and nondiscriminatory basis. The FERC's efforts have significantly
altered the marketing and transportation of natural gas. Commencing in April
1992, the FERC issued Order Nos. 636, 636-A, 636-B and 636-C (collectively,
"Order No. 636"), which, among other things, required interstate pipelines to
"restructure" their services to provide transportation separate or "unbundled"
from the pipelines' sales of gas. Also, Order No. 636 requires interstate
pipelines to provide open-access transportation on a nondiscriminatory basis
that is equal for all natural gas shippers. Order No. 636 has been implemented
through decisions and negotiated settlements in individual pipeline services
restructuring proceedings. In many instances, the result of Order No. 636 and
related initiatives has been to substantially reduce or eliminate the interstate
pipelines' traditional role as wholesalers of natural gas, and has substantially
increased competition and volatility in natural gas markets. The FERC has issued
final orders in virtually all Order No. 636 pipeline restructuring proceedings.
In July 1996, the United States Court of Appeals for the District of Columbia
Circuit largely upheld Order No. 636 and remanded certain issues for further
explanation or clarification. Numerous petitions for review of the individual
pipeline restructuring orders are currently pending in that court. The issues
remanded for further action do not appear to materially affect the Company.
Proceedings on the remanded issues are currently ongoing before the FERC
following its issuance of Order No. 636-C in February 1997. Although it is
difficult to predict when all appeals of pipeline restructuring orders will be
completed or their impact on the Company, the Company does not believe that it
will be affected by the restructuring rule and orders any differently than other
natural gas producers and marketers with which it competes.
Although Order No. 636 does not regulate natural gas production
operations, the FERC has stated that Order No. 636 is intended to foster
increased competition within all phases of the natural gas industry. It is
unclear what impact, if any, increased competition within the natural gas
industry under Order No. 636 will have on the Company and its natural gas
marketing efforts. Although Order No. 636 could provide the Company with
additional market access and more fairly applied transportation service rates,
terms and conditions, it could also subject the Company to more restrictive
pipeline imbalance tolerances and greater penalties for violation of those
tolerances.
53
The Company does not believe, however, that it will be affected by any action
taken with respect to Order No. 636 materially differently than other natural
gas producers and marketers with which it competes.
The FERC has recently announced its intention to re-examine certain of
its transportation-related policies, including the appropriate manner for
setting rates for new interstate pipeline construction, the manner in which
interstate pipeline shippers may release interstate pipeline capacity under
Order No. 636 for resale in the secondary market, the price that shippers can
charge for their released capacity, and the use of negotiated and market-based
rates and terms and conditions for interstate gas transmission. Several
pipelines have obtained FERC authorization to charge negotiated rates as an
alternative to traditional, cost-of-service rate making methodology. In February
1997, the FERC announced a broad inquiry into issues facing the natural gas
industry to assist the FERC in establishing regulatory goals and priorities in
the post-Order No. 636 environment. In December 1997, the FERC requested
comments on the financial outlook of the natural gas pipeline industry,
including among other matters, whether the FERC's current rate making policies
are suitable in the current industry environment. In April 1998, the FERC issued
a new rule to further standardize pipeline transaction tariffs that, as the
result of newly standardized provisions regarding firm intra day transportation
nominations, could adversely affect the reliability of scheduled interruptible
transportation service on some pipelines. While any resulting FERC action would
affect the Company only indirectly, any new rules and policy statements may have
the effect of enhancing competition in natural gas markets.
Additional proposals and proceedings that might affect the natural gas
industry are considered from time to time by Congress, the FERC and state
regulatory bodies. The Company cannot predict when or if any such proposals
might become effective, or their effect, if any, on the operations of the
Company. The natural gas industry historically has been very heavily regulated;
therefore, there is no assurance that the less stringent regulatory approach
recently pursued by the FERC and Congress will continue indefinitely. The
regulatory burden on the oil and natural gas industry increases the Company's
cost of doing business and, consequently, affects its profitability and cash
flow. In as much as such laws and regulations are frequently expanded, amended
or reinterpreted, the Company is unable to predict the future cost or impact of
complying with such regulations.
LOUISIANA LEGISLATION
The Louisiana legislature passed Act 404 in 1993, which permits a party
transferring an oil field site to establish a site-specific trust account for
such oil field. If the site-specific trust account is established in accordance
with the requirements of the statute, the party transferring the oil field site
may not thereafter be held liable by the state for any site restoration costs or
actions associated with the transferred oil field site. The parties to a
transfer may elect not to establish a site-specific trust account. However, in
the absence of such an account, the transferring party will continue to have
liability for the costs of restoration of the site. If the parties to a transfer
elect to establish a site-specific trust account pursuant to the statute, the
Louisiana Department of Natural Resources (the "DNR") requires an oil field site
restoration assessment to be made at the time of the transfer or within one year
thereafter, to determine the site restoration requirements existing at the time
of transfer. Based upon the site restoration assessment, the parties to the
transfer must propose to the DNR a funding schedule for the site-specific trust
account, providing for some contribution to the account at the time of transfer
and at least quarterly payment thereafter. If the DNR approves the establishment
and funding of the site-specific trust account, the purchaser will thereafter be
the responsible party to the state, except that the failure of a transferring
party to make a good faith disclosure of all oil field site conditions existing
at the time of the transfer will render that party liable for the costs of
restoration of such undisclosed conditions in excess of the balance of the
site-specific trust fund.
OIL SALES AND TRANSPORTATION RATES
The FERC also regulates rates and service conditions for interstate
transportation of crude oil, liquids and condensate, which can affect the amount
the Company receives from the sale of these products. Rates for such
transportation are generally subject to an indexing system under which rates may
be increased as long as they do not exceed an index rate that is tied to
inflation. Over time, this indexing system could have the effect of increasing
the cost of transporting crude oil, liquids and condensate by pipeline. Sales of
crude oil, condensate and gas liquids by the Company are not regulated and are
made at market prices. The price the Company receives from the sale of these
products is affected by the cost of transporting the products to market.
54
ENVIRONMENTAL MATTERS
The Company's oil and natural gas exploration, development and
production operations are subject to stringent federal, state and local laws
governing the discharge of materials into the environment or otherwise relating
to environmental protection. Numerous governmental agencies, such as the
Environmental Protection Agency (the "EPA"), issue regulations to implement and
enforce such laws, which often require difficult and costly compliance measures
that carry substantial civil and criminal penalties for failure to comply. These
laws and regulations may require the acquisition of a permit before drilling
commences, restrict the types, quantities and concentrations of various
substances that can be released into the environment in connection with drilling
and production activities, limit or prohibit drilling activities on certain
lands lying within wilderness, wetlands, ecologically sensitive and other
protected areas, require some form of remedial action to prevent pollution from
former operations, such as plugging abandoning wells, and impose substantial
liabilities for pollution resulting from the Company's operations. In addition,
these laws, rules and regulations may restrict the rate of oil and natural gas
production below the rate that would otherwise exist. The regulatory burden on
the oil and gas industry increases the cost of doing business and consequently
affects its profitability. Changes in environmental laws and regulations occur
frequently, and any changes that result in more stringent and costly waste
handling, disposal or cleanup requirements could adversely affect the Company's
operations and financial position, as well as those of the oil and gas industry
in general. While management believes that the Company is in substantial
compliance with current applicable environmental laws and regulations and the
Company has not experienced any material adverse effect from compliance with
these environmental requirements, there is no assurance that this will continue
in the future.
The primary environmental statutory and regulatory programs that affect
the Company's operations include the following:
The Comprehensive Environmental Response, Compensation and Liability
Act, as amended ("CERCLA") also known as "Superfund", imposes liability without
regard to fault or the legality of the original conduct, on certain classes of
persons who are considered to be responsible for the release of a "hazardous
substance" into the environment. These persons include (i) the current owner and
operator of a facility from which hazardous substances are released, (ii) owners
and operators of the facility at the time the disposal of hazardous substances
took place, (iii) generators of hazardous substances who arranged for the
disposal or treatment at or transportation to such facility of hazardous
substances and (iv) transporters of hazardous substances to disposal or
treatment facilities selected by them.
Under CERCLA, such persons may be subject to joint and several
liability for the costs of cleaning up the hazardous substances that have been
released into the environment, for damages to natural resources and for the
costs of certain health studies, and it is not uncommon for neighboring
landowners and other third parties to file claims for personal injury and
property damage allegedly caused by the release of hazardous substances or other
pollutants into the environment. Furthermore, although petroleum, including
crude oil and natural gas, is exempt from CERCLA, at least two courts have ruled
that certain wastes associated with the production of crude oil may be
classified as "hazardous substances" under CERCLA, and thus such wastes may
become subject to liability and regulation under CERCLA. Regulatory programs
aimed at remediation of environmental releases could have a similar impact on
the Company.
The Federal Water Pollution Control Act of 1972 ("FWPCA") as amended,
also known as the Clean Water Act (the "CWA"), imposes restrictions and strict
controls regarding the discharge of pollutants, including produced waters and
other oil and gas wastes, into waters of the United States (as defined in the
CWA). The discharge of pollutants into regulated waters is prohibited, except in
accordance with the terms of a permit issued by the EPA or the state. These
proscriptions also prohibit certain activities in wetlands unless authorized by
a permit issued by the U.S. Army Corps of Engineers. Sanctions for unauthorized
discharges include administrative, civil and criminal penalties, as well as
injunctive relief.
The Oil Pollution Act of 1990 (the "OPA") amends certain provisions of
the CWA, and other statutes as they pertain to the prevention of and response to
spills or discharges of hazardous substances or oil into navigable waters. Under
the OPA, a person owning or operating a facility or equipment (including land
drilling equipment) from which there is a discharge or threat of a discharge of
oil into or upon navigable waters or adjoining shorelines is liable, regardless
of fault, as a "responsible party" for removal costs and damages. Federal law
impose strict, joint and several liability on facility owners for containment
and clean-up cost and certain other damages, including natural resource damages,
arising from a spill.
55
The EPA is also authorized to seek preliminary and permanent injunctive
relief and, in certain cases, criminal penalties and fines. State laws governing
the control of water pollution also provide varying civil and criminal penalties
and liabilities in the case of releases of petroleum or its derivatives into
surface waters or into the ground. If a discharge occurs at a well site at which
the Company is conducting production operations, the Company may be exposed to
claims that it is liable under the OPA, the CWA or similar state laws.
The Resource Conservation and Recovery Act ("RCRA"), as amended,
generally does not regulate most wastes generated by the exploration and
production of oil and gas. RCRA specifically excludes from the definition of
hazardous waste "drilling fluids, produced waters, and other wastes associated
with the exploration, development, or production of crude oil, natural gas or
geothermal energy." However, these wastes may be regulated by the EPA or state
agencies as solid waste. Moreover, ordinary industrial wastes, such as paint
wastes, waste solvents, laboratory wastes, and waste compressor oils, may be
regulated as hazardous waste. Pipelines used to transfer oil and gas may also
generate some hazardous wastes. Although the costs of managing solid and
hazardous waste may be significant, the Company does not expect to experience
more burdensome costs than similarly situated companies involved in oil and gas
exploration and production.
TITLE TO PROPERTIES
Title to properties is subject to royalty, overriding royalty, carried
working, net profits, working and other similar interests and contractual
arrangements customary in the oil and gas industry, liens for current taxes not
yet due and other encumbrances. As is customary in the industry in the case of
undeveloped properties, little investigation of record title is made at the time
of acquisition (other than a preliminary review of local records).
Investigations, including a title opinion covering the drill site by local
counsel, generally are made before commencement of drilling operations. With
respect to acquisitions of producing properties, it is customary to review title
opinions, review engineering reserve reports and conduct environmental and
operational reviews before the closing of the purchase.
OPERATING HAZARDS AND INSURANCE
The oil and gas business involves a variety of operating risks,
including the risk of fire, explosions, blow-outs, pipe failure, abnormally
pressured formations, and environmental hazards such as oil spills, gas leaks,
ruptures or discharges of toxic gases, the occurrence of any of which could
result in substantial losses to the Company due to injury or loss of life,
severe damage to or destruction of property, natural resources and equipment,
pollution or other environmental damage, cleanup responsibilities, regulatory
investigation and penalties and suspension of operations.
The Company maintains an oil and gas lease operator insurance policy
that insures the Company against certain sudden and accidental risks associated
with drilling, completing and operating its wells. In addition, we require
certain parties conducting operations for us to maintain general comprehensive
liability policies with contractual coverage to support the contractors'
obligations to indemnify and defend us in certain circumstances. There can be no
assurance that this insurance will be adequate to cover any losses or exposure
to liability. The Company also carries comprehensive general liability policies
and an umbrella policy. Although the Company believes that the amount of
coverage it maintains is customary in the industry, it does not provide complete
coverage against all operating risks. An uninsured or partially insured claim,
if successful and of sufficient magnitude, could have a material adverse effect
on the Company and its financial condition. If the Company experiences
significant claims or losses, the Company's insurance premiums could be
increased, which may adversely affect the Company and its financial condition,
or limit the ability of the Company to obtain coverage. Any difficulty in
obtaining coverage may impair the Company's ability to engage in its business
activities.
LEGAL PROCEEDINGS
The Company is involved in routine litigation arising in the ordinary
course of business. Management believes that the results of each proceedings,
individually and in the aggregate, will not have a material adverse effect on
the Company's financial position or results of operations.
56
FACILITIES
The Company maintains approximately 25,100 square feet of office space
in Houston, Texas, which is leased at an annual rent of $396,187. The lease
expires January 31, 2003. The Company believes it will be able to renew the
lease on acceptable terms, and is currently offering up to half of the space for
sublease.
EMPLOYEES
The Company has 21 full-time employees in its Houston, Texas office as
of May 31, 1999. Their functions include management, production, engineering,
geology, geophysics, land, gas marketing, accounting, financial planning and
administration. Certain operations of the Company's field activities are
accomplished through independent contractors who are supervised by the Company.
The Company believes its relations with its employees and contractors are good.
No employees of the Company are represented by a union.
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth certain information regarding the Company's
directors and executive officers. Officers of the Company are elected by the
board of directors and serve at the discretion of the board. All of the current
directors serve until the next annual shareholders' meeting or until their
successors have been duly elected and qualified.
NAME AGE POSITION
- ---------------------------------------------------------------------------------------------------------
Prentis B. Tomlinson, Jr. (1) 56 Chairman of the Board and Chief Executive Officer
Robert S. Herlin (1)(2) 44 Director, Senior Vice President and Chief Financial Officer
Todd E. Grabois 39 Vice President, Treasurer & Secretary
Robert L. Zorich (1) 49 Director
Yale Fisher (2) 53 Director
David P. Quint (3) 48 Director
Gary Peterson (3) 53 Director
Russell Cleveland (3) 60 Director
- --------------------------------
(1) Member of the Executive Committee.
(2) Member of the Audit Committee.
(3) New directors elected by the Board on June 2, 1999 to fill vacant
seats. Elected to serve until next annual shareholders' meeting.
PRENTIS B. TOMLINSON, JR. has been involved in the oil and gas industry
for the past 30 years and has been involved with the Company as its President
and Chief Executive Officer since its inception in October 1996. Mr. Tomlinson
served as Chairman of Texstar North America, Inc. from 1984 to 1995, founded and
served as Chairman of TGS Geophysical Company, Inc. from 1983 to 1993 and served
as Chairman and President of Tomlinson Interests, Inc. from 1973 to 1983. Mr.
Tomlinson commenced his career in the oil and gas industry as a geophysicist
with Western Geophysical Inc. in 1969.
ROBERT S. HERLIN has been Senior Vice President, Chief Financial
Officer and Director of the Company since November 1997, when he joined the
Company. Mr. Herlin has 17 years experience in finance, planning and corporate
development in the oil and gas industry with several companies, including his
own management consulting firm. Most recently, he was vice president of Enron
Liquids Services, a subsidiary of Enron Corporation, and Manager of Planning and
Investor Relations for Kelley Oil & Gas Corporation.
TODD E. GRABOIS has been Vice President, Treasurer and Secretary of the
Company since November 1997. Prior, thereto, Mr. Grabois served as Chief
Financial Officer of the Company from September 1997 until November 1997 and
Director of the Company from inception in October 1996 until November 1997. He
has served in various other positions with the Company or its predecessors since
1984.
57
ROBERT L. ZORICH has been a Director of the Company since November
1997. He is the Managing Director and co-founder of EnCap, a Houston-based
venture capital and mezzanine fund for the energy industry. Before founding
EnCap, Mr. Zorich was a senior officer in the energy group of Republic Bank.
EnCap recently announced its sale to El Paso Field Services.
YALE FISHER has been a Director of the Company since January 1997. He
is, and has been, an independent investment banker based in California since
July 1994. Before that he was head of trading at Bank of America in Los Angeles
and San Francisco, California and New York, New York.
DAVID P. QUINT was elected by the Board to serve as a director on
June 2, 1999. Mr. Quint has been Managing Director of RP&C International, Inc.,
an international investment banking firm based in London and Zurich, for over
five years.
GARY PETERSON, was elected by the Board to serve as a director on
June 2, 1999. Mr. Peterson has been Managing Director of EnCap, a
Houston-based venture capital and mezzanine fund for the energy industry for
the past five years.
RUSSELL CLEVELAND was elected by the Board to serve as a director on
June 2, 1999. Mr. Cleveland is the principal founder and the majority
shareholder of Renaissance Capital Group Inc. Renaissance Capital provides
capital to emerging publicly owned companies. Mr. Cleveland currently serves as
President of the Managing General Partner of Renaissance Capital Partners,
Limited., President and Director of Renaissance Capital Growth & Income Fund
III, Inc. (which is traded on NASDAQ), and a Director of Renaissance U.S. Growth
and Income Trust PLC, which is traded on the London Stock Exchange. Mr.
Cleveland also currently serves as a director of Danzer Corp. (formerly Global
Environmental Corp.), Feminique, Inc. (formerly Biopharmaceutics, Inc.), Tutogen
Medical, Inc., Bentley Pharmaceuticals, Inc., and Technology Research, Inc.
AGREEMENT RELATING TO ELECTIONS OF DIRECTORS
Pursuant to an agreement dated December 16, 1998 (the "December 1998
Funding Agreement") between the Company, Mr. Tomlinson and EnCap, the Company
agreed to make certain changes in its Bylaws restricting the number of directors
to seven. The Agent now has the right to designate up to two directors to serve
on the board of directors during a two year period. The Agent has exercised the
board representation right described above.
58
EXECUTIVE COMPENSATION
The following table sets forth the compensation, including bonuses, paid by
the Company during the years ended December 31, 1998, 1997 and 1996 to the Chief
Executive Officer and to those executive officers whose aggregate cash
compensation exceeded $100,000 during the last fiscal year other than the Chief
Executive Officer of the Company (collectively the "Named Executive Officers").
Number of All
Year Ended Annual Compensation Securities Other
December 31, ----------------------------- Underlying Compensation
Name and Principal Position (1) Salary Bonus Options (2)
- ---------------------------------------------------------------------------------------------------------------------
Prentis B. Tomlinson, Jr. (6) 1998 $243,750 -- -- $3,400
Chairman & Chief 1997 150,000 210,000 1,621,000 4,750
Executive Officer 1996 (3) 25,000 -- -- --
Ernest J. LaFlure (5) 1998 200,000 -- -- 2,500
Former Director, President 1997 (4) 46,282 100,000 300,000 --
And Chief Operating Officer 1996 -- -- -- --
Robert S. Herlin (6) 1998 165,000 -- -- 5,250
Director, Senior Vice 1997 (4) 14,884 110,000 300,000 --
President and Chief 1996 -- -- -- --
Financial Officer
Todd E. Grabois (6) 1998 105,000 -- -- 4,865
Vice President, 1997 85,000 -- 140,000 4,750
Treasurer and Secretary 1996 69,462 -- -- --
- --------------------------------
(1) In 1997, the Company changed its fiscal year end from August 31 to
December 31.
(2) Other compensation includes Company contributions made to each person's
respective account under the Company's 401(k) plan.
(3) Total compensation to Mr. Tomlinson for the year ended December 31,
1996 was $150,000, including amounts paid before the inception of the
Company.
(4) Salary for Messrs. LaFlure and Herlin represent amounts paid from date
of hire to the end of the year.
(5) Mr. LaFlure resigned as President and Chief Operating Officer of the
Company effective February 15, 1999; and as Director in April 1999.
(6) Effective February 1, 1999, the salaries of Messrs. Tomlinson, Herlin
and Grabois were reduced to $184,248, $105,000 and $84,000,
respectively. Effective May 17, 1999, the salary of Mr. Grabois was
reinstated.
DIRECTOR COMPENSATION
Certain non-employee directors are individually awarded stock options
and receive cash compensation at the Board's discretion.
EMPLOYMENT AND TERMINATION AGREEMENTS
The Company entered into a three-year employment agreement with Mr.
LaFlure on September 30, 1997 pursuant to which Mr. LaFlure served as the
Company's President and Chief Operating Officer.
Under the employment agreement, Mr. LaFlure received a monthly salary
of $16,666.67 and an initial bonus of $100,000. Mr. LaFlure was entitled to
participate in all other employee compensation and welfare benefit plans and
programs available to the Company's other employees and executive officers,
including, but not limited to, health, dental and 401(k) plans. If the Company
terminated the employment agreement other than for cause or for
59
disability or death (as each such term is defined in the agreement) at any
time before the expiration thereof, then the Company was obligated to pay Mr.
LaFlure $1,500,000 minus (i) the amount of monthly salary for each month Mr.
LaFlure was paid; (ii) all cash bonuses received by Mr. LaFlure before the
termination; and (iii) the value of his stock options, such value being the
difference between the option price and the value of the option shares as of
the date of termination.
The Company terminated Mr. LaFlure's employment without cause effective
January 15, 1999 and requested Mr. LaFlure to resign all of his positions with
the Company except his position as a director of the Company. Mr. LaFlure
resigned as a director in April of 1999. Pursuant to a settlement agreement, Mr.
LaFlure was entitled to receive $1,150,000 payable as follows:
- - Payments of $10,000 per month for 12 months commencing February 15, 1999;
- - Payment of $400,000 on January 15, 2000
- - Payment of $200,000 on July 15, 2000; and
- - Payment of the balance due under his agreement, as adjusted, (as
described in the immediately following paragraphs,) on January 15, 2001.
In addition, Mr. LaFlure was granted new stock options in lieu of the
previous options for 300,000 shares of Common Stock granted on December 18,
1997. The new stock option agreement dated February 15, 1999 is for 500,000
shares of Common Stock at an exercise price of Cdn.$0.53 per share. The
remaining amounts due under the settlement agreement payable on January 15,
2001, shall be reduced by the difference between the option price under the new
option agreement for 500,000 shares of Common Stock and the 500,000 option
shares as of the date the payment of the balance of the agreed amounts. All cash
payments payable to Mr. LaFlure shall be reduced by applicable federal, state of
local withholding taxes. The Company also agreed that at its sole cost and
expense to continue current health insurance coverage for Mr. LaFlure as
required by applicable law until January 15, 2000.
The Company entered into a two-year employment agreement with Mr.
Herlin on November 15, 1997. Under the employment agreement, Mr. Herlin receives
an initial monthly salary of $11,250 and an initial bonus of $110,000. Mr.
Herlin is entitled to participate in all other employee compensation and welfare
benefit plans and programs available to the Company's other employees and
executive officers, including, but not limited to, health, dental and 401(k)
plans. If the Company terminates the employment agreement other than for cause,
disability or death at any time before the expiration thereof, then the Company
must pay to Mr. Herlin the remaining amount of salary accrued or otherwise to be
paid throughout the remainder of the term of the agreement; provided that the
remaining amount may be no less than 12 months of Mr. Herlin's salary. If such
termination is due to a change of control of the Company, the minimum remaining
amount must be equal to 24 months of Mr. Herlin's salary.
In the event of termination of Mr. Herlin for cause, such agreement
terminates immediately and the Company's sole remaining obligation is to pay any
amounts accrued thereunder through the date of termination.
On December 16, 1998, the Company entered into an agreement with EnCap,
the largest secured creditor of the Company, that should Mr. Tomlinson's
employment be terminated, except for cause, following certain events, then EnCap
will make a cash payment to Mr. Tomlinson of $1.0 million within 30 days of
severance, enter into a consulting agreement with a three year term providing
for payments of $185,000 per annum, and grant Mr. Tomlinson an overriding
royalty interest in certain properties. These payments are obligations of the
Company and EnCap has agreed to provide financing to fund such payment
obligation.
OPTION REPRICING
In February 19, 1999, the board re-priced stock options previously
awarded to certain employees of the Company, including the Named Executive
Officers, one director of the Company and one contract employee. Options were
re-priced at CDN. $0.50, which was the previous 10-day average closing price of
the Common Stock as reported on Canada Stockwatch. Such re-pricing of options
held by the Named Executive Officers and the director is subject to shareholder
and regulatory approval.
60
OPTION GRANTS
No options were granted to the Named Executive Officers in 1998. See
"Management-Executive Compensation."
OPTION EXERCISE AND YEAR-END VALUES
The following table provides information with respect to options to
purchase Common Stock exercised by the Named Executive Officers during 1998 and
with respect to the number and value of unexercised options held by the Named
Executive Officers at December 31, 1998.
Value of Unexercised
Number of Securities Underlying In-The-Money Options at
Number of Unexercised Options at December 31, 1998
Shares Value December 31, 1998 CDN$
Acquired on Realized --------------------------------------------------------------------
Exercise CDN Exercisable (1) Unexercisable Exercisable Unexercisable
-----------------------------------------------------------------------------------------------
Prentis B. Tomlinson, Jr. -- -- 983,700 -- -- --
Ernest J. LaFlure (2) -- -- 300,000 -- -- --
Robert S. Herlin -- -- 300,000 -- -- --
Todd Grabois -- -- 140,000 -- -- --
- ---------------------------------
(1) All options held by employees of the Company as of February 19, 1999,
including Named Executive Officers, were re-priced to Cdn$0.50, subject to
shareholder approval.
(2) Subject to the terms of a settlement agreement of Mr. LaFlure's employment
contract, his original options were replaced with 500,000 options with an
exercise price of Cdn$0.53 and a term through January 15, 2001.
PRINCIPAL SHAREHOLDERS
The following table sets forth certain information, as at March 31,
1999, regarding the persons or companies known by the Company to own
beneficially, directly or indirectly, or exercise control or direction over 5%
or more of the issued Common Stock:
Percentage of
issued and
Outstanding
Name Number of Shares Common Stock
- ------------------------------------------ --------------------- ---------------
Prentis B. Tomlinson, Jr. 13,240,603 (1) 35.90%
Encap Investors 3,228,269 (2) 9.05%
Donald W. Busby 2,406,685 (3) 6.70%
Heather Tomlinson 2,350,000 (4) 6.53%
- ----------------------------------
(1) Includes:
(a) 1,193,000 shares in the name of Houston Trust, a trust of
which Mr. Tomlinson is the trustee and exercises control or
direction;
(b) 850,000 shares in the name of Ruston Trust, a trust which Mr.
Tomlinson is the trustee and exercises control or direction;
(c) 5,525,000 shares in the name of Slattery Trust, a trust of
which Mr. Tomlinson is the beneficiary;
(d) 2,452,774 shares in the name of Texstar Holdings LLC, a
private company controlled by Mr. Tomlinson;
(e) 1,933,910 shares in the name of Calibre, controlled by Mr.
Tomlinson; and
61
(f) 983,700 shares issuable upon the exercise of stock options.
(2) Shares in the name of Lasco Energy Partners, L.P., an affiliate of
EnCap.
(3) Held through Boone Petroleum Inc., a private corporation wholly owned
by Mr. Busby.
(4) Includes 2,330,000 shares held in the name of Starbucks Trust, a trust
which Mrs. Tomlinson, wife of the Chairman and CEO, is the beneficiary.
As at March 31 1999, the directors, officers, promoters and other
members of management of the Company, as a group, beneficially owned, directly
or indirectly, 16,430,717 shares of Common Stock, representing 41.70% of the
issued and outstanding shares of the Common Stock of the Company.
SECURITIES SUBJECT TO POOLING AGREEMENTS
Pursuant to an agreement dated April 18, 1997, as amended on
September 11, 1997 (the "Pooling Agreement"), between the Company, certain
shareholders of the Company including Mr. Tomlinson and other senior
management of the Company, and Montreal Trust, the Company's registrar and
transfer agent, as well as the agent under the Pooling Agreement, a total of
10,342,497 shares of Common Stock were deposited on a pooled basis. In
addition, a total of 2,000,000 shares of Common Stock to be issued on
exercise of outstanding share purchase warrants were, once exercised, to be
deposited and held by Montreal Trust pursuant to the terms and conditions of
the Pooling Agreement. All Common Stock subject to the Pooling Agreement will
be released over a period of three years ending April 18, 2000, subject to
earlier release from the pool in certain circumstances. As of April 19, 1999,
a total of 313,000 shares of Common Stock are held by Montreal Trust pursuant
to the terms and conditions of the Pooling Agreement.
Pursuant to an agreement dated September 15, 1997 (the "Escrow
Agreement"), between the Company, certain shareholders of the Company, Mr.
Tomlinson, Mr. Busby and Montreal Trust, a total of 13,505,780 shares of Common
Stock were deposited with Montreal Trust to be held in escrow pursuant to the
Escrow Agreement. All Common Stock subject to the Escrow agreement will be
released in accordance with the policies of the Ontario Securities Commission.
As of April 19, 1999, a total of 10, 804,624 shares of Common Stock are held in
escrow by Montreal Trust pursuant to the Escrow Agreement.
Pursuant to an option agreement between Boone Petroleum Inc., a
corporation controlled by Mr. Busby, and Texstar Petroleum, L.L.C., a company
controlled by Mr. Tomlinson, Boone Petroleum Inc. granted Texstar Petroleum,
L.L.C. an option to purchase 1,200,000 shares of Common Stock from Boone
Petroleum Inc. The option was exercised and 1,100,000 shares of the Company's
Common Stock were transferred within escrow on September, 1998 to Texstar
Petroleum, L.L.C. As of April 19, 1999, the remaining 100,000 shares of Common
Stock have not been transferred within escrow.
Pursuant to an unsigned agreement dated October 9, 1997 (the "Pledge
Agreement"), between EnCap Energy, Montreal Trust, the Company, Texstar
Holdings, L.L.C. and the Slattery Trust, Texstar Holdings, L.L.C. and the
Slattery Trust granted to EnCap Energy a security interest in 535,521 shares of
Common Stock owned by Texstar Holdings, L.L.C. and 5,525,000 shares of Common
Stock owned by the Slattery Trust subject to the Escrow Agreement.
INTERESTS OF MANAGEMENT AND OTHERS IN MATERIAL TRANSACTIONS
The Company has entered into several agreements with entities that are
owned or managed by certain of its directors, officers or other affiliates, or
in which certain of its directors, officers or affiliates have an interest. The
Company also has entered into agreements with certain of its former directors
and officers. Although some of these transactions were approved by the Company's
outside directors, there can be no assurance that these transactions were
negotiated at arms-length or on terms that would have been negotiated with
unaffiliated third parties. The related entities with which the Company has
entered into transactions include:
- EnCap Capital Fund III L.P., a partnership whose general
partner is EnCap Investments, L.C., which is managed by Robert
L. Zorich, one of the Company's directors;
- Slattery Trust, a private trust of which Mr. Tomlinson is the
beneficiary;
62
- Starbucks Trust, a private trust of which Heather Tomlinson,
is the beneficiary;
- Calibre Energy, LLC, a limited liability company owned by
Slattery Trust, Starbucks Trust, Mr. Grabois and Mr. Novak,
and which is managed by Heather Tomlinson;
- Lasco, an affiliate of EnCap;
- Texstar Holdings, L.L.C., a private limited liability company
owned by certain of the Company's shareholders;
- Stanford Energy, Inc., a company affiliated with Donald W.
Busby, the former chairman of the Company's board of
directors; and
- RP&C International of which David Quint is a director and
shareholder.
RELATED PARTY TRANSACTIONS
ENCAP CREDIT FACILITY
In 1997, the Company entered into a $20.0 million credit agreement with
EnCap consisting of an Original Note for $12.0 million and a Supplemental Note
for $8.0 million. The Original Note bears interest at 10.0% per annum, and was
due, with accrued interest, in December 1998. The Supplemental Note, which has
been repaid in full, bore interest at 10.0% per annum until July 1, 1998 and at
18.0% per annum thereafter. Under the terms of the Supplemental Note, EnCap was
issued warrants for the purchase of 1.5 million shares of common stock at an
exercise price of $1.28 per share. The Original Note is secured by a first lien
on the properties acquired and a second lien on certain other properties. The
Original Note has been guaranteed by Mr. Tomlinson, Calibre and certain of
Calibre's affiliates.
Under the Original Note, the Company agreed to convey to EnCap a 25.0%
net profit interest from the properties acquired with the proceeds of the
borrowing. EnCap also required Slattery Trust, Texstar Holdings and certain of
the Company's shareholders to enter into a Put/Call Agreement pursuant to which
those shareholders, under certain conditions, have the right to obtain or "call"
the EnCap NPI in exchange for 1.5 million shares of the Company's common stock.
The Put/Call Agreement also gives EnCap the right, under certain conditions, to
sell, or put, portions of the EnCap NPI to the shareholders for $1.5 million or
3.5 million shares of the Company's common stock as of December 31, 1998 or
March 31, 1999, respectively. The shareholders' rights and obligations under the
Put/Call Agreement have been transferred to the Company.
STANFORD ENERGY DEBENTURE
In August 1997, Stanford Energy issued the Company an unsecured
convertible debenture in the principal amount of Cdn.$200,000. The debenture
bore interest at a rate of 8.0% per annum, payable quarterly. The debenture was
repaid on August 6, 1997.
ADVANCES TO CALIBRE EQUADOR
In the Spring of 1997, the Company and Slattery Trust, Starbucks Trust,
Mr. Grabois, Mr. Novak and James Alexander formed Calibre Ecuador, Inc. to
develop certain oil and gas prospects in Ecuador. The Company owned 50% of the
outstanding common stock of Calibre Ecuador and the other parties collectively
owned the other 50%. The development of the prospects required enactment of
certain enabling legislation that would permit non-Ecuador citizens to own oil
and gas properties in Ecuador. Pending the enactment of such legislation, the
Company advanced funds to Calibre Ecuador to generate the prospect, all rights
to were contributed to Calibre Ecuador by the parties other than the Company. As
of December 31, 1997 the Company had written off advances totaling $402,192 made
to Calibre Ecuador. Calibre Ecuador had no means with which to repay the
advances. The advances were non-interest bearing and due upon demand. Due to the
write-off, the Company obtained rights to substantially all of Calibre Equador's
common stock.
In November, 1998, the Company entered into a Participation Agreement
with Burlington Resources International Inc. to develop the gas fields in
Ecuador. The Company and Burlington have participation interests of 25% and 75%,
respectively. Burlington has indicated it might not renew the agreement and the
action could have an
63
impact on the Company's ability to maintain an interest in the region.
However, the Company would retain a 25% interest in any project related to
the subject area pursued by Burlington for one year.
CALIBRE TRANSACTIONS
In December 1997, the Company advanced funds to Calibre Oil & Gas, Inc.
Net advances to Calibre Oil & Gas, Inc. totaled $1,768,772 at December 31, 1997.
The advances bore no interest and were due upon demand.
On April 22, 1998, in a single transaction, the Company acquired all of
the outstanding shares of Calibre Oil & Gas, Inc. from Calibre and certain oil
and gas properties owned by the Slattery Trust, the Starbucks Trust, Todd
Grabois, Robert Novak, Prentis B. Tomlinson, Jr., and Calibre Oil & Gas, Inc.
The shares of Calibre Oil & Gas, Inc. were valued at $3,820,713 and were paid
for through the issuance to Calibre of 1,927,426 shares of common stock of the
Company valued at Cdn. $2.80 per share. The total purchase price for the oil and
gas properties acquired from the other parties was $2,261,000, paid $261,000 in
cash and $2,000,000 in promissory notes issued by Texstar Petroleum Inc. in
differing amounts to each party. These notes were guaranteed by the Company,
paid 10% annual interest and were to be repaid in two equal installments due on
April 1, 1998 and September 1, 1998. The purchase price was to be adjusted by a
credit for proceeds from production attributable to each property through
January 31, 1998.
In connection with the acquisition of the oil and gas properties and
shares of Calibre Oil & Gas, Inc., $1.45 million of the advances to Calibre Oil
& Gas, Inc. were reclassified as an assumption of payables and the remaining
$318,772 was written off as a bad debt. Calibre Oil & Gas, Inc. was subsequently
merged into the Company and ceased to exist on January 7, 1999.
LASCO ACQUISITION
In January 1998, and effective on December 1, 1997, the Company
acquired proved reserves in Texas and Louisiana from Lasco for 2.57 million
shares of Common Stock and 12.0 million shares of the Company's Series 1
preferred stock. In December 1998, the Company reconveyed a portion of those
interests to Lasco in exchange for approximately 2.5 million shares of the
Company's Series 1 preferred stock.
STARBUCKS NOTE
On January 1, 1998, the Company loaned Starbucks Trust $2.5 million
pursuant to a promissory note due December 31, 1998 that bears interest at 9.0%
per annum. Starbucks Trust is a grantor trust with the sole beneficiary and
trustee being Heather Tomlinson, Prentis Tomlinson's spouse. Total advances and
accrued interest under the note are $2.9 million as of March 31, 1999. Funds
that the Company lent to Starbucks Trust were a portion of the proceeds the
Company received from the Offering of the Notes that are being exchanged in the
Offering. The loan was intended to (i) give the Company a greater return on
investment than it was receiving at the time; (ii) acquire shares of the
Company's common stock in the open market to support the public trading price;
and (iii) acquire Common Stock that was reconveyed by Starbucks Trust to certain
of the Company's lenders in an effort to deliver to those lenders freely
tradeable Company common stock. The entire principal interest outstanding under
the note remains due and payable and is carried on the Company's books as an
account receivable; however, Starbucks Trust lost money on the securities
transactions it made with the proceeds of the loan and currently is unable to
repay the loan.
Starbucks has claimed and requested credits, for expenses incurred on
behalf of the Company, against the amounts owed under the note of Cdn. $740,240.
Separately, and pursuant to the terms of the Starbucks Trust Acquisition
Agreement, the Company owes the Starbucks Trust $1,283,462 inclusive of accrued
interest as of December 31, 1998. Pursuant to the Calibre Acquisition Agreement,
as of December 31, 1998, the Company further owes the Starbucks Trust $213,918
and Prentis Tomlinson $1,588,489 inclusive of accrued interest. On December 28,
1998, as part of the Shell transaction, the above parties and Texstar Holdings,
LLC and Security Oil, LLC signed a standstill agreement wherein all parties
mutually deferred payments and further agreed not to pursue collection of any
amounts until the Termination Date of the Shell transaction and to toll the
applicable statutes of limitations related to claims arising from any such
amounts until the earlier of the Termination Date or December 31, 2003.
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STARBUCKS ACQUISITION
In July 1998, the Company entered into the Starbucks Acquisition
pursuant to which the Company acquired certain proved non-producing oil and gas
properties in Mississippi, Texas and Louisiana from Starbucks Trust for $2.33
million and 600,000 shares of Common Stock. The purchase is subject to approval
by the Vancouver Stock Exchange and is subject to certain post-closing
adjustments relating to purchase value. The purchase value is guaranteed and
secured by 2.1 million shares of Common Stock owned by the Starbucks Trust.
OTHER RELATED PARTY TRANSACTIONS
The Company had an agreement with DWB Management Ltd. to provide
management, professional and office services. DWB Management is a private
company owned by Donald W. Busby, the Company's former chairman of the board.
During the four months ended December 31, 1997, the Company paid DWB Cdn.$8,000.
Under the agreement, the Company paid DWB for services rendered a fee of
Cdn.$8,000 per month. The agreement with DWB Management was terminated in
September 1997.
The Company entered into an agreement with Chase Management Ltd. to
provide management, professional and office services to the Company, including
daily accounting services as required, and general legal assistance for routine
Canadian securities filings. Chase Management is a private company owned by Nick
DeMare, a former officer and director of the Company. The agreement was for one
year commencing on the first day of October 1997 through the last day of
September 1998. Thereafter, the agreement continues in effect from year to year
unless terminated by either party upon 60 days' written notice. During the last
fiscal year the Company paid Chase Management Cdn.$60,000 and for the remaining
term of the agreement, the Company will pay Chase Management Cdn.$5,000 per
month for services rendered.
DESCRIPTION OF CAPITAL STOCK
The Company's Certificate of Incorporation provides for authorized
capital stock of 400,000,000 shares, consisting of 300,000,000 shares of Common
Stock, par value $0.01 per share and 100,000,000 shares of Preferred Stock, par
value $1.00 per share. The following summary description of the capital stock is
qualified in its entirety by reference to the Certificate of Incorporation and
the attached Certificate of Designation. As of May 31, 1999, 33,727,724 shares
of Common Stock and 9,488,140 Class A, Series I Preferred Shares
(non-convertible 10% dividend) were issued and outstanding.
COMMON STOCK
Holders of Common Stock are entitled to one vote per share in the
election of directors and on all other matters on which stockholders are
entitled or permitted to vote. Holders of Common Stock are not entitled to
cumulative voting rights. Therefore, holders of a majority of the shares voting
for the election of directors can elect all the directors. Subject to the terms
of any outstanding series of preferred stock, the holders of Common Stock are
entitled to dividends in such amounts and at such times as may be declared by
our board of directors out of funds legally available therefor. Upon liquidation
or dissolution, holders of Common Stock are entitled to share ratably in all net
assets available for distribution to stockholders after payment of any
liquidation preferences to holders of preferred stock. Holders of Common Stock
have no redemption, conversion or preemptive rights.
PREFERRED STOCK
The board of directors has the authority to cause the Company to issue
up to the authorized number of shares of preferred stock in one or more series,
to designate the number of shares constituting any series, and to fix the
rights, preferences, privileges and restrictions thereof, including dividend
rights, voting rights, redemption and conversion rights and liquidation
preferences of such series, without further action by the stockholders. The
issuance of preferred stock with voting and conversion rights may adversely
affect the voting power of the holders of the common stock.
SERIES I PREFERRED STOCK
On March 6, 1998, the Company's board of directors authorized the
issuance of 12,000,000 shares of Series I preferred stock. Set forth below is a
summary of the terms of the Series I preferred stock.
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DIVIDENDS. The shares of Series I preferred stock are entitled
to dividends at the Designated Rate (as defined below), to be paid in
cash quarterly on March 31, June 30, September 30, and December 31 of
each year and are cumulative whether or not declared or whether or not
there are funds legally available to pay the dividend on the aggregate
price paid or deemed to be paid (the "Purchase Price") for the shares.
Such dividends will be prior and in preference to any declaration or
payment of any dividends paid on Junior Stock. The Designated Rate is
10% per annum, but upon the occurrence or continuance of a Voting Event
(as defined below), the rate shall be 14% per annum. For the first
eight quarters dividends are due, the board of directors may elect to
make payment in Common Stock.
LIQUIDATION PREFERENCE. In the event of any liquidation,
dissolution, or winding up, voluntary or involuntary, the shares of
Series I preferred stock are entitled to preference to the Junior Stock
of a cash amount equal to the Purchase Price plus dividends accumulated
but not paid (the "Liquidation Amount"). A consolidation or merger of
the Company with or into any other entity, or a sale or transfer in a
single transaction or a series of related transactions of all or
substantially all of the Company's assets, shall be deemed to be a
liquidation for purposes hereof.
OPTIONAL REDEMPTION. Upon five business days advance notice,
the Company has the option to redeem any or all of the shares of Series
I preferred stock at any time at a cash redemption price per share
equal to the Liquidated Amount divided by the number of shares of
Series I preferred stock originally issued.
MANDATORY REDEMPTION. If the Series I preferred stock has not
been redeemed within five years of being issued, the Company is
required to redeem the shares at a cash redemption price per share
equal to the Liquidation Amount divided by the number of shares of
Series I preferred stock originally issued. If a qualified public
offering of at least $25 million has not been completed by January 23,
2001, the Series I preferred stock may be put back to the Company for
cash redemption. The holder of the Series I preferred stock has agreed
to waive this put redemption right contingent upon the completion of
the Offering. Redemption of the Series II Preferred Stock will require
either the redemption for cash of the Series I preferred stock or
consent of the holders of the Series I preferred stock.
VOTING RIGHTS. The Series I preferred stock have no voting
rights, except as set forth below. Upon the occurrence of a Voting
Event, the Series I shareholders shall be, voting as a single class,
entitled to elect (i) two directors at any time there are more than
1,200,000 Series I shares outstanding, or (ii) one director if there
are 1,200,000 Series I shares or less. Any director so elected shall
serve until all Voting Events have ceased to be continuing. Voting
Events include: (i) the failure to pay at least two dividends on the
Series I shares as they become due and payable; (ii) the failure to
redeem the Series I shares when required for the put redemption, (iii)
the failure to redeem the Series I preferred stock when required for
the mandatory redemption, (iv) bankruptcy, insolvency, appointment of a
receiver, liquidator or similar official, monetary judgments in excess
of $500,000 not covered by insurance, or writs or warrants of
attachment or similar process against all or a substantial part of our
assets.
SERIES II PREFERRED STOCK
See "Summary - the Offering" and "Comparison of the Notes and Preferred
Stock" for a summary of certain terms of the Preferred Stock. The Certificate of
Designation is attached hereto as Appendix A.
PROVISIONS OF THE CERTIFICATE OF INCORPORATION AND DELAWARE LAW
The Company's Certificate of Incorporation authorizes the board of
directors, without stockholder approval, to establish and to issue shares of one
or more series of preferred stock, each such series having such voting rights,
dividend rates, liquidation, redemption, conversion and other rights as may be
fixed by the board. The Company's Bylaws direct that special meetings of the
stockholders may only be called by a majority of the members of the board of
directors, the chairman of the board of directors, the president or the holders
of not less than 30% of the total voting power of all shares of its capital
stock entitled to vote in the election of directors. The Bylaws further provide
that stockholders' nominations to the board of directors and other stockholder
business proposed to be
66
transaction at stockholder meetings must be timely received by the Company in
a proper written form which meets the prescribed content requirements.
The above provisions may have the effect of deterring certain tender
offers or hostile takeovers or may delay or prevent changes in control of our
management.
LIMITATION OF DIRECTOR LIABILITY
Section 102(b)(7) of the Delaware General Corporation Law ("Section
102(b)") authorizes corporations to limit or eliminate the personal liability of
directors to corporations and their stockholders for monetary damages for breach
of directors' fiduciary duty of care. Although Section 102(b) does not change
directors' duty of care, it enables corporations to limit available relief to
equitable remedies such as injunction or rescission. The Company's Certificate
of Incorporation limits the liability of its directors or its stockholders (in
their capacity as directors but not in their capacity as officers) to the
fullest extent permitted by Section 102(b). Specifically, the Company's
directors will not be personally liable for monetary damages for breach of a
director's fiduciary duty as a director, except for liability: (i) for any
breach of the director's duty of loyalty to the Company or its stockholders,
(ii) for acts or omissions not in good faith or that involve intentional,
misconduct or a knowing violation of law, (iii) for unlawful payments of
dividends or unlawful stock repurchases or redemptions as provided in Section
174 of the Delaware General Corporation Law, or (iv) for any transaction from
which the director derived an improper personal benefit.
INDEMNIFICATION
To the maximum extent permitted by law, the Certificate of
Incorporation and Bylaws provide for mandatory indemnification of directors, and
permit indemnification of the Company's officers, employees and agents against
all expense, liability and loss to which they may become subject or which they
may incur as a result of being or having been a director, officer, employee or
agent. In addition, the Company must advance or reimburse directors, and may
advance or reimburse officers, employees and agents, for expenses incurred by
them in connection with indemnifiable claims.
DELAWARE ANTI-TAKEOVER LAW
Section 203 of the Delaware General Corporation Law ("Section 203")
generally provides that a stockholder acquiring more than 15% of the outstanding
voting stock of a corporation subject to the statute (an "Interested
Stockholder") but less than 85% of such stock may not engage in certain
"Business Combinations" with the corporation for a period of three years after
the date on which the stockholder became an Interested Stockholder unless (i)
before such date, the corporation's board of directors approved either the
Business Combination or the transaction in which the stockholder became an
Interested Stockholder, or (ii) the Business Combination is approved by the
corporation's board of directors and authorized at a stockholders' meeting by a
vote of at least two-thirds of the corporation's outstanding voting stock not
owned by the Interested Stockholder. Under Section 203, these restrictions will
not apply to certain Business Combinations proposed by an Interested Stockholder
following the earlier of the announcement or notification of one of certain
extraordinary transactions involving the corporation and a person who was not an
Interested Stockholder during the previous three years or who became an
Interested Stockholder with the approval of the corporation's board of
directors, if such extraordinary transaction is approved or not opposed by a
majority of the directors who were directors prior to any person becoming an
Interested Stockholder during the previous three years or were recommended for
election or elected to succeed such directors by a majority of such directors.
Section 203 defines the term "Business Combination" to encompass a wide
variety of transactions with or caused by an Interested Stockholder, including
transactions in which the Interested Stockholder receives or could receive a
benefit on other than a pro rata basis with other stockholders, such as mergers,
certain asset sales, certain issuances of additional shares to the Interested
Stockholder, transactions with the corporation which increase the proportionate
interest in the corporation directly or indirectly owned by the Interested
Stockholder, or transactions in which the Interested Stockholder receives
certain other benefits.
The provisions of Section 203, together with the ability of the
Company's board of directors to issue preferred stock without further
stockholder action, could delay or frustrate the removal of incumbent directors
or a change in the Company's control. The provisions also could discourage,
impede or prevent a merger, tender offer or
67
proxy contest, even if such event would be favorable to the interests of
stockholders. The Company's stockholders, by adopting an amendment to the
Company's Certificate of Incorporation or Bylaws, may elect not to be
governed by Section 203 effective 12 months after such adoption. Neither the
Company's Certificate of Incorporation nor Bylaws currently exclude the
Company from the restrictions imposed by Section 203.
SUBSCRIPTION AND SALE
Pursuant to the terms of the Agency Agreement, the Company will pay the
Agent an advisory fee of $200,000 payable in Common Stock and will reimburse the
Agent for all reasonable out-of-pocket expenses, including legal expenses. In
addition, the Company will pay the Agent a fee payable in cash equal to 8% of
the gross cash proceeds resulting from the sale of the Preferred Stock offered
by the Company pursuant to the terms of this Offering and a fee payable in
Common Stock equal to 4% of the nominal value of the Notes tendered in exchange
for the Preferred Stock. Common Stock issued with respect to the 4% fee shall be
offset against the shares issued to the Agent with respect to the $200,000 fee
referenced above. The Company shall also pay the Agent a fee payable in Common
Stock of $100,000 for advice on structuring and documentation and for ongoing
financial services. All Common Stock issued with respect to the fees referenced
in this paragraph will be valued at a per share price of Cdn. $0.35. The Company
will indemnify the Agent against certain liabilities in connection with the
offer and sale of the Preferred Stock. Pursuant to the terms of the Agency
Agreement, the Company will issue to the Agent phantom common share purchase
warrants with each warrant representing the right to receive a cash payment from
the Company equal to the difference (i) between the closing Market Price of the
Common Stock on the Stock Exchange Business Day prior to the date of exercise
and (ii) the lower of Cdn.$0.35 or the Preferred Conversion Price as of April 1,
2000. The number of warrants issued shall be equal to the quotient of (a) the
sum of 10% of the aggregate cash proceeds of the Offering plus 1% of the nominal
value of Notes exchanged for Preferred Stock divided by (b) Cdn. $0.35. The
warrants will have a term of two years. In addition to the foregoing, in
exchange for the Agent agreeing to provide services as a European conversion
agent, the Company shall pay the Agent an annual fee of $15,000 with the first
payment due on the Closing Date and subsequent payments due on each anniversary
thereof that Preferred Stock remains outstanding.
SELLING RESTRICTIONS
UNITED STATES AND CANADIAN SELLING RESTRICTIONS
The Preferred Stock and the Common Stock issuable on conversion of the
Preferred Stock (and any other Common Stock issued in lieu of dividends or
otherwise in connection with the Preferred Stock) have not been registered under
the Securities Act and until registered under the Securities Act may not be
offered or sold within the United States or to, or for the account or benefit
of, U.S. persons except in certain transactions exempt from the registration
requirements of the Securities Act or pursuant to a registration. Terms used in
this paragraph have the meanings given to them in Regulation S under the
Securities Act. The Company has undertaken to file a registration statement
pursuant to the Securities Act with respect to the Preferred Stock and the
Common Stock issuable on conversion of the Preferred Stock that is declared
effective pursuant to the Securities Act within four months after the Closing
Date.
Each person or entity acquiring the Preferred Stock will be required to
certify, and will be deemed to have represented and agreed, as follows:
1. it is not a "U.S. person", as defined in Regulation S under the
Securities Act, and it is not acquiring the Preferred Stock or the
Common Stock issuable upon exchange of the Preferred Stock
(collectively, the "Securities"), for the account or benefit of any
U.S. person;
2. the Securities have not been registered under the Securities Act, are
being offered only in transactions not involving any public offering
within the meaning of the Securities Act, and may not be offered or
sold within the United States or to, or for the account or benefit of,
U.S. persons except as permitted below;
3. prior to the end of the one year Distribution Compliance Period (as
defined in Regulation S), the Securities may be resold, pledged or
transferred only (i) to the Company, (ii) pursuant to offers and sales
that occur outside the United States in a transaction meeting the
requirements of Rule 904 of Regulation S under the
68
Securities Act or (iii) pursuant to an effective registration
statement under the Securities Act, in each case in accordance with
any applicable securities laws of the United States;
4. after one year but within two years after the date of original
issuance of the Securities or within three months after it
ceases to be an affiliate (within the meaning of Rule 144 under
the Securities Act) of the Company, the Securities may be resold,
pledged or transferred only (i) to the Company, (ii) pursuant to
offers and sales that occur outside the United States in a
transaction meeting the requirements of Rule 904 of Regulation S
under the Securities Act, (iii) pursuant to an exemption from the
registration requirements of the Securities Act provided by
Rule 144 (if applicable) under the Securities Act or (iv) pursuant
to an effective registration statement under the Securities Act,
in each case in accordance with any applicable securities laws of
any state of the United States;
5. hedging transactions are prohibited by Regulation S, unless permitted
by the Securities Act;
6. it understands that the Certificate representing the Preferred Stock
will bear the following legend:
NEITHER THIS PREFERRED STOCK NOR THE COMMON STOCK OF THE ISSUER
ISSUABLE ON CONVERSION OF THIS PREFERRED STOCK (THE "SHARES") HAVE BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE
"SECURITIES ACT"), OR THE SECURITIES LAWS OF ANY STATE. THIS PREFERRED
STOCK MAY NOT BE EXCHANGED FOR SHARES BY OR ON BEHALF OF ANY U.S.
PERSON (AS DEFINED IN REGULATION S UNDER THE SECURITIES ACT) UNLESS
REGISTERED UNDER THE SECURITIES ACT OR AN EXEMPTION FROM REGISTRATION
IS AVAILABLE. THE HOLDER HEREOF, BY PURCHASING THIS PREFERRED STOCK,
AGREES FOR THE BENEFIT OF THE ISSUER THAT THIS PREFERRED STOCK AND THE
SHARES MAY NOT BE RESOLD, PLEDGED OR OTHERWISE TRANSFERRED, EXCEPT AS
FOLLOWS.
PRIOR TO THE FIRST ANNIVERSARY OF THE ISSUANCE OF THIS PREFERRED STOCK,
THIS PREFERRED STOCK OR THE SHARES MAY NOT BE SO TRANSFERRED OTHER THAN
(1) TO THE ISSUER, (2) PURSUANT TO OFFERS AND SALES TO NON-U.S. PERSONS
THAT OCCUR OUTSIDE THE UNITED STATES IN A TRANSACTION MEETING THE
REQUIREMENTS OF REGULATION S (RULES 901 THROUGH 905) UNDER THE
SECURITIES ACT, OR (3) PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT
UNDER THE SECURITIES ACT, IN EACH CASE IN ACCORDANCE WITH ANY
APPLICABLE SECURITIES LAWS OF ANY STATE OF THE UNITED STATES.
AFTER THE FIRST ANNIVERSARY AND PRIOR TO THE SECOND ANNIVERSARY OF THE
ISSUANCE OF THIS PREFERRED STOCK, THIS PREFERRED STOCK OR THE SHARES
MAY NOT BE SO TRANSFERRED OTHER THAN (1) TO THE ISSUER, (2) PURSUANT TO
OFFERS AND SALES TO NON-U.S. PERSONS THAT OCCUR OUTSIDE THE UNITED
STATES IN A TRANSACTION MEETING THE REQUIREMENTS OF REGULATION S
(RULES 901 THROUGH 905) UNDER THE SECURITIES ACT, (3) PURSUANT TO AN
EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT
PROVIDED BY RULE 144 (IF APPLICABLE) UNDER THE SECURITIES ACT, OR
(4) PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE
SECURITIES ACT, IN EACH CASE IN ACCORDANCE WITH ANY APPLICABLE
SECURITIES LAWS OF ANY STATE OF THE UNITED STATES.
IF THE HOLDER OF THIS PREFERRED STOCK OR THE SHARES WAS AN AFFILIATE OF
THE ISSUER AT ANY TIME DURING THE THREE MONTHS PRECEDING THE DATE OF
ANY SUCH TRANSFER, THE FOREGOING CONDITIONS MUST BE COMPLIED WITH
REGARDLESS OF WHEN SUCH TRANSFER IS MADE.
NO HEDGING TRANSACTIONS INVOLVING THIS PREFERRED STOCK OR THE SHARES
MAY BE CONDUCTED UNLESS IN COMPLIANCE WITH THE SECURITIES ACT.
NEITHER THIS PREFERRED STOCK NOR THE SHARES HAVE BEEN QUALIFIED FOR
DISTRIBUTION UNDER THE SECURITIES LEGISLATION OF BRITISH COLUMBIA OR
ANY PROVINCE OF CANADA. THIS PREFERRED STOCK AND THE SHARES ISSUABLE ON
CONVERSION OF THIS PREFERRED STOCK ARE SUBJECT TO A HOLD PERIOD WHICH
EXPIRES AT 12:00 A.M. (MIDNIGHT) (VANCOUVER TIME) ON [ INSERT DATE
WHICH IS 4 MONTHS FROM DATE OF ISSUANCE OF PREFERRED STOCK] AND MAY NOT
BE TRADED IN
69
BRITISH COLUMBIA UNTIL SUCH TIME EXCEPT AS PERMITTED BY THE
SECURITIES ACT (BRITISH COLUMBIA) AND THE RULES AND REGULATION MADE
THEREUNDER.
and that the Common Stock will bear the following legend until the
Common Stock has been registered as provided herein:
THE COMMON STOCK (THE "SHARES") OF BENZ ENERGY INC. (THE "CORPORATION")
REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE
SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY STATE
SECURITIES LAWS AND MAY NOT BE TRANSFERRED IN VIOLATION OF SUCH ACT OR
LAWS, OR THE RULES AND REGULATIONS THEREUNDER. THE HOLDER HEREOF AGREES
FOR THE BENEFIT OF THE CORPORATION THAT THE SHARES MAY NOT BE RESOLD,
PLEDGED OR OTHERWISE TRANSFERRED OTHER THAN (1) TO THE CORPORATION,
(2) PURSUANT TO OFFERS AND SALES TO NON-U.S. PERSONS THAT OCCUR OUTSIDE
THE UNITED STATES IN A TRANSACTION MEETING THE REQUIREMENTS OF
REGULATION S (RULES 901 THROUGH 905) UNDER THE SECURITIES ACT,
(3) PURSUANT TO AN EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF
THE SECURITIES ACT PROVIDED BY RULE 144 (IF APPLICABLE) UNDER THE
SECURITIES ACT, OR (4) PURSUANT TO AN EFFECTIVE REGISTRATION
STATEMENT UNDER THE SECURITIES ACT, IN EACH CASE IN ACCORDANCE WITH
ANY APPLICABLE SECURITIES LAWS OF ANY STATE OF THE UNITED STATES.
IF THE HOLDER OF THE SHARES WAS AN AFFILIATE OF THE CORPORATION AT ANY
TIME DURING THE THREE MONTHS PRECEDING THE DATE OF ANY SUCH TRANSFER,
THE FOREGOING CONDITIONS MUST BE COMPLIED WITH REGARDLESS OF WHEN SUCH
TRANSFER IS MADE.
NO HEDGING TRANSACTIONS INVOLVING THE SHARES MAY BE CONDUCTED UNLESS IN
COMPLIANCE WITH THE SECURITIES ACT.
THE SHARES ARE SUBJECT TO A HOLD PERIOD WHICH EXPIRES AT 12:00 A.M.
(MIDNIGHT) (VANCOUVER TIME) ON [INSERT DATE WHICH IS 4 MONTHS FROM DATE
OF ISSUANCE OF PREFERRED STOCK] AND MAY NOT BE TRADED IN BRITISH
COLUMBIA UNTIL SUCH TIME EXCEPT AS PERMITTED BY THE SECURITIES ACT
(BRITISH COLUMBIA) AND THE RULES AND REGULATION MADE THEREUNDER;
7. that the Preferred Stock to be acquired in connection with the
Offering, including Preferred Stock acquired in exchange for the Notes
tendered hereby, (i) is being acquired in the ordinary course of
business of the owner of such Notes and (ii) is being acquired for its
own account, not for the benefit of any other person;
8. it is not engaging and does not intend to engage in the distribution of
the Preferred Stock and has no arrangement or understanding with any
person to participate in the distribution of the Preferred Stock.
9. it (i) has such knowledge and experience in financial and business
matters as to be capable of evaluating the merits and risks of its
prospective investment in the Securities and (ii) has the ability to
bear the economic risks of its prospective investment and can afford
the complete loss of such investment;
10. if the undersigned is in the United Kingdom, it is (i) a person
whose ordinary activities involve it in acquiring, holding, managing
or disposing of investments (as principal or agent) for the purposes
of its business or has otherwise been offered the Securities in
circumstances which have not resulted and will not result in an
offer to the public in the United Kingdom within the meaning of the
Public Offers of Securities Regulations 1995, and (ii) with respect
to any document received by it in connection with the issue of the
Securities, is a kind of person described in Article 11(3) of the
Financial Services Act 1986 (Investment Advertisements)(Exemptions)
Order 1996, as amended, or is a person to whom such document may
otherwise be issued or passed on;
11. it understands that prior to receiving any Common Stock upon its
election to convert the Preferred Stock, it may be required to
(i) certify that it is not a U.S. person, is located outside the
United States, acquired the Preferred Stock outside the United
States and is not a person acting on behalf of an affiliate of the
Company, or (ii) provide the Company with an opinion of United
States legal counsel, in form and substance satisfactory to the
Company to the effect that the exchange of the Preferred Stock is
exempt from registration under the Securities Act;
70
12. it understands that (i) the Preferred Stock may not be converted by, or
on behalf of, a U.S. person, unless an opinion of counsel satisfactory
to the Company is provided that such conversion is registered under the
Securities Act or exempt from registration thereunder and (ii) the
Preferred Stock may not be converted within the United States and the
Common Stock issuable upon the conversion thereof may not be delivered
within the United States, other than in an offering within the meaning
of the definition of "offshore transaction" pursuant to Regulation S
unless such exercise or exchange is registered under the Securities Act
or exempt from registration thereunder;
13. it acknowledges that none of the Notes being purchased by the Company
in exchange for the Preferred Stock have been purchased from persons
who are residents of British Columbia, or any other province of
Canada, or from any holder in British Columbia, or any other
province of Canada and it is not a resident of British Columbia or
any other Province of Canada and is not acquiring the Preferred
Stock for the account or benefit of any resident of British Columbia
or any other Province of Canada and it understands that prior to
receiving any Common Stock upon its election to exchange the
Preferred Stock, it may be required to certify that it is not a
resident of British Canada or any other Province of Canada;
14. it understands that the Company, the Agent and others will rely upon
the truth and accuracy of the foregoing acknowledgments,
representations and agreements and agrees that if any of the
acknowledgments, representations and agreements deemed to have been
made by it by its purchase of the Securities are no longer accurate, it
shall promptly notify the Company and the Agent. If it is acquiring the
Securities as a fiduciary or agent for one or more investor accounts,
it represents that it has full power to make the foregoing
acknowledgments, representations and agreements on behalf of such
account;
15. it acknowledges that no securities commission or similar regulatory
authority has reviewed or passed on the merits of the Preferred Stock;
16. it acknowledges that there is no government or other insurance covering
the Preferred Stock;
17. it acknowledges that there are risks associated with the purchase of
the Preferred Stock;
18. it acknowledges that the Company has advised the purchaser that the
Company is relying on an exemption from the requirements to provide the
purchaser with a prospectus and to sell securities through a person
registered to sell securities under the B.C. Act and, as a consequence
of acquiring securities pursuant to this exemption, certain
protections, rights and remedies provided by the B.C. Act, including
statutory rights of rescission or damages, will not be available to the
purchaser;
19. it acknowledges that there are restrictions on the Purchaser's ability
to resell the Preferred Stock and it is the responsibility of the
Purchaser to find out what those restrictions are and to comply with
them before selling the Preferred Stock; and
20. it will, if requested by the Company, deliver to the Company a
certificate which will confirm the matters referred to in paragraphs 11
to 19 above to the satisfaction of the Company, acting reasonably.
The Company may, in its discretion, revise the selling restrictions on
the Preferred Stock and/or the Common Stock if the Commission should, subsequent
to the date of this Offering Circular, give advice or interpretations respecting
such restrictions imposed by Regulation S or should the Commission amend
Regulation S respecting such restrictions. If the Issuer so revises the selling
restrictions, it will give notice to the holders and will give notice of the
same to the Exchange Agent.
In addition, until one year after the Closing Date, an offer or sale of
Preferred Stock within the United States by any dealer that is not participating
in the offering may violate the registration requirements of the Securities Act.
DEFINITION OF U.S. PERSON UNDER REGULATION S
1. U.S. Person.
(a) "U.S. person" means:
(i) Any natural person resident in the United States;
71
(ii) Any partnership or corporation organized or
incorporated under the laws of the United States;
(iii) Any estate of which any executor or administrator is
a U.S. person;
(iv) Any trust of which any trustee is a U.S. person;
(v) Any agency or branch of a foreign entity located in
the United States;
(vi) Any non-discretionary account or similar account
(other than an estate or trust) held by a dealer or
other fiduciary for the benefit or account of a
U.S. person;
(vii) Any discretionary account or similar account (other
than an estate or trust) held by a dealer or other
fiduciary organized, incorporated, or (if an
individual) resident in the United States; and
(viii) Any partnership or corporation if: (A) organized or
incorporated under the laws of any foreign
jurisdiction; and (B) formed by a U.S. person
principally for the purpose of investing in
securities not registered under the Securities Act,
unless it is organized or incorporated, and owned, by
accredited investors (as defined in Rule 501(a) of
the Securities Act) who are not natural persons,
estates or trusts.
(b) The following are not "U.S. persons":
(i) Any discretionary account or similar account (other
than an estate or trust) held for the benefit or
account of a non-U.S. person by a dealer or other
professional fiduciary organized, incorporated, or
(if an individual) resident in the United States;
(ii) Any estate of which any professional fiduciary acting
as executor or administrator is a U.S. person if:
(A) An executor or administrator of the estate who is
not a U.S. person has sole or shared investment
discretion with respect to the assets of the estate;
and
(B) The estate is governed by foreign law;
(iii) Any trust of which any professional fiduciary acting
as trustee is a U.S. person, if a trustee who is not
a U.S. person has sole or shared investment
discretion with respect to the trust assets, and no
beneficiary of the trust (and no settlor if the trust
is revocable) is a U.S. person;
(iv) An employee benefit plan established and administered
in accordance with the law of a country other than
the United States and customary practices and
documentation of such country;
(v) Any agency or branch of a U.S. person located outside
the United States if:
(A) The agency or branch operates for valid business
reasons; and
(B) The agency or branch is engaged in the business
of insurance or banking and is subject to substantive
insurance or banking regulation, respectively, in the
jurisdiction where located; and
(vi) The International Monetary Fund, the International
Bank for Reconstruction and Development, the
Inter-American Development Bank, the Asian
Development Bank, the African Development Bank, the
United Nations, and their agencies, affiliates and
pension
72
plans, and any other similar international
organizations, their agencies, affiliates and pension
plans.
2. United States. "United States" means the United States of America, its
territories and possessions, any State of the United States, and the
District of Columbia.
UNITED KINGDOM SELLING RESTRICTIONS
No prospectus has been or will be registered in the United Kingdom in
respect of the Preferred Stock and, accordingly, the Preferred Stock may not be
distributed nor may any of the Preferred Stock be offered, in the United Kingdom
except to persons whose ordinary activities involve them in acquiring, holding,
managing or disposing of investments (as principal or agent) for the purposes of
their businesses or who it is reasonable to expect will acquire, hold, manage or
dispose of investments (as principal or agent) for the purposes of their
businesses, or otherwise in circumstances which do not constitute an offer to
the public within the meaning of the Public Offers of Securities Regulations
1995. The Agent has agreed (a) to comply with all applicable provisions of the
Public Offers of Securities Regulations 1995 in connection with anything done by
it in relation to the sale of the Securities in, from or otherwise involving the
United Kingdom, (b) it has complied and will comply with all applicable
provisions of the Financial Services Act 1986 with respect to anything done by
it in relation to the Securities in, from or otherwise involving the United
Kingdom; and (c) it has only issued or passed on and will only issue or pass on
in the United Kingdom any document received by it in connection with the issue
of the Securities to a person who is a kind of person described in Article 11(3)
of the Financial Services Act 1986 (Investment Advertisements) (Exemptions)
Order 1996, as amended, or is a person to whom such document may otherwise
lawfully be issued or passed on.
CANADIAN SELLING RESTRICTIONS
The Preferred Stock is not being offering in Canada. Preferred Stock
(and the Common Stock issued as dividends thereon or on exchange or on exercise
thereof) are being offered and issued to persons who are not resident in Canada,
in reliance upon certain exceptions from the prospectus and registration
requirements of applicable Canadian securities legislation. The foregoing
securities cannot be offered or resold in Canada unless (a) the resale is
qualified by a prospectus, a receipt for which has been issued by the applicable
securities commission in Canada; (b) pursuant to available statutory exemptions
for resale; or (c) pursuant to a discretionary order, and in compliance with
application registration requirements.
ADDITIONAL RESTRICTIONS
No action has been or will be taken that would permit a public offering
of the Preferred Stock or the possession or distribution of this Offering
Circular or any other offering material relating to the Preferred Stock in any
jurisdiction where action for that purpose is required. Accordingly, the
Preferred Stock may not be offered or sold, directly or indirectly, and neither
this Offering Circular nor any circular, prospectus, form of application,
advertisement or other offering material relating to the Preferred Stock may be
distributed in or from or published in any country or jurisdiction, except under
circumstances that will result in compliance with any applicable laws and
regulations.
The distribution of the Offering Circular and the Offering of the
Preferred Stock in certain jurisdictions may be restricted by law. Persons into
whose possession this Offering Circular may come are required by the Company to
inform themselves about and to observe any such restrictions. This Offering
Circular does not relate to any securities other than the Preferred Stock and
the Common Stock acquired as dividends thereon or upon exchange of the Preferred
Stock, and does not constitute an offer to sell or a solicitation of an offer to
buy any of the Preferred Stock or Common Stock in any jurisdiction to any person
to whom it is unlawful to make such offer or solicitation in such jurisdiction.
Acquisition of the Securities may result in tax or other legal consequences
not discussed herein. Prospective purchasers are not to construe this Offering
Circular or any prior or subsequent communication from the Company or the Agent
or any of their respective directors, officers, agents or employees as legal or
investment or tax advice. Each prospective purchaser should consult with and
rely on such purchaser's own professional advisers, including legal counsel and
tax advisers, as to the consequences of any investment in the Preferred Stock
and the Common Stock acquired as dividends thereon or upon exchange of the
Preferred Stock.
73
The Preferred Stock is being offered when, as and if issued, and
subject to prior sale or withdrawal, cancellation or modification of the offer
without notice, and subject to the satisfaction of certain legal matters by
counsel and certain other conditions.
TAX CONSIDERATIONS
UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
GENERAL
The following are the material United States federal income tax
consequences of an exchange (the "Exchange") of Preferred Stock for Notes
pursuant to the Offering to the Company and to U.S. Holders and Non-U.S. Holders
(as such terms are defined below) and the material United States federal income
and estate tax consequences to Non-U.S. Holders of holding and disposing of the
Notes or Preferred Stock. This discussion is based on the United States Internal
Revenue Code of 1986, as amended (the "Code"), existing and proposed Treasury
Regulations ("Regulations") promulgated thereunder, Internal Revenue Services
("IRS") rules and pronouncements, reports of congressional committees, judicial
decisions and current administrative rulings and practice, all as in effect on
the date hereof. This discussion is based on current law, which is subject to
change. Any such change could be retroactive and, accordingly, could modify the
tax consequences discussed herein. No advance ruling from the IRS with respect
to the matters discussed herein has been requested. THIS DISCUSSION OF UNITED
STATES FEDERAL INCOME TAX CONSEQUENCES REPRESENTS COUNSEL'S BEST LEGAL JUDGEMENT
AND IS NOT BINDING ON THE IRS OR ANY COURT AND NO ASSURANCE CAN BE GIVEN THAT
THE IRS WILL NOT CHALLENGE PART OR ALL OF THE CONCLUSIONS REACHED HEREIN OR THAT
A CHALLENGE WOULD NOT BE SUCCESSFUL. FURTHERMORE, THIS DISCUSSION RELIES UPON
AND IS PREMISED UPON THE ACCURACY OF STATEMENTS AND REPRESENTATIONS OF THE
COMPANY.
This discussion does not address tax considerations applicable to U.S.
Holders (as defined below) who actually or constructively own 10% or more (by
vote or value) of the stock of the Company. Furthermore, this discussion does
not address all of the United States federal income tax consequences that may be
relevant to particular shareholders in light of their personal circumstances or
to certain types of shareholders (such as dealers in securities, insurance
companies, foreign individuals and entities, financial institutions and
tax-exempt entities) who may be subject to special treatment under the federal
income tax laws. This discussion also does not address the federal income tax
consequences to holders of stock options or to shareholders who acquired their
stock of the Company through the exercise of employee stock options or otherwise
as compensation. Furthermore, this discussion does not address any tax
consequences under state, local or foreign law.
For purposes of this discussion, the term "U.S. Holder" means a
beneficial owner of the stock or notes of the Company that is for United States
federal income tax purposes (i) a citizen or resident of the United States; (ii)
a corporation or partnership created or organized in the United States or under
the laws of the United States or of any State thereof; or (iii) an estate or
trust described in Section 7701(a)(3) of the Code. The term "Non-U.S. Holder"
means a beneficial owner of the stock or notes of the Company that is not a U.S.
Holder. Furthermore, the following discussion of the United States federal
income tax consequences is limited to (a) U.S. Holders and Non-U.S. Holders who
hold notes and/or shares of stock and/or will hold notes and/or shares of stock
as "capital assets" within the meaning of Section 1221 of the Code; (b) U.S.
Holders whose ownership, receipt or disposition of stock and/or notes is not
attributable to a permanent establishment in a country other than the United
States for purposes of an income tax treaty to which the United States is a
party; (c) Non-U.S. Holders whose ownership, receipt or disposition of stock
and/or notes is not attributable either to the conduct of a trade or business in
the United States or to a permanent establishment in the United States;
(d) Non-U.S. Holders who do not actually or constructively own (and have not
at any time in the preceding five-year period actually or constructively
owned) five percent or more (by vote or value) of the stock of the Company;
(e) U.S. Holders who are not residents of a country other than the United
States for purposes of an income tax treaty to which the United States is a
party; and (f) Non-U.S. Holders who are not residents of the United States
for purposes of United States federal income tax law or an income tax treaty
to which the United States is a party. U.S. Holders and Non-U.S. Holders who
do not meet one or more of the foregoing criteria are urged to consult their
tax advisors regarding their particular United States federal income tax
consequences.
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THE FOLLOWING DISCUSSION IS FOR GENERAL INFORMATION AND IS NOT TAX ADVICE.
ACCORDINGLY, EACH HOLDER OF STOCK, INCLUDING PREFERRED STOCK, OR NOTES IS
ADVISED TO CONSULT HIS TAX ADVISOR AS TO THE PARTICULAR TAX CONSEQUENCES OF THE
EXCHANGE AND OF HOLDING AND DISPOSING OF NOTES OR STOCK OF THE COMPANY INCLUDING
THE APPLICATION AND EFFECT OF STATE, LOCAL AND FOREIGN INCOME AND OTHER TAX LAWS
AND ANY PENDING OR PROPOSED LEGISLATION.
UNITED STATES INCOME TAX CONSEQUENCES OF THE EXCHANGE
EXCHANGE OF THE NOTES FOR PREFERRED STOCK - COMPANY
The transfer of Preferred Stock to the holders of Notes in the Exchange
should constitute a reorganization within the meaning of Section 368(a)(1)(E) of
the Code. The Exchange will give rise to discharge of indebtedness income to the
Company to the extent the issue price of the Notes exceeds the fair market value
of the Preferred Stock. Based on the Company's representations that the issue
price of the Notes will not exceed the fair market value of the Preferred Stock,
the Company should not recognize income from discharge of indebtedness, or
otherwise, in the Exchange.
EXCHANGE OF THE NOTES FOR PREFERRED STOCK - U.S. HOLDERS
Based on the foregoing conclusion that the Exchange will qualify as a
reorganization, a U.S. Holder should not recognize gain or loss upon the
exchange of Notes or Notes and cash for Preferred Stock. The U.S. Holder's tax
basis in shares of Preferred Stock received in the exchange should be the same
as the U.S. Holder's tax basis of the Notes exchanged therefor (increased by the
amount of any cash exchanged and reduced by the portion of such tax basis
allocable to any fractional Preferred Stock interest for which the U.S. Holder
receives a cash payment from the Company). In addition, the holding period of
the Preferred Stock received in the Exchange should include the holding period
of the Notes exchanged therefor (to the extent that Notes, and not cash, were
exchanged). A U.S. Holder generally should recognize gain (or loss) upon the
Exchange to the extent that any cash paid in lieu of a fractional share of
Preferred Stock exceeds (or is less than) such holder's tax basis allocable to
such fractional share. In addition, because the Exchange is not substantially
the same as the receipt of a stock dividend, the Preferred Stock should not be
"section 306 stock."
UNITED STATES FEDERAL INCOME TAX CONSEQUENCES TO U.S. HOLDERS OF OWNING AND
DISPOSING OF PREFERRED STOCK OR NOTES
CASH DIVIDENDS PAID ON PREFERRED STOCK
Cash dividends paid on the Preferred Stock will be taxable to a U.S.
Holder as ordinary income, to the extent paid out of the Company's current or
accumulated earnings and profits. Subject to certain restrictions, dividends
received by a corporate U.S. Holder generally should be eligible for the seventy
percent (70%) dividends-received deduction.
IN-KIND DIVIDENDS PAID ON PREFERRED STOCK
In-kind dividends paid on the Preferred Stock in Common Stock will be
taxable to a U.S. Holder as ordinary income. The U.S. Holder's basis in the
Common Stock received will be the value of the shares distributed and the
holding period for such shares will commence on the day ownership of the Common
Stock is acquired by the U.S. Holder. Subject to certain restrictions, dividends
received by a corporate U.S. Holder generally should be eligible for the seventy
percent (70%) dividends-received deduction.
SALE OF PREFERRED STOCK
In general, a U.S. Holder of Preferred Stock who sells or otherwise
disposes of such stock in a taxable transaction will recognize long-term capital
gain or loss on the difference between the cash and the fair market value of any
property received from that sale and the U.S. Holder's tax basis in such
Preferred Stock deemed held for more than twelve (12) months as of the date of
sale or disposition.
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CONVERSION OF PREFERRED STOCK TO COMMON STOCK
A U.S. Holder should not recognize gain or loss upon the conversion of
Preferred Stock for Common Stock. The U.S. Holder's tax basis in shares of
Common Stock received in any such conversion should be the same as the U.S.
Holder's tax basis of the Preferred Stock exchanged therefor (reduced by the
portion of such tax basis allocable to any fractional Common Stock interest for
which the U.S. Holder receives a cash payment from the Company). In addition,
the holding period of the Common Stock received in the exchange should include
the holding period of the Preferred Stock that was exchanged therefor. A U.S.
Holder generally should recognize gain (or loss) upon the exchange to the extent
that any cash paid in lieu of a fractional share of Common Stock exceeds (or is
less than) its tax basis allocable to such fractional share.
ADJUSTMENTS TO CONVERSION PRICE
Pursuant to Treasury Regulations promulgated under Section 305 of the
Code, a U.S. Holder of Preferred Stock should be treated as having received a
constructive distribution from the Company upon an adjustment in the conversion
price of the Preferred Stock if (i) as a result of such adjustment, the
proportionate interest of such U.S. Holder in the assets or earnings and profits
of the Company is increased and (ii) the adjustment is not made pursuant to a
bona fide, reasonable antidilution formula. An adjustment in the conversion
price would not be considered made pursuant to such formula if the adjustment
were made to compensate for certain taxable distributions with respect to the
Common Stock into which the Preferred Stock is convertible. Thus, under certain
circumstances, a decrease in the conversion price of the Preferred Stock may be
taxable to a U.S. Holder of Preferred Stock as a dividend to the extent of the
current or accumulated earnings and profits of the Company. In addition, the
failure to adjust fully the conversion price of the Preferred Stock to reflect
distributions of stock dividends with respect to the Common Stock may result in
a taxable dividend to the U.S. Holders of the Common Stock.
TAXATION OF INTEREST ON NOTES
In general, interest paid on the Notes will be taxable to a U.S. Holder
as ordinary interest income in accordance with the holder's method of tax
accounting at the time that such interest is accrued or (actually or
constructively) received.
ORIGINAL ISSUE DISCOUNT ON THE NOTES
The Notes may be initially issued with original issue discount for
United States federal income tax purposes. The amount of original issue discount
with respect to each Note will be equal to the excess of the "stated redemption
price at maturity" of such Note over its "issue price." For these purposes, the
"issue price" of a Note is the initial offering price at which the first Note is
sold. The "stated redemption price at maturity" of each Note will include all
cash payments (other than stated interest to the extent that it is
unconditionally payable at least annually at a single fixed rate ("qualified
stated interest")) required to be made thereunder until maturity. The amount of
original issue discount with respect to a debt instrument is considered to be
zero if such discount is less than one-fourth of one percent of its stated
redemption price at maturity (as defined above) multiplied by the number of
complete years from the issue date to the maturity date of the debt instrument
("de minimis" original issue discount).
TAXATION OF ORIGINAL ISSUE DISCOUNT ON NOTES
If there is more than de minimis original issue discount, each holder
of a Note will be required to include in gross income (as ordinary interest
income) an amount equal to the sum of the "daily portions" of the original issue
discount on the Notes for each day such holder holds a Note. The daily portions
of original issue discount required to be included in a holder's gross income
will be determined on a constant yield basis by allocating to each day during
the taxable year in which the holder holds the Notes a pro rata portion of the
original issue discount thereon which is attributable to the "accrual period."
Thus, such original issue discount may be included in income prior to the
receipt of any cash.
The amount of the original issue discount attributable to each accrual
period will be the product of the "adjusted issue price" of the Notes at the
beginning of such accrual period and the "yield to maturity" of the Notes, less
the amount of any qualified stated interest allocable to the accrual period.
Appropriate adjustments will be made in computing the amount of original issue
discount attributable to the initial accrual period. The adjusted issue price of
the Notes at the beginning of the first accrual period is the issue price.
Thereafter the adjusted issue price of
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a Note is the issue price of the Note plus the aggregate amount of original
issue discount that accrued in all prior accrual periods, less payments
(other than payments of qualified stated interest) on the Note. The yield to
maturity of a Note will be the discount rate that, when used to compute the
present value (on a semi-annual compounded basis) of all principal and
interest payments to be made under a Note, produces a present value equal to
the issue price of the Note.
The "accrual periods" of a Note (other than the initial accrual period)
are each of the six-month periods during the term of the Notes that end on March
31 and September 30 of each year.
BOND PREMIUM ON NOTES
If a holder acquires a Note at a premium (as defined below), either at
original issuance or subsequently, the holder may elect to amortize such premium
under recently issued Treasury Regulations. If the election is made, the holder
of a Note generally offsets bond premium allocable to an accrual period against
qualified stated interest income allocable to such accrual period.
Amortizable bond premium in excess of qualified stated interest for an
accrual period is allowed as a bond premium deduction. However, the amount
allowable as a bond premium deduction for any accrual period is limited to the
amount by which the holder's aggregate interest inclusions on the Note for prior
accrual periods exceeds the aggregate bond premium deductions in such prior
accrual periods. Any excess deduction is carried forward as bond premium in
successive accrual periods.
The amortizable bond premium on a Note will generally be equal to the
amount, if any, by which the sum of all amounts payable on a Note (other than
qualified stated interest) exceeds the holder's initial tax basis in such Note.
Under the Regulations, amortizable bond premium deduction will be treated as
accruing in each accrual period under a constant yield method over the term of
such Note. However, in certain circumstances, such as a call or prepayment of a
Note, the offset or deduction for unamortized bond premium may be accelerated.
The "accrual periods" of a Note are each of the six-month periods
during the term of the Notes that end on March 31 and September 30 of each year.
For the above consequences to apply, the holder must make an election
in the manner prescribed in Regulations Section 1.171-4. Such election applies
not only to the Notes, but to all bonds held by the holder during or after the
taxable year to which the election applies, including all bonds thereafter
acquired. The election is binding for all subsequent taxable years may only be
revoked with the consent of the Commissioner of the Internal Revenue Service.
MARKET DISCOUNT
The resale of a Note, or Preferred Stock exchanged for Notes with
"market discount," to a U.S. Holder may be affected by the "market discount"
provisions of the Code. For this purpose, the market discount on a Note will
generally be equal to the amount, if any, by which the stated redemption price
at maturity of the Note immediately after its acquisition exceeds the holder's
tax basis in the Note. Subject to a de minimis exception, these provisions
generally require a U.S. Holder of a Note acquired at a market discount to treat
as ordinary income any principal payment on, or any gain recognized on the
disposition of such Note to the extent of the "accrued market discount" on such
Note at the time of disposition. In general, market discount on a Note will be
treated as accruing on a straight-line basis over the term of such Note, or, at
the election of the holder, under a constant yield method. If a Note exchanged
for Preferred Stock has "market discount," such discount will carry over to the
Preferred Stock and be taxed as interest income when the Preferred stock is
disposed of.
In addition, any U.S. Holder of a Note acquired at a market discount
may be required to defer the deduction of a portion of the interest on any
indebtedness incurred or maintained to purchase or carry the Note until the Note
is disposed of in a taxable transaction. The foregoing rule will not apply if
the holder elects to include accrued market discount in income currently. This
election to include market discount in income currently, once made, applies to
all market discount obligations acquired on or after the first taxable year to
which the election applies and may not be revoked without the consent of the
IRS.
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SALE, EXCHANGE OR REDEMPTION OF NOTES
In general, a U.S. Holder of a Note will recognize gain or loss upon
the sale, redemption, retirement or other disposition of a Note measured by the
difference between (i) the amount of cash and the fair market value of any
property received (except to the extent attributable to the payment of accrued
interest) and (ii) the holder's tax basis in the Note. A holder's tax basis in a
Note generally will equal the cost of the Note to the holder increased by the
amount of market discount or original issue discount, if any, previously taken
into income by the holder, or decreased by any bond premium offset or deduction
theretofore allowable to the holder with respect to the Note. Subject to the
market discount rules discussed above, the gain or loss on the disposition of
the Notes will be capital gain or loss and will be long-term gain or loss if the
Notes have been held for more than one year at the time of such disposition.
BACKUP WITHHOLDING AND INFORMATION REPORTING
A U.S. Holder of a Note or Preferred Stock may be subject to
information reporting and possible backup withholding. If applicable, backup
withholding would apply at a rate of thirty-one percent (31%) with respect to
interest or dividends on, or the proceeds of a sale, exchange, redemption,
retirement, or other disposition of, such Note or Preferred Stock, as the case
may be, unless (i) such U.S. Holder is a corporation or comes within certain
other exempt categories and, when required, demonstrates this fact, or (ii)
provides a taxpayer identification number, certifies as to no loss of exemption
from backup withholding, and otherwise complies with applicable backup
withholding rules.
UNITED STATES FEDERAL TAX CONSEQUENCES TO NON-U.S. HOLDERS OF OWNING AND
DISPOSING OF PREFERRED STOCK OR NOTES
DIVIDENDS PAID IN CASH OR COMMON STOCK ON PREFERRED STOCK
In general, dividends paid to a Non-U.S. Holder with respect to
Preferred Stock, including dividends that are paid in Common Stock, will be
subject to United States withholding tax at a rate of 30 percent (or a lower
rate prescribed by an applicable income tax treaty) unless the dividends are
either (i) effectively connected with a trade or business carried on by the
Non-U.S. Holder within the United States, or (ii) if certain income tax treaties
apply, attributable to a permanent establishment in the United States maintained
by the Non-U.S. Holder. Dividends effectively connected with a United States
trade or business or attributable to a United States permanent establishment
generally will not be subject to United States withholding tax if the Non-U.S.
Holder files certain forms with the payor of the dividend, and generally will be
subject to United States federal income tax on a net income basis, in the same
manner as if the Non-U.S. Holder were a resident of the United States. A
Non-U.S. Holder that is a corporation may be subject to an additional branch
profits tax at a rate of 30% (or such lower rate as may be specified by an
applicable income tax treaty). Under the income tax treaty between the United
States and Canada, the withholding tax rate on dividends paid to most
shareholders who are resident in Canada will be 15%. To determine the
applicability of a tax treaty providing for a lower rate of withholding under
the currently effective Regulations (the "Current Regulations"), dividends paid
to an address in a foreign country are presumed to be paid to a resident of that
country absent knowledge to the contrary. Under Regulations issued on October 7,
1997 (the "Final Regulations") generally effective for payments made after
December 31, 1999, a Non-U.S. Holder (including, in certain cases of Non-U.S.
Holders that are fiscally transparent entities, the owner or owners of such
entities) will be required to provide to the payor certain documentation that
such Non-U.S. Holder (or the owner or owners of such fiscally transparent
entities) is a foreign person in order to claim a reduced rate of withholding
pursuant to an applicable income tax treaty. With respect to dividends paid in
Common Stock, the Non-U.S. Holders' tax basis in such shares will be the value
of the shares for purposes of the dividend and the holding period will commence
on the day ownership of the Common Stock is acquired by the holder.
SALE OF PREFERRED STOCK
In general, a Non-U.S. Holder will not be subject to United States
federal income tax on any gain realized upon the sale or other disposition of
such holder's shares of Preferred Stock unless (i) such gain either is
effectively connected with a trade or business carried on by the Non-U.S. Holder
within the United States or, if certain income tax treaties apply, is
attributable to a permanent establishment in the United States maintained by the
Non-U.S. Holder (and in either case, the branch profits tax discussed above may
also apply if the Non-U.S. Holder is a corporation); (ii) the Non-U.S. Holder is
an individual who holds shares of Preferred Stock as a capital asset and is
78
present in the United States for at least 183 days during the taxable year of
the disposition, and certain other tests are met; or (iii) the Company is or has
been a "United States real property holding corporation" for federal income tax
purposes, as such term is defined by Section 897(c) of the Code, and the
Non-U.S. Holder owned directly or pursuant to certain attribution rules at any
time during the five-year period ending on the date of disposition more than 5%
of the Company's Common Stock (assuming that the Common Stock is regularly
traded on an established securities market, within the meaning of Section
897(c)(3) of the Code and Regulations Sections 1.897-1(m) and 1.897-9T(d)).
Because the Company believes it has been, and that the Company will be, a United
States real property holding corporation and because the Preferred Stock is
convertible into Common Stock and may pay dividends in Common Stock, certain
provisions of the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA")
discussed below may be relevant to Non-U.S. Holders.
FIRPTA
Although capital gains of Non-U.S. Holders from the sale of stock are
generally not subject to U.S. income tax, gains from the sale of a United States
real property holding corporation ("USRPHC") are taxable to such persons,
subject to certain exceptions. The Company is almost certainly a USRPHC since
the value of its indirectly held U.S. mineral holdings equals or exceeds 50% of
the value of its assets used in a trade or business and its real property
interests. Buyers of USRPHC securities are obligated to obtain certain
certifications from sellers, or withhold tax from the sales proceeds. However,
gain on the sale of securities of a USRPHC that are regularly traded on an
established securities market are not subject to the FIRPTA tax, unless the
seller has held more than 5% of such class of stock during the five years
preceding the sale. Thus, the FIRPTA rules are a concern only for the larger
Non-U.S. Holders. Non-U.S. Holders should also be aware that by conversion of
Preferred Stock to Common Stock or by receipt of Common Stock paid as a dividend
on Preferred Stock, or the combined effect of conversions and dividends, such
holders may become holders of more than 5% of the Company's Common Stock and
thus become subject to the FIRPTA rules.
CONVERSION OF PREFERRED STOCK TO COMMON STOCK
A Non-U.S. Holder should not recognize gain or loss upon the conversion
of the Preferred Stock into Common Stock except with respect to cash received in
lieu of a fractional share. The Non-U.S. Holder's tax basis in Common Stock
should be the same as the Non-U.S. Holder's tax basis of the Preferred Stock
exchanged therefor (reduced by the portion of such tax basis allocable to any
fractional interest for which the Non-U.S. Holder receives a cash payment from
the Company). In addition, the holding period of the Common Stock received in
the exchange should include the holding period of the Preferred Stock was
exchanged therefor. A holder of Notes generally will recognize capital gain or
loss in connection with any cash received in lieu of a fractional share in an
amount equal to the difference between the amount of cash received and the
adjusted basis of such fractional share. Non-U.S. Holders of Common Stock are
subject to the same rules with respect to taxation of dividends and sales as
described above in the case of holders of Preferred Stock.
ADJUSTMENTS TO CONVERSION PRICE
Pursuant to Regulations promulgated under Section 305 of the Code, a
Non-U.S. Holder of Preferred Stock should be treated as having received a
constructive distribution from the Company upon an adjustment in the conversion
price of the Preferred Stock if (i) as a result of such adjustment, the
proportionate interest of such Non-U.S. Holder in the assets or earnings and
profits of the Company is increased and (ii) the adjustment is not made pursuant
to a bona fide, reasonable antidilution formula. An adjustment in the conversion
price would not be considered made pursuant to such formula if the adjustment
were made to compensate for certain taxable distributions with respect to the
Common Stock into which the Preferred Stock is convertible. Thus, under certain
circumstances, a decrease in the conversion price of the Preferred Stock may be
taxable to a Non-U.S. Holder of Preferred Stock as a dividend to the extent of
the current or accumulated earnings and profits of the Company. In addition, the
failure to adjust fully the conversion price of the Preferred Stock to reflect
distributions of stock dividends with respect to the Common Stock may result in
a taxable dividend to the Non-U.S. Holders of the Common Stock.
INTEREST ON NOTES
Interest that is paid to a Non-U.S. Holder on a Note that is not United
States trade or business income will not be subject to United States tax if the
interest qualifies as "portfolio interest."
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Generally, interest on Notes in bearer form that is paid by the Company
will qualify as portfolio interest if (i) arrangements were made to ensure that
the Notes would be sold (or resold in connection with the original issue of the
Notes) only to persons that are not U.S. persons; (ii) interest on the Notes is
payable only outside the United States and its possessions; and (iii) the face
of the Notes bears a prescribed legend to the effect that any U.S. persons
holding the Notes will be subject to certain United States tax laws.
The Company has represented that (i) the Notes were sold only to
persons who were not U.S. persons, (ii) interest on the Notes is payable only
outside the United States and its possessions, and (iii) there will be affixed
to the Notes the following statement: "Any United States person who holds this
obligation will be subject to limitations under the United States income tax
laws, including the limitations provided in section 165(j) and 1287(a) of the
Internal Revenue Code." Based on these representations, interest paid on the
Notes issued in bearer form should qualify for the "portfolio interest"
exception. If a Non-U.S. Holder of Notes owns ten percent or more of the total
combined voting power of all classes of the Company entitled to vote, such
Non-U.S. Holder will not qualify for the portfolio interest exception. Ownership
of stock may occur indirectly, by attribution of ownership of shares held by
other persons and Non-U.S. Holders of Notes should consult their tax advisors in
this regard.
Generally, interest on notes in registered form will qualify as
portfolio interest if (i) the Non-U.S. Holder does not own, actually or
constructively, 10% or more of the total combined voting power of all classes of
stock of the Company entitled to vote within the meaning of section 871(h)(3) of
the Code and the regulations thereunder; (ii) the Non-U.S. Holder is not a
controlled foreign corporation that is related to the Company through actual or
constructive stock ownership; (iii) the Non-U.S. Holder is not a bank which
acquired the notes in consideration for an extension of credit made pursuant to
a loan agreement entered into in the ordinary course of business; and (iv) the
Company, or its paying agent, receives a properly executed certification as set
forth in Section 871(h) and 881(c) of the Code and the regulations thereunder,
signed under penalties of perjury that the beneficial owner is not a "U.S.
person" for United States federal income tax purposes and which provides the
beneficial owner's name and address.
Payments of interest, including original issue discount, to a Non-U.S.
Holder that do not qualify for the portfolio interest exception discussed above
and which are not effectively connected with a United States trade or business
will be subject to withholding of United States federal income tax at a rate of
30% unless a United States income tax treaty applies to reduce the rate of
withholding. To claim a treaty reduced rate or an exemption from withholding
because the interest is effectively connected with a United States trade or
business, the Non-U.S. Holder must provide a properly executed Form 1001 (or
successor form) or Form 4224 (or successor form), respectively.
SALE, EXCHANGE OR REDEMPTION OF NOTES
Any gain realized by a Non-U.S. Holder on the sale, exchange or
redemption of Notes, generally will not be subject to United States federal
income tax provided that (i) such gain is not effectively connected with a
United States trade or business; (ii) the Non-U.S. Holder is not an individual
who is present in the United States for 183 days or more in the taxable year of
the disposition and meets certain other requirements; and (iii) the Non-U.S.
Holder is not subject to tax pursuant to the provisions of United States tax law
applicable to certain United States expatriates.
ESTATE TAX
Preferred Stock or Common Stock owned (or treated as owned) by an
individual who, at the time of death, is neither a citizen or a domiciliary of
the United States will be includable in his gross estate for United States
federal estate tax purposes and thus may be subject to United States estate tax,
unless an applicable estate tax treaty provides otherwise. Notes held (or
treated as held) by an individual who is a Non-U.S. Holder at the time of his
death (or theretofore transferred subject to certain retained rights or powers)
will not be subject to United States federal estate tax provided that any
interest thereon would be exempt as portfolio interest if such interest were
received by the Non-U.S. Holder at the time of his death. Such individual's
estate may be subject to United States federal estate tax on the property
includable in the estate for United federal estate tax purposes.
INFORMATION REPORTING AND BACKUP WITHHOLDING
The Company must report annually to the Internal Revenue Service and to
each shareholder the amount of cash proceeds paid as a result of the Exchange
and dividends paid to, and the tax withheld with respect to, each
80
shareholder. These reporting requirements apply regardless of whether
withholding was reduced or eliminated by an applicable tax treaty. Copies of
these information returns may also be made available under the provisions of
a specific treaty or agreement with the tax authorities in the country in
which a Non-U.S. Holder resides or is established.
Under the Current Regulations, United States backup withholding tax
(which generally is imposed at the rate of 31% on certain payments to persons
that fail to furnish the information required under the United States
information reporting requirements) and information reporting requirements
(other than those discussed above under "Dividends Paid in Cash or Common Stock
on Preferred Stock") generally will not apply to dividends paid on Preferred
Stock or Common Stock to a Non-U.S. Holder at an address outside the United
States. Backup withholding and information reporting generally will apply,
however, to dividends paid on shares of Preferred Stock or Common Stock to a
Non-U.S. Holder at an address in the United States, if such holder fails to
establish an exemption or to provide certain other information to the payor.
Under the Current Regulations, the payment of proceeds from the
disposition of Notes or Preferred Stock to or through a United States office of
a broker will be subject to information reporting and backup withholding unless
the beneficial owner, under penalties of perjury, certifies, among other things,
its status as a Non-U.S. Holder or otherwise establishes an exemption. The
payment of proceeds from the disposition of Notes or Preferred Stock to or
through a non-U.S. office of a non-U.S. broker generally will not be subject to
backup withholding and information reporting except as noted below. In the case
of proceeds from a disposition of Notes or Preferred Stock paid to or through a
non-U.S. office of a broker that is (i) a United States person, (ii) a
"controlled foreign corporation" for United States federal income tax purposes,
or (iii) a foreign person 50% or more of whose gross income from certain periods
is effectively connected with a United States trade or business, information
reporting (but not backup withholding) will apply unless the broker has
documentary evidence in its files that the owner is a Non-U.S. Holder or the
broker otherwise establishes an exemption, provided such broker does not have
actual knowledge that the owner is a U.S. Holder.
Under the Final Regulations, the payment of dividends, interest, or the
payment of proceeds from the disposition of Notes or Preferred Stock to a
Non-U.S. Holder may be subject to information reporting and backup withholding
unless such recipient provides to the payor certain documentation as to its
status as a Non-U.S. Holder or otherwise establishes an exemption.
Backup withholding is not an additional tax. Any amounts withheld under
the backup withholding rules from a payment to a Non-U.S. Holder will be
refunded or credited against the Non-U.S. Holder's United States federal income
tax liability, if any, provided that the required information is furnished to
the Internal Revenue Service in a timely manner.
LEGAL OPINIONS OF COMPANY COUNSEL
Certain matters pertaining to the issuance of the securities offered
hereby will be passed upon for the Company by Montpellier McKeen Varabioff
Talbot & Giuffre and Porter & Hedges, LLP.
ADDITIONAL INFORMATION
The Company extends to each prospective purchaser the opportunity,
prior to the consummation of the sale of the securities offered hereby, to ask
questions of, and receive answers from, the Company concerning the Preferred
Stock, its Common Stock and the terms and conditions of this Offering and to
obtain any additional information he or she may consider necessary in making an
informed investment decision and any information in order to verify the accuracy
of the information set forth herein, to the extent the Company possesses the
same or can acquire it without unreasonable effort or expense and can make such
information available without divulging information deemed by the Company, in
its absolute discretion, to be proprietary and confidential. All such requests
shall be in writing, and an offeree shall not rely upon any such responses
unless in writing from a duly authorized officer of the Company. Requests for
such additional information can be directed to Benz Energy Inc., 1000 Louisiana
Street, Suite 1500, Houston, Texas 77002, U.S.A., attention: Robert S. Herlin
(tel. 1-713-739-0351); or RP&C International Limited, 56 Green Street, London
W1Y 3RH, attention: David P. Quint (tel. 44-171-491-2434); or the office of
the Exchange Agent.
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BENZ ENERGY INC.
1000 Louisiana Street
Suite 1500
Houston, Texas 77002 U.S.A.
(Tel: 1 713 739 0351)
TRUSTEE
Montreal Trust Company
7th Floor, 530-8th Avenue S.W.
Calgary, Alberta T2P 3S8
Canada
COMPANY REGISTRAR
AS TO THE PREFERRED STOCK
American Stock Transfer & Trust Company
40 Wall Street
New York, N.Y. 10005
U.S.A.
AGENT
RP&C International
56 Green Street
London W1Y 3RH
(Tel : 44 171 491 2434)
LEGAL ADVISORS
TO THE COMPANY
Porter & Hedges LLP
700 Louisiana, 38th Floor
Houston, Texas 77002-2764
U.S.A.
McKeen Varabioff Talbot & Giuffre
Suite 2323, Three Bentall Centre
595 Burrard Street
Vancouver, B.C., V7X 1K8
Canada
TO THE AGENT
Bracewell & Patterson LLP
33 Davies Street
London W1Y 1FN
INDEPENDENT AUDITORS
Merdinger, Fruchter, Rosen & Corso P.C.
888 Seventh Avenue
New York, New York 10106
U.S.A.
EXCHANGE AGENT
Midland Bank plc
Mariner House
Pepys Street
London EC3N 4DA
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