U.S. 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 June 30, 2005
( ) TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the Transition Period from To
-------- ---------------
Commission File No. 0-19485
ADVANCED ENERGY RECOVERY, INC.
--------------------------------------------
(Name of small business issuer in its charter)
DELAWARE 84-1069416
------------------------------ ----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
5799 Broadmoor, Ste 750, Mission, KS 66203
-------------------------------------- --------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number (913) 535-1072
APPLICABLE ONLY TO CORPORATE ISSUERS
As of June 30, 2005, the Issuer had 2,396,503 shares of its common stock
outstanding.
Transitional Small Business Disclosure Format: Yes No X
----- -----
FORM 10-QSB
Part 1
------
Item 1. Financial Statements
--------------------
Page
----
Unaudited Condensed Consolidated Balance Sheet -June 30, 2005 3
Unaudited Condensed Consolidated Statement of Operations for
the three months ended June 30, 2004 and 2005 4
Unaudited Condensed Consolidated Statement of Cash Flows for
the three months ended June 30, 2004 and 2005 5
Notes to Consolidated Financial Statements 6
Part 1I
Items 1-5. 21
2
ADVANCED ENERGY RECOVERY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(Unaudited)
ASSETS June 30,
2005
-----------
Cash $ 22,887
Accrued interest receivable 143,448
Other receivables 116,523
Prepaid expenses and other 70,414
-----------
Current Assets 353,272
Property, plant and equipment,net 1,040,898
Deferred project costs and prepaid lease 70,590
-----------
Total Assets $ 1,464,760
===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Accounts payable $ 269,386
Accrued expenses 84,926
Accounts payable - related parties 8,010
Notes payable 361,853
Dividends accrued- preferred stock of subsidiary 138,919
-----------
Current Liabilities 863,094
-----------
Commitments and Contingencies-
Minority interest 565,481
-----------
STOCKHOLDERS' EQUITY (DEFICIENCY)
Preferred Stocks of Subsidiary-
Series A, $10.00 Par Value:
900 shares authorized, 900 shares issued and
outstanding 9,000
Paid-in capital, Series A Preferred Stock 891,000
Subscriptions receivable, Series A Preferred Stock (900,000)
-----------
--
-----------
Series B, $10.00 Par Value:
595 shares authorized, 466.625 shares issued and
outstanding 5,950
Paid-in capital, Series B Preferred Stock 589,050
Subscriptions receivable, Series A Preferred Stock (108,451)
-----------
486,549
-----------
Preferred stock, Series B, $.005 par value; 1,000,000
shares authorized, none issued and outstanding --
-----------
Common stock, $.003 par value; 10,000,000 shares
authorized, 2,396,503 issued and outstanding 7,189
Paid-in capital 1,330,503
Accumulated deficit (1,788,056)
-----------
(450,364)
-----------
Total Stockholders' Equity 36,185
-----------
$ 1,464,760
===========
The accompanying notes are an integral part of these statements.
3
ADVANCED ENERGY RECOVERY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
Three Months Three Months
June 30, 2004 June 30, 2005
----------- -----------
REVENUES
Natural gas sales $ -- 25,147
Interest and guaranteed return 33,750 33,750
Other 948 --
----------- -----------
Total Revenues 34,698 58,897
----------- -----------
EXPENSES
Cost of natural gas purchased -- 13,710
Operating expenses -- 90,239
General and administrative costs 13,015 15,746
Interest 3,740 5,721
Depreciation -- 15,077
----------- -----------
Total Expenses 16,755 140,493
----------- -----------
OPERATING INCOME (LOSS) 17,943 (81,596)
Gain on Exchange Transaction 1,569,476 --
----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES AND
MINORITY INTEREST 1,587,419 (81,596)
Income taxes -- --
Minority interest -- 45,739
----------- -----------
NET INCOME (LOSS) 1,587,419 (35,857)
Subsidiary preferred stock dividends accrued (22,511) (45,190)
----------- -----------
EARNINGS (LOSS) FOR COMMON STOCK $ 1,564,908 $ (81,047)
=========== ===========
Weighted-average shares outstanding 1,955,379 2,396,503
=========== ===========
Earnings (Loss) Per Common Share $ 0.80 $ (0.03)
=========== ===========
The accompanying notes are an integral part of these statements.
4
ADVANCED ENERGY RECOVERY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
Three Months Three Months
June 30, 2004 June 30, 2005
----------- -----------
Cash flows from operating activities
Net income (loss) $ 1,587,419 $ (35,857)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation -- 15,077
Gain on Exchange Transaction (1,569,476) --
Net change in assets and liabilities 1,001 (82,220)
----------- -----------
Net cash provided (used) in operating activities 18,944 (103,000)
----------- -----------
Cash flows from investing activities
Interest receivable-Gateway Energy Corporation (33,906) (33,750)
Project price upside payments received 26,453 48,044
Acquisitions of property, plant and equipment -- (47,088)
Minority interest contributions -- 29,334
Deferred project costs and other -- (18,132)
----------- -----------
Net cash provided by (used in) investing activities (7,453) (21,592)
----------- -----------
Cash flows from financing activities
Payments on notes payable (1,350) (4,547)
Issuance of subsidary preferred stock -- 99,333
Advances from related parties, net of repayments -- 285
Subsidiary preferred stock dividends paid (16,569) (29,379)
----------- -----------
Net cash provided by financing activities (17,919) 65,692
----------- -----------
Net increase (decrease) in cash (6,428) (58,900)
Cash, beginning of period 6,734 81,787
----------- -----------
Cash, end of period $ 306 $ 22,887
=========== ===========
The accompanying notes are an integral part of these statements.
5
Advanced Energy Recovery, Inc.
and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies applied in the preparation of
the accompanying financial statements follows.
1. Organization and Principles of Consolidation
Advanced Energy Recovery, Inc. (Formerly known as Advanced Financial, Inc.) (the
"Company" or "AER") is a Delaware corporation formed in September 1986. Advanced
Financial, Inc. operated in the financial services sector through March 31,
2004. Through its two wholly owned subsidiaries, AIH Receivable Management
Services and AIH Early Recovery Systems ("AIH"), the Company collected debts for
others for a fee and purchased charged-off credit card debt to collect at a
profit from debtors located throughout the United States. Through AIH, the
Company was also engaged in the business of collecting nonperforming receivables
on behalf of third parties. During the year 2004, the Company changed its focus
and growth efforts to the energy industry with its primary emphasis on natural
gas.
Advanced Energy Recovery, Inc., currently owns 100% of Allen Drilling
Acquisition Company ("ADAC"). In addition, as of October 14, 2004, through ADAC,
the Company owns 52.5% of Elgin Holdings, LLC ("Elgin"). ADAC and Elgin are
engaged in operations in the energy industry.
Under date of February 27, 2004, the Company, through an Information Statement
pursuant to Section 14 (c) of the Securities Exchange Act and Regulation 14A,
solicited the consents of the common stockholders (the "Solicitation") to effect
several transactions in an effort, among other things, to restructure the
Company, to dispose of the financial service operations which have accumulated
significant losses and to change its focus and growth efforts to the energy
industry with its primary emphasis on natural gas. The consents solicited
included the following:
1. To adopt an amendment to the Company's Certificate of Incorporation
to; (i) change the name of the corporation to "Advanced Energy
Recovery, Inc."; (ii) effect a 1 for three reverse split of the
outstanding Common Stock of the Company; and (iii) set the authorized
Common Stock of the Company at 10,000,000 common shares.
2. To obtain Stockholders' consent to an exchange of 100% of the
outstanding stock of AIH Receivable Management Services, Inc. ("AIH")
(a wholly owned subsidiary of the Company) for an assumption by the
primary secured lender of the Company of all of the AIH liabilities
("the Exchange Transaction").
6
3. To obtain Stockholders' consent and ratification of the engagement by
the Board of Directors of Weaver and Martin L.P. as the Company's
independent public accountants.
4. To obtain Stockholders' consent and ratification of the appointment by
the Board of Directors of two directors to fill two vacancies created
by resignations. Such directors will serve until the next annual
meeting of Stockholders.
On March 24, 2004, the Company, under a Form 8-K under date thereof, announced
that it had received the requisite affirmative consent votes from the common
shareholders to effect the four proposals set forth in the February 27, 2004
Solicitation.
The Exchange Transaction was completed in August, but was effective as of 12:01
AM April 1, 2004.
2. The Exchange Transaction
The AIH operations had resulted in significant losses despite the efforts by the
Company to restructure and reorganize various AIH segment operations. These
losses were funded by ARGUS.
The following sets forth in summary form the consolidated results of operations
for five years:
Fiscal Year Fiscal Year Fiscal Year Fiscal Year Fiscal Year
Financial Position 03/31/00 03/31/01 03/31/02 03/31/03 03/31/04
----------- ----------- ----------- ----------- -----------
Total assets $ 1,139,576 $ 742,348 $ 562,750 $ 435,032 $ 332,697
Total liabilities 1,027,060 1,272,620 1,589,521 1,873,184 2,234,107
Stockholders' equity $ 112,516 $ (530,272) $(1,026,771) $(1,438,152) $(1,901,410)
Amounts due to ARGUS $ 560,000 $ 765,840 $ 1,129,772 $ 1,318,709 $ 1,442,618
Operations
Total revenues $ 977,439 $ 1,423,153 $ 1,152,171 $ 1,128,441 $ 987,819
Total expenses 1,898,423 2,119,914 1,648,669 1,539,822 1,361,077
Net loss $ (920,984) $ (696,761) $ (496,498) $ (411,381) $ (373,258)
The consolidated operations for the fiscal year ended March 31, 2004, included
amounts with respect to the Company's wholly owned subsidiary's, (ADAC)
participation in the Madisonville Project as described in Note C herein. For the
fiscal year then ended, ADAC reported net income of $105,616.
As of December 31, 2003, the accumulation of debt to ARGUS had grown to a point
where the Company could no longer service this outstanding debt given the
downsizing of the Company that was the result of the reorganization and
restructuring of the various AIH segment operations. Also during these years,
and to the current date, the current President and Treasurer of the Company did
7
not draw a salary, nor were any amounts accrued with respect thereto. With the
completion of the Madisonville Project investment, and the joint venture with
GulfWest Energy Inc. as discussed later, the Company had determined that the
ability to generate long-term value for the common shareholders could be
enhanced if the present Company operations, (AIH) were sold and the Company
concentrated its growth efforts in the energy industry, focusing primarily on
natural gas. In accordance with this business strategy, an agreement was entered
into with ARGUS, subject to common shareholder approval, wherein the common
shares of AIH would be exchanged for an assumption by ARGUS of all of the AIH
liabilities (the "Exchange Transaction"). The Board of Directors engaged an
investment banking firm (Morgan Stanley) to determine the fair market value of
the AIH operations on a going concern basis. Morgan Stanley, through its
SPARDATA affiliate, determined such value to be $345,000. On March 24, 2004, the
Company received the requisite affirmative consent votes from the common
shareholders to effect the Exchange Transaction. The Exchange Transaction was
effective at the beginning of business on April 1, 2004.
The following sets forth the opening consolidated balance sheet on April 1,
2004, reflecting the Exchange Transaction :
Condensed Consolidated Balance Sheet
March 31,2004
Assets Actual Transaction April 1,2004
----------- ----------- -----------
Cash (overdrafts) $ (112,489) $ 119,223 $ 6,734
Receivables and other 65,927 (40,791) 25,136
Accrued interest receivable 96,095 96,095
Property, net 36,063 (36,063) 0
Customer lists, net 134,612 (134,612) 0
Escrow deposit 75,000 75,000
Escrow depost reserve (75,000) (75,000)
----------- -----------
$ 220,208 $ 127,965
=========== ===========
Liabilities
Payables and accrued expenses $ 396,742 (352,861) 43,881
Payables to related parties 52,815 A 52,815
Notes payable 1,594,658 B (1,308,858) 285,800
Preferred stock dividends accrued 77,403 77,403
----------- -----------
Total 2,121,618 459,899
----------- -----------
Stockholders Equity (Deficiency)
Subsidary preferred stock 900,000 900,000
Subscriptions receivable (900,000) (900,000)
Series B Preferred stock 0 0
Common stock and paid in capital 1,259,126 1,259,126
Accumulated deficit (3,160,536) C 1,569,476 (1,591,060)
----------- -----------
Total (1,901,410) (331,934)
----------- -----------
$ 220,208 $ 127,965
=========== ===========
8
Notes to Condensed Consolidated Balance Sheet:
(A) At March 31, 2004, the amounts due to related parties consisted of
$52,815 due to AFI Capital Corporation. In August, 2004, the $52,815 was settled
by the issuance of common stock of the Company.
(B) Notes payable at March 31, 2004, consisted of the following:
Due ARGUS, $1,442,618, interest at prime, due on demand, secured by
substantially all of the Company's assets.
Due AFI Capital Corporation, $75,000, interest at 8%, unsecured, due on
demand.
Due bank, $77,040 under a $100,000 Line of Credit, interest at 2% over
prime, unsecured, due March 31, 2004, guaranteed by a director of the
Company.
The ARGUS note payable included $185,900 which was used to fund general
Company corporate operations since the Company's emergence from its Chapter
XI filing in 1999. A new prime interest rate demand note (accrued interest
of $33,381 with respect to such note is included in accrued expenses above)
was issued to ARGUS. The balance ($1,308,858) related to the funding of the
AIH operations and was included in the Exchange Transaction.
The AFI Capital Corporation note payable consists of two advances to ADAC
in connection with a proposed acquisition transaction
The bank note payable relates to the operations of AIH and was included in
the Exchange Transaction.
(C) The gain to the Company on the Exchange Transaction. Such gain was the
difference between the ARGUS obligations cancelled and the AIH operation's net
assets (assets less liabilities assumed by ARGUS). During the quarter ended
December 31, 2004, this gain was reduced by $59,925 as a result of a final
settlement of certain payables and certain additional costs related to the
Exchange Transaction.
3. Property, Plant and Equipment
At June 30, 2005, property, plant and equipment, all of which is held in Elgin,
consisted of approximately $520,000 related to a pipeline and natural gas
treating facilities located in Hardin County, Texas, and $538,000 of acreage and
related costs for oil and gas properties located in Madison County, Texas. The
properties are stated at cost in the case of assets acquired within Elgin and at
fair market value in the case of assets contributed to Elgin by the members.
Property and Equipment
- ----------------------
All property, furniture, and equipment as of March 31, 2004 was owned by AIH and
accordingly included in the Exchange Transaction and the determination of the
gain thereon. Depreciation is provided on pipelines and treating facilities
using the straight-line method over an estimated useful life of 10 years.
Oil And Gas Properties
- ----------------------
The Company has elected to use the successful efforts method of accounting for
oil and gas producing activities. Costs to acquire mineral interests in oil and
gas properties, to drill and equip exploratory wells that find proved reserves,
9
and to drill and equip development wells, will be capitalized. Costs to drill
exploratory wells that do not find proved reserves, and geological and
geophysical costs will be expensed. As the Company acquires significant oil and
gas properties, any unproved property that is considered individually
significant will be periodically assessed for impairment of value, and a loss
will be recognized at the time of impairment by providing an impairment
allowance. Capitalized costs of producing oil and gas properties and support
equipment, after considering estimated dismantlement and abandonment costs and
salvage values, will be depreciated and depleted by the unit-of-production
method. In the event of the sale of an entire interest in an unproved property,
the gain or loss on the sale will be recognized, taking into consideration the
amount of any recorded impairment if the property has been assessed
individually. In the case of a sale of a partial interest in a proved property,
the gain or loss will be recognized, based upon the fair values of the interests
sold and retained.
4. Income Taxes
The Company accounts for income taxes under the asset and liability method where
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
applied to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date. Deferred tax assets are recognized to the extent
management believes that it is more likely than not that they will be realized.
5. Income (Loss) Per Common Share
Income (Loss) per common share is based on the weighted average number of common
shares outstanding during the periods presented
6. Stock-Based Compensation
The Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25) and related interpretations in
accounting for its employee stock options. Under APB 25, because the exercise
price of employee stock options exceeds the market price of the underlying stock
on the date of grant, no compensation expense is recorded. The Company has
adopted the disclosure-only provisions of Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123).
Stock-Based Compensation
10
7. Accounting Pronouncements and Recent Regulatory Developments
In January 2003, the SEC adopted rules implementing Sections 406 and 407 of the
Act. Section 406 of the Act requires public companies to annually disclose
whether the company has adopted a code of ethics for its principal executive and
financial officers, and if it has not, to explain why it has not. Additionally,
the rules will require disclosure on a Form 8-K filing any amendments to or
waivers from the code of ethics relating to those officers. Section 407 of the
Act required public companies to disclose annually whether it has at least one
"audit committee financial expert", as defined in the rules, on the Company's
audit committee, and if so, the name of the audit committee financial expert and
whether the expert is independent of management. A company that does not have an
audit committee financial expert will be required to disclose this fact and
explain why it has no such expert. Both rules are effective for small business
issuers' annual reports for fiscal years ending on or after December 15, 2003.
As of June 30, 2005, because of its recent restructuring and small size of the
Board, the Company did not have on its Board of Directors a member who could
meet the qualifications as defined in the rules for serving on an audit
committee, or a member who could meet the qualifications of an audit committee
financial expert.
8. Use of Estimates
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements and revenues and expenses during the reporting period. Actual results
could differ from those estimates.
NOTE B - GOING CONCERN
At March 31, 2005, the Company's financial statements were subject to "Going
Concern" issues, and the consolidated financial statements with respect thereto
were prepared on going concern basis, which contemplated the Company's
continuity of operations, realization of assets, and liquidation of liabilities
in the ordinary course of business. Those statements, however, did not reflect
adjustments that might result if the Company were unable to continue as a going
concern. To address those issues, early in fiscal year 2004, management of the
Company developed a plan to restructure the Company and to change its focus and
business strategy as later described herein. The plan was implemented throughout
the year, and culminated in the Exchange Transaction in August 2004, which
transaction was effective on April 1, 2004.
NOTE C -AGREEMENTS
1. AFI Capital Corporation Agreement
In July, 2001, the Company entered into a four year Agreement with AFI Capital
Corporation ("Capital") a Nebraska corporation. Pursuant to the agreement,
Capital provided financial, acquisition, and general public company business
consulting services in other than the financial services industry. Compensation
for such services was based on a "successful efforts" basis and primarily
consisted of the Company's common equity and cash performance fees as earned. At
March 31, 2004, $52,815 was due to Capital under the compensation portion of the
11
Agreement, which amount was converted to 337,500 shares of Common Stock (post
reverse split basis) subsequent to March 31, 2004, in accordance with the
provisions of the Agreement. Upon issuance of the shares, the Agreement was
terminated and all parties released from any obligations arising there from.
Larry J. Horbach, who was appointed assistant secretary of the Company, and
appointed to fill a vacant Company director position in March, 2003, is the
president and a director of AFI Capital Corporation. Mr. Holtgraves is a
founding director and an officer of Capital. Upon issuance of the shares, Mr.
Holtgraves resigned as a director and officer of Capital and his Capital shares
were redeemed by Capital.
1. The Gateway Energy/Madisonville Project Agreement
On March 6, 2003, the Company executed an Agreement which was closed on April
30, 2003, with Gateway Energy Corporation and certain of its subsidiaries of
Houston, Texas ("Gateway") under which it provided, through the Company's
wholly-owned subsidiary, Allen Drilling Acquisition Company ("ADAC"), $900,000
of credit enhancements in the form of Letters of Credit. These credit
enhancements enabled Gateway to obtain additional financing, in the form of a
three year Balloon Note from a Houston bank to complete the construction of
certain natural gas pipeline facilities ("Pipeline Facilities") located in
Madison County, Texas, (The "Madisonville Project"). ADAC secured the Letters of
Credit through the private placement of a new series of participating preferred
stock (the "Series A"), to two investor groups. The Certificate of Designation
for the Series A provides, among other things, for dividend payments to the
named holders thereof, equal to sixty-six and two thirds, (66.67%) of cash
distributions received by ADAC from Gateway, and an unanimous vote of the Series
A to exercise the Equity Participation Option as further described below.
The Agreement provides, among other things, that ADAC will receive, during the
term of the additional financing, one-half (50%) of the price upside portion
only, if any, of the monthly fee to be received by Gateway from the Madisonville
Project. The Agreement also provides that ADAC will have the option to either:
(i) receive at the end of the Balloon Note term a lump-sum payment, which when
added to the payments received, if any, for the price upside portion, will
result in a 15% pre-tax internal rate of return on the $900,000, or (ii) to
exercise the Equity Participation Option by paying off the Balloon Note on or
before the end of the Balloon Note term in exchange for a thirty-three and
one-third (33.33%) ownership interest in the Pipeline Facilities from that date
forward. Gateway is obligated to pay the periodic interest payments on the
Balloon Note during the three year term of the Balloon Note. Further, Gateway
has granted liens to ADAC, subordinate to its banks, on its economic interest in
the Madisonville Project and certain other natural gas operating systems and
natural gas operating assets. The Agreement contains cross collateral and cross
default provisions linking it to an additional Gateway term note at the same
bank, the proceeds of which were used by Gateway to fund the Madisonville
Project.
The Madisonville Project is operated under a long-term agreement between
Gateway, Hanover Compression Limited Partnership, and Redwood Energy Production,
L. P. and is designed to treat gas to remove impurities from the gas to enable
the gas to meet pipeline sales quality specifications. The Madisonville Project
employs the state-of-the-art, patented, absorption based technology developed by
Advanced Extraction Technologies, Inc., for which Gateway has the exclusive U.
S. license, to remove nitrogen from the gas.
During the quarter ended June 30, 2005, the Company's wholly owned subsidiary
(ADAC) accrued $33,750, the minimum guaranteed return and received $44,044 in
price upside payments. These payments were offset to the accrued minimum
guaranteed return. During the quarter ADAC also accrued Series A Preferred Stock
12
dividends payable of $22,500, representing 66-2/3% of such minimum guaranteed
return and paid cash dividends of $29,379. The dividends are not payable until
such time as ADAC receives project cash distributions from Gateway. The plant
was deemed to be in service on October 1, 2003, which is the date that the price
up side provisions of the agreement became effective.
To implement the provisions, terms and conditions of the various agreements
including the Certificate of Designation for the ADAC Series A Preferred Stock:
(i) Larry J. Horbach and Christopher D. Davis were appointed to the Board of
Directors of the Registrant to fill the vacancies created by the resignation of
two directors following the Registrant's emergence from it's Chapter XI
Reorganization, serving until elected at the next meeting of shareholders; and
(ii) Mr. Horbach resigned as a director of ADAC, with that position then being
filled by Mr. Davis. The Registrant, as the sole shareholder of ADAC, effected
such ADAC director changes and entered into an agreement to amend the ADAC
By-laws to provide that the number of ADAC directors shall be fixed at three as
long as any Series A Preferred Shares remain outstanding. In addition, Mr. Davis
as well as the Registrant's President, Charles Holtgraves, were elected to the
ADAC board of directors.
Mr. Holtgraves is currently a director of Gateway. Mr. Horbach, who was a
director of Gateway for several years, resigned his directorship on August 27,
2004. Mr. Davis has no affiliation with Gateway. Mr. Holtgraves owns 14.65% of
an entity that owns 55.56% of the ADAC Series A Preferred Stock. Mr. Davis
serves as the Trustee of the Davis Investment Management Trust for the Davis
Investments VI LP, which LP owns 44.44% of the ADAC Series A Preferred Stock.
Mr. Horbach owns no ADAC common stock or Series A Preferred Stock.
Reference is made to the Subsequent Event footnote herein for additional
information concerning this agreement
GulfWest Energy Inc. Joint Venture
On July 21, 2004, the Company entered into a Letter of Intent, subject to the
execution of definitive agreements, with GulfWest Energy Inc. ("GWEI") located
in Houston, Texas, under which the Company and GWEI, through one or more Joint
Venture LLCs, would develop certain oil and gas assets owned by GWEI in Grimes
and Madison County, Texas. Certain of the Madison County reserves, if developed
and produced, are expected to require treatment similar to that as earlier
described in the Madisonville Project. On October 14, 2004, the Company, through
ADAC, became a member of a Texas LLC (Elgin Holdings, LLC) (the "LLC") ("Elgin")
with GWEI for the purpose of initially developing certain portions of the GWEI
oil and gas asset bases in Madison County and Hardin County, Texas.
Participation in the development of the Grimes County asset base by ADAC was
deferred and will not be a part of this LLC. GWEI contributed certain assets
valued at approximately $540,000, and the Company committed to provide up to
$595,000 in initial capital funding to the LLC as provided for in the LLC's
Regulations. Through March 31, 2005 the Company had funded $485,000, leaving a
balance of $110,000 remaining to be funded in the current fiscal year. The
capital funding is being raised by ADAC through a private placement of a new
series (Series B) of participating preferred stock. The various agreement
transaction requirements were completed on November 15, 2004. The transaction
agreements included among other items, an operating and management agreement
with a wholly-owned subsidiary of GWEI and a gas purchase agreement with a
wholly-owned subsidiary of GWEI. The Company owns 52.5% of the LLC, and holds
two of the three manager positions, such positions filled by Charles A.
Holtgraves and Larry J. Horbach, directors and officers of the Registrant.
13
The initial capital funding was raised by ADAC through a private placement of
595 shares of a new series preferred stock. The Senior Series B Preferred Stock,
Stated Value $1,000 per share provides, among other things, for a preferential
dividend right based on the Company's proportionate interest in the operations
and cash flow from Elgin, and a preferential liquidation right consisting of a
proportionate share of the Company's Capital Account in Elgin.
Charles Holtgraves, Philip Holtgraves, Larry Horbach and Christopher Davis are
directors of the Registrant. Charles Holtgraves, Philip Holtgraves and Mr.
Horbach are officers of the Registrant. Entities in which these individuals
either control or have an interest in, have subscribed for 577 of the 595
authorized shares.
AER/Elgin and Gateway Energy Corporation Agreement
On November 15, 2004, AER and Elgin entered into a LICENSE AGREEMENT (the
"Agreement") with Gateway Energy Corporation and certain of its subsidiaries.
The Agreement, provides, among other things, for the granting of a sublicense to
AER and Elgin to enable Elgin to treat the gas produced from the leasehold
interests owned by Elgin in Madison County, Texas, which interests fall within a
defined Area of Mutual Interest, ("AMI"). The AMI is described in certain
agreements with respect to the "The Gateway Energy/Madisonville Project
Agreement" discussed above. In addition, the Agreement provides that AER and
Elgin will dedicate the gas produced from its interests in the AMI to the
Madisonville Project plant and will advance up to $91,250 to Gateway, $30,413 of
which will represent a prepayment by the Company of the license and other fees
due Advanced Extraction Technologies ("AET") for the processing of a minimum of
5,000 Mcf per day. The balance of the advance ($60,837) will be repaid by
Gateway from Gateway's share of the initial project cash flows. The funds were
advanced in December 2004. The Agreement further grants to AER or its designees,
an option to participate pari passu with Gateway, subject to certain
limitations, interests in future projects which require the treatment of natural
gas containing high nitrogen, which projects utilize the AET license held by
Gateway.
NOTE D - NOTES PAYABLE
The following summarizes the Company's notes payable at June 30, 2005:
Due ARGUS, interest at prime, due on demand,
secured by substantially all of the assets of AER $199,950
Due to two officers and directors of the Company,
under an assignment by AFI Capital Corporation,
interest at 8%, unsecured, due on demand 75,000
Due to bank, interest at prime, due December 20, 2005,
with renewable terms, guaranteed by Mr. Horbach
and Mr. Holtgraves, officers and directors of the
Company 86,903
------
Notes Payable, All Current $361,853
--------
14
NOTE E - ACCOUNTS PAYABLE - RELATED PARTY
At June 30, 2005 accounts payable related parties, consisted of amounts due and
officer and director (Mr. Horbach) of the Company for un-reimbursed travel
expenses.
NOTE G - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at:
June 30, June 30,
2005 2004
----------- -----------
Non evaluated, non producing leaseholds $ 537,563 $ --
Plant and equipment 520,145 --
----------- -----------
$ 1,057,708 $ --
Accumulated depreciation (16,810) --
----------- -----------
$ 1,040,898 $ --
=========== ===========
Depreciation provided $ 15,077 $ --
=========== ===========
Office Lease
On August 31, 2004, the Company entered into a month to month lease for office
space and equipment located at 5799 Broadmoor, Suite 750, Mission, KS, 66203, at
a cost of $1,000 per month with a former subsidiary of the Company.
NOTE H- RELATED PARTIES
Larry J. Horbach who was appointed to fill a vacant director's position in May
2003, and Charles A. Holtgraves, the Chairman of the Board and President of the
Registrant are also directors of Gateway Energy Corporation. Mr. Horbach
resigned as a director from Gateway on August 27, 2004.
Mr. Horbach is the President and Chairman of the Board of AFI Capital
Corporation. Mr. Holtgraves is a director of AFI Capital Corporation. Mr.
Holtgraves resigned as a director of AFI Capital Corporation on August 27, 2004.
Argus Investment Group, Inc. ("ARGUS ") is a family owned corporation involved
in venture capital lending and financing. The stock of ARGUS is 100% owned by
the Philip J. Holtgraves Irrevocable Trust DTD 9/20/93. Philip J. Holtgraves is
the Chairman of ARGUS , a Director of the Registrant and the father of Charles
A. Holtgraves. Charles A. Holtgraves is the President of ARGUS and Chairman,
President and Director of the Registrant.
15
Charles Holtgraves, Philip Holtgraves, Larry Horbach and Christopher Davis are
directors of the Registrant. Charles Holtgraves, Philip Holtgraves and Mr.
Horbach are officers of the Registrant. Entities in which these individuals
either control or have an interest in, have subscribed for 577 of the 595
authorized ADAC Series B Preferred Stock shares being issued in connection with
the Elgin Holdings, LLC joint venture.
Mr. Holtgraves owns 14.65% of an entity that owns 55.56% of the ADAC Series A
Preferred Stock. Mr. Davis serves as the Trustee of the Davis Investment
Management Trust for the Davis Investments VI LP, which LP owns 44.44% of the
ADAC Series A Preferred Stock. Mr. Horbach owns no ADAC common stock or Series A
Preferred Stock.
In December, 2004, 103,000 shares of the Company's common stock were issued to
Mr. Horbach for services rendered in connection with the completion of the
restructuring and recapitalization of the Company.
NOTE I- SUBSEQUENT EVENT
On July 26, 2005, ADAC executed an "Amendment To Agreement" (the "Amendment"),
which Amendment modified certain provisions of the March 6, 2003, agreement
between ADAC and Gateway Energy Corporation as related to the Madisonville
Project Pipeline Facilities. The Amendment was necessary to enable Gateway to
sell certain of the Pipeline Facilities. The Amendment provides among other
things for; (a) a waiver of the notification by ADAC of it's election to pay off
the $900,000 Term Note and exercise of the Equity Participation Option; (b)
receipt by ADAC of certain consideration pursuant to a May 7, 2004 amendment to
the 2003 agreement, and; (c) the transfer to a newly formed LLC, which LLC will
be owned by ADAC (33.33%) and by Gateway (66.67%), of the 10" Transportation
System along with certain ancillary equipment, and a Transportation Agreement
between Gateway and the purchaser of the Pipeline Facilities. The transactions
were closed and funded on August 30, 2005.
16
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
GENERAL
- -------
Effective April 1, 2004, the Company completed a restructuring and changed its
business focus to the energy industry, having disposed of all of its financial
service related operations.
The following discussion of the financial condition and results of operations of
the Company should be read in conjunction with the consolidated financial
statements and notes thereto included elsewhere in this report particularly
those dealing with the Exchange Transaction and the Subsequent Events footnote.
This discussion contains forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ materially from those
anticipated in any forward-looking statements included herein. In addition,
because of the change to a new business strategy, the Company will be subject to
all of the energy industry common and traditional risks associated with the
economic production of hydrocarbons including, but not limited to, acquisition
of reserves that can produce adequate returns to attract the necessary
investment capital to develop such reserves, the petroleum engineering of
underground oil and gas reserves, drilling of the wells, and the fluctuation of
hydrocarbon prices. The Company has limited capital resources and management has
somewhat limited experience with respect to this segment of the energy industry.
Accordingly, the Company is utilizing the joint venture approach to mitigate
these risks.
RESULTS OF OPERATIONS
- ---------------------
Three Month's Ended June 30, 2004
- ---------------------------------
Liquidity and Capital Resources
- -------------------------------
As of December 31, 2003, the accumulation of debt to ARGUS had grown to a point
where the Company could no longer service this outstanding debt given the
downsizing of the Company that was the result of the reorganization and
restructuring of the various AIH segment operations. Also during these years,
and to the current date, the current President and Treasurer of the Company did
not draw a salary, nor were any amounts accrued with respect thereto. With the
completion of the Madisonville Project investment, and the joint venture with
GulfWest Energy Inc. as discussed later, the Company had determined that the
ability to generate long-term value for the common shareholders could be
enhanced if the present Company operations, (AIH) were sold and the Company
concentrated its growth efforts in the energy industry, focusing primarily on
natural gas. In accordance with this business strategy, an agreement was entered
into with ARGUS, subject to common shareholder approval, wherein the common
shares of AIH would be exchanged for an assumption by ARGUS of all of the AIH
liabilities (the "Exchange Transaction"). The Board of Directors engaged an
17
investment banking firm (Morgan Stanley) to determine the fair market value of
the AIH operations on a going concern basis. Morgan Stanley, through its
SPARDATA affiliate, determined such value to be $345,000. On March 24, 2004, the
Company received the requisite affirmative consent votes from the common
shareholders to effect the Exchange Transaction. The Exchange Transaction was
effective at the beginning of business on April 1, 2004. In the Exchange
Transaction, ARGUS assumed $1,661,719 of liabilities, (including $1,308,858 of
notes payable, substantially all of which carried a prime interest rate),
resulting in a gain to the Company on the exchange of $1,569,476
Subsequent to June 30, 2004 the Company entered into two transactions which
significantly impacted the Company-
GulfWest Energy Inc. Joint Venture
On July 21, 2004, the Company entered into a Letter of Intent, subject to the
execution of definitive agreements, with GulfWest Energy Inc. ("GWEI") located
in Houston, Texas, under which the Company and GWEI, through one or more Joint
Venture LLCs, would develop certain oil and gas assets owned by GWEI in Grimes
and Madison County, Texas. Certain of the Madison County reserves, if developed
and produced, are expected to require treatment similar to that described in the
Madisonville Project as discussed earlier under the April 30, 2003 Gateway
Energy Corporation Agreement. On October 14, 2004, the Company, through its
wholly owned subsidiary, Allen Drilling Acquisition Company ("ADAC"), became a
member of a Texas LLC (Elgin Holdings, L.L.C.) (the "LLC") ("Elgin") with GWEI
for the purpose of initially developing certain portions of the GWEI oil and gas
asset bases in Madison County and Hardin County, Texas. Participation in the
development of the Grimes County asset base by ADAC was deferred and will not be
a part of this LLC. GWEI contributed certain assets valued at approximately
$540,000, and the Company committed to provide up to $595,000 in initial capital
funding to the LLC. The Company owns 52.5% of the LLC, and hold two of the three
manager positions, such positions filled by Charles A. Holtgraves and Larry J.
Horbach, directors and officers of the Registrant. The various agreement
transaction requirements were completed on November 15, 2004, including the
required cash initial capital funding requirements. The transaction agreements
included among other items, an operating and management agreement with a
wholly-owned subsidiary of GWEI and a gas purchase agreement with a wholly-owned
subsidiary of GWEI.
The initial capital funding was raised by ADAC through a private placement of
595 shares of a new series preferred stock. The Senior Series B Preferred Stock,
Stated Value $1,000 per share provides, among other things, for a preferential
dividend right based on the Company's proportionate interest in the operations
and cash flow from Elgin, and a preferential liquidation right consisting of a
proportionate share of the Company's Capital Account in Elgin.
Charles Holtgraves, Philip Holtgraves, Larry Horbach and Christopher Davis are
directors of the Registrant. Charles Holtgraves, Philip Holtgraves and Mr.
Horbach are officers of the Registrant. Entities in which these individuals
either control or have an interest in, have subscribed for 577 of the 595
authorized shares.
18
The Company/Elgin and Gateway Energy Corporation Agreement
On November 15, 2004, the Company and Elgin entered into a LICENSE AGREEMENT
(the "Agreement") with Gateway Energy Corporation and certain of its
subsidiaries. The Agreement, provides, among other things, for the granting of a
sublicense to the Company and Elgin to enable Elgin to treat the gas produced
from the leasehold interests owned by Elgin in Madison County, Texas, which
interests fall within a defined Area of Mutual Interest, ("AMI"). In addition,
the Agreement provides that the Company and Elgin will dedicate the gas produced
from its interests in the AMI to the Madisonville Project plant and will advance
up to $91,250 to Gateway, in the form of a prepayment, the license and other
fees due Advanced Extraction Technologies ("AET") for the processing of a
minimum of 5,000 Mcf per day. The Agreement further grants to the Company or its
designees, an option to participate pari passu with Gateway, subject to certain
limitations, in future projects which require the treatment of natural gas
containing high nitrogen, which projects utilize the AET license held by
Gateway.
Operations
- ----------
The revenues for the three months ended June 30, 2004 consisted of the interest
and guaranteed return from the Madisonville Project. During the quarter ended
June 30, 2004, the Company's wholly owned subsidiary (ADAC) accrued $33,750, the
minimum guaranteed return and received $26,453 in price upside payments. These
payments were offset to the accrued minimum guaranteed return. During the
quarter ended June 30, 2004, ADAC also accrued Series A Preferred Stock
dividends payable of $22,511, representing 66-2/3% of such minimum guaranteed
return and paid cash dividends of $16,569. The dividends are not payable until
such time as ADAC receives project cash distributions from Gateway. The plant
was deemed to be in service on October 1, 2003, which is the date that the price
up side provisions of the agreement became effective.
Operating income was $17,943 after general and administrative costs of $13,015
and interest of $3,740, generating net positive cash flow of $18,944. Such
general and administrative costs are not indicative of future operations as the
sole three employees/officers of the Company (Charles Holtgraves, Philip
Holtgraves and Larry Horbach) have waived current compensation in order to
preserve cash flow for Company investment in on going projects. For such waiver
of current compensation, these individuals have been given the right to invest
on a pari-passu basis in these initial high risk capital projects along side the
Company and other outside accredited investors. To date, entities in which these
individuals either control or have an interest in, have provided a majority of
all of the capital invested in the initial energy projects described above.
During the quarter ended June 30, 2004, the Company recognized a gain on the
Exchange Transaction of $1,569,476. Such gain was the difference between the
ARGUS obligations cancelled and the AIH operation's net assets (assets less
liabilities assumed by ARGUS).
19
RESULTS OF OPERATIONS
- ---------------------
Three Month's Ended June 30, 2005
- ---------------------------------
Liquidity and Capital Resources
- -------------------------------
At June 30, 2005, the Company had an excess of current liabilities over current
assets of $509,822. Included, however, in the current liabilities are
approximately $343,000 of obligations due to related parties, (officers and
directors of the Company or entities controlled by such officers and directors),
and approximately $139,000 of subsidiary accrued preferred stock dividends,
substantially all of which actual dividend payments are subject to and based on
cash distributions from projects.
The Company has not yet called the final Series B Preferred Stock subscription
of $108,450, which subscription is not shown in current assets. The Company
intends to call this subscription at the beginning of the third quarter.
The Company believes that with the above matters and the subsequent event
described below, that it will be able to meet its obligations.
SUBSEQUENT EVENT
In July 26, 2005, ADAC executed an "Amendment To Agreement" (the "Amendment"),
which Amendment modified certain provisions of the March 6, 2003, agreement
between ADAC and Gateway Energy Corporation as related to the Madisonville
Project Pipeline Facilities. The Amendment was necessary to enable Gateway to
sell certain of the Pipeline Facilities. The Amendment provides among other
things for; (a) a waiver of the notification by ADAC of it's election to pay off
the $900,000 Term Note and exercise of the Equity Participation Option; (b)
receipt by ADAC of certain consideration pursuant to a May 7, 2004 amendment to
the 2003 agreement, and; (c) the transfer to a newly formed LLC, which LLC will
be owned by ADAC (33.33%) and by Gateway (66.67%), of the 10" Transportation
System along with certain ancillary equipment, and a Transportation Agreement
between Gateway and the purchaser of the Pipeline Facilities. The transactions
were closed and funded on August 30, 2005.
On August 30, 2005,
Operations
- ----------
The revenues for the quarter ended June 30, 2005 consisted of the interest and
guaranteed return from the Madisonville Project and a limited amount of revenue
from sales of gas from the Saratoga Project. During the quarter ended June 30,
2005, the Company's wholly owned subsidiary (ADAC) accrued $33,750, the minimum
guaranteed return and received $44,044 in price upside payments. These payments
were offset to the accrued minimum guaranteed return. During the quarter ADAC
accrued Series A Preferred Stock dividends payable of $22,500, representing
66-2/3% of such minimum guaranteed return and paid cash dividends of $29,379.
ADAC also began accruing dividends at the stated 10% rate on the Series B
Preferred Stock. The dividends are not payable until such time as ADAC receives
project cash distributions from Gateway and Elgin.
The operations for the quarter resulted in a loss of $81,596 substantially all
of which was the result of the start up of the Hardin County operations
(Saratoga Project), which start up was initiated in late March of 2005.
20
Operating expenses including depreciation, direct general and administrative
expenses, and the cost of gas purchased for processing totaled approximately
$121,440, while the revenues were approximately $25,150 (only sales of natural
gas, with no liquids sales) resulting in an operating loss within Elgin of
$96,292. The minority interest in Elgin reduced this loss to the Company's
common shareholders by $45,739. During August, 2005, substantial changes were
made in the basic processing system, including the return of several leased
equipment items to the suppliers in an effort to lower the operating costs.
The operating loss includes general and administrative costs of $15,746 and
interest of $5,721. Such general and administrative costs are not indicative of
future operations as the sole three employees/officers of the Company (Charles
Holtgraves, Philip Holtgraves and Larry Horbach) have waived current
compensation in order to preserve cash flow for Company investment in on going
projects. For such waiver of current compensation, these individuals have been
given the right to invest on a pari-passu basis in these initial high risk
capital projects along side the Company and other outside accredited investors.
To date, entities in which these individuals either control or have an interest
in, have provided a majority of all of the capital invested in the initial
energy projects described above. The interest expense results from bank
borrowings related to the License Agreement described earlier, and certain
carryover debt from the Exchange Transaction.
Part II
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. Exhibits and Reports on Form 8-K
On August 1, 2005, the Registrant filed a Form 8-K reporting
under Item 1.01--ENTRY INTO A MATERIAL DEFINITIVE AGREEMENT.
Exhibit 31.1 - Certification of CEO pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 - Certification of CEO/CFO pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
21
SIGNATURES
----------
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
ADVANCED ENERGY RECOVERY, INC.
(Registrant)
Dated: 09/14/2005 By: /s/ Charles A. Holtgraves
--------------------------------
Charles A. Holtgraves
Chairman, President, and
Treasurer
22