UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from _______, 20___ to _______, 20___.
Commission File Number: 0-10157
CAPCO ENERGY, INC.
---------------------------------------------------------------
(Exact Name of Small Business Issuer as Specified in its Charter)
COLORADO 84-0846529
-------------------------------- -----------------------
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification Number)
5555 SAN FELIPE, SUITE 725
HOUSTON, TEXAS 77056
--------------------------------------
Address of Principal Executive Offices
(713) 622-5550
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(Registrant's Telephone Number, Including Area Code)
4800 SUGAR GROVE BLVD., SUITE 601, STAFFORD, TX 77477
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(Former Name, Former Address and Former Fiscal Year,
If Changed Since Last Report)
Check whether the Issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the Issuer was required to file such reports), and 2) has
been subject to such filing requirements for the past 90 days.
[ X ] Yes [ ] No
There were 99,735,768 shares of the Registrant's $.001 par value common stock
outstanding as of November 3, 2004.
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CAPCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2004
(Unaudited)
ASSETS
(Dollars in Thousands)
Current Assets:
Cash $ 198
Accounts receivable-trade, net of
allowance of $46 374
Accounts receivable-related party 26
Note receivable 208
Deferred tax asset 27
Other current assets 22
------
Total Current Assets 855
Oil and gas properties, using full cost accounting,
less accumulated depreciation and depletion of $2,259 12,061
Other Assets:
Assets attributable to businesses under contract
for sale (note 3) 4,013
Land 214
Other property, less accumulated depreciation of $64 113
Other assets 812
------
Total Assets $ 18,068
======
Accompanying notes are an integral part of the consolidated financial
statements.
2
CAPCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (continued)
SEPTEMBER 30, 2004
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
(Dollars in Thousands)
Current Liabilities:
Accounts payable, trade $ 952
Current maturities, long-term debt, including a
related party 2,010
Accrued expenses 851
-------
Total Current Liabilities 3,813
-------
Non-current Liabilities:
Long term debt, less current maturities 3,595
Long term liabilities 1,766
Accounts payable, related parties 402
Deferred tax liability 27
-------
Total Non-current Liabilities 5,790
-------
Liabilities attributable to businesses under contract
for sale, (note 3) 4,346
-------
Total Liabilities 13,949
-------
Commitments and Contingencies --
Stockholders' Equity:
Common stock, $0.001 par value;
authorized 150,000,000 shares;
97,298,716 shares issued 98
Additional paid in capital 2,635
Treasury stock, 1,267,708 shares, at cost (138)
Retained earnings 1,524
-------
Total Stockholders' Equity 4,119
-------
Total Liabilities and
Stockholders' Equity $ 18,068
=======
Accompanying notes are an integral part of the consolidated financial
statements.
3
CAPCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
For the Three Months Ended September 30, 2004 and 2003
(Unaudited)
(Dollars in Thousands except per share)
2004 2003
------ ------
Sales $ 1,145 $ 819
Cost of sales 633 335
------ ------
Gross profit 512 484
------ ------
General and administrative expenses 404 186
Depreciation, depletion and amortization 141 152
------ ------
Total operating expenses 545 338
------ ------
(Loss) income from operations (33) 146
Other Income (Expenses):
Interest income 4 43
Interest expense (108) (22)
Gain on sales of investments-
marketable securities -- 1
Holding losses-marketable securities (1) (14)
Other (57) --
------ ------
(Loss) income from continuing operations
before taxes and minority interest (195) 154
Provision for income taxes -- --
Minority interest in income of consolidated
subsidiary -- (1)
------ ------
(Loss) income from continuing operations (195) 153
Discontinued operations: (note 2)
Loss from operations of business transferred
under contractual obligation to a
related party during the year 2003 (net of
applicable income tax benefit of $-0-) -- (305)
Loss on disposal of discontinued operations
to a related party -- (730)
(Continued on Next Page)
Accompanying notes are an integral part of the consolidated financial
statements.
4
CAPCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
For the Three Months Ended September 30, 2004 and 2003
(Unaudited)
(Dollars in Thousands except per share)
(continued)
2004 2003
------ ------
Net loss and comprehensive loss $ (195) $ (882)
====== ======
Earnings per share-basic:
Income from continuing operations $ -- $ --
Loss from discontinued operations,
including business transferred under
contractual obligation -- (0.01)
------ ------
Net loss $ -- $ (0.01)
====== ======
Earnings per share-diluted:
Income from continuing operations $ -- $ --
Loss from discontinued operations,
including business transferred under
contractual obligation -- (0.01)
------ ------
Net loss $ -- $ (0.01)
====== ======
Weighted average common share and common
share equivalents:
Basic 95,363,332 77,091,108
========== ==========
Diluted 101,306,267 79,819,312
=========== ==========
Accompanying notes are an integral part of the consolidated financial
statements.
5
CAPCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
For the Nine Months Ended September 30, 2004 and 2003
(Unaudited)
(Dollars in Thousands except per share)
2004 2003
------ ------
Sales $ 3,702 $ 2,354
Cost of sales 1,914 1,100
------ ------
Gross profit 1,788 1,254
------ ------
General and administrative expenses 912 721
Depreciation, depletion and amortization 454 474
------ ------
Total operating expenses 1,366 1,195
------ ------
Income from operations 422 59
Other Income (Expenses):
Interest income 10 43
Interest expense (263) (98)
Losses on sales of investments-
marketable securities (63) (11)
Holding (losses) gains-marketable securities (2) 64
Other (57) 100
------ ------
Income from continuing operations
before taxes and minority interest 47 157
Provision for income taxes -- --
Minority interest in loss of consolidated
subsidiary -- 1
------ ------
Income from continuing operations 47 158
Discontinued operations: (note 2)
Loss from operations of business transferred
under contractual obligation to a
related party during the year 2003 (net of
applicable income tax benefit of $-0-) -- (1,264)
Loss on disposal of discontinued operations
to a related party -- (730)
(Continued on Next Page)
Accompanying notes are an integral part of the consolidated financial
statements.
6
CAPCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
For the Nine Months Ended September 30, 2004 and 2003
(Unaudited)
(Dollars in Thousands except per share)
(continued)
2004 2003
------ ------
Net income (loss) 47 (1,836)
Other comprehensive loss-net of tax
Foreign currency translation adjustment -- (18)
Less: minority interest in comprehensive
loss of consolidated subsidiary -- 2
------ ------
Comprehensive income (loss) $ 47 $(1,852)
====== ======
Earnings per share-basic:
Income from continuing operations $ -- $ --
Loss from discontinued operations,
including business transferred under
contractual obligation -- (0.02)
------ ------
Net income (loss) $ -- $ (0.02)
====== ======
Earnings per share-diluted:
Income from continuing operations $ -- $ --
Loss from discontinued operations,
including business transferred under
contractual obligation -- (0.02)
------ ------
Net income (loss) $ -- $ (0.02)
====== ======
Weighted average common share and common
share equivalents:
Basic 95,101,333 77,098,876
========== ==========
Diluted 103,495,977 79,500,980
=========== ==========
Accompanying notes are an integral part of the consolidated financial
statements.
7
CAPCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2004 and 2003
(Unaudited)
(Dollars in Thousands)
2004 2003
------ ------
Cash Flows From Continuing Operating
Activities:
Net income (loss) $ 47 $(1,836)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Net loss from discontinued operations -- 1,264
Loss on disposal of discontinued operations -- 730
Depreciation, depletion and amortization 454 474
Losses on sales of investments-marketable
securities 63 11
Holding losses (gains)-marketable securities 2 (64)
Foreign currency translation adjustment 57 --
Minority interest in loss of
consolidated subsidiary -- 1
Compensation cost resulting from grant of
options to acquire Common Stock -- 38
Decrease in deferred tax asset 77 29
Decrease in deferred tax liability (77) (29)
Changes in assets and liabilities:
(Increase) decrease in assets:
Accounts receivable-trade (141) (425)
Note receivable 2 --
Other current assets 3 29
Other assets (16) 87
Increase (decrease) in liabilities:
Accounts payable 562 (41)
Accrued expenses 255 99
------ ------
Net cash provided by continuing operating
activities 1,288 367
------ ------
Cash Flows From Discontinued Operating Activities:
Net loss -- (1,264)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation, depletion and amortization -- 595
Loss on sale of assets -- 126
Decrease (increase) in deferred tax asset -- 219
(Decrease) increase in deferred tax liability -- (219)
(Continued on Next Page)
Accompanying notes are an integral part of the consolidated financial
statements.
8
CAPCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2004 and 2003
(Unaudited)
(Dollars in Thousands)
(continued)
2004 2003
------ ------
Changes in assets and liabilities:
(Increase) decrease in assets:
Accounts receivable-trade -- 2,741
Inventory -- 1,653
Other current assets -- (194)
Other assets -- 5
Increase (decrease) in liabilities:
Accounts payable -- (455)
Accrued expenses -- (262)
Taxes payable -- (448)
------ ------
Net cash provided by discontinued operating
activities -- 2,497
------ ------
Net cash provided by all operating activities 1,288 2,864
------ ------
Cash Flows From Continuing Investing Activities
(Decrease) increase in related party accounts (125) 966
Equity contribution to subsidiary -- (400)
Capital expenditures for oil and gas property (1,674) (185)
Expenditures for other property and assets (110) --
Proceeds from sale of marketable securities 129 63
Increase in other assets (8) --
Purchase of marketable securities -- (2)
------ ------
Net cash (used in) provided by continuing
investing activities (1,788) 442
------ ------
Cash Flows From Discontinued Investing Activities:
Cash applicable to assets held for sale -- 1
Net (advances) repayments with related parties -- (482)
Cash proceeds from sale of equity investment -- 766
Cash proceeds from sale of property -- 87
Cash proceeds from equity contribution -- 400
Purchase of property and equipment -- --
Notes receivable payments, net -- 35
------ ------
Net cash provided by discontinued investing
activities -- 807
------ ------
Net cash (used in) provided by all investing
activities (1,788) 1,249
------ ------
(Continued on Next Page)
Accompanying notes are an integral part of the consolidated financial
statements.
9
CAPCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2004 and 2003
(Unaudited)
(Dollars in Thousands)
(continued)
2004 2003
------ ------
Cash Flows From Continuing Financing Activities:
Proceeds from long-term debt 1,710 --
Payments on long term debt (1,025) (796)
Increase in other assets (75) --
Purchase of Common Stock (12) (3)
Sale of Common Stock 65 --
------ ------
Net cash provided by (used in) continuing
financing activities 663 (799)
------ ------
Cash Flows from Discontinued Financing Activities:
Net (payments) advances on revolver -- (3,022)
Decrease in book overdraft -- (83)
Payments on long term debt -- (639)
Decrease in restricted cash -- 441
------ ------
Net cash used in discontinued
financing activities -- (3,303)
------ ------
Net cash provided by (used in) all
financing activities 663 (4,102)
------ ------
Net increase in cash 163 11
Cash, beginning of period 35 2
------ ------
Cash, end of period $ 198 $ 13
====== ======
Supplemental disclosure of cash flow information for continuing operations:
Interest paid $ 235 $ 76
====== ======
Taxes paid $ -- $ --
====== ======
Supplemental disclosure of cash flow information for discontinued operations:
Interest paid $ -- $ 383
====== ======
Taxes paid $ -- $ --
====== ======
(Continued on Next Page)
Accompanying notes are an integral part of the consolidated financial
statements.
10
CAPCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2004 and 2003
(Unaudited)
(Dollars in Thousands)
(continued)
2004 2003
------ ------
Supplemental disclosure of non-cash financing and investing activities for
continuing operations:
Common Stock issued in settlement of liability $ 30 $ --
====== ======
Paid in capital provided as equity component of
debt financing $ 112 $ --
====== ======
Debt issued for oil and gas property acquisition $ 160 $ --
====== ======
Accrual for acquisition cost of oil and gas
property to be settled with issuance of
Common Stock $ 443 $ --
====== ======
Long-term debt issued for asset acquisition $ -- $ 500
====== ======
Supplemental disclosure of non-cash financing and investing activities for
discontinued operations:
Note receivable and account receivable provided as
proceeds in connection with sale of preferred
membership interests $ -- $ 349
====== ======
Long-term debt and accrued expenses reduced for
property sold/exchanged $ -- $ 975
====== ======
Accompanying notes are an integral part of the consolidated financial
statements.
11
CAPCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Capco Energy, Inc. ("Capco" or the "Company") is an independent energy company
engaged primarily in the acquisition, exploration, development, production and
sale of oil, gas and natural gas liquids. The Company's production activities
are located in the United States of America. Effective December 31, 2003, the
Company divested of its oil and gas interests in Canada which were not
significant to either consolidated financial position or consolidated results of
operations. Capco's operations consist of one segment of business, oil and gas
production. The principal executive offices of the Company are located at 5555
San Felipe, Suite 725, Houston, Texas 77056. The Company was incorporated as
Alfa Resources, Inc. a Colorado corporation on January 6, 1981. In November
1999, the Company amended its articles of incorporation to change its name from
Alfa Resources, Inc. to Capco Energy, Inc.
The Company's future financial condition and results of operations will depend
upon prices received for its oil and natural gas and the costs of finding,
acquiring, developing and producing reserves. Prices for oil and natural gas are
subject to fluctuations in response to changes in supply, market uncertainty and
a variety of other factors beyond the Company's control. These factors include
worldwide political instability (especially in the Middle East), the foreign
supply of oil and natural gas, the price of foreign imports, the level of
consumer product demand and the price and availability of alternative fuels.
BASIS OF PRESENTATION
These financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America for interim
financial information. Accordingly, they do not include all of the information
and footnotes required by accounting principles generally accepted in the United
States of America for complete financial statements. In the opinion of
management, such interim statements reflect all adjustments (consisting of
normal recurring accruals) necessary to present fairly the financial position
and the results of operations and cash flows for the interim periods presented.
The results of operations for these interim periods are not necessarily
indicative of the results to be expected for the full year. These financial
statements should be read in conjunction with the audited consolidated financial
statements and footnotes for the year ended December 31, 2003, filed with the
Company's Form 10-KSB.
12
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America, which contemplate continuation of the Company as a going concern. The
Company has had recurring losses and marginal or negative cash flows from
continuing operations in each of the last two fiscal years, and has negative
working capital as of September 30, 2004. The Company is the guarantor to
certain lending agreements for which the obligor, a former subsidiary, is in
default. These factors raise substantial doubt about the Company's ability to
continue as a going concern. Without realization of additional capital, it would
be unlikely for the Company to continue as a going concern. The financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts, or amounts and classification of
liabilities that might be necessary should the Company be unable to continue its
existence.
The Company has taken steps to improve its operating income and satisfy its
working capital requirements.
1. Effective November 1, 2003, the Company's interest in producing property
located in Michigan was pledged as additional collateral in connection with
an acquisition of producing property in Montana. The net cash flow from
both the Michigan and Montana properties is being used to retire the debt
that was incurred with the acquisition.
2. Effective November 30, 2003, the Company acquired a 65% working interest in
producing properties located in the Texas Gulf Coast that are providing
positive cash flow to the Company.
3. In October 2002, the Company's board of directors authorized management to
pursue a plan that would result in the divestiture of its petroleum
products marketing and convenience store operation segments, operations
that have been reported as discontinued operations in the accompanying
financial statements.
4. In December 2002, an agreement was reached for the sale of principally all
of the Company's assets in the state of New Mexico. Consideration for this
transaction consisted primarily of the assumption by the buyer of
approximately $4.5 million of indebtedness related to the assets.
5. In March 2003, a company owned by the Company's Chief Executive Officer
submitted a proposal to acquire the remaining business interests designated
for divestiture for total cash consideration of $2.5 million, plus other
consideration. The Company's Board of Directors accepted the proposal,
subject to the receipt of a fairness opinion that was received in August
2003 and subsequently amended in October 2003. Following adjustments to the
agreement that reduced the sales price to $1.75 million, the Company
recorded the sale of the business interests, effective September 30, 2003,
recording a loss of $730,000 for the disposal of the discontinued business
interests.
13
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued
6. In February 2004, the Company's Board of Directors authorized management to
seek additional financing. A private placement of convertible notes payable
closed in June 2004, providing the Company with net proceeds of $1.0
million. A second private placement of a convertible note payable closed in
September 2004, providing the Company with net proceeds of $0.7 million. A
portion of the proceeds from the additional financing is being used to fund
property development activities in an effort to increase cash flow to the
Company.
7. Effective September 30, 2004, the Company sold its interests in
non-operated properties located in Alabama and Louisiana to a company
owned by the Company's Chief Executive Officer. Sales proceeds in the
amount of $0.4 million were received by the Company in October 2004 and
were used for working capital.
In connection with some of the transactions described above, the Company is
considering the availability of equity and/or debt financing opportunities,
although no decisions have been reached in this regard at this time.
Management believes that an increase in cash flow from (1) existing properties,
and (2) properties to be acquired during the year 2004, coupled with proceeds
from additional financing and the disposition of non-operated producing
properties will enable the Company to meet its working capital requirements.
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of Capco and its
wholly and majority owned subsidiaries. All references herein to Capco or the
Company include the consolidated results. All significant intercompany accounts
and transactions have been eliminated in consolidation. The Company's
significant subsidiaries in the year 2004 include Capco Offshore, Inc. and Capco
Asset Management, Inc. Effective December 31, 2003, the Company agreed to sell
its equity ownerships in Capco Resource Corporation ("Resource"), except for
interests in certain non-operated oil and gas producing properties, and Capco
Resources Ltd. ("Limited") to a related party. The historical operations of
Resource and Limited are included in the results of operations from continuing
operations for the three and nine month periods ended September 30, 2003.
Effective January 1, 2003, the Company agreed to sell Meteor Enterprises, Inc.
("Enterprises"), including all of that company's subsidiaries, the most
significant of which at that date was Meteor Marketing, Inc. ("Marketing"). The
results of operations of Enterprises for the three and nine month periods ended
September 30, 2003, are reported as discontinued operations.
MAJOR CUSTOMERS
Two customers accounted for 60% and 18%, respectively, of the Company's net
sales for the three months ended September 30, 2004, and one customer accounted
for 81% of the Company's net sales for the three months ended September 30,
2003. Two customers accounted for 58% and 26%, respectively, of the Company's
net sales for the nine months ended September 30, 2004, and two customers
accounted for 80% and 11%, respectively, of the Company's net sales for the nine
months ended September 30, 2003. Four customers accounted for 34%, 18%, 10% and
10%, respectively, of the Company's accounts receivable at September 30, 2004.
14
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued
OIL AND GAS PROPERTY
In April 2004, the Company announced that it has elected to divest of its
ownership of producing properties located in the state of Michigan. Sales
proceeds, after settlement of secured indebtedness of approximately $1.0
million, were to be used principally to place shut-in wells on the Company's
Texas Gulf Coast property into production. Following a period of marketing and
analysis of offered bids, the Company decided to discontinue the sales effort
and retain the property interest. Net revenue from this property will continue
to be applied to the indebtedness issued by the Company in November 2003 in
connection with the acquisition of producing property in Montana.
During the quarter ended September 30, 2004, the Company incurred expenditures
of approximately $1.6 million in its oil and gas acquisition and development
activities. Of this amount, $0.6 million was expended on the Company's Brazos
Field in the Texas Gulf Coast, principally on well workovers in an effort to
increase gas production from the property. Capital expenditures on the Green
Ranch property in Stephens County, Texas totaled $0.6 million, consisting of
$0.4 million for prospect acquisition costs and $0.2 million for the drilling
and completion of a gas well. Approximately 70% of the acquired working interest
in the property was acquired either from individuals, or entities controlled by
individuals, who have either a direct, or beneficial, relationship to the
Company; however, the negotiated acquisition price was determined in a manner
uniform to all members of the selling group. Sales from the completed gas well
began in the month of October. The Company also participated in a Black Warrior
Basin drilling prospect located in Fayette County, Alabama. Capital expenditures
during the quarter ended September 30, 2004, totaled $0.2 million, consisting
principally of prospect acquisition costs. One well was drilled on the prospect
and is currently being tested for commercial production as a gas well.
The Company charged a total of $0.1 million of in-house and third party general
and administrative charges to the full cost pool as a result of time and
expenses incurred during the quarter ended September 30, 2004, in its efforts to
acquire and develop additional oil and gas reserves.
LONG-TERM DEBT
During the quarter ended September 30, 2004, the Company retired $0.3 million of
indebtedness that was issued in November 2003 in connection with the acquisition
of producing properties in the state of Montana. The debt service payments were
funded by net cash flow from the acquired oil and gas properties and from the
Company's producing properties located in the state of Michigan. For the period
of time from November 2003 to September 30, 2004, the acquisition debt has been
reduced from $4.5 million to $3.3 million.
15
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued
During the quarter ended September 30, 2004, the Company closed on a $0.7
million private placement of a convertible three-year note with an annual
interest rate of 9%. The note is convertible into 4,125,000 shares of Common
Stock. If the note is not converted during the three-year period from date of
sale it will be redeemed for its face amount on the third anniversary from the
subscription date. Net proceeds from the offering of the note are to be used for
development activities on properties in the Texas Gulf Coast region and for
working capital. The indebtedness is convertible at the option of the holder at
issuance and, pursuant to EITF 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios", a
discount attributable to the beneficial conversion feature of approximately
$83,000 was recorded as additional paid in capital. The discount will be
amortized using the effective interest rate method over the term of the
indebtedness.
COMMON STOCK
During the quarter ended September 30, 2004, the Company issued 1.0 million
shares of Common Stock for the exercise of options, receiving proceeds in the
amount of $63,000.
The Company acquired 42,600 shares of Common Stock to be held as Treasury Stock
at a cost of $8,100.
STOCK BASED COMPENSATION
During the quarter ended September 30, 2004, the Company granted to employees
and directors options to acquire 6.2 million shares of Common Stock at exercise
prices ranging from $0.175 to $0.35, which prices were in excess of the market
price on the dates of grant. A portion of the options were fully vested on the
grant date; the balance vest over a period of five years from the date of grant.
The options are exercisable over a period of time ranging from five to six years
from date of grant. Any unexercised options remaining at the end of the
respective exercise periods will expire.
Had compensation cost been determined based on the fair value at grant dates for
stock option awards consistent with SFAS 123 and SFAS 148, the Company's net
(loss) income for the three and nine month periods ended September 30, 2004 and
2003, would have been adjusted to the pro forma amounts indicated below (in
thousands):
Three Months Nine Months
Ended September 30, Ended September 30,
2004 2003 2004 2003
------ ------ ------ ------
Net (loss) income:
As reported $ (195) $ (882) $ 47 $(1,836)
Compensation recognized
under SFAS 123 $ (220) $ -- $ (250) $ (390)
Proforma $ (415) $ (882) $ (203) $(2,226)
16
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued
During the quarter ended September 30, 2003, the Company did not grant any stock
option awards. There were, however, outstanding stock option awards that had
been granted in prior periods. A portion of the compensation expense recognized
under SFAS 123 for the three and nine month periods ended September 30, 2004 and
2003, is attributable to options granted in prior periods that vested during the
respective periods in 2004 and 2003.
The pro forma compensation expense based on the fair value of the options is
estimated on the grant date using the Black-Scholes options-pricing model with
the following assumptions used for the grants in 2004 and 2003: no dividends;
expected lives ranging from 3.0 years to 5.0 years; expected volatility ranging
from 0.85% to 11.9%; and risk free rates of return ranging from
2.27% to 3.81%. The weighted average fair value of the purchase rights granted
in 2004 and 2003 ranged from $0.05 to $0.18.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2003, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 104, "Revenue Recognition." SAB 104 supersedes
SAB 101, "Revenue Recognition in Financial Statements." SAB 104's primary
purpose is to rescind accounting guidance contained in SAB 101 related to
multiple element revenue arrangements, superseded as a result of the issuance of
EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables."
Additionally, SAB 104 rescinds the SEC's Revenue Recognition in Financial
Statements Frequently Asked Questions and Answers ("the FAQ") issued with SAB
101 that had been codified in SEC Topic 13, Revenue Recognition. Selected
portions of the FAQ have been incorporated into SAB 104. While the wording of
SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue
recognition principles of SAB 101 remain largely unchanged by the issuance of
SAB 104, which was effective upon issuance. The adoption of SAB 104 did not
impact the consolidated financial statements.
In March 2004, the Financial Accounting Standards Board (FASB) approved the
consensus reached on the Emerging Issues Task Force (EITF) Issue No. 03-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments." The objective of this Issue is to provide guidance for identifying
impaired investments. EITF 03-1 also provides new disclosure requirements for
investments that are deemed to be temporarily impaired. The accounting
provisions of EITF 03-1 are effective for all reporting periods beginning after
June 15, 2004, while the disclosure requirements are effective only for annual
periods ending after June 15, 2004. The Company has evaluated the impact of the
adoption of EITF 03-1 and does not believe the impact will be significant to the
Company's overall results of operations or financial position.
FOUR-FOR-ONE FORWARD STOCK SPLIT
Effective December 26, 2003, the Company's Board of Directors approved a
four-for-one forward stock split on all outstanding shares of Common Stock. The
Company's outstanding stock option awards and convertible notes were also
adjusted accordingly. All share and per share amounts have been adjusted to give
retroactive effect to this split for all periods presented.
17
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued
RECLASSIFICATION
Certain reclassifications for the prior year have been made to conform to the
current year's presentation.
NOTE 2 - DISCONTINUED OPERATIONS
In October 2002, the Company's Board of Directors directed management to sell
all assets and liabilities of the petroleum marketing operations, including the
convenience stores operations. In December 2002, the Company closed on the sale
of assets located in the state of New Mexico (see Note 3).
In March 2003, the Company received a proposal from Sedco, Inc. ("Sedco"), a
private company owned by Ilyas Chaudhary, the Company's Chief Executive Officer,
to acquire Enterprises, except for 4.0 million shares of Enterprises' equity
ownership in Network Fueling Corp. ("NFC"), at a cash price of $2.5 million,
effective January 1, 2003. The Company's Board of Directors accepted the
proposal, subject to the receipt of a fairness opinion that was received in
August 2003. At that time the Company had received a nonrefundable deposit in
the amount of $300,000, a 7% promissory note in the amount of $1.0 million due
October 31, 2003, and a second 7% promissory note in the amount of $1.2 million
due April 30, 2004. In addition, Sedco provided 12,000,000 shares of the
Company's Common Stock as security for payment of the two promissory notes. In
September 2003, the transaction was amended for the following: the cash purchase
price was reduced to $1.75 million and the 4,000,000 shares of NFC common stock
were returned to Enterprises. In addition, Sedco assumed an obligation in the
amount of $1.45 million that the Company owed to Enterprises. This amount,
combined with the nonrefundable deposit in the amount of $300,000, constituted
full payment of the amended purchase price of $1.75 million. In October 2003,
the Company received a revised fairness opinion that reflected the changes to
the transaction as originally proposed. The Company recorded the sale of the
business interests, effective September 30, 2003, recording a loss of $730,000
for the disposal of the discontinued business interests.
The historical operations of the business interests subject to the disposition
have been presented in the 2003 interim period statements of operations and
statements of cash flows as discontinued operations. The Company is guarantor of
certain obligations of Enterprises and its subsidiaries in the aggregate amount
of $1.5 million at September 30, 2004. The obligations consist of vendor trade
accounts, and real estate and equipment purchases. Management believes that
there is sufficient underlying collateral value in the related assets to
significantly reduce the potential loss, if any, to the Company.
The Company is a guarantor of a portion of indebtedness that was included in the
sale of its propane distribution operation in April 2002, and the lender has yet
to release the Company from the guarantee. As a result, the Company has included
in its balance sheet at September 30, 2004, under the captions "Other Assets"
and "Long term liabilities" the amount of $432,000 to reflect management's
estimate of the underlying asset value and outstanding debt balance at September
30, 2004, applicable to this indebtedness.
18
NOTE 2 - DISCONTINUED OPERATIONS, Continued
Summarized below are the results of discontinued operations for the three and
nine month periods ended September 30, 2003 (in thousands):
Three Months Nine Months
Ended September 30, Ended September 30,
2003 2003
-------- --------
Sales $ 11,042 $ 49,082
Gross profit $ 2,308 $ 8,860
Loss from operations $ (292) $ (841)
Net loss from operations $ (305) $ (1,264)
NOTE 3 - BUSINESSES UNDER CONTRACT FOR SALE
Effective December 31, 2002, the Company entered into an agreement to sell
Graves and Capco Monument LLC, subsidiaries whose assets, consisting principally
of land, buildings and equipment, were primarily located in the state of New
Mexico, at a sales price of $10,000 cash. The assets of Graves were utilized in
the distribution of refined petroleum products. The convenience store business
consisted of two store locations that were in operation in Albuquerque and
Farmington, New Mexico.
The Company agreed to continue to operate the businesses for a period of time
subsequent to the date of sale to allow the buyer time to make separate credit
arrangements with lenders and suppliers, and to negotiate for the removal of the
Company as the guarantor of a significant portion of the indebtedness assumed by
the buyer. The sales transaction resulted in a gain to the Company in the amount
of $182,000; however, due to the significant risk still assumed by the Company
in the form of the loan guarantees, the gain was deferred until such time that
the risk had either been significantly reduced or eliminated.
At September 30, 2004, approximately $3.7 million of indebtedness, including
accrued interest, was owed to one lender, and the borrower, a former subsidiary,
was in default on the indebtedness. Remedies available to the lender include
declaring the entire note balances, including accrued and unpaid interest,
immediately due and payable, foreclosing on the pledged security, which includes
land, buildings, and equipment, and collecting on any guarantees. Discussions
have been held with the lender, but no settlement has been reached at this time.
Beginning in the year 2003, the buyer marketed the real estate for sale, and
certain properties are currently under contract for sale. The sale of one
property closed in September 2003, resulting in a reduction in the amount of
$623,000 to the total debt assumed by the buyer. Effective September 30, 2003,
the Company re-evaluated the exposure relating to the debt guarantees. While
management believed that there was sufficient value in the underlying assets
such that the Company would not incur a loss from this disposal, the Company
believed that the disposal no longer met the criteria to be recorded as a
divestiture of a subsidiary for accounting purposes. Accordingly, the decision
was made at September 30, 2003, to restore the assets and liabilities
attributable to the businesses that were sold to the Balance Sheet to be
reported as "Assets attributable to businesses under contract for sale" and
"Liabilities attributable to businesses under contract for sale".
19
NOTE 3 - BUSINESSES UNDER CONTRACT FOR SALE, Continued
The Company further evaluated the exposure relating to the debt guarantees as of
December 31, 2003, and determined that there was not sufficient value in the
underlying assets such that the Company will, in all likelihood, incur a loss
from this disposal. It was estimated that the liabilities which are guaranteed
by the Company exceed the underlying net assets by approximately $333,000. The
Company accounted for this deficit by eliminating the deferred gain of $182,000
that was recorded at December 31, 2002, and by recording a charge to year 2003
operations in the amount of $151,000.
In August 2004, the debt was reduced $100,000 by proceeds from the sale of a
property.
Net assets and liabilities attributable to the Company's guarantees consisted of
the following at September 30, 2004 (in thousands):
Net assets to be realized $ 4,013
=====
Liabilities, including accrued
interest of $378 $ 4,346
=====
No additional loss contingency has been recorded for the three and nine month
periods ended September 30, 2004.
NOTE 4 - EARNINGS PER SHARE
The Company uses SFAS No. 128, "Earnings Per Share" for calculating the basic
and diluted earnings (loss) per share. Basic earnings (loss) per share are
computed by dividing net income (loss) attributable to common stockholders by
the weighted average number of common shares outstanding. Diluted earnings
(loss) per share is computed similar to basic earnings (loss) per share except
that the numerator is increased by the amount of interest expense attributable
to the convertible promissory notes payable and the denominator is increased to
include the number of additional common shares that would have been outstanding
if the potential common shares had been issued and if the additional common
shares were dilutive. On a diluted basis, under the treasury method of
calculating the additional shares outstanding, the Company's weighted average
shares outstanding for the nine months ended September 30, 2004, have been
increased for 5,556,688 shares of Common Stock as associated stock options have
a dilutive effect on net income. The Company's weighted average number of shares
outstanding for the three months ended September 30, 2004, would have increased
for 5,243,294 shares of Common Stock if associated stock options would have had
a dilutive effect; however, due to the net loss for the period the effect of the
options is antidilutive. Additionally, the number of shares outstanding for the
three and nine month periods ended September 30, 2004, have been increased for
5,942,935 and 2,837,956 shares of Common Stock, respectively, determined under
the "if converted" method, due to the issuance of convertible notes payable
during the nine months ended September 30, 2004. On a diluted basis, the
20
NOTE 4 - EARNINGS PER SHARE, Continued
Company's weighted average shares outstanding for the three and nine month
periods ended September 30, 2003, have been increased for 2,728,204 and
2,402,104 shares of Common Stock, respectively, as associated stock options have
a dilutive effect on income from continuing operations, which is the benchmark
number for determining whether potential common stock is included in determining
earnings (loss) per share. In accordance with SFAS No. 128, the stock options
are also considered to be potential common stock in determining loss per share
on loss from discontinued operations and net loss, even though the stock options
are antidilutive.
NOTE 5 - BUSINESS SEGMENTS
During the three and nine month periods ended September 30, 2004 and 2003, the
Company operated in one business segment: acquisition, exploration, development,
and production of oil and gas reserves, including investments in the equity
securities of other public companies involved in similar activities. The
Company's headquarters and all of its operations are located in the United
States of America. Effective December 31, 2003, the Company divested of its oil
and gas interests located in Canada. A summary of the Company's revenues and
long-lived assets by geographic area is as follows (in thousands):
United
Canada States Total
-------- -------- -------
Sales:
Three months ended September 30, 2004 $ -- $ 1,145 $ 1,145
====== ====== ======
Three months ended September 30, 2003 $ 8 $ 811 $ 819
====== ====== ======
Nine months ended September 30, 2004 $ -- $ 3,702 $ 3,702
====== ====== ======
Nine months ended September 30, 2003 $ 8 $ 2,346 $ 2,354
====== ====== ======
At September 30, 2004:
Oil and gas properties (net) $ -- $ 12,061 $ 12,061
====== ====== ======
Land $ 214 $ -- $ 214
====== ====== ======
Other property and equipment (net) $ -- $ 113 $ 113
====== ====== ======
21
NOTE 6 - SUBSEQUENT EVENTS
Effective September 30, 2004, the Company sold its interest in non-operated
properties located in Alabama and Louisiana to a company owned by the Company's
Chief Executive Officer. Sales proceeds in the amount of $0.4 million were
received by the Company in October 2004 and were used for working capital. The
sales proceeds were credited against the Company's basis in oil and gas
properties. No gain or loss was recognized from the sale as the disposition did
not represent a significant portion of the Company's proved reserves. The
Company has the option to repurchase the properties for an amount equal to the
sales price within the next twelve month period. If it is determined through due
diligence by the Company that the properties could have been sold for an amount
greater than $0.4 million, then the related party has the obligation to pay such
excess to the Company.
In October 2004, the Company issued 3.6 million shares of Common Stock in
settlement of the acquisition cost of the Green Ranch property in Stephens
County, Texas, that had been accrued as of September 30, 2004.
22
Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934 that include, among others, statements concerning: the benefits expected
to result from Capco's divestiture of its petroleum marketing operations,
including decreased expenses and expenditures that are expected to be realized
by Capco as a result of the divestiture, and other statements of: expectations,
anticipations, beliefs, estimations, projections, and other similar matters that
are not historical facts, including such matters as: future capital, development
and exploration expenditures (including the amount and nature thereof), drilling
of wells, reserve estimates (including estimates of future net revenues
associated with such reserves and the present value of such future net
revenues), future production of oil and gas, repayment of debt, business
strategies, and expansion and growth of business operations.
These statements are based on certain assumptions and analyses made by the
management of Capco in light of past experience and perception of: historical
trends, current conditions, expected future developments, and other factors that
the management of Capco believes are appropriate under the circumstances. Capco
cautions the reader that these forward-looking statements are subject to risks
and uncertainties, including those associated with: the financial environment,
the regulatory environment, and trend projections, that could cause actual
events or results to differ materially from those expressed or implied by the
statements. Such risks and uncertainties include those risks and uncertainties
identified below.
Significant factors that could prevent Capco from achieving its stated goals
include: declines in the market prices for oil and gas and adverse changes in
the regulatory environment affecting Capco. Capco or persons acting on its or
their behalf should consider cautionary statements contained or referred to in
this report in connection with any subsequent written or oral forward-looking
statements that may be issued. Capco undertakes no obligation to release
publicly any revisions to any forward-looking statements to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
RESULTS OF OPERATIONS
- ---------------------
THREE MONTHS ENDED SEPTEMBER 30, 2004, COMPARED TO SEPTEMBER 30, 2003
Capco's revenues from oil and gas activities were $1.1 million in 2004 compared
to $0.8 million in 2003. This increase is due principally to increases in
quantities of oil and gas sold from properties that were acquired by the Company
during the fourth calendar quarter of 2003. Revenues from the sale of oil and
gas provided by the property acquisitions in Montana and the Texas Gulf Coast
totaled $0.5 million in 2004. On a barrel of oil equivalent ("BOE") basis, the
price paid at the wellhead for the Company's production decreased from $34.78 in
2003 to $33.98 in 2004, resulting in a decrease in total revenue of $19,000.
Revenues from operator fees and pipeline transmission tariffs increased from
$-0- in 2003 to $0.1 million in 2004.
23
Capco's cost of sales increased to $0.6 million in 2004 from $0.3 million in
2003, due principally to an increase in production volumes from 23,600 BOE in
2003 to 30,400 BOE in 2004. A total of 15,900 BOE was produced from the
acquisitions in Montana and the Texas Gulf Coast. On a BOE basis, cost of sales
attributable to the production of oil and gas increased from $14.23 in 2003 to
$18.87 in 2004. The cost of price hedging programs on the Michigan and Montana
properties, and remedial expenses incurred on the Texas Gulf Coast property were
principally responsible for this increase.
Net operating revenues from Capco's oil and gas production are very sensitive to
changes in the price of oil; thus it is difficult for management to predict
whether or not the Company will be profitable in the future.
General and administrative expenses were $0.4 million in 2004 and $0.2 million
in 2003. Non-recurring compensation costs of approximately $0.1 million
associated with the employment of full-time and part-time personnel was the
principal component of this increase.
Depreciation, depletion and amortization was $0.1 million in 2004 and $0.2
million in 2003. This change is attributable to the increase in the depletable
basis of the Company's United States full cost pool resulting principally from
acquisitions during the fourth quarter of year 2003, the increase in production
volumes resulting from the acquisitions and an increase in proved reserves from
1.0 million BOE at January 1, 2003, to 3.5 million BOE at January 1, 2004. The
cost depletion rate per BOE decreased from $6.52 in 2003 to $4.50 in 2004 as a
result of the changes in the depletable basis and proved reserves.
Interest expense increased to $0.1 million in 2004 from $22,000 in 2003, due to
the debt assumed in November 2003 with the acquisition of producing properties
in the state of Montana and the private placements of convertible notes payable
that closed in June and September 2004.
Losses from sales of marketable securities, including unrealized holding gains,
resulted in a losses of $13,000 in 2003 and $1,000 in 2004 as the Company had
liquidated its marketable securities portfolio in prior periods.
NINE MONTHS ENDED SEPTEMBER 30, 2004, COMPARED TO SEPTEMBER 30, 2003
Capco's revenues from oil and gas activities were $3.7 million in 2004 compared
to $2.4 million in 2003. This increase is due principally to increases in
quantities of oil and gas sold from properties that were acquired by the Company
during the fourth calendar quarter of 2003. Revenues from the sale of oil and
gas provided by the property acquisitions in Montana and the Texas Gulf Coast
totaled $1.7 million in 2004. On a barrel of oil equivalent ("BOE") basis, the
price paid at the wellhead for the Company's production decreased from $32.54 in
2003 to $32.44 in 2004, resulting in a decrease in total revenue of $8,000.
Revenues from operator fees and pipeline transmission tariffs increased from
$1,000 in 2003 to $0.3 million in 2004.
24
Capco's cost of sales increased to $1.9 million in 2004 from $1.1 million in
2003, due principally to an increase in production volumes from 73,300 BOE in
2003 to 104,500 BOE in 2004. A total of 55,500 BOE was produced from the
acquisitions in Montana and the Texas Gulf Coast. On a BOE basis, cost of sales
attributable to the production of oil and gas increased from $15.21 in 2003 to
$16.80 in 2004. The cost of price hedging programs on the Michigan and Montana
properties, and remedial expenses incurred on the Texas Gulf Coast property were
principally responsible for this increase.
Net operating revenues from Capco's oil and gas production are very sensitive to
changes in the price of oil; thus it is difficult for management to predict
whether or not the Company will be profitable in the future.
General and administrative expenses were $0.9 million in 2004 and $0.7 million
in 2003. Non-recurring compensation costs of approximately $0.1 million
associated with the employment of full-time and part-time personnel during the
three month period ended September 30, 2004, was the principal component of this
increase.
Depreciation, depletion and amortization was $0.5 million in both 2004 and in
2003. The cost depletion rate per BOE decreased from $6.51 in 2003 to $4.27 in
2004 as a result of changes in the depletable basis and proved reserves during
the respective periods.
Interest expense increased to $0.3 million in 2004 from $0.1 million in 2003,
due to the debt assumed in November 2003 with the acquisition of producing
properties in the state of Montana and the private placements of convertible
notes payable that closed in June and September 2004.
Losses from sales of marketable securities, including unrealized holding
(losses) gains, decreased to a loss of $65,000 in 2004 from a gain of $53,000 in
2003, as the Company liquidated its marketable securities portfolio.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2004, the Company had a working capital deficit of $3.0
million. This negative working capital is due, in large part, to the current
portion of long-term debt, $2.0 million, which includes an obligation in the
amount of $1.3 million that was incurred in connection with the acquisition of a
producing oil and gas property during the year 2003. This debt, plus an
additional $1.9 million that is classified as non-current, is to be repaid from
future cash flow from the acquired property and other property owned by the
Company that is located in the state of Michigan. Assuming current cash flow, it
is estimated that the debt will be paid in full during the year 2007, after
which the net cash flow will be paid to the Company. In addition, current
liabilities at September 30, 2004, include accrued expenses in the amount of
$0.4 million for the acquisition cost of an oil and gas property. This amount
was paid in October 2004 by the issuance of Common Stock to the sellers of the
acquired property.
25
Management of the Company has implemented plans and initiated actions in an
effort to reduce the working capital deficit. These actions include the
following:
1. Effective November 1, 2003, the Company's interest in producing property
located in Michigan was pledged as additional collateral in connection with
an acquisition of producing property in Montana. The net cash flow from
both the Michigan and Montana properties is being used to retire the debt
that was incurred with the acquisition.
2. Effective November 30, 2003, the Company acquired a 65% working interest in
producing properties located in the Texas Gulf Coast that are providing
positive cash flow to the Company.
3. Gross profit from property operations increased from $1.3 million in 2003
to $1.8 million in 2004, due principally to property acquisitions closed by
the Company during the calendar years 2002 and 2003.
4. The Company's Board of Directors approved a plan in October 2002, which
authorized management to pursue the divestiture of its petroleum products
marketing and convenience store operations.
5. In December 2002, an agreement was reached for the sale of principally all
of its assets in the state of New Mexico. Consideration for this
transaction consisted primarily of the assumption by the buyer of
approximately $4.5 million of indebtedness related to the assets.
6. In March 2003, a company owned by the Company's Chief Executive Officer
submitted a proposal to acquire the remaining business interests designated
for divestiture for total cash consideration of $2.5 million. The Company's
Board of Directors accepted the proposal, subject to the receipt of a
fairness opinion that was received in August 2003 and subsequently amended
in October 2003. Following adjustments to the agreement that reduced the
sales price to $1.75 million, the Company recorded the sale of the business
interests, effective September 30, 2003.
7. In February 2004, the Company's Board of Directors authorized management to
seek additional financing. A private placement of convertible notes payable
closed in June 2004, providing the Company with net proceeds of $1.0
million. A second private placement of a convertible note payable closed in
September 2004, providing the Company with net proceeds of $0.7 million. A
portion of the proceeds from the additional financing is being used to fund
property development activities in an effort to increase cash flow to the
Company.
8. Effective September 30, 2004, the Company sold its interest in
non-operated properties located in Alabama and Louisiana to a company
owned by the Company's Chief Executive Officer. Sales proceeds in the
amount of $0.4 million were received by the Company in October 2004 and
were used for working capital.
In connection with some of the transactions described above, the Company is
considering the availability of equity and/or debt financing opportunities,
although no decisions have been reached in this regard at this time.
26
CONTINUING OPERATIONS
Net cash provided by operating activities totaled $1.3 million for the nine
months ended September 30, 2004, compared to cash provided by operating
activities of $0.4 million for the nine months ended September 30, 2003. In
2004, net income, adjusted for reconciling items, provided a cash inflow of $0.6
million. Changes in assets and liabilities in 2004 resulted in a cash inflow of
$0.7 million. In 2003, net loss, adjusted for reconciling items, resulted in a
cash inflow of $0.6 million. Changes in assets and liabilities resulted in a
cash outflow of $0.2 million.
Net cash used in investing activities totaled $1.8 million for the nine months
ended September 30, 2004, compared to cash provided by investing activities of
$0.4 million for the nine months ended September 30, 2003. Proceeds from the
sale of marketable securities in the amount of $0.1 million were the principal
source of cash inflow in 2004. Expenditures for oil and gas property and other
assets totaled $1.8 million, due principally to the Company's capital program to
enhance and improve the infrastructure and gas delivery capability of its
offshore platforms in the Texas Gulf Coast and conduct workover operations on
wells in that area. Payments to reduce amounts owed to related parties, net of
related advances, totaled $0.1 million in 2004. Net advances from related
parties in the amount of $1.0 million, was the principal source of cash inflow
in 2003. An equity contribution to a subsidiary in the amount of $0.4 million
was the principal outflow of cash in 2003.
Net cash provided by financing activities totaled $0.7 million for the nine
months ended September 30, 2004, and net cash used in financing activities
totaled $0.8 million for the nine months ended September 30,2003. Proceeds from
the private placement of convertible notes payable provided cash inflow in the
amount of $1.7 million in 2004. Payments on long term debt in the amount of $1.0
million and $0.8 million in 2004 and 2003, respectively, resulted in cash
outflows in both periods.
The Company has various loans which require principal payments of $2.0 million
during the twelve month period ending September 30, 2005. Of this amount,
approximately $1.3 million will be repaid from future cash flow from specific
producing oil and gas properties. The remainder of the payments are anticipated
to be made from cash flow available from the operations of other producing
property, and from proceeds from the sale of assets and equity and/or debt
fundings. To the extent such cash flow is insufficient to make the debt payments
and provide adequate working capital for the business of the Company, the
Company may be required to reduce or curtail certain operations or seek other
sources of capital. The Company does not currently have any agreements or
arrangements providing for such financing and it may not be available on terms
acceptable to the Company.
The Company is the guarantor of approximately $5.6 million of indebtedness for
which the obligors are former subsidiaries of the Company. Approximately $1.9
million of the indebtedness is being serviced by the respective debtor
companies. The obligor for the remaining $3.7 million is in default to the
lender. Discussions have been held with the lender, but no settlement has been
reached at this time. The Company is currently not making payments with regard
to any of these obligations. While management believes that there is sufficient
underlying asset value in the respective companies to significantly mitigate any
potential loss exposure to the Company over the amounts already recorded by the
Company, there is no assurance that the Company may not be called upon to settle
some portion of the indebtedness in the future.
27
The Company is obligated to pay operating lease costs of approximately $0.1
million during the twelve month period ending September 30, 2005, for land and
facilities.
The Company is responsible for any contamination of land it owns or leases.
However, there may be limitations on any potential contamination liabilities as
well as claims for reimbursement from third parties.
DISCONTINUED OPERATIONS
The following discussion relates to only the nine month period ended September
30, 2003. The Company divested of the discontinued business interests effective
September 30, 2003, and as a result, there is no reporting of discontinued
operations during the year 2004.
Net cash provided by operating activities totaled $2.5 million. Net loss,
adjusted for reconciling items, resulted in a cash outflow of $0.5 million.
Changes in assets and liabilities resulted in a cash inflow of $3.0 million.
Net cash provided by investing activities totaled $0.8 million. Proceeds from
the sale of an equity investment of $0.8 million and an equity contribution of
$0.4 million were the principal sources of cash inflow. Advances to related
parties in the amount of $0.5 million were the principal cash outflow.
Net cash used in financing activities totaled $3.3 million. Net payments on
the revolving line of credit and long term debt resulted in cash outflows of
$3.0 million and $0.6 million, respectively. A decrease in restricted cash
provided a cash inflow of $0.4 million.
EFFECT OF CHANGES IN PRICES
Changes in prices during the past few years have been a significant factor in
the oil and gas industry. The price received for the oil and gas produced by
Capco has fluctuated significantly during the last year. Changes in the price
that Capco receives for its oil and gas is set by market forces beyond Capco's
control as well as government intervention. The volatility and uncertainty in
oil and gas prices have made it more difficult for a company like Capco to
increase its oil and gas asset base and become a significant participant in the
oil and gas industry. Most of Capco's oil and gas production is sold to certain
major oil companies and gas transmission companies. However, in the event these
purchasers discontinued oil and gas purchases, Capco has made contact with other
purchasers who would purchase the oil and gas at terms standard in the industry.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses the Company's consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. On an on-going
basis, management evaluates its estimates and judgments, including those related
to revenue recognition, intangible assets, recovery of oil and gas reserves,
financing operations, and contingencies and litigation.
28
Management bases its estimates and judgments on historical experience and on
various other factors that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying value of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. The most significant accounting estimates inherent in
the preparation of the Company's financial statements include estimates as to
the appropriate carrying value of certain assets and liabilities which are not
readily apparent from other sources, primarily allowance for doubtful accounts,
the discounted value of recoverable oil and gas reserves, the proceeds to be
realized from the sale of real property, and the recognition and classification
of net operating loss carryforwards between current and long-term assets. These
accounting policies are described at relevant sections in this discussion and
analysis and in the notes to the consolidated financial statements included in
our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2003.
Item 3: CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures designed to ensure that
information required to be disclosed by the Company in the reports that it files
or submits under the Securities Exchange Act of 1934 (the "1934 Act") is
recorded, processed, summarized and reported within the time periods specified
in the rules and forms of the Securities and Exchange Commission (the "SEC").
Those disclosure controls and procedures include, without limitation, controls
and procedures designed to ensure that information required to be disclosed by
the Company in the reports that it files or submits under the 1934 Act is
accumulated and communicated to the Company's management, including its
principal executive and principal accounting officers, or persons performing
similar functions, as appropriate, to allow timely decisions regarding required
disclosure. Based upon the evaluation of those controls and procedures performed
as of September 30, 2004, the Company's management, with the participation of
its chief executive officer and chief accounting officer, concluded that the
Company's disclosure controls and procedures were adequate.
The Company has implemented a process designed by, or under the supervision of,
its principal executive and principal accounting officers, or persons performing
similar functions, and effected by the Company's board of directors, management
or other personnel, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles and
includes those policies and procedures that: (1) pertain to the maintenance of
records that in reasonable detail accurately and fairly reflect the transactions
and dispositions of the Company's assets; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that
the Company's receipts and expenditures are being made only in accordance with
authorizations of the Company's management and directors; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the Company's assets that could have a
material effect on the financial statements. The Company's management, with the
participation of its chief executive officer and chief accounting officer, has
determined that there has been no change in the Company's internal control over
financial reporting that occurred during the Company's last fiscal quarter that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
29
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 2. Changes in Securities.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
The Registrant does not have procedures in place by which security holders
may recommend nominees to the Registrant's Board of Directors.
Item 6. Exhibits and Reports on Form 8-K.
(a) The following exhibits are filed as part of this report:
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Accounting Officer
32.1 Certification of Chief Executive Officer pursuant to
18 U.S.C. section 1350
32.2 Certification of Chief Accounting Officer pursuant to
18 U.S.C. section 1350
(b) Reports on Form 8-K
None
30
SIGNATURES
In accordance with the requirements of the Exchange Act, the Issuer caused this
Report to be signed on its behalf by the undersigned, thereunto duly authorized.
CAPCO ENERGY, INC.
Dated: November 15, 2004 By: /s/ Ilyas Chaudhary
------------------------
Ilyas Chaudhary, Chief Executive Officer
31