Filed pursuant to Rule 424(b)(3)
Registration No. 333-125539
Prospectus
PETROSEARCH ENERGY CORPORATION
16,108,524 SHARES OF COMMON STOCK
This prospectus relates to the offering for resale of up to 7,966,710 shares of
our common stock, $0.001 par value currently held by certain selling
stockholders and 8,141,814 shares of common stock underlying the warrants
currently held by certain selling stockholders. For a list of the selling
stockholders, please see "Selling Stockholders." We are not selling any shares
of our Common Stock in this offering and therefore will not receive any proceeds
from the sale thereof. We may, however, receive proceeds upon the exercise of
the warrants held by certain selling stockholders for which we are registering
the underlying shares in the event that such warrants are exercised and paid
for. We will bear all expenses, other than selling commissions and fees of the
selling stockholders, in connection with the registration and sale of the shares
being offered by this prospectus.
These shares may be sold by the selling stockholders from time to time in the
over-the-counter market or other national securities exchange or automated
inter-dealer quotation system on which our Common Stock is then listed or
quoted, through negotiated transactions or otherwise at market prices prevailing
at the time of sale or at negotiated prices.
Our Common Stock currently trades in the over-the-counter market and is quoted
on the Over the Counter Bulletin Board under the symbol "PTSG.OB." On May 9,
2006, the last reported sales price of our Common Stock was $1.38 per share.
INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISKS. PLEASE REFER TO
THE "RISK FACTORS" BEGINNING ON PAGE 2.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES, OR DETERMINED IF
THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
THE DATE OF THIS PROSPECTUS IS JUNE 8, 2006.
PETROSEARCH ENERGY CORPORATION
675 BERING DRIVE, SUITE 200
HOUSTON, TEXAS 77057
(713) 961-9337
TABLE OF CONTENTS
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PROSPECTUS SUMMARY . . . . . . . . . . . . . . . . . . . . . 1
RISK FACTORS . . . . . . . . . . . . . . . . . . . . . . . . 2
CAUTIONARY STATEMENT CONCERNING
FORWARD LOOKING STATEMENTS. . . . . . . . . . . . . . 13
THE BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . 14
LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . . 25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION. . . . . . . . . . 26
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS . . 38
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE. . . . . . . . 39
USE OF PROCEEDS. . . . . . . . . . . . . . . . . . . . . . . 39
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS 40
SECURITY OWNERSHIP OF CERTAIN
BENEFICAL OWNERS AND MANAGEMENT . . . . . . . . . . . 47
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS . . . . 48
SELLING STOCKHOLDERS . . . . . . . . . . . . . . . . . . . . 49
PLAN OF DISTRIBUTION . . . . . . . . . . . . . . . . . . . . 55
DESCRIPTION OF SECURITIES. . . . . . . . . . . . . . . . . . 57
INTEREST OF NAMED EXPERTS AND COUNSEL. . . . . . . . . . . . 59
EXPERTS. . . . . . . . . . . . . . . . . . . . . . . . . . . 60
RESERVE ENGINEERS. . . . . . . . . . . . . . . . . . . . . . 60
COMMISSION POSITION OF INDEMNIFICATION FOR
SECURITIES ACT LIABILITIES. . . . . . . . . . . . . . 60
WHERE YOU CAN FIND MORE INFORMATION. . . . . . . . . . . . . 61
FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . F-1
PROSPECTUS SUMMARY
The following summary highlights material information contained in this
prospectus. This summary does not contain all of the information you should
consider before investing in the securities. Before making an investment
decision, you should read the entire prospectus carefully, including the risk
factors section, the financial statements and the notes to the financial
statements. You should also review the other available information referred to
in the section entitled "Where you can find more information" on page 61 in this
prospectus and any amendment or supplement hereto. Unless otherwise indicated,
the terms the "Company," "we," "us," and "our" refer and relate to Petrosearch
Energy Corporation and its consolidated subsidiaries.
THE COMPANY
Petrosearch Energy Corporation, a Nevada corporation formed in November 2004, is
an independent crude oil and natural gas exploration and production company. We
are the successor of Petrosearch Corporation, a Texas corporation formed in
August 2003. All references to capitalization and business operations herein
apply to our current capitalization and operating history, including our
predecessor, Petrosearch Texas. We have established production in North Dakota,
Texas and Oklahoma, and are currently engaged in exploration and development
activities, including direct operator activities, through its subsidiary,
Petrosearch Operating Company, LLC, in North Dakota, Texas, Oklahoma,
Mississippi, and Louisiana. We continue to implement our business plan which is
to find high quality prospects and projects and provide the capital, along with
the technical, operational and administrative support and management oversight,
needed to develop the projects. (see "Business Plan" and "Business Model"
sections herein).
THE OFFERING
Outstanding 31,099,570 shares (as of May 9, 2006).
Common Stock
Common Stock Up to 7,966,710 shares of common stock held by certain selling stockholders and
Offered 8,141,814 shares of common stock issuable upon the exercise of warrants, which
warrants have an exercise price range of $0.98 to $9.75 per share (with a weighted
average price of $3.40).
Offering Price Determined at the time of sale by the selling stockholders.
Proceeds We will not receive any proceeds from the sale of the common stock offered by the
selling stockholders that may be sold pursuant to this prospectus. We will, however,
receive proceeds of approximately $30,155,506 upon the exercise of and payment for
the warrants held by certain selling stockholders for which we have registered the
underlying shares, if all such warrants are exercised. Proceeds, if any, received from
the exercise of warrants will be used for general corporate purposes.
Risk Factors The securities offered hereby involve a high degree of risk. See "Risk Factors" herein.
Page 1
RISK FACTORS
An investment in our Common Stock involves a high degree of risk. You should
carefully consider the risks described below before deciding to purchase shares
of our Common Stock. If any of the events, contingencies, circumstances or
conditions described in the risks below actually occurs, our business, financial
condition or results of operations could be seriously harmed. The trading price
of our Common Stock could, in turn, decline and you could lose all or part of
your investment.
RISKS RELATED TO THE COMPANY AND THE OFFERING
OUR LIMITED HISTORY MAKES AN EVALUATION OF US AND OUR FUTURE EXTREMELY
DIFFICULT, AND PROFITS ARE NOT ASSURED.
We have a limited operating history, having begun commercial drilling operations
in August 2003. There can be no assurance that we will be profitable in the
future or that the shareholders' investments in us will be returned to them in
full, or at all, over time. In view of our limited history in the oil and gas
exploration business, an investor must consider our business and prospects in
light of the risks, expenses and difficulties frequently encountered by
companies in their early stage of development. There can be no assurance that we
will be successful in undertaking any or all of the activities required for
successful commercial drilling operations. Our failure to undertake successfully
such activities could materially and adversely affect our business, prospects,
financial condition and results of operations. In addition, there can be no
assurance that our exploration and production activities will produce oil and
gas in commercially viable quantities, if any at all. There can be no assurance
that sales of our oil and gas production will ever generate significant
revenues, that we will ever generate additional positive cash flow from our
operations or that we will be able to achieve or sustain profitability in any
future period.
IT IS POSSIBLE THAT OUR INTEREST IN THE BARNETT SHALE PROJECT COULD BE DECREASED
OR ENTIRELY PRECLUDED.
We have entered various agreements with Harding Company to participate in the
Barnett Shale project in five counties in North Texas. As discussed herein, we
subsequently learned that Harding had not obtained from ExxonMobil a consent to
transfer and waiver of ExxonMobil's preferential purchase right. On May 9, 2006,
we entered a Heads of Agreement with Exxon Mobil Corporation, Harding Company,
Eagle Oil & Gas Co., PS Gas Partners, LLC, and Gas Partners, L.P. (the
"ExxonMobil/Harding Agreement"). The ExxonMobil/Harding Agreement addresses the
economic terms of the proposed project, provides the alternative structure under
which the new integrated venture in the Barnett Shale Project will operate, and
provides the structure within which the parties will negotiate definitive
agreements. Formation of the new integrated venture is conditioned upon
execution of definitive agreements. The ExxonMobil/Harding Agreement also
extends for 60 days Exxon Mobil Corporation's preferential purchase rights and
preserves all Petrosearch's legal rights under the Amended and Restated Program
Agreement. In the event that the parties cannot formulate the Definitive project
agreements before July 8, 2006, Exxon Mobil Corporation could exercise its
preferential purchase right which, if exercised, would prevent our participation
in the project. In the event of such a loss of this opportunity to participate
in the project, our legal rights are not prejudiced by the Heads of Agreement
and we would then expect to pursue all potential remedies available to us
relating to the factual circumstances surrounding these agreements.
WE HAVE EXPERIENCED RECENT SUBSTANTIAL OPERATING LOSSES AND MAY INCUR ADDITIONAL
OPERATING LOSSES IN THE FUTURE.
During the twelve month period ended December 31, 2005 and the three-month
period ended March 31, 2006, we incurred net losses of $2,901,031 and $844,630,
respectively. In the event we are unable to increase our gross margins, reduce
our costs and/or generate sufficient additional revenues to offset our
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increased costs, we may continue to sustain losses and our business plan and
financial condition will be materially and adversely affected.
SHAREHOLDERS COULD INCUR NEGATIVE IMPACT DUE TO THE REGISTRATION OF A
SIGNIFICANT NUMBER OF SHARES AND THE REMOVAL OF THE LEGEND ON OUTSTANDING SHARES
OF COMMON STOCK.
The registration of up to 16,108,524 shares pursuant to this registration
statement will increase the number of common shares which could be sold in the
public market. Additionally, as of May 2006, approximately 2,066,069 shares of
our common stock were eligible to be sold pursuant Rule 144 of the Securities
Act of 1933, as amended. In the event that a substantial number of these shares
are offered for sale in the market by several holders, the market price of our
common stock could be adversely affected. The availability of public trading for
such a large number of shares may have an adverse effect on the trading prices
of our common stock. Further, we are not engaging an underwriter to assist in a
distribution of shares on behalf of the selling stockholders. No prediction can
be made as to the effect, if any, that sales of shares of our common stock or
the availability of such shares for sale will have on the market prices
prevailing from time to time. Nevertheless, the possibility that substantial
amounts of common stock may be sold in the public market would likely have an
adverse effect on prevailing market prices for the common stock.
THE TRADING PRICE OF OUR COMMON STOCK ENTAILS ADDITIONAL REGULATORY
REQUIREMENTS, WHICH MAY NEGATIVELY AFFECT SUCH TRADING PRICE.
The trading price of our common stock is below $5.00 per share. As a result of
this price level, trading in our common stock would be subject to the
requirements of certain rules promulgated under the Securities Exchange Act of
1934, as amended. These rules require additional disclosure by broker-dealers in
connection with any trades generally involving any non-NASDAQ equity security
that has a market price of less than $5.00 per share, subject to certain
exceptions. Such rules require the delivery, before any penny stock transaction,
of a disclosure schedule explaining the penny stock market and the risks
associated therewith, and impose various sales practice requirements on
broker-dealers who sell penny stocks to persons other than established customers
and accredited investors (generally institutions). For these types of
transactions, the broker-dealer must determine the suitability of the penny
stock for the purchaser and receive the purchaser's written consent to the
transaction before sale. The additional burdens imposed upon broker-dealers by
such requirements may discourage broker-dealers from effecting transactions in
our common stock. As a consequence, the market liquidity of our common stock
could be severely affected or limited by these regulatory requirements.
IN THE FUTURE, WE WILL INCUR SIGNIFICANT INCREASED COSTS AS A RESULT OF
OPERATING AS A PUBLIC COMPANY, AND OUR MANAGEMENT WILL BE REQUIRED TO DEVOTE
SUBSTANTIAL TIME TO NEW COMPLIANCE INITIATIVES.
Due to the effectiveness of our registration statement on September 8, 2005, we
have begun to incur significant legal, accounting and other expenses as a
fully-reporting public company. In addition, the Sarbanes-Oxley Act of 2002, as
well as new rules subsequently implemented by the SEC, has imposed various new
requirements on public companies, including requiring changes in corporate
governance practices. Our management and other personnel will need to devote a
substantial amount of time to these new compliance initiatives. Moreover, these
rules and regulations will increase our legal and financial compliance costs and
will make some activities more time-consuming and costly. For example, we expect
these new rules and regulations to make it more difficult and more expensive for
us to obtain director and officer liability insurance, and we may be required to
incur substantial costs to maintain the same or similar coverage.
In addition, the Sarbanes-Oxley Act requires, among other things, that we
maintain effective internal controls for financial reporting and disclosure
controls and procedures. In particular, commencing in fiscal 2007, we must
perform system and process evaluation and testing of our internal controls over
financial reporting to allow management and our independent registered public
accounting firm to report
Page 3
on the effectiveness of our internal controls over financial reporting, as
required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the
subsequent testing by our independent registered public accounting firm, may
reveal deficiencies in our internal controls over financial reporting that are
deemed to be material weaknesses. Our compliance with Section 404 will require
that we incur substantial accounting expense and expend significant management
efforts. We currently do not have an internal audit group, and we will need to
hire additional accounting and financial staff with appropriate public company
experience and technical accounting knowledge. Moreover, if we are not able to
comply with the requirements of Section 404 in a timely manner, or if we or our
independent registered public accounting firm identifies deficiencies in our
internal controls over financial reporting that are deemed to be material
weaknesses, the market price of our stock could decline, and we could be subject
to sanctions or investigations by the SEC or other regulatory authorities, which
would require additional financial and management resources.
OUR MANAGEMENT CONTROLS A SIGNIFICANT PERCENTAGE OF OUR CURRENT OUTSTANDING
COMMON STOCK AND THEIR INTERESTS MAY CONFLICT WITH THOSE OF OUR SHAREHOLDERS.
As of May 9, 2006, our Directors and executive officers and their respective
affiliates collectively and beneficially owned approximately 14% of our
outstanding common stock, including all warrants exercisable within 60 days.
This concentration of voting control gives our Directors and executive officers
and their respective affiliates substantial influence over any matters which
require a shareholder vote, including, without limitation, the election of
Directors, even if their interests may conflict with those of other
shareholders. It could also have the effect of delaying or preventing a change
in control of or otherwise discouraging a potential acquirer from attempting to
obtain control of us. This could have a material adverse effect on the market
price of our common stock or prevent our shareholders from realizing a premium
over the then prevailing market prices for their shares of common stock.
CUMULATIVE VOTING IS NOT AVAILABLE TO STOCKHOLDERS.
Cumulative voting in the election of Directors is expressly denied in our
Articles of Incorporation. Accordingly, the holder or holders of a majority of
the outstanding shares of our common stock may elect all of our Directors.
Management's large percentage ownership of our outstanding common stock helps
enable them to maintain their positions as such and thus control of our business
and affairs.
WE ARE DEPENDENT ON KEY PERSONNEL.
We depend to a large extent on the services of certain key management personnel,
including our executive officers and other key consultants, the loss of any of
which could have a material adverse effect on our operations. Specifically, we
rely on Mr. Richard Dole, Chairman, President and CEO, to maintain the strategic
direction of the Company. We also rely on Mr. Wayne Beninger, Chief Operating
Officer, to oversee the technical evaluation of projects as well as operations
of the Company. Although Messrs. Dole and Beninger currently serve under
employment agreements, there is no assurance that they will continue to be
employed by us. We do not maintain, nor do we plan to maintain, key-man life
insurance with respect to any of our officers or Directors.
WE ARE SUBJECT TO POTENTIAL LIABILITY FROM OPERATIONS.
We are subject to potential liability from our operations, such as injuries to
employees or third parties, which are inherent in the management of oil and gas
programs. While we intend to obtain and maintain appropriate insurance coverage
for these risks, there can be no assurance that our operations will not expose
us to liabilities exceeding such insurance coverage or to liabilities not
covered by insurance.
Page 4
OUR APPROACH TO TITLE ASSURANCE COULD MATERIALLY ADVERSELY AFFECT OUR BUSINESS
AND OPERATIONS.
We intend to purchase working and revenue interests in oil and gas leasehold
interests from third parties or directly from the mineral fee owners as the
inventory upon which we will perform our exploration activities. The existence
of a material title deficiency can render a lease worthless and can result in a
large expense to us. Title insurance covering the mineral leaseholds is not
generally available and in all instances, we forego the expense of retaining
lawyers to examine the title to the mineral interest to be placed under lease or
already placed under lease until the drilling block is assembled and ready to be
drilled. We rely upon the judgment of oil and gas lease brokers or experienced
landmen who perform the field work in examining records in the appropriate
governmental office before attempting to acquire or place under lease a specific
mineral interest. This is customary practice in the oil and gas industry. Our
operating agreements require us to obtain a preliminary title review of the
spacing unit within which the proposed oil and gas well is to be drilled prior
to drilling in order to ensure there are no obvious deficiencies in title to the
well. As a result of such examinations, certain curative work may have to be
performed to correct deficiencies in the marketability of the title, and such
curative work entails expense. The work might include obtaining affidavits of
heirship or causing an estate to be administered. Occasionally, the examination
made by the title lawyers reveals that the oil and gas lease or leases are
worthless, having been purchased in error from a person who is not the owner of
the mineral interest desired. In such instances, the amount paid for such oil
and gas lease or leases is generally lost. In general, the loss of a lease does
not create a material adverse effect, but if the defective lease covers acreage
which is critical to the success of a particular project, the loss could have a
material adverse effect by making the target area potentially undrillable. Our
customary practice is to obtain a drill site title opinion prior to drilling a
well.
WE MAY EXPERIENCE POTENTIAL FLUCTUATIONS IN RESULTS OF OPERATIONS.
Our future revenues may be affected by a variety of factors, many of which are
outside our control, including (a) the success of project results; (b) swings in
availability of drilling services needed to implement projects and the pricing
of such services; (c) a volatile oil and gas pricing market which may make
certain projects that we undertake uneconomic; (d) the ability to obtain new
prospects in a timely and effective manner; and (e) the amount and timing of
operating costs and capital expenditures relating to conducting our business
operations and infrastructure. As a result of our limited operating history and
the emerging nature of our business plan, it is difficult to forecast revenues
or earnings accurately, which may fluctuate significantly from quarter to
quarter.
WE RELY UPON AN EXISTING CREDIT FACILITY.
Our sole exiting credit facility has been provided by Fortuna Energy, L.P., a
private entity. Since a private entity is not governed by typical banking
regulations, the negotiated terms of the Fortuna Credit Facility are unique and
could, in given circumstances, be less favorable to us than traditional
financing. In September 2005, we amended and restated our revolving credit
agreement to $10 million which allowed Fortuna Energy, L.P. to participate in
the ownership and development of an eight prospect package in our inventory.
The significant provisions of the Credit Facility are as follows:
The Credit Facility matures on the 30-month anniversary of the initial
advance (which occurred on September 29, 2005) and may be prepaid at any
time. Repayment of each tranche borrowed shall be interest only for six
months and shall then amortize on a 30 month basis with all then
outstanding tranches due and payable April 1, 2008. The last date for
advances shall be October 15, 2007.
The proceeds may be utilized for past, present or future acquisitions of
oil and gas leases, including associated costs of technical review and
analysis, drilling, reworking, production, transportation, marketing and
plugging. The proceeds may also be used to fund all lender charges and
fees, including legal fees of Fortuna's counsel.
Page 5
Subject to the draw limitations and funds availability provisions described
below, we are required to utilize the funds from the Credit Facility to
fund lease acquisitions by our Beacon Petrosearch, L.L.C. and Anadarko
Petrosearch, L.L.C. subsidiaries before resorting to funds which may be
available internally or from third parties (other than drilling
co-venturers).
The collateral for the Credit Facility includes a first and prior lien on
the oil and gas leases acquired with Fortuna's funds, as well as the
equipment on any well drilled with Fortuna's funds. The collateral also
includes all existing and future lease interests in the eight project
package listed above and the State of Oklahoma, and all existing lease
interests in North Dakota (regardless of whether Fortuna's funds are
utilized in North Dakota) as well as our membership in Beacon Petrosearch,
L.L.C. and Anadarko Petrosearch, L.L.C.
Under the Credit Facility, Fortuna will receive a 2% overriding royalty
interest of Petroseach's proportionate net revenue interest in the leases
acquired or drilled using Fortuna's funds, as well as a like overriding
royalty in current leases held in Beacon Petrosearch, L.L.C. and certain
leases held in Anadarko Petrosearch, L.L.C. in Oklahoma. Under the terms of
the Credit Facility, principal is to be repaid in 24 monthly installments
equal to 1/30th of the principal commencing six months after the initial
advance, with the balance being paid at the maturity of the facility.
Interest shall be repaid under the Credit Facility at Wall Street Journal
prime +3% per annum payable monthly in arrears.
As of May, 9, 2006, the principal balance outstanding pursuant to the Credit
Facility was $5,207,500.
It is Management's intent to utilize the Credit Facility to acquire new leases
and develop existing leases with these funds, securing the debt with the
collateral required under the terms of the Credit Facility.
WE PARTICIPATE IN OIL AND GAS LEASES WITH THIRD PARTIES.
We may own less than 100% of the working interest in certain leases acquired by
us, and other parties will own the remaining portion of the working interest.
Financial risks are inherent in any operation where the cost of drilling,
equipping, completing and operating wells is shared by more than one person. We
could be held liable for the joint activity obligations of the other working
interest owners such as nonpayment of costs and liabilities arising from the
actions of the working interest owners. In the event other working interest
owners do not pay their share of such costs, we would likely have to pay those
costs. In such situations, if we were unable to pay those costs, we could become
insolvent.
WE MAY ISSUE ADDITIONAL SHARES OF COMMON STOCK IN THE FUTURE, WHICH COULD CAUSE
DILUTION TO ALL SHAREHOLDERS.
We may seek to raise additional equity capital in the future. Any issuance of
additional shares of our common stock will dilute the percentage ownership
interest of all shareholders and may dilute the book value per share of our
common stock.
WE DERIVE OUR REVENUES FROM A LIMITED NUMBER OF CUSTOMERS.
During the fiscal year ending December 31, 2005, we derived all of our revenues
from a limited number of customers (purchasers of oil and gas). Our revenues
from these customers were comprised of the following percentages: Eighty Eight
Oil, LLC- 51.8%; Gulfmark Energy, Inc.- 32.5%; Bear Paw Energy, LLC - 4.1%;
Plains Marketing - 10.1%; and others 1.5%. The loss of any particular customer
could have a material adverse impact on our financial condition if we are not
able to find another purchaser of comparable quantities of oil and gas.
However, we believe there is a sufficient market to support our revenues in the
event we were to lose all current customers given the commodity nature of our
product.
Page 6
EXPANSION OF OUR EXPLORATION PROGRAM WILL REQUIRE CAPITAL FROM OUTSIDE SOURCES.
We do not currently have the financial resources to explore and drill all of our
currently identified prospects. Absent raising additional capital or entering
into joint venture agreements, we will not be able to increase our exploration
and drilling operations at the projected rate. This could limit the size of our
business. There is no assurance that capital will be available in the future to
us or that capital will be available under terms acceptable to us. We will need
to raise additional money, either through the sale of equity securities (which
could dilute the existing stockholders' interest), through the entering of joint
venture agreements (which, while limiting our risk, could reduce our ownership
interest in particular assets), or from borrowings from third parties (which
could result in additional assets being pledged as collateral and which would
increase our debt service requirements).
Additional capital could be obtained from a combination of funding sources, many
of which could have a material adverse effect on our business, results of
operations and financial condition. These potential funding sources, and the
potential adverse effects attributable thereto, include:
- cash flow from operating activities, which is sensitive to prices we
receive for oil and natural gas and the success of current and future
operations;
- borrowings from financial institutions, which may subject us to
certain restrictive covenants, including covenants restricting our
ability to raise additional capital or pay dividends;
- debt offerings, which would increase our leverage and add to our need
for cash to service such debt (which could result in additional assets
being pledged as collateral and which could increase our debt service
requirements);
- additional offerings of equity securities, which would cause dilution
of our common stock;
- sales of prospects generated by the exploration program, which would
reduce futurerevenues from that program;
- additional sales of interests in our projects, which could reduce
future revenues; and
- arrangement of a business development loan from, or prepayment of
terminal use fees by, prospective sellers or purchasers of oil and
gas.
Our ability to raise additional capital will depend on the results of operations
and the status of various capital and industry markets at the time such
additional capital is sought. Accordingly, capital may not become available to
us from any particular source or at all. Even if additional capital becomes
available, it may not be on terms acceptable to us. Failure to obtain additional
financing on acceptable terms may have a material adverse effect on our
business, results of operations and financial condition.
WE DEPEND ON INDUSTRY VENDORS AND MAY NOT BE ABLE TO OBTAIN ADEQUATE SERVICES.
We are and will continue to be largely dependent on industry vendors for the
success of our oil and gas exploration projects. These contracted services
include, but are not limited to, accounting, drilling, completion, workovers
(remedial down hole work on a well) and reentries (entering an existing well and
changing the direction and/or depth of a well), geological evaluations,
engineering, leasehold acquisitoin (landmen), operations, legal, investor
relations/public relations, and prospect generation. We could be harmed if we
fail to attract quality industry vendors to participate in the drilling of
prospects which we
Page 7
identify or if our industry vendors do not perform satisfactorily. We often
have, and will continue to have, little control over factors that would
influence the performance of our vendors.
WE RELY ON THIRD PARTIES FOR PRODUCTION SERVICES AND PROCESSING FACILITIES.
The marketability of our production depends upon the proximity of our reserves
to, and the capacity of, facilities and third party services, including oil and
natural gas gathering systems, pipelines, trucking or terminal facilities, and
processing facilities. The unavailability or lack of capacity of such services
and facilities could result in the shut-in of producing wells or the delay or
discontinuance of development plans for properties. A shut-in or delay or
discontinuance could materially adversely affect our financial condition. In
addition, federal and state regulation of oil and natural gas production and
transportation affect our ability to produce and market oil and natural gas on a
profitable basis.
WE DO NOT OPERATE ALL PROJECTS.
We do not operate all properties in which we have an interest; as a result, we
may have limited ability to exercise influence over, and control the risks
associated with, operations of these properties. The failure of a well operator
to adequately perform operations, an operator's breach of the applicable
agreements or an operator's failure to act in ways that are in our best interest
could reduce our production and revenues. The success and timing of our
development activities on properties operated by others therefore depend upon a
number of factors outside of our control, including the operator's:
- timing and amount of capital expenditures;
- expertise and financial resources;
- inclusion of other participants in drilling wells; and
- use of technology.
OUR DIRECTORS AND OFFICERS HAVE LIMITED LIABILITY AND HAVE RIGHTS TO
INDEMNIFICATION.
Our Articles of Incorporation and Bylaws provide, as permitted by governing
Nevada law, that our Directors and officers shall not be personally liable to us
or any of our stockholders for monetary damages for breach of fiduciary duty as
a Director or officer, with certain exceptions. The Articles further provide
that we will indemnify our Directors and officers against expenses and
liabilities they incur to defend, settle, or satisfy any civil litigation or
criminal action brought against them on account of their being or having been
its Directors or officers unless, in such action, they are adjudged to have
acted with gross negligence or willful misconduct.
The inclusion of these provisions in the Articles may have the effect of
reducing the likelihood of derivative litigation against Directors and officers,
and may discourage or deter stockholders or management from bringing a lawsuit
against Directors and officers for breach of their duty of care, even though
such an action, if successful, might otherwise have benefited us and our
stockholders.
The Articles provide for the indemnification of our officers and Directors, and
the advancement to them of expenses in connection with any proceedings and
claims, to the fullest extent permitted by Nevada law. The Articles include
related provisions meant to facilitate the indemnitee's receipt of such
benefits. These provisions cover, among other things: (i) specification of the
method of determining entitlement to indemnification and the selection of
independent counsel that will in some cases make such determination, (ii)
specification of certain time periods by which certain payments or
determinations must be made and actions must be taken, and (iii) the
establishment of certain presumptions in favor of an indemnitee.
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Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to our directors, officers and controlling persons pursuant to the
foregoing provisions, we have been advised that in the opinion of the Securities
and Exchange Commission, such indemnification is against public policy as
expressed in the Securities Act and is therefore unenforceable.
GENERAL RISKS OF THE OIL AND GAS BUSINESS
INVESTMENT IN THE OIL AND GAS BUSINESS IS RISKY.
Oil and gas exploration and development is an inherently speculative activity.
There is no certain method to determine whether or not a given lease will
produce oil or gas or yield oil or gas in sufficient quantities and quality to
result in commercial production. There is always the risk that development of a
lease may result in dry holes or in the discovery of oil or gas that is not
commercially feasible to produce. There is no guarantee that a producing asset
will continue to produce. Because of the high degree of risk involved, there
can be no assurance that we will recover any portion of our investment or that
our investment in leases will be profitable.
WE ARE SUBJECT TO DRILLING AND OPERATIONAL HAZARDS.
The oil and gas business involves a variety of operating risks, including:
- blowouts, cratering and explosions;
- mechanical and equipment problems;
- uncontrolled flows of oil and gas or well fluids;
- fires;
- marine hazards with respect to offshore operations;
- formations with abnormal pressures;
- pollution and other environmental risks; and
- natural disasters.
Any of these events could result in loss of human life, significant damage to
property, environmental pollution, impairment of our operations and substantial
losses. Locating pipelines near populated areas, including residential areas,
commercial business centers and industrial sites, could increase these risks.
In accordance with customary industry practice, we will maintain insurance
against some, but not all, of these risks and losses. The occurrence of any of
these events not fully covered by insurance could have a material adverse effect
on our financial position and results of operations.
WE HAVE COMPETITION FROM OTHER COMPANIES.
A large number of companies and individuals engage in drilling for gas and oil,
and there is competition for the most desirable prospects. We will encounter
intense competition from other companies and other entities in the sale of our
gas and oil production. We could be competing with numerous gas and oil
companies which may have financial resources significantly greater than ours.
Further, the quantities of
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gas and oil to be delivered by us may be affected by factors beyond our control,
such as the inability of the wells to deliver at the necessary quality and
pressure, premature exhaustion of reserves, changes in governmental regulations
affecting allowable production and priority allocations and price limitations
imposed by federal and state regulatory agencies.
WE MAY BE UNABLE TO ACQUIRE OIL AND GAS LEASES.
To engage in oil and gas exploration, we must first acquire rights to conduct
exploration and recovery activities on identified prospects. We may not be
successful in acquiring "farm-outs" (agreements whereby the owner of lease
interests grants to a third party the right to earn an assignment of an interest
in the lease, typically by drilling one or more wells), permits, lease options,
leases or other rights to explore for or recover oil and gas. The U.S.
Department of the Interior and the states in which we and our subsidiaries
conduct operations award oil and gas leases on a competitive bidding basis.
Non-governmental owners of the onshore mineral interests within the area covered
by our exploration program are not obligated to lease their mineral rights to us
except where we have already obtained lease options. In addition, other major
and independent oil and gas companies with financial resources significantly
greater than ours may bid against us for the purchase of oil and gas leases. If
we or our subsidiaries are unsuccessful in acquiring these leases, permits,
options and other interests, our prospect inventory for exploration and drilling
could be significantly reduced, and our business, results of operations and
financial condition could be substantially harmed.
THE UNAVAILABILITY OR HIGH COST OF DRILLING RIGS, EQUIPMENT, SUPPLIES, PERSONNEL
AND OILFIELD SERVICES COULD MATERIALLY ADVERSELY IMPACT US.
Drilling activity in the area of our proposed initial activities is extremely
high. Increased drilling activity in these areas could decrease the availability
of rigs and our access to oilfield services. Either shortages or increases in
the cost of drilling rigs, equipment, supplies or personnel could delay or
adversely affect our operations. There can be no assurance that we will be able
to obtain the necessary equipment or services may not be available to us at
economical prices.
OIL AND GAS PRICES ARE VOLATILE.
Our revenues, cash flow, operating results, financial condition and ability to
borrow funds or obtain additional capital depend substantially on the prices
that we receive for oil and gas production. Declines in oil and gas prices may
materially adversely affect our financial condition, liquidity, ability to
obtain financing and operating results. Lower oil and gas prices also may
reduce the amount of oil and gas that we can produce economically. High oil and
gas prices could preclude acceptance of our business model. Depressed prices in
the future would have a negative effect on our future financial results.
Historically, oil and gas prices and markets have been volatile, with prices
fluctuating widely, and they are likely to continue to be volatile. Prices for
oil and gas are subject to wide fluctuations in response to relatively minor
changes in supply of and demand, market uncertainty and a variety of additional
factors that are beyond our control. These factors include:
- the domestic and foreign supply of oil;
- the level of consumer product demand;
- weather conditions;
- political conditions in oil producing regions, including the
Middle East;
Page 10
- the ability of the members of the Organization of Petroleum
Exporting Countries to agree to and maintain oil price and
production controls;
- the price of foreign imports;
- actions of governmental authorities;
- domestic and foreign governmental regulations;
- the price, availability and acceptance of alternative fuels; and
- overall economic conditions.
These factors and the volatile nature of the energy markets make it impossible
to predict with any certainty future oil and gas prices. Our inability to
respond appropriately to changes in these factors could negatively affect their
profitability.
WE MAY HAVE WRITEDOWNS OF OUR ASSETS DUE TO PRICE VOLATILITY.
SEC accounting rules require us to review the carrying value of our oil and gas
properties on a quarterly basis for possible write-down or impairment. Under
these rules, capitalized costs of proved reserves may not exceed a ceiling
calculated at the present value of estimated future net revenues from those
proved reserves. Capital costs in excess of the ceiling must be permanently
written down. A decline in oil and natural gas prices could cause a write down
which would negatively affect our net income.
ESTIMATES OF OIL AND GAS RESERVES ARE UNCERTAIN AND MAY VARY SUBSTANTIALLY FROM
ACTUAL PRODUCTION.
There are numerous uncertainties inherent in estimating quantities of proved
reserves and in projecting future rates of production and timing of
expenditures, including many factors beyond our control. Our oil and gas
reserves set forth in this prospectus represent the estimated quantities of oil
and gas based on reports prepared by third party reserve engineers. There is a
reasonable certainty of recovering the proved reserves as disclosed in those
reports. Information relating to our proved oil and gas reserves is based
upon engineering data which demonstrates, with reasonable certainty, to be
recoverable in future years from known reservoirs under existing economic and
operating conditions. Reserve engineering is a subjective process of estimating
underground accumulations of oil and natural gas that cannot be measured in an
exact manner. The accuracy of any reserve estimate is a function of the quality
of available geological, geophysical, engineering and economic data, the
precision of the engineering and judgment. As a result, estimates of different
engineers often vary. The estimates of reserves, future cash flows and present
value are based on various assumptions, including those prescribed by the SEC
relating to oil and natural gas prices, drilling and operating expenses, capital
expenditures, taxes and availability of funds, and are inherently imprecise.
You should not assume that the present values referred to herein represent the
current market value of our estimated oil and natural gas reserves. In
accordance with requirements of the SEC, the estimates of present values are
based on prices and costs as of the date of the estimates. Actual future prices
and costs may be materially higher or lower than the prices and costs as of the
date of the estimate.
Quantities of proved reserves are estimated based on economic conditions,
including oil and natural gas prices in existence at the date of assessment. Our
reserves and future cash flows may be subject to revisions based upon changes in
economic conditions, including oil and natural gas prices, as well as due to
production results, results of future development, operating and development
costs and other factors. Downward revisions of our reserves could have an
adverse affect on our financial condition, operating results and cash flows.
Page 11
WE ARE SUBJECT TO GOVERNMENTAL REGULATIONS.
Gas and oil operations in the United States are subject to extensive government
regulation and to interruption or termination by governmental authorities on
account of ecological and other considerations. The Environmental Protection
Agency of the United States and the various state departments of environmental
affairs closely regulate gas and oil production effects on air, water and
surface resources. Furthermore, proposals concerning regulation and taxation of
the gas and oil industry are constantly before Congress. It is impossible to
predict future proposals that might be enacted into law and the effect they
might have on us. Thus, restrictions on gas and oil activities, such as
production restrictions, price controls, tax increases and pollution and
environmental controls may have a material adverse effect on us.
THE OIL AND GAS INDUSTRY IS SUBJECT TO HAZARDS RELATED TO POLLUTION AND
ENVIRONMENTAL ISSUES.
Hazards in the drilling and/or the operation of gas and oil properties, such as
accidental leakage or spillage, are sometimes encountered. Such hazards may
cause substantial liabilities to third parties or governmental entities, the
payment of which could reduce distributions or result in the loss of our leases.
Although it is anticipated that insurance will be obtained by third-party
operators for our benefit, we may be subject to liability for pollution and
other damages due to environmental events which cannot be insured against due to
prohibitive premium costs, or for other reasons. Environmental regulatory
matters also could increase substantially the cost of doing business, may cause
delays in producing oil and gas or require the modification of operations in
certain areas.
Our operations are subject to numerous stringent and complex laws and
regulations at the federal, state and local levels governing the discharge of
materials into the environment or otherwise relating to environmental
protection. Failure to comply with these laws and regulations may result in the
assessment of administrative, civil and criminal penalties, the imposition of
remedial requirements, and the imposition of injunctions to force future
compliance.
The Oil Pollution Act of 1990 and its implementing regulations impose a variety
of requirements related to the prevention of oil spills, and liability for
damages resulting from such spills in United States waters. OPA 90 imposes
strict joint and several liability on responsible parties for oil removal costs
and a variety of public and private damages, including natural resource damages.
While liability limits apply in some circumstances, a party cannot take
advantage of liability limits if the spill was caused by gross negligence or
willful misconduct or resulted from violation of a federal safety, construction
or operation regulation. If a party fails to report a spill or to cooperate
fully in a cleanup, liability limits likewise do not apply. Even if applicable,
the liability limits for offshore facilities require the responsible party to
pay all removal costs, plus up to $75 million in other damages. For onshore
facilities, the total liability limit is $350 million. OPA 90 also requires a
responsible party at an offshore facility to submit proof of its financial
ability to cover environmental cleanup and restoration costs that could be
incurred in connection with an oil spill.
The Comprehensive Environmental Response, Compensation, and Liability Act, also
known as the "Superfund" law, and analogous state laws impose strict, joint and
several liability on certain classes of persons that are considered to have
contributed to the release of a "hazardous substance" into the environment.
These parties include the owner or operator of the site where the release
occurred, and those that disposed or arranged for the disposal of hazardous
substances found at the site. Responsible parties under CERCLA may be subject to
joint and several liability for remediation costs at the site, and may also be
liable for natural resource damages. Additionally, it is not uncommon for
neighboring landowners and other third parties to file tort claims for personal
injury and property damage allegedly caused by hazardous substances released
into the environment.
Page 12
State statutes and regulations require permits for drilling operations, drilling
bonds and reports concerning operations. In addition, there are state statutes,
rules and regulations governing conservation matters, including the unitization
or pooling of oil and gas properties, establishment of maximum rates of
production from oil and gas wells and the spacing, plugging and abandonment of
such wells. Such statutes and regulations may limit the rate at which oil and
gas could otherwise be produced from our properties and may restrict the number
of wells that may be drilled on a particular lease or in a particular field.
WE MAY EXPERIENCE RAPID INCREASES IN OUR OPERATING COSTS.
The gas and oil industry historically has experienced periods of rapid cost
increases from time to time. Increases in the cost of exploration and
development would affect our ability to acquire equipment and supplies.
Increased drilling activity could lead to shortages of equipment and material
which would make timely drilling and completion of wells impossible. The costs
of producing oil and gas and conducting field operations may also be subject to
rapid cost changes that are not in our control. There is no assurance that over
the life of any project there will not be fluctuating or increasing costs in
doing business.
TERRORIST ATTACKS AND CONTINUED HOSTILITIES IN THE MIDDLE EAST OR OTHER
SUSTAINED MILITARY CAMPAIGNS MAY ADVERSELY IMPACT THE INDUSTRY AND US.
The terrorist attacks that took place in the United States on September 11,
2001, were unprecedented events that have created many economic and political
uncertainties, some of which may materially adversely impact us. The long-term
impact that terrorist attacks and the threat of terrorist attacks may have on
the oil and gas business is not known at this time. Uncertainty surrounding
continued hostilities in the Middle East or other sustained military campaigns
may adversely impact us in unpredictable ways.
CAUTIONARY STATEMENT CONCERNING
FORWARD-LOOKING STATEMENTS
This document contains "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. These statements are subject
to risks and uncertainties and are based on the beliefs and assumptions of
management and information currently available to management. The use of words
such as "believes," "expects," "anticipates," "intends," "plans," "estimates,"
"should," "likely" or similar expressions, indicates a forward-looking
statement.
Forward-looking statements are not guarantees of performance. They involve
risks, uncertainties and assumptions. Future results may differ materially from
those expressed in the forward-looking statements. Many of the factors that will
determine these results are beyond our ability to control or predict.
Stockholders are cautioned not to put undue reliance on any forward-looking
statements, which speak only to the date made. For those statements, we claim
the protection of the safe harbor for forward-looking statements contained in
the Private Securities Litigation Reform Act of 1995.
Forward-looking statements include statements concerning plans, objectives,
goals, strategies, future events, or performance and underlying assumptions and
other statements, which are other than statements of historical facts. These
statements are subject to uncertainties and risks including, but not limited to,
product and service demands and acceptance, changes in technology, economic
conditions, the impact of competition and pricing, and government regulation and
approvals. Petrosearch cautions that assumptions, expectations, projections,
intentions, or beliefs about future events may, and often do, vary from actual
results and the differences can be material. Some of the key factors which could
cause actual results to vary from those Petrosearch expects include changes in
natural gas and oil prices, the timing of planned capital expenditures,
availability of acquisitions, uncertainties in estimating proved reserves and
Page 13
forecasting production results, operational factors affecting the commencement
or maintenance of producing wells, the condition of the capital markets
generally, as well as our ability to access them, and uncertainties regarding
environmental regulations or litigation and other legal or regulatory
developments affecting our business.
Our expectations, beliefs and projections are expressed in good faith and are
believed to have a reasonable basis, including without limitation, our
examination of historical operating trends, data contained in our records and
other data available from third parties. There can be no assurance, however,
that our expectations, beliefs or projections will result, be achieved, or be
accomplished. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. We undertake
no duty to update these forward-looking statements.
For a discussion of some additional factors that may cause actual results to
differ materially from those suggested by the forward-looking statements, please
read carefully the information under "Risk Factors" beginning on page 2. The
identification in this document of factors that may affect future performance
and the accuracy of forward-looking statements is meant to be illustrative and
by no means exhaustive. All forward-looking statements should be evaluated with
the understanding of their inherent uncertainty.
We operate in a very competitive and rapidly changing environment. New risks
emerge from time to time and it is not possible for our management to predict
all risks, nor can we assess the impact of all risks on our business or the
extent to which any risk, or combination of risks, may cause actual results to
differ from those contained in any forward-looking statements. All
forward-looking statements included in this prospectus are based on information
available to us on the date of the prospectus. Except to the extent required by
applicable laws or rules, we undertake no obligation to publicly update or
revise any forward-looking statement, whether as a result of new information,
future events or otherwise. All subsequent written and oral forward-looking
statements attributable to us or persons acting on our behalf are expressly
qualified in their entirety by the cautionary statements contained throughout
this prospectus.
You may rely only on the information contained in this prospectus. We have not
authorized anyone to provide information different from that contained in this
prospectus. Neither the delivery of this prospectus nor the sale of Common Stock
means that information contained in this prospectus is correct after the date of
this prospectus. This prospectus is not an offer to sell or solicitation of an
offer to buy these securities in any circumstances under which the offer or
solicitation is unlawful.
THE BUSINESS
BUSINESS
Petrosearch Energy Corporation, a Nevada corporation formed in November 2004, is
an independent crude oil and natural gas exploration and production company. We
are the successor of Petrosearch Corporation, a Texas corporation formed in
August 2003. All references to capitalization and business operations herein
apply to our current capitalization and operating history, including our
predecessor, Petrosearch Texas. We have established production in North Dakota,
Texas and Oklahoma, and are currently engaged in exploration and development
activities, including direct operator activities, through our subsidiary,
Petrosearch Operating Company, L.L.C., in North Dakota, Texas, Oklahoma,
Mississippi and Louisiana.
OUR HISTORY
We are the successor to the business of Petrosearch Corporation, a Texas
corporation that was formed in August 2003 pursuant to a multi-step merger and
holding company restructure. Under this merger plan, Petrosearch Corporation, a
privately held Delaware corporation formed in April 2002, merged into a
Page 14
Texas subsidiary of Texas Commercial Resources, Inc., a publicly traded company.
Simultaneously, TCRI created Petrosearch Texas as a subsidiary, and then
consummated a holding company reorganization which resulted in the parent
company (TCRI) and the subsidiary (Petrosearch Texas) reversing positions, such
that TCRI became a subsidiary of Petrosearch Texas. In November 2003,
immediately following the merger, we agreed to sell the outstanding stock of the
TCRI subsidiary back to its former shareholders. Under the terms of the
agreement, Petrosearch Texas conveyed the capital stock of the TCRI subsidiary
to a designated trustee and paid certain existing liabilities of TCRI in
exchange for 1,500,000 shares of TexCom, Inc. a separate Texas corporation, plus
an indemnity related to certain existing TCRI liabilities.
In November 2004, shareholders of Petrosearch Texas approved a 6.5-to-1 reverse
stock split which took effect immediately prior to its merger with the Company
on December 30, 2004. The effect of the merger, among other things, was to
redomicile to Nevada. Upon the completion of the merger, shareholders of
Petrosearch Texas were issued shares of our common stock representing 100% of
the then issued and outstanding common shares.
BUSINESS PLAN
We were founded on the belief that, despite the steady decline of U.S.
hydrocarbon reserves and production during the past three decades, the
consolidation and restructuring of the upstream portion of the oil and gas
industry (including exploration, drilling and production) had left a significant
number of valuable oil and gas prospects and projects available for acquisition
and development throughout North America.
We continue to implement our business plan which is to find high quality
prospects and projects and provide the capital, along with the technical,
operational and administrative support and management oversight, needed to
develop the projects. We have increased our SEC PV-10 proved reserves from
$13.7 million as of December 31, 2004 to $46.5 million as of December 31, 2005.
We have also successfully improved the quality of our portfolio and have
acquired assets that have multiple year growth potential that allow us to
efficiently control the amount and timing of our capital expenditures. In 2006
we plan to focus on the development of our high quality properties which will
have a significant impact on our production, revenues and cash flows.
In late 2005 and early 2006, we entered into two agreements, for significant
resource projects that we believe will have a major impact on our future growth:
1. In November 2005, we acquired a 100% working interest in 1,755 acres in the
Quinduno Field in Roberts County, Texas, in the Anadarko Basin. The
agreement provided for the payment of the purchase price of $2,000,000 cash
and 3,000,000 shares of unregistered common shares of the Company to occur
in three phases as the project progresses. Should the project not proceed
past the first phase, Petrosearch's maximum obligation would be $750,000 in
cash and 1,000,000 unregistered common shares plus the cost of capital
expenditures for the first phase which are estimated to be $2,900,000. The
project is in the first phase of the water flood. Upon completion of the
entire project, the seller will back in for a 10% working interest after
Petrosearch has been repaid all capital expenditure costs plus $9.5
million. Our working interest reduces to 90% at payout, including the cost
of acquisition. Proved reserves are estimated by Ryder Scott to be 2.0 MMbo
and 1.1 Bcf of gas with an SEC PV-10 value of $33.7 million (at December
31, 2005).
2. The second project is covered by agreements with the Harding Company
(Dallas, Texas) ("Harding") which entered into a strategic Lease
Acquisition and Development Agreement with ExxonMobil Corporation dated
June 29, 2005 (the "Acquisition and Development Agreement"). The
Acquisition and Development Agreement provides for the acquisition by
Harding of leases and development in an area of mutual interest comprised
of approximately 1.6 million acres in the
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Barnett Shale trend of five North Texas counties. Harding is responsible to
serve as operator for a significant portion of the area of mutual interest.
ExxonMobil is responsible for the construction of the gathering and
evacuation system which will serve the area of mutual interest. Pursuant to
our agreements with Harding, we funded $2,800,000 in February 2006.
The First Amended and Restated Program Agreement between Harding Company
and Petrosearch (the "First Amended and Restated Program Agreement")
provided for our acquisition from Harding of a 24.938% before payout and
14% after payout working interest in the project. Harding has also extended
participation rights to two other companies under separate agreements. At
the time of execution of the First Amended and Restated Program Agreement,
Harding had not obtained from ExxonMobil a consent to transfer and waiver
of ExxonMobil's a preferential purchase right set forth in the Acquisition
and Development Agreement. At the time of our execution of and initial
funding under the First Amended and Restated Program Agreement, Petrosearch
did not have a direct contractual relationship with ExxonMobil. We believed
that all conditions necessary to assign and convey the working interest
from Harding had been met.
We subsequently learned that ExxonMobil had not waived its right to consent
and its preferential purchase rights. We further learned that ExxonMobil
desired to explore possible alternative ownership structures beneficial to
all concerned before providing a waiver of the preferential rights. On
March 30, 2006, we entered into an Extension Agreement with ExxonMobil,
Harding, and two other parties that extended the preferential purchase
right of ExxonMobil until May 2, 2006 (the "Extension Agreement"). We
entered a second Extension Agreement to extend the deadline until May 9,
2006. The purpose of the Extension Agreement was to give all the parties
involved the ability to explore possible alternative structures with the
goal to form an integrated venture which would include both upstream and
pipeline assets and activities, which would better align each party's
interest, and which would enhance the ability of the venture to assure that
adequate pipeline capacity would be available to move natural gas to
market. The opportunity to participate in an integrated venture which
includes the gathering and evacuation system was not present in the First
Amended and Restated Program Agreement and thus, the potential alternative
structure has potential positive features.
On May 9, 2006, we entered into a Heads of Agreement with Exxon Mobil
Corporation, Harding Company, Eagle Oil & Gas Co., PS Gas Partners, LLC,
and Gas Partners, L.P. (the "ExxonMobil/Harding Agreement"). The
ExxonMobil/Harding Agreement addresses the economic terms of the project,
provides the alternative structure under which the new integrated venture
in the Barnett Shale Project will operate, and provides the structure
within which the parties will negotiate definitive agreements. Formation of
the new integrated venture is conditioned upon execution of definitive
agreements. The ExxonMobil/Harding Agreement also extends for 60 days Exxon
Mobil Corporation's preferential purchase rights and preserves all
Petrosearch's legal rights under the Amended and Restated Program
Agreement.
In the event that the parties cannot formulate the Definitive project
agreements before July 8, 2006, Exxon Mobil Corporation could exercise its
preferential purchase right which, if exercised, would prevent our
participation in the project. In the event of such a loss of this
opportunity to participate in the project, our legal rights are not
prejudiced by the Heads of Agreement and we would then expect to pursue all
potential remedies available to us relating to the factual circumstances
surrounding these agreements.
We also signed a letter agreement ("Letter Agreement") on May 7, 2006, with
Harding Company that defines the terms of participation and interest
between Harding Company and Petrosearch in the formation of a new venture
entity. The terms of the Letter Agreement are subject to the completion of
the definitive agreements as outlined in the ExxonMobil/Harding Agreement.
Page 16
BUSINESS MODEL
In broad outline, our business model consists of:
1. Identifying and supplying business resources to develop strategic projects
in opportunistic regions.
2. A multi-tiered review process whereby each proposed project is vetted at up
to four levels:
- The independent producer and the independent producer's advisors;
- Our management and internal committees;
- Our independent technical advisors; and
- The institutional partners and the institutional partners' advisors.
The fourth level of review applies only when we have an institutional
drilling partner. Although success is not guaranteed, we believe that this
multi-tiered process is a rigorous quality control system that increases
the probability of successful projects.
3. An experienced management team supported by a commitment to contracting
services for the maximum possible number of business functions. This
management structure is intended to allow rapid decision making; the policy
of contracting services for technical, administrative and professional
input is intended to avoid building costly layers of fixed overhead while
at the same time having access to expertise appropriate to each project and
situation.
SOURCES OF FINANCING EMPLOYED BY US TO DATE
Corporate Financing
As discussed herein in the section entitled "Management's Discussion and
Analysis", we have historically financed our activities through the issuance of
common stock, preferred stock, a series of bonds, agreements with Rock (see
further discussion below), a revolving line of credit and internally generated
cash flow from oil and gas production.
Project Financing and Right of First Refusal
On January 11, 2006, we entered into an Agreement with Rock Energy Partners
("Rock") covering the geographic areas of current operations in Jefferson
County, Mississippi and Colorado County, Texas affecting the Company and Rock,
including agreements and stipulations regarding future operations in those
geographic areas, the terms under which future exploration and development
participation opportunities shall be offered by the Company to Rock, and agreed
procedures for conducting internal audits and accounting reconciliations. As
part of the transaction with Rock, the parties have executed an Amended Right of
First Refusal Agreement (the "Amended ROFR") which replaces the previous Right
of First Refusal Agreement between the Company and Rock which was entered in
March 2004 (the "ROFR").
The Amended ROFR has more limited applicability to our various projects than the
ROFR. While the original agreement required all of our prospects to be
presented to Rock for consideration by Rock, the Amended ROFR does not require
that all our prospects be offered to Rock for participation. The Amended ROFR
also does not require that we offer to Rock prospects in any specified area,
although the parties have separately stipulated to certain specified areas of
mutual interest in the Mississippi and Colorado County areas based upon
historical operations in those areas. The Amended ROFR permits us to decide
which projects will be offered to Rock, so long as the projects actually
presented are projects in
Page 17
which the Company owns or intends to retain a minimum of ten percent (10%) of
the project interest available to the Company.
Under the Amended ROFR, Rock's percentage participation is limited to the range
between ten percent (10%) minimum participation and forty percent (40%) maximum
participation. The minimum and maximum participation limits are proportional
to the interest available to the Company. The Amended ROFR also calls for a
minimum funding commitment required from Rock equal to $3,000,000 per year for
new projects, without the right to carry over to any subsequent year as credit
expenditures above the minimum required commitment for that year. Rock is also
obligated to spend up to $8,800,000 for the drilling of one new well and one
well re-entry to test the deep Wilcox at the SW Garwood prospect during 2006.
This obligation of Rock's will cover 100% of the capital requirements for the
two projects.
The Amended ROFR provides that the Company retain, in each prospect which is
accepted by Rock, a twenty-five percent (25%) reversionary interest in the
interest assigned to Rock, with the reversion to take effect upon "payout" or
recoupment of Rock's development costs net to that interest.
SALE OF INVESTMENT ASSET
In May, 2006, we received $1,000,000 from the sale of 1,500,000 shares of common
stock of TexComm, Inc. which we received as part of the transaction with TCRI in
September 2003.
RECENT SALE OF ASSETS IN FORT BEND COUNTY, TEXAS, OF TK PETROSEARCH, L.L.C.
In June 2005, we entered into an option agreement to sell all of the assets of
our TK Petrosearch subsidiary for a cash purchase price of approximately
$2,140,000. The option agreement was exercised on August 3, 2005 with the
effective date of the transfer being July 1, 2005. The assets sold account for
$1,370,110 of our PV-10 proved reserves as of December 31, 2004, or
approximately 10% of our total proved reserve value at that time.
COMPETITION
The petroleum and natural gas industry is intensely competitive, and we compete
with other companies that have substantially larger financial resources,
operations, staffs and facilities. Many of these companies not only explore for
and produce crude oil and natural gas, but also carry on refining operations and
market oil and other products on a regional, national or worldwide basis. Such
companies may be able to pay more for productive oil and natural gas properties
and exploratory prospects or define, evaluate, bid for and purchase a greater
number of properties and prospects than our financial or human resources permit.
In addition, such companies may have a greater ability to continue exploration
activities during periods of low hydrocarbon market prices. Our ability to
acquire additional properties and to discover reserves in the future will be
dependent upon our ability to evaluate and select suitable properties and to
consummate transactions in a highly competitive environment
GOVERNMENTAL REGULATIONS AND THE COST OF COMPLIANCE
We are an independent crude oil and natural gas exploration and development
company. Federal, state and local laws and regulations have been enacted
regulating the industry which create liability for certain environmental
contamination. Environmental laws regulate, among other things, the
transportation, storage, and handling of oil and gas products. Governmental
regulations govern matters such as the protection of fresh water sources, both
surface and subsurface, remediation of soil and water contamination resulting
from business operations or accidents, disposal of residual chemical wastes,
operating procedures, waste water discharges, air emissions, fire protection,
worker and community right-to-know and emergency response plans. Moreover,
so-called "toxic tort" litigation has increased markedly in recent years as
persons allegedly injured by chemical contamination seek recovery for
Page 18
personal injuries or property damage. These legal developments present a risk
of liability should we be deemed to be responsible for contamination or
pollution caused or increased by any activities we undertake, or for an accident
which occurs in the course of such activities. There can be no assurance that
our policy of establishing and implementing proper procedures for complying with
environmental regulations will be effective at preventing us from incurring a
substantial environmental liability. If we were to incur a substantial
uninsured liability for environmental damage, our financial condition could be
materially adversely affected.
We presently have the ability to deliver remediation and recycling services
through our vendors that meet applicable federal and state standards for the
delivery of our services, and for the level of contaminant removal. The
government can, however, impose new standards. If new regulations were to be
imposed, we may not be able to comply in either the delivery of our services, or
in the level of contaminant removal from the waste stream.
Permits are generally required by federal and state environmental agencies for
the operation of our activities. The costs of acquiring the operating permits
have been borne by us. Most of these permits must be renewed periodically and
the governmental authorities involved have the power, under various
circumstances, to revoke, modify, or deny issuance or renewal of these permits.
EXPLORATION AND DEVELOPMENT ACTIVITIES
Since inception, we have drilled or participated in 19 new wells in six states
(Texas, Montana, North Dakota, Mississippi, Louisiana and Oklahoma). This number
excludes all wells and operations in the Fort Bend County, Texas property which
we sold in July 2005. We are in the process of drilling, completing or testing
six wells. We presently have gross production from nine wells of approximately
147 barrels of oil equivalent per day with a net interest to us of approximately
64 barrels of oil equivalent per day from seven wells as we have a reversionary
interest only in two wells.
As of December 31, 2005, we had approximately $46,500,000 in proven PV-10
reserves. These proven PV-10 reserves are comprised of: North Dakota -
$8,000,000; Woodward County, Oklahoma - $47,000; Tensas Parish, Louisiana -
$685,000 ; Roberts County, Texas $33,700,000 and Colorado County, Texas -
$4,000,000. Reserves for North Dakota Louisiana, Roberts County, Texas and
Colorado County, Texas were estimated by independent third party engineers,
while reserves for Oklahoma were estimated by our engineering consultant with
methodology confirmed by an independent third party engineer.
EMPLOYEES
As of May 9, 2006, we employed nine full-time employees, of which six are in
management positions, including corporate, administrative and operations.
RESEARCH AND DEVELOPMENT EXPENDITURES
During fiscal 2005, we did not have any expenses for research and development
costs.
DESCRIPTION OF PROPERTY
BARNETT SHALE PROJECT
In February 2006, we entered into a First Amended and Restated Program Agreement
(the "First Amended and Restated Program Agreement") with Harding Company
(Dallas, Texas) which provides for our participation with Harding Company and
other oil and gas companies in the development of an Area of Mutual Interest
representing a total of 1.6 million acres of Barnett Shale lands located in five
North Texas Counties. The first well was spudded on February 8, 2006, in
Tarrant County, Texas; casing was
Page 19
cemented at 9,264 feet total measured depth on March 4, 2006, and this initial
well is awaiting fracture stimulation and completion. The second horizontal well
in the project was spudded on March 15, 2006, in Ellis County and reached total
depth of 11,530 feet as of this filing. Casing on the well was cemented at
11,483 feet measured depth and this well is also awaiting fracture stimulation
and completion. A third well is scheduled to be spudded in May 2006, in Tarrant
County, Texas. This project is subject to the pending resolution of all matters
relating to the First Amended and Restated Program Agreement between the Company
and Harding, and the contingencies set forth in the ExxonMobil/Harding Agreement
as previously described herein.
NORTH TEXAS/PANHANDLE WATER FLOOD PROJECT
In November 2005, we acquired a 100% working interest in 1,755 acres in the
Quinduno Field in Roberts County, Texas, in the Anadarko Basin. The Company's
working interest reduces to 90% at payout, including the cost of acquisition.
Proved reserves are estimated by Ryder Scott to be 2.0 MMbo and 1.1 Bcf of gas
with an SEC PV-10 value of $33.7 million (at December 31, 2005). The purchase
price (in November 2005) equated to $3.37 per proved barrel of oil equivalent
(boe) based on a conversion factor of 6 Mcf/bo. As operator, we intend to
extract the reserves through conventional water flood technology. The first
phase of the project began in March 2006 with the drilling of a new well, the
Maddox #42, for production to a depth of 4,495 feet. An unexpected oil saturated
fourteen foot limestone interval was found, and tested, approximately 180 feet
below the top of the target water flood horizon (Lower Albany Dolomite). The
reservoir appears to be normally pressured and does not appear to have been
produced in the past. The well was completed April 13, 2006, and is producing
at the rate of approximately 8 to 12 BOPD. As a result of this new zone
discovery, the company is evaluating plans to develop the zone without
interfering with the planned water flood development. During 2006, a minimum of
4 old wells will be converted to injection wells and water injection will begin.
RODNEY ISLAND, TENSAS PARISH, LOUISIANA
In October 2005, we took over operations of the Harper Z-1 well on the Rodney
Island prospect from the previous operator after casing was set and cemented.
We are in the process of completing the well that was directionally drilled to a
measured depth of 11,701 feet (vertical depth = 9,373 feet) and logged
approximately 19 feet of oil sand in the Tuscaloosa Massive Sand.
Re-mapping based on the additional data from the Harper Z-1 well indicates as
many as 2 additional proved locations and 3 other identified locations. Ryder
Scott estimates proved reserves net to our share as of December 31, 2005 to be -
49.4 Mbo and 26 MMcf. We have a 25% working interest before payout in the Harper
Z-1 well and 18.75% working interest after payout. We have an 18.75% working
interest in all additional wells.
GRUMAN PROSPECT, STARK COUNTY, NORTH DAKOTA
In September 2005, we purchased an additional 21.25% working interest, giving us
an 85% working interest in this Lodgepole Reef oil well. An increased density
well was drilled in April, 2006 to 9,890 feet, measured depth. The well
encountered the Reef approximately 65 feet below the Gruman 18-1 (existing
producer) and, as such, will be completed for water injection. Water injection
is expected to provide pressure support for the existing well with a resulting
increase in the production rate. Proved developed reserves in the prospect to
our share of the well as of December 31, 2005, are 309 Mbo and 82 MMcf of
natural gas, as estimated by a third party engineering firm, McCartney
Engineering, LLC. Water injection is expected to begin in the third quarter of
2006.
SW GARWOOD, COLORADO COUNTY, TEXAS
The initial well on this prospect, the Pintail #1, completed in the Upper Wilcox
in December 2004, is expected to pay out by the end of the second quarter of
2006 from the first of 5 potentially productive
Page 20
zones. The well is currently producing approximately 479 Mcfd with 7 barrels of
condensate. After pay out we will back-in for 33-1/3% working interest until
payout of all project money spent to-date, including acquisition costs, at which
time our working interest will reduce to 13.33%.
The second well, Pintail Flats #1, was completed and fracture stimulated in May,
2005 in the deepest sand penetrated by the well in the Lower Wilcox. Completion
problems resulting from the fracture treatment have resulted in the well
performing below expectations (producing approximately 170 Mcfd) from this zone.
An engineering review of has been completed and work is underway to recomplete
in 3 zones uphole, in the Lower Wilcox. The well has an additional 2
potentially productive zones in the Lower Wilcox and 3 in the Upper Wilcox.
Net proved reserves for this project, as estimated by Ryder Scott Company are
1.2 Mbo and 642 MMcf of natural gas. Of the 2,402 acres in the prospect, we
have: 20% working interest in approximately 240 acres; 33.33% working interest
after payout on a well by well basis in 1,018 acres that reduces to 13.33% after
project payout; 33.33% working interest after payout on a well-by-well basis in
640 acres that reduces to 18.33% at project payout; and 21.5% working interest
after payout on a well by well basis in 444 acres that reduces to 19.25% at
project payout. The cost of the two existing wells has been funded by our
drilling partner.
BUENA VISTA, JEFFERSON COUNTY, MISSISSIPPI
We fracture stimulated and tested approximately 80 feet of potentially
productive sands at the base of the Hosston zone without establishing commercial
production in the Phillips-Burkley #1 well during 2005. The presence of gas was
established but production rates were non-commercial. These sands have been
abandoned and we plan to test and complete the well in a portion of
approximately 280 feet of potentially productive Hosston sands up-hole, which
appear to have superior reservoir properties compared to the sands already
tested.
The Phillips-Burkley # 1, an exploratory gas well on a leasehold position of
7,481 acres, has been funded by our drilling partner. We are the operator and
have a 50% working interest in the well and acreage. If commercial reserves can
be established, the structure could support in excess of 22 additional wells.
MISSISSIPPI TUSCALOOSA PROJECTS
We have identified five Tuscaloosa oil prospects in the Mississippi Inland Salt
Basin, in Yazoo County, comprising a maximum of 2,295 acres and up to 18
potential drilling locations. Eight locations are planned to be drilled in
2007, ranging from 6,150 feet to 7,500 feet in depth. Approximately 40% of the
required acreage has been leased and seismic data on the prospects is being
reprocessed. We own 100% of the prospects and will operate the project.
CENTRAL TEXAS/GULF COAST PROJECTS
TAIT PROJECTS - COLORADO COUNTY, TEXAS. The initial well on this 1,250 net acre
prospect, the Sealy #1, was drilled to a depth of 10,895 feet and logged on May
12, 2006. The primary Upper Wilcox target at 10,600 was shaled out and a
secondary Wilcox objective at 10,350 feet was tight. We elected not to
participate in an uphole Frio Sand completion attempt. Two additional updip Frio
locations remain on this acreage. We have a 10% non-operated interest in the
project.
BURLESON COUNTY, TEXAS, PROJECTS. A multi-well natural gas project that includes
a total of 15 development and step-out locations in the Austin Chalk and
Georgetown formations at approximately 10,000 feet vertical depth on a maximum
leasehold position of up to 8,400 acres. Horizontal wells are planned with total
measured length of approximately 13,000 feet. The initial well is planned to be
Page 21
spudded in the third quarter of 2006 with a second well planned in the fourth
quarter of 2006. We will have a 37.5% non-operated working interest in the
project.
OIL AND NATURAL GAS RESERVES
Our estimate of proved reserves is based on the quantities of oil and gas which
geological and engineering data demonstrate, with reasonable certainty, to be
recoverable in future years from known reservoirs under existing economic and
operating conditions. The accuracy of any reserve estimate is a function of the
quality of available data, engineering and geological interpretation, and
judgment. For example, we must estimate the amount and timing of future
operations, development activities and costs, and work-over costs, all of which
may in fact vary considerably from actual results. In addition, as prices and
costs change from year to year, the estimate of proved reserves also changes.
Any significant variance in these assumptions could materially affect the
estimated quantity and value of our reserves.
Despite the inherent imprecision in these engineering estimates, our reserves
are used throughout our financial statements. For example, since we use the
unit-of-production method to amortize our oil and gas properties, the quantity
of reserves could significantly impact our depreciation, depletion and
amortization expense and accretion expense. Our oil and gas properties are also
subject to a "ceiling" limitation based in part on the quantity of our proved
reserves. Finally, these reserves are the basis for our supplemental oil and gas
disclosures.
For the vast majority of our reserves, we engage independent petroleum
engineering firms to prepare our estimates of proved hydrocarbon liquid and gas
reserves. These reserve estimates have not previously been filed with any other
Federal authority or agency.
The following tables set forth summary information with respect to our proved
reserves as of December 31, 2005, as estimated by compiling reserve information,
which was prepared by the engineering firms of Ryder Scott Company, McCartney
Engineering, LLC and internally generated engineering estimates (internal
estimates make up less than 1% of our proved reserve estimates).
Net Reserves Pre-Tax Present
Value of Future
Net Revenues
Category Oil (Bbls) Gas (Mcf) BOE(1)
December 31, 2005
Proved Developed 330,838 229,747 369,129 $ 9,368,196
Proved Undeveloped 2,014,956 1,614,000 2,283,956 $ 37,084,128
Total Proved 2,345,794 1,843,747 2,642,011 $ 46,452,324
-------------------------------------------------------------------------------------------
(1) Estimated using a conversion ratio of 1.0 Bbl/6.0 Mcf (thousand cubic feet).
Reserve engineering is a subjective process of estimating underground
accumulations of crude oil, condensate and natural gas that cannot be measured
in an exact manner, and the accuracy of any reserve estimate is a function of
the quality of available data and of engineering and geological interpretation
and judgment. The quantities of oil and natural gas that are ultimately
recovered, production and operating costs, the amount and timing of future
development expenditures and future oil and natural gas sales prices may differ
from those assumed in these estimates. Therefore, the pre-tax 10% Present Value
of Future Net Revenues amounts shown above should not be construed as the
current market value of the oil and natural gas reserves attributable to our
properties.
Page 22
In accordance with the guidelines of the Securities and Exchange Commission, the
engineers' estimates of future net revenues from our properties and the pre-tax
10% Present Value of Future Net Revenues thereof are made using oil and natural
gas sales prices in effect as of the effective dates of such estimates and are
held constant throughout the life of the properties, except where such
guidelines permit alternate treatment, including the use of fixed and
determinable contractual price escalations.
Productive Wells
The following table sets forth the total number of our active well bores and
working interest (WI) we maintain in each well as of May 9, 2006:
NO. OF WI WI
WELLS (OIL) (GAS)
----------------------- ------ ------ ------
Gruman 18-1 1 85% 85%
----------------------- ------ ------ ------
Gordon 1-18 1 95% N/A
----------------------- ------ ------ ------
Maddox (Quinduno)(1) 5 100% 100%
----------------------- ------ ------ ------
Pintail #1(2) 1 33.33% 33.33%
----------------------- ------ ------ ------
REP Pintail Flats(2) 1 33.33% 33.33%
----------------------- ------ ------ ------
TOTAL PRODUCTIVE WELLS 9
-----------------------------------------------
<FN>
(1) Project in which the Company's working interest reduces to 90%
(as described in the North Texas/Panhandle Water Flood Project).
(2) Well in which we have a reversionary back-in interest after
payout (as described in the SW Garwood, Colorado County, TX)
Productive wells consist of producing wells and wells capable of production,
including gas wells awaiting pipeline connections as of May 9, 2006.
Acreage
The following table summarizes our gross and net developed and undeveloped
natural gas and oil wells and acreage under lease as of May 9, 2006:
----------- --------------
WELLS ACREAGE
- --------------------- ------- ----------- --------------
STATE GROSS NET GROSS NET
- --------------------- ------- ----- ---- ------ ------
DEVELOPED ACREAGE:
- --------------------- ------- ----- ---- ------ ------
Texas
Garwood Gas 2 .667 1280 426
Maddox (Quinduno) 5 Oil 5 5 1755 1755
- --------------------- ------- ----- ---- ------ ------
North Dakota Oil (1) 1 .85 280 238
- --------------------- ------- ----- ---- ------ ------
Oklahoma Oil 1 .95 610 579
- --------------------- ------- ----- ---- ------ ------
- --------------------- ------- ----- ---- ------ ------
UNDEVELOPED ACREAGE:
- --------------------- ------- ----- ---- ------ ------
Louisiana 2,000 500
- --------------------- ------- ----- ---- ------ ------
Page 23
Texas 9,347 3,173
- --------------------- ------- ----- ---- ------ ------
- --------------------- ------- ----- ---- ------ ------
Mississippi 7,925 4,325
- --------------------- ------- ----- ---- ------ ------
Oklahoma 7,366 6,563
- --------------------- ------- ----- ---- ------ ------
Montana 2,108 2,108
- --------------------- ------- ----- ---- ------ ------
TOTAL 9 7.5 32,671 19,667
- --------------------- ------- ----- ---- ------ ------
Undeveloped acreage is considered to be those lease acres on which wells have
not been drilled or completed to the extent that would permit the production of
commercial quantities of natural gas or oil, regardless of whether or not such
acreage contains proved reserves. As is customary in the oil and gas industry,
we can retain our interest in undeveloped acreage by drilling activity that
establishes commercial production sufficient to maintain the leases or by
payment of delay rentals during the remaining primary term of such a lease. The
natural gas and oil leases in which we have an interest are for varying primary
terms; however, most of our developed lease acreage is beyond the primary term
and is held so long as natural gas or oil is produced.
OPERATOR ACTIVITIES
We currently operate all of our producing properties, and will generally seek to
become the operator of record on properties we drill or acquire in the future
where possible. We will have a non-operated interest in the Barnett Shale
project (pending resolution of all matters associated with Program Agreement and
Extension Agreement described herein) and in one exploratory well being drilled
in Woodward County, Oklahoma.
Drilling Activities
The following table sets forth our drilling activities for the last 3 fiscal
years. Our working interests in the productive wells owned as of December 31,
2005, range from a direct working interest of 100% to after payout working
interest of 33-1/3%. In 2005, we drilled two additional wells not shown on the
table; the Harper Z-1 in Rodney Island, Tensas Parish, Louisiana and the
Phillips-Burkley #1 in Jefferson County, Mississippi. Both of these wells were
in various stages of testing or completion as of May 9, 2006 and commercial
viability had not been established as of that date. Subsequent to December 31,
2005, we have drilled or participated in one exploratory well in Texas and one
in Oklahoma, three development wells in Texas, and spudded a water injection
well in North Dakota.
-------------------------------------------------------
Year Ended December 31,
------------------ -----------------------------------
2005 2004 2003
------------------ ----------- ---------- ----------
Development Wells:
------------------ ----------- ---------- ----------
Productive 4 (1) 5 -0-
------------------ ----------- ---------- ----------
Non-Productive 0 -0- -0-
------------------ ----------- ---------- ----------
TOTAL 4 5 -0-
------------------ ----------- ---------- ----------
Page 24
------------------ ----------- ---------- ----------
Exploratory Wells:
------------------ ----------- ---------- ----------
Productive 1 (2) 4 3
------------------ ----------- ---------- ----------
Non-Productive 3 10 -0-
------------------ ----------- ---------- ----------
TOTAL 4 14 3
------------------ ----------- ---------- ----------
------------------ ----------- ---------- ----------
Total Wells:
------------------ ----------- ---------- ----------
Productive 5 9 3
------------------ ----------- ---------- ----------
Non-Productive 3 10 -0-
------------------ ----------- ---------- ----------
------------------ ----------- ---------- ----------
TOTAL 8 19 3
-------------------------------------------------------
<FN>
(1) These four wells were in the Blue Ridge property, which we sold
effective July 1, 2005.
(2) We have a 33-1/3% working interest after payout in this well, the
REP Pintail Flats. Our working interest reduces to 13.33% at project
payout as described in SW Garwood, Colorado County, TX).
Net Production, Unit Prices and Costs
The following table presents certain information with respect to oil, gas and
condensate production attributable to interests in all of our fields (including
the average sales prices received and average production costs during the fiscal
periods ended December 31, 2005 and December 31, 2004).
----------------------------------------------------------------
2005 2004
------------------------------------------------ ------ ------
Average sales price per barrel of oil equivalent $50.34 $36.06
------------------------------------------------ ------ ------
Lifting costs per barrel of oil equivalent $11.19 $ 5.90
----------------------------------------------------------------
Description of Office Properties
We currently have two office locations, one in Houston and one in Dallas, Texas.
The addresses are as follows:
675 Bering Drive, Suite 200 4925 Greenville Avenue, Suite 670
Houston, TX 77057 Dallas, Texas 75206
On August 1, 2005, we leased our Dallas location, comprised of approximately
2,100 square feet of office space which is held under a sixty-four month lease
at a rate of approximately $2,800 per month (with payments which began December
2005). Our principal executive offices consisting of approximately 3,700 square
feet of office space are located at 675 Bering Drive, Houston, Texas. We hold
this space under a five-year lease agreement at a lease rate of approximately
$5,000 per month. We believe these properties are adequate for our corporate
office needs.
LEGAL PROCEEDINGS
- ------------------
We are not currently a party to any pending material legal proceeding.
Page 25
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------
OVERVIEW
We were founded on the belief that, despite the steady decline of U.S.
hydrocarbon reserves during the past three decades, the consolidation and
restructuring of the upstream oil and gas industry, which includes exploration
and production, had left a significant number of valuable oil and gas prospects
available for acquisition and development throughout North America.
In order to identify and target such prospects for exploration and development,
we continue to implement our business plan and business model, which includes
locating high quality prospects and projects and supplying the exploration
capital, along with the technical, operational and administrative support and
management oversight, needed to develop the prospects.
Management believes we can provide shareholder value with the implementation of
our business plan which encompasses high quality financial and oil and gas
relationships, agreements for the development of oil and gas prospects, a vast
inventory of prospects, minimal debt, and a commitment to low administrative
expenses.
In 2005, as a new management team, our main focus was on improving the quality
of our portfolio of oil and gas assets. We increased our proved PV-10 reserves
from $13.7 million at December 31, 2004 to $46.5 million as of December 31,
2005. By high grading our portfolio we have acquired assets that have multiple
year growth potential that allows us to more efficiently control the amount and
timing of our capital expenditures. In 2005 we have also disposed of assets
that did not meet our risk/reward parameters. Our current portfolio is
extremely diversified relative to oil versus gas, big capital needs versus
smaller capital needs, and high risk exploration versus lower risk/reward
development. This gives us the ability to make sound decisions as to where our
capital should most appropriately be deployed. We believe we were successful in
2005 at creating an extremely high-graded portfolio of oil and gas assets and a
sound infrastructure, which enables us in 2006 to focus on the development of
our high quality properties which should have a significant impact on our
production, revenues and cash flows.
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our audited
consolidated financial statements and the related notes to the financial
statements included in this Prospectus.
The factors that most significantly affect our results of operations are: (i)
the sale prices of crude oil and natural gas; (ii) the amount of production
sales; and (iii) the amount of lease operating expenses. Sales of production and
level of borrowings are significantly impacted by our ability to maintain or
increase production and reserves from existing oil and gas properties through
exploration and development activities.
Page 26
FOR THE YEAR ENDED DECEMBER 31, 2005 COMPARED TO THE YEAR ENDED DECEMBER 31,
2004
Revenues
Consolidated oil and gas production revenues for the year ended December 31,
2005 were $1,701,043 versus $4,718,313 for the year ended December 31, 2004.
The decrease in revenues from 2004 to 2005 is a result of several factors
including the sale of the Blue Ridge Field in Fort Bend County, Texas in July
2005. The Blue Ridge field accounted for 32,500 barrels of oil in 2004 versus
only 12,600 barrels in 2005, due primarily to the sale of the asset in mid 2005.
Secondly, the decrease in production in 2005 was due to the continued pressure
depletion and eventual temporary shut down in October 2005 of our Gruman 18-1
well in Stark County North Dakota. In mid 2004 the well started to experience
significant pressure depletion which continued through 2005. The Gruman 18-1
well produced 98,600 boe in 2004 (86% of that production in the first 6 months
of 2004), versus total production of 19,800 boe in 2005. We have attempted to
mitigate the effects of the pressure depletion with a submersible pump, however
this pump was down from October 27, 2005 through March 9, 2006. We drilled an
increased density well in April, 2006 to 9,890 feet, measured depth which is
being completed for water injection. The water injection is expected to provide
pressure support for the existing well with a resulting increase in the
production rate.
Our future revenue will be principally dependent upon the success of the
development of our current quality prospects and projects as well as the market
price for crude oil and natural gas. We plan to focus capital resources on the
Barnett Shale resource project (pending resolution of all matters associated
with Program Agreement and Extension Agreement described herein), the
development of our proved properties in Texas, Louisiana and North Dakota, as
well as our exploration projects in Texas and Mississippi.
We have not previously utilized any hedging instruments and have no plans to do
so in the foreseeable future.
Lease Operating and Production Tax Expense
Lease operating and production tax expense for the years ended December 31,
2005, and December 31, 2004, were $581,313 and $773,723, respectively. These
expenses, which are primarily outsourced to third party vendors and contractors
relate to the day to day costs that are incurred to operate and maintain our
wells and related production equipment. The decrease is partly related to the
decrease in production from 2004 to 2005 as explained above. However; although
these expenses have decreased from 2004 to 2005, they have not decreased on the
same proportion as production revenue. This relates to the fact that even
though production taxes reduce proportionately to production revenue, lease
operating expenses will not necessarily reduce proportionately; lease operating
expenses continue to be incurred even when production is declining as in the
case of our North Dakota well.
Depletion, Depreciation and Amortization
Costs for depletion, depreciation and amortization for the years ended December
31, 2005, and December 31, 2004, were $563,252 and $2,219,998, respectively.
Depletion expense per barrel
Page 27
of oil equivalent was $15.24 and $16.83 for the years ended December 31, 2005
and 2004 respectively. Although there was an increase in properties subject to
amortization of depletion of $6,359,073 ($11,849,520 and $5,490,447 in December
31, 2005 and 2004 respectively), that increase was offset by two factors that
would cause a decrease in total depletion: 1) the significant decrease in
production from 2004 to 2005 (35,676 boe and 131,194 boe for the years ending
December 31, 2005 and 2004, respectively), and 2) the increase in proved
reserves of 2.1 million boe from 2004 to 2005. Depletion is calculated using
the percentage of units of production over the total proved reserves.
Therefore, being that our total units produced decreased and our total proved
reserves increased, our depletion percentage of proved properties subject to
amortization of depletion decreased.
General and Administrative Expenses
General and administrative expenses for the years ended December 31, 2005, and
December 31, 2004, were $3,268,088 and $3,239,184 respectively. Although the
general and administrative expenses for these periods were comparable, there
were differences in the actual expenses that were incurred. In 2004 the Company
did not have any employees and all the personnel costs were treated as
consulting fees. In January 2005 all of the officers and other personnel became
employees.
Also in 2005 we reduced significant areas of the general and administrative
expenses while also increasing the quality and effectiveness of the resources
that we spent our funds on. These decreases are not directly apparent to the
total general and administrative expenses due to inclusion of the write-offs in
2005 of bad debts and prepaid credits related to prior period operations.
In May 2005 we increased our technical expertise by hiring 5 technical
employees, including our COO, Manager of Operations, Manager of Geology, Manager
of Land and Manager of Engineering. We believe we achieved a significant
accomplishment by increasing our technical expertise and writing off bad debts
and prepaid credits with our general and administrative expenses remaining
constant from 2004 to 2005. Significant details of general and administrative
expenses listed below:
- -------------------------------------------------------------------
2004 2005 DIFFERENCE
- ----------------------------- ---------- ---------- ------------
Third Party Consulting $2,051,844 $ 590,581 $(1,461,263)
- ----------------------------- ---------- ---------- ------------
Employee Costs -0- 1,413,398 1,413,398
- ----------------------------- ---------- ---------- ------------
Travel and Entertainment 213,444 138,227 (75,217)
- ----------------------------- ---------- ---------- ------------
Accounting and Legal 491,154 416,114 (75,040)
- ----------------------------- ---------- ---------- ------------
Bad debts and prepaid credits -0- 205,443 205,443
- -------------------------------------------------------------------
Net Loss from Operations
We generated a net operating loss of $2,711,610 or $0.11 per share, for the year
ended December 31, 2005, compared to a net loss of $1,514,592 or $0.09 per
share, for the year ended December 31, 2004. The $1,197,018 variance is related
mainly to the decrease in production from our North Dakota well as explained
above and due to the sale of our Blue Ridge Field asset. There
Page 28
was no profit and loss effect of the sale of the Blue Ridge Field asset because
under full cost accounting no gain or loss is recorded on the sale of an asset.
As explained above, our main focus during 2005 was to improve the quality of
our portfolio of our oil and gas assets and dispose of assets that did not meet
our risk/reward parameters. Our current portfolio is extremely diversified. We
believe we were successful in 2005 in creating an extremely high-graded
portfolio of oil and gas assets and a sound infrastructure, which will enable us
to focus on the development of our high quality properties in 2006 which we
anticipate, will have a positive impact on our production, revenues and cash
flows.
FOR THE THREE MONTHS ENDED MARCH 31, 2006 COMPARED TO THE THREE MONTHS ENDED
MARCH 31, 2005
Revenues
Consolidated oil and gas production revenue for the quarter ended March 31,
2006, was $121,914 versus $654,164 for the quarter ended March 31, 2005. The
decrease was primarily due to our North Dakota well being down from October 2005
until March 2006 as a result of the pump being down. However, we have drilled an
increased density well in April, 2006 to 9,890 feet, measured depth which is
being completed for water injection. The water injection is expected to provide
pressure support for the existing well with a resulting increase in the
production rate.
Other projects that may have a near term affect on our revenues are 1) the first
well in the SW Garwood project should payout in the second quarter of 2006, 2)
the first well in the Rodney Island project will be sidetracked and completed in
the second quarter of 2006, 3) in the Buena Vista, Mississippi prospect, we plan
to test and complete the well in a portion of approximately 280 feet of
potentially productive Hosston sands up-hole, which appears to have superior
reservoir properties compared to the sands already tested.
The decrease in revenue can also be attributed to the sale of our Blue Ridge
Field property in Fort Bend County, Texas effective July 1, 2005, which
previously accounted for an average of 1,845 barrels of oil per month of
production.
Our revenue will principally be dependent upon the success of the acquisition
and development of future quality prospects as well as the market price for
crude oil and natural gas.
Lease Operating and Production Tax Expense
Lease Operating Expenses and Production Taxes
Lease operating and production tax expense for the quarters ended March 31, 2006
and 2005 were $161,690 and $177,060, respectively. These expenses relate to the
costs that are incurred to operate and maintain our wells and related production
equipment, including the costs applicable to the operating costs of support
equipment and facilities. Although there was a significant decrease in
production from 2005 to 2006, the lease operating expenses remained relatively
constant because in November 2005 we added approximately 30 existing wells
associated with our Quinduno Field Prospect, Roberts County, Texas that require
lease operating costs to be incurred even though the wells have minimal
production. These existing, but non-
Page 29
productive wells are vital to the success of the waterflood project that we will
be needed to realize the reserves in the Quinduno Field.
Depletion, Depreciation and Amortization
Costs for depletion, depreciation and amortization for the quarters ended March
31, 2006, and 2005, were $37,381 and $334,459 respectively. This decrease is
attributable to both lower production in the first quarter of 2006 compared with
the first quarter of 2005 and the significant increase in proved reserves in the
first quarter of 2006 compared with the first quarter of 2005. Production in
the first quarter of 2005 was 14,187 Boe as compared to 1,544 Boe in the first
quarter of 2006. The proved reserves increased to approximately 2.6 million Boe
as of March 31, 2006 as opposed to approximately 580,000 as of March 31, 2005.
Given the fact that depletion is calculated by multiplying the net amortizable
costs times the units of production in the related period relative to the total
proved reserves, the depletion amount for the first quarter of 2006 was
significantly lower than the depletion for the same period in 2005.
General and Administrative Expenses
General and administrative expenses for the quarters ended March 31, 2006 and
2005, were $722,548 and $638,080, respectively. The increase can be attributed
mainly to the hiring of several technical and financial employees after the
first quarter of 2005.
Net Loss/Income from Operations
We generated a net operating loss of $(799,705) or $(0.03) per share, for the
quarter ended March 31, 2006, compared to net operating loss of $(495,435) or
$(0.03) per share, for the quarter ended March 31, 2005. The $(304,270)
variance is related mainly to the fact that revenues decreased a total of
$532,250 from the same period in 2005 to 2006 offset by a decrease in total
costs and expenses of $227,980 from 2005 to the same period in 2006. The
decrease in revenue was due primarily to the decrease in the production of our
North Dakota well (as discussed herein) due to operational problems with a pump.
Off-Balance Sheet Arrangements
We had no off-balance sheet arrangements during the fiscal year ended December
31, 2005 or during the three month period ended March 31, 2006.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have primarily financed our operating and investing cash
flow needs through private offerings of equity securities, sales of crude oil
and natural gas, and the use of debt instruments such as corporate bonds and
revolving credit facilities. The proceeds from, and the utilization of, all
these methods have been and Management believes will continue to be, sufficient
to keep the operations funded and the business plan moving forward. We plan to
continue to utilize these methods to access capital in order to implement our
business plan, which we believe will be an effective vehicle to carry out our
business plan.
Page 30
Financial Advisors
On December 21, 2005, we engaged the Corporate Finance Division of Macquarie
Securities (USA) Inc. as an exclusive financial advisor. Macquarie's services
will be utilized in connection with debt or equity transactions the Company may
contemplate.
Private Placements
In April 2005, we completed sales of $12.6 million of our common stock in
private offerings. We received net proceeds of approximately $11.9 million
which were to be used for general corporate purposes, including the drilling of
projects in our prospect inventory.
In February 2006, we completed sales of $2.7 million of our common stock in a
private offering. We received net proceeds of approximately $2.56 million which
are to be used for general corporate purposes, including the drilling of
projects in our prospect inventory.
Revolving Credit Agreement
In September 2005, we amended and restated our revolving credit agreement to $10
million which allowed Fortuna Energy, L.P. to participate in the ownership and
development of an eight prospect package in our inventory. The significant
provisions of the Credit Facility are as follows:
The Credit Facility matures on the 30-month anniversary of the initial advance
(which occurred on September 29, 2005) and may be prepaid at any time. Repayment
of each tranche borrowed shall be interest only for six months and shall then
amortize on a 30 month basis with all then outstanding tranches due and payable
April 1, 2008. The last date for advances shall be October 15, 2007.
The proceeds may be utilized for past, present or future acquisitions of oil and
gas leases, including associated costs of technical review and analysis,
drilling, reworking, production, transportation, marketing and plugging. The
proceeds may also be used to fund all lender charges and fees, including legal
fees of Fortuna's counsel.
Subject to the draw limitations and funds availability provisions described
below, we are required to utilize the funds from the Credit Facility to fund
lease acquisitions by our Beacon Petrosearch, L.L.C. and Anadarko Petrosearch,
L.L.C. subsidiaries before resorting to funds which may be available internally
or from third parties (other than drilling co-venturers).
The collateral for the Credit Facility includes a first and prior lien on the
oil and gas leases acquired with Fortuna's funds, as well as the equipment on
any well drilled with Fortuna's funds. The collateral also includes all
existing and future lease interests in the eight project package listed above
and the State of Oklahoma, and all existing lease interests in North Dakota
(regardless of whether Fortuna's funds are utilized in North Dakota) as well as
our membership interest in Beacon Petrosearch, L.L.C. and Anadarko Petrosearch,
L.L.C.
Under the Credit Facility, Fortuna will receive a 2% overriding royalty interest
of Petroseach's proportionate net revenue interest in the leases acquired or
drilled using Fortuna's funds, as well
Page 31
as a like overriding royalty in current leases held in Beacon Petrosearch,
L.L.C. and certain leases held in Anadarko Petrosearch, L.L.C. in Oklahoma.
Under the terms of the Credit Facility, principal is to be repaid in 24 monthly
installments equal to 1/30th of the principal commencing six months after the
initial advance, with the balance being paid at the maturity of the facility.
Interest shall be repaid under the Credit Facility at Wall Street Journal prime
+3% per annum payable monthly in arrears.
As of May, 9, 2006, the principal balance outstanding pursuant to the Credit
Facility was $5,207,500.
It is Management's intent to utilize the Credit Facility to acquire new leases
and develop existing leases with these funds, securing the debt with the
collateral required under the terms of the Credit Facility.
Sale of Property
In June 2005, we entered into an option agreement to sell all of the assets of
our TK Petrosearch subsidiary for a cash purchase price of approximately
$2,140,000. The option agreement was exercised on August 3, 2005 with the
effective date of the transfer being July 1, 2005. The assets sold accounted
for $1,370,110 of our PV-10 proved reserves as of December 31, 2004, or
approximately 10% of our total proved reserve value at that date.
Project Financing and Right of First Refusal
On January 11, 2006, we entered into an Agreement with Rock Energy Partners
("Rock") covering the geographic areas of current operations in Jefferson
County, Mississippi and Colorado County, Texas affecting the Company and Rock,
including agreements and stipulations regarding future operations in those
geographic areas, the terms under which future exploration and development
participation opportunities shall be offered by the Company to Rock, and agreed
procedures for conducting internal audits and accounting reconciliations. As
part of the transaction with Rock, the parties have executed an Amended Right of
First Refusal Agreement (the "Amended ROFR") which replaces the previous Right
of First Refusal Agreement between the Company and Rock which was entered in
March 2004 (the "ROFR").
The Amended ROFR has more limited applicability to our various projects than the
ROFR. While the original agreement required all of our prospects to be
presented to Rock for consideration by Rock, the Amended ROFR does not require
that all our prospects be offered to Rock for participation. The Amended ROFR
also does not require that we offer to Rock prospects in any specified area,
although the parties have separately stipulated to certain specified areas of
mutual interest in the Mississippi and Colorado County areas based upon
historical operations in those areas. The Amended ROFR permits us to decide
which projects will be offered to Rock, so long as the projects actually
presented are projects in which the Company owns or intends to retain a minimum
of ten percent (10%) of the project interest available to the Company.
Under the Amended ROFR, Rock's percentage participation is limited to the range
between ten percent (10%) minimum participation and forty percent (40%) maximum
participation. The minimum and maximum participation limits are proportional
to the interest available to the
Page 32
Company. The Amended ROFR also calls for a minimum funding commitment required
from Rock equal to $3,000,000 per year for new projects, without the right to
carry over to any subsequent year as credit expenditures above the minimum
required commitment for that year. Rock is also obligated to spend up to
$8,800,000 for the drilling of one new well and one well re-entry to test the
deep Wilcox at the SW Garwood prospect during 2006. This obligation of Rock's
will cover 100% of the capital requirements for the two projects.
The Amended ROFR provides that the Company to retain in each prospect which is
accepted by Rock a twenty-five percent (25%) reversionary interest in each
interest assigned to Rock, with the reversion to take effect upon "payout" or
recoupment of Rock's development costs net to that interest.
Sale of Investment Asset
During May, 2006, we received $1,000,000 from the sale of 1,500,000 shares of
common stock of TexComm, Inc. which we received as part of the transaction with
TCRI in September 2003.
Drilling Partnerships
We continue to strive to develop relationships with institutional or high net
worth individuals to participate in our prospects. Management believes this
will reduce our capital risk and increase the diversity of the projects in which
we use our own capital. We intend to establish these drilling partnership
relationships with terms that are standard in the oil and gas industry.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of operations
are based upon financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States, or GAAP. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses. We analyze our estimates, including those related to oil and gas
properties, income taxes, commitments and contingencies and stock-based
compensation, and base our estimates on historical experience and various other
assumptions that we believe to be reasonable under the circumstances. Actual
results may differ from these estimates. We believe the following critical
accounting policies are subject to significant judgments and estimates used in
the preparation of our financial statements:
Oil and Gas properties. The Company uses the full cost method of accounting for
oil and gas operations. Accordingly, all costs, including nonproductive costs
and certain overhead costs associated with acquisition, exploration and
development of oil and gas properties, are capitalized. Net capitalized costs
are limited to the future net revenues, after income taxes, discounted at 10%
per year, from proven oil and gas reserves plus the cost of the properties not
subject to amortization. Such capitalized costs, including the estimated future
development costs and remediation costs, if any, are depleted by an equivalent
units-of-production method, converting gas units (MCF) to oil units (barrels) at
the ratio of six MCF of gas to one barrel of oil. Also, with full cost
accounting, no gain or loss is recognized upon the disposal of oil and gas
properties, unless such dispositions significantly alter the relationship
between capitalized costs
Page 33
and proven oil and gas reserves. Oil and gas properties not subject to
amortization consist of the cost of undeveloped leaseholds and other geological
and exploration costs, and totaled $3,513,597 at December 31, 2005. These costs
are reviewed periodically by management for impairment, with the impairment
provision included in the cost of the oil and gas properties subject to
amortization. Factors considered by management in its impairment assessment
include drilling results, re-evaluations of properties, terms of oil and gas
leases not held by production and available funds for exploration and
development.
Income taxes. The Company uses the asset and liability method of accounting for
income taxes, under which deferred tax assets and liabilities are recognized for
the future tax consequences of (1) temporary differences between the financial
statement carrying amounts and the tax bases of existing assets and liabilities,
and (2) operating loss and tax credit carryforwards. Deferred income tax assets
and liabilities are based on enacted tax rates applicable to the future period
when those temporary differences are expected to be recovered or settled. The
effect of a change in tax rates on deferred tax assets and liabilities is
recognized in income during the period the rate change is enacted. Deferred tax
assets are recognized in the year in which realization becomes determinable.
Periodically, management performs a forecast of its taxable income to determine
whether it is more likely than not that a valuation allowance is needed, looking
at both positive and negative factors. A valuation allowance for our deferred
tax assets is established, if in management's opinion, it is more likely than
not, that some portion will not be realized. At December 31, 2005, a valuation
allowance of $1,628,636 has been provided for deferred tax assets.
Commitments and contingencies. Liabilities for loss contingencies arising from
claims, assessments, litigation or other sources are recorded when it is
probable that a liability has been incurred and the amount can be reasonably
estimated. Management does not see any circumstances that would require the
Company to record a loss contingency; therefore, to date no commitments or
contingencies have been recorded.
Stock Based Compensation - In the past, the Company has periodically issued
incentive stock warrants to officers, executives, directors, and consultants to
provide additional incentives to promote the success of the Company's business
and to enhance the ability to attract and retain the services of qualified
persons. The issuance of such warrants has been approved by the Board of
Directors. The exercise price of a warrant granted is determined by the fair
market value of the stock on the date of grant. In December 2004, the FASB
issued SFAS 123(R), which is a revision of SFAS 123. SFAS 123(R) requires all
share-based payments to employees, including grants of employee stock options,
to be recognized as stock-based compensation expense in the Company's
Consolidated Statements of Operations based on their fair values. Proforma
disclosure is no longer an alternative, as was permitted by SFAS 123. Until
the adoption of the provisions of SFAS 123(R) on January 1, 2006, the Company
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 and warrants because the alternative fair value
accounting provided for under FASB Statement No. 123, "Accounting for
Stock-Based Compensation", required use of option valuation models that were not
developed for use in valuing employee stock options or warrants. Under APB 25,
if the exercise price of the Company's employee stock options is greater than or
equal to the market price of the underlying stock on the date of grant, no
compensation expense was recognized. Currently, the Company has no plans to
issue stock warrants to any parties other than in financing
Page 34
arrangements with third parties. Consequently, based on current plans, the
adoption of SFAS 123(R)'s fair value method will not have a significant impact
on the Company's future results of operations or financial position. The
adoption of SFAS 123(R) will not result in any compensation charges in 2006
related to options outstanding at December 31, 2005, because all employee stock
options were vested as of December 31, 2005. There was no compensation expense
related to warrants during the three month periods ended March 31, 2006 and
2005.
BUSINESS CONDITIONS AFFECTING THE COMPANY
The crude oil and natural gas industry is extremely cyclical in nature. During
the peaks in this cycle, oil prices are higher, exploration activities are more
prolific and the costs associated with investing in and developing quality
prospects are generally higher than during the downward phase of the cycle.
Inherent in this industry during the peaks and valleys are several issues that
can affect our ability to be successful in our business plan. These issues are
as follows:
Oil and Gas Prices. Commodity prices have been relatively high for the past few
years and are currently at or near all time highs. The entire industry in all
aspects is extremely active, mainly due to the high prices and current political
and economic climate surrounding the energy industry. Because of the increase
in prices, many more exploration and production companies have been formed and
many existing companies have increased exploration programs or are interested in
investing in exploration.
Quality Prospects-Competition. There is intense competition in the oil and gas
industry with respect to the acquisition of producing properties and undeveloped
prospects. Many major and independent oil and gas companies are actively
pursuing and bidding for the mineral rights of desirable properties. Although
we have many quality prospects in our inventory, it will be essential to our
success to continue to acquire and develop new prospects. The sustained
commodity prices could continue to make it more difficult or more costly to
acquire these properties.
Oil-field Services. We rely on independent contractors to assist in conducting
our operations. However, as the competition in the industry intensifies, it may
become harder for the Company to obtain drilling rigs and other oil-field
services to successfully conduct our operations. There is increased competition
in the oil and gas industry for contract drillers, geologists and all other oil
field services. However, we believe that current demand in the areas that we
are targeting for drilling prospects has generally been stable and our ability
to acquire the necessary services will be sufficient to execute our business
plan.
PLAN OF OPERATIONS
CURRENT PROJECTS AND CAPITAL REQUIREMENTS
BARNETT SHALE PROJECT - In February 2006, we entered into a First Amended and
Restated Program Agreement (the "First Amended and Restated Program Agreement")
with Harding Company (Dallas, Texas) which provides for our participation with
Harding Company and other oil and gas companies in the development of an Area of
Mutual Interest representing a total of 1.6 million acres of Barnett Shale lands
located in five North Texas Counties. The first well was spudded on February 8,
2006, in Tarrant County, Texas, casing was cemented at 9,264 feet total depth on
March 4, 2006, and this initial well is awaiting fracture stimulation and
completion. The second horizontal well in the project was spudded on
Page 35
March 15, 2006, in Ellis County and drilled to a depth of 11,530 feet. On May 9,
2006, casing was cemented at 11,483 feet measured depth. This well is also
awaiting fracture stimulation and completion. A third well is scheduled to
spudded in May, 2006, in Tarrant County, Texas. This project is subject to the
pending resolution of all matters relating to the First Amended and Restated
Program Agreement between the Company and Harding, and the contingencies set
forth in the ExxonMobil/Harding Agreement as previously described herein.
NORTH TEXAS/PANHANDLE WATER FLOOD PROJECT - In November 2005, we acquired a 100%
working interest in 1,755 acres in the Quinduno Field in Roberts County, Texas,
in the Anadarko Basin. The Company's working interest reduces to 90% at payout,
including the cost of acquisition. Proved reserves are estimated by Ryder Scott
to be 2.0 MMbo and 1.1 Bcf of gas with an SEC PV-10 value of $33.7 million (at
December 31, 2005). The purchase price (in November 2005) equated to $3.37 per
proved barrel of oil equivalent (boe) based on a conversion factor of 6 Mcf/bo.
As operator, we intend to extract the reserves through conventional water flood
technology. The first phase of the project began in March 2006 with the
drilling of a new well, the Maddox #42, for production to a depth of 4,495 feet.
An unexpected oil saturated fourteen foot limestone interval was found, and
tested, approximately 180 feet below the top of the target water flood horizon
(Lower Albany Dolomite). The reservoir appears to be normally pressured and
does not appear to have been produced in the past. The well was completed April
13, 2006, and is producing at the rate of approximately 8 to 12 BOPD. As a
result of this new zone discovery, the company is evaluating plans to develop
the zone without interfering with the planned water flood development. During
2006, a minimum of 4 old wells will be converted to injection wells and water
injection will begin.
SW GARWOOD, COLORADO COUNTY, TEXAS - The initial well on this prospect, the
Pintail #1, completed in the Upper Wilcox in December 2004, is expected to pay
out by the end of the second quarter of 2006 from the first of 5 potentially
productive zones. The well is currently producing approximately 479 Mcfd with 7
barrels of condensate. After payout we will back-in for 33-1/3% working interest
until payout of all project money spent to-date, including acquisition costs, at
which time our working interest will reduce to 13.33%.
The second well, Pintail Flats #1, was completed and fracture stimulated in May
2005 in the deepest sands penetrated by the well in the Lower Wilcox formation.
Completion problems resulting from the fracture treatment have resulted in the
well performing below expectations (producing approximately 170 Mcfd) from this
zone. The well has an additional 5 potentially productive zones in the Lower
Wilcox and 3 in the Upper Wilcox. An engineering review of available data to
determine the best way to maximize the production rate from the well has been
completed. Plans are being made to re-complete and stimulate the well in 3 or 4
of the shallower Lower Wilcox zones by the end of the second quarter.
Net proved reserves for this project, as estimated by Ryder Scott Company, are
1.2 Mbo and 642 MMcf of natural gas. Of the 2,402 acres in the prospect, we
have: 20% working interest in approximately 240 acres; 33.33% working interest
after payout on a well by well basis in 1,018 acres that reduces to 13.33% after
project payout; 33.33% working interest after payout on a well-by-well basis in
640 acres that reduces to 18.33% at project payout; and 21.5% working interest
after payout on a well by well basis in 444 acres that reduces to 19.25% at
project payout. The cost of the two existing wells has been funded by our
drilling partner.
Page 36
BUENA VISTA, JEFFERSON COUNTY, MISSISSIPPI - We fracture stimulated and tested
approximately 80 feet of potentially productive sands at the base of the Hosston
zone without establishing commercial production in the Phillips-Burkley #1 well
during 2005. The presence of gas was established but production rates were
non-commercial. These sands have been abandoned and we plan to test and
complete the well in a portion of approximately 280 feet of potentially
productive Hosston sands up-hole, which appear to have superior reservoir
properties compared to the sands already tested. We plan to complete the work by
the end of June 2006.
The Phillips-Burkley # 1, an exploratory gas well on a leasehold position of
7,481 acres, has been funded by our drilling partner. We are the operator and
have a 50% working interest in the well and acreage. If commercial reserves can
be established, the structure could support in excess of 22 additional wells.
AIRPORT PROSPECT, WOODWARD COUNTY, OKLAHOMA - We farmed out this 640-acre
prospect in November 2005 and retained a 10% working interest. The initial well,
the Corbett N 13 #1 was spudded on March 7, 2006, and reached total depth of
8,323 feet in the Morrow Sands on March 27, 2006. Three sands were perforated
and tested gas. The well is currently awaiting fracture stimulation.
PROJECTS ASSOCIATED WITH REVISED CREDIT AGREEMENT
GRUMAN PROSPECT, STARK COUNTY, NORTH DAKOTA - In September 2005, we purchased an
additional 21.25% working interest, giving us an 85% working interest in this
Lodgepole Reef oil well. On March 28, 2006, we spudded a well (the Gruman 18-3)
intended to be either an increased density well or a water injection well, updip
of the Gruman 18-1. The well reached total depth of 9.890 feet on April 14,
2006, and is being completed as an injection well.
Proved developed reserves in the prospect to our share of the well as of
December 31, 2005, are 309 Mbo and 82 MMcf of natural gas, as estimated by a
third party engineering firm, McCartney Engineering, LLC.
RODNEY ISLAND, TENSAS PARISH, LOUISIANA - In October 2005, we took over
operations of the Harper Z-1 well on the Rodney Island prospect from the
previous operator after casing was set and cemented. Downhole mechanical
difficulties hindered our attempt to complete the well, which was directionally
drilled to a measured depth of 11,701 feet (vertical depth = 9,373 feet) and
logged approximately 19 feet of oil sand in the Tuscaloosa Massive Sand. We are
now finalizing our well program and rig selection for sidetracking the well to
improve wellbore conditions. We expect the work to be done by the end of July.
Re-mapping based on the additional data from the Harper Z-1 well indicates as
many as 2 additional proved locations and 3 other identified locations. Ryder
Scott estimates proved reserves net to our share as of December 31, 2005 to be -
49.4 Mbo and 26 MMcf. We have a 25% working interest before payout in the Harper
Z-1 well and 18.75% working interest after payout. We have an 18.75% working
interest in all additional wells.
TAIT PROJECTS - COLORADO COUNTY, TEXAS -. The initial well on this 1,250 net
acre prospect, the Sealy #1, was drilled to a depth of 10,895 feet and logged on
May 12, 2006. The primary Upper Wilcox target at 10,600 was shaled out and a
secondary Wilcox objective at 10,350 feet was
Page 37
tight. We elected not to participate in an uphole Frio Sand completion attempt.
Two additional updip Frio locations remain on this acreage. We have a 10%
non-operated interest in the project.
BURLESON COUNTY, TEXAS, PROJECTS -- A multi-well natural gas project that
includes a total of 15 development and step-out locations in the Austin Chalk
and Georgetown formations at approximately 10,000 feet vertical depth on a
targeted leasehold position of approximately 11,000 acres, with 7,361 net acres
having been leased. Horizontal wells are planned with total measured length of
approximately 13,000 feet. The initial well is planned to be spudded in the
third quarter of 2006 with a second well planned in the fourth quarter of 2006.
We will have a 37.5% non-operated working interest in the project.
MISSISSIPPI TUSCALOOSA PROJECTS -- We have identified five Tuscaloosa oil
prospects in the Mississippi Inland Salt Basin, in Yazoo County, comprising a
maximum of 2,295 acres and up to 18 potential drilling locations. Eight
locations are planned to be drilled in 2007, ranging from 6,150 feet to 7,500
feet in depth. Approximately 55% of the required acreage has been leased.
Seismic data on the prospects has been reprocessed and confirmed our original
geological analysis. We own 100% of the prospects and will operate the project.
MARKET FOR COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
-------------------------------
Our common stock is quoted on the OTCBB under the symbol "PTSG.OB." The
following table sets forth the quarterly high and low closing prices per share
for the common stock for the last two fiscal years and the subsequent interim
period. Our fiscal year ended December 31, 2005.
- -----------------------------------
QUARTER HIGH LOW
- -------------------- ------ -----
1st Quarter 2004 (1) $20.15 $4.42
- -------------------- ------ -----
2nd Quarter 2004 (1) $ 6.57 $4.16
- -------------------- ------ -----
3rd Quarter 2004 (1) $ 5.79 $2.21
- -------------------- ------ -----
4th Quarter 2004 (1) $ 3.90 $1.95
- -------------------- ------ -----
1st Quarter 2005 $ 2.60 $1.18
- -------------------- ------ -----
2nd Quarter 2005 $ 2.20 $1.13
- -------------------- ------ -----
3rd Quarter 2005 $ 1.83 $0.90
- -------------------- ------ -----
4th Quarter 2005 $ 1.49 $0.72
- -------------------- ------ -----
1st Quarter 2006 $ 1.80 $1.10
- -----------------------------------
<FN>
(1) All figures shown for fiscal quarters prior to first quarter 2005 are
stated using post-reverse split (6.5-to-1) bid price equivalents.
On May 9, 2006, the last reported sales price of our Common Stock was $1.38 per
share. On May 19, 2006, there were approximately 2,500 stockholders of record.
Page 38
EQUITY COMPENSATION PLAN INFORMATION
------------------------------------
The following table sets forth all equity compensation plans as of December 31,
2005:
- ------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
FUTURE ISSUANCE UNDER
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE EQUITY COMPENSATION
BE ISSUED UPON EXERCISE EXERCISE PRICE OF PLANS (EXCLUDING
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, SECURITIES REFLECTED IN
WARRANTS AND RIGHTS WARRANTS AND RIGHTS COLUMN (A))
PLAN CATEGORY (A) (B) (C)
- --------------------- ------------------------ ---------------------- -----------------------
Equity compensation
plans approved by N/A N/A N/A
security holders
- --------------------- ------------------------ ---------------------- -----------------------
Equity compensation
plans not approved by 8,495,045 $ 3.57 N/A
security holders
- --------------------- ------------------------ ---------------------- -----------------------
TOTAL 8,495,045 $ 3.57 N/A
- ------------------------------------------------------------------------------------------------
Dividends
There are no restrictions in our articles of incorporation or bylaws that
prevent us from declaring dividends. The Nevada Revised Statutes, however, do
prohibit us from declaring dividends where, after giving effect to the
distribution of the dividend:
We would not be able to pay our debts as they become due in the usual course of
business; or
Our total assets would be less than the sum of our total liabilities plus the
amount that would be needed to satisfy the rights of stockholders who have
preferential rights superior to those receiving the distribution.
We have not declared any dividends and we do not plan to declare any dividends
in the foreseeable future. Our current policy is to retain any earnings in
order to finance the expansion of our operations. Our Board of Directors will
determine future declaration and payment of dividends, if any, in light of the
then-current conditions they deem relevant and in accordance with the Nevada
Revised Statutes.
CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
--------------------------------------------------
We have had no changes in or disagreements with accountants on accounting and
financial disclosure.
USE OF PROCEEDS
---------------
We are not selling any shares of our Common Stock and therefore, there will be
no proceeds to us from the sale of shares of Common Stock. However, we may
receive up to approximately
Page 39
$30,155,506 upon the exercise and payment for the outstanding warrants held by
certain selling stockholders for which we have registered shares of common
stock. We intend to use any proceeds from the exercise of warrants for working
capital purposes.
DIRECTORS, EXECUTIVE OFFICERS,
PROMOTERS AND CONTROL PERSONS
-----------------------------
The following table sets forth our Directors and executive officers as of May 9,
2006:
- -----------------------------------------------------------
Name Age Position
- --------------- --- -------------------------------------
Richard D. Dole 60 Director, Chairman, President and CEO
- --------------- --- -------------------------------------
Wayne Beninger 52 Chief Operating Officer
- --------------- --- -------------------------------------
David Collins 37 Chief Financial Officer
- --------------- --- -------------------------------------
Gerald Agranoff 59 Director
- --------------- --- -------------------------------------
Richard Majeres 39 Director
- -----------------------------------------------------------
RICHARD D. DOLE, DIRECTOR, CHAIRMAN OF THE BOARD, PRESIDENT AND CEO
Mr. Dole joined us as a Director in July 2004, and assumed the positions of
Chairman, President and CEO in December 2004. Mr. Dole previously served as
Vice President and Chief Financial Officer for Burlington Resources
International from 1998 to 2000. Since that time he has been active in
consulting and financial services. He was a co-founder of Benefits Access
Solutions, LLC, a company formed to provide financial services and benefit
options to employees and members of corporate organizations. He was also
co-founder and managing partner of Innovation Growth Partners, LLC, a firm that
provided management and consulting services to early stage companies. Mr. Dole's
extensive industry experience includes being National Partner-in-Charge of
Business Process Solutions at KPMG. Prior to that he was with Coopers & Lybrand
(now PriceWaterhouse Coopers) where he served as Assurance and Business Advisory
Partner for nearly 20 years and also served in numerous senior management roles,
including National Chairman for the Energy and Natural Resources Industry
practices for over 15 years and as the Vice Chairman for the U.S. Process
Management business unit. From August 2003 to July 2004, Mr. Dole was also a
member of the Board of Directors of Westport Resources Corporation (NYSE: WRC),
a member of its audit committee and a designated financial expert. He currently
serves as a director of Double Eagle Petroleum Company (DBLE, NASDAQ, small cap)
and chairs the audit committee and is the designated financial expert. Mr. Dole
graduated from Colorado State University.
WAYNE BENINGER, CHIEF OPERATING OFFICER
Mr. Beninger joined us as Chief Operating Officer in May 2005. Prior to May
2005, Mr. Beninger served as President of Southwest Oil & Gas Management, Inc.
("SOGMI") which he founded in 1997 to provide oil and gas property evaluation
services, geologic prospect review, contract operating services, technical
support for initial public offerings and strategic planning solutions for
domestic and international projects. Prior to Mr. Beninger joining the Company,
SOGMI provided a significant amount of our engineering and geological services
for all projects. From 1995 to 1997, Mr. Beninger was the Vice President for
Strategic Planning with WRT
Page 40
Energy Corporation. From 1982 to 1995 he was first employed by, and then was a
partner in, The Scotia Group, a domestic and international consulting firm where
he provided petroleum engineering and geological services for companies and
projects in the majority of active petroleum basins in both the U.S. and
overseas. He has been active in the oil and gas industry since 1976. Mr.
Beninger holds undergraduate degrees in both petroleum engineering and geology
from the University of Southern California and has a number of industry
publications to his credit. He is a member of the Society of Petroleum
Engineers, Pi Epsilon Tau (petroleum engineering honorary fraternity) and Sigma
Gamma Epsilon (geologic honorary fraternity).
DAVID COLLINS, VICE PRESIDENT, CHIEF FINANCIAL OFFICER
Mr. Collins joined Petrosearch Corporation as a Vice President and the Chief
Financial Officer in October 2003. Previously, he served as the Controller of
Kazi Management VI, LLC, a diversified investment and management organization
actively involved in energy, retail food chains, aquaculture and biotechnology
from February 2002 to October 2003. At Kazi Management VI, he was responsible
for the financial operations of multiple accounting offices across the United
States, as well as fourteen international and domestic Companies. Mr. Collins
was also the Chief Financial Officer of ZK Petroleum, an independent oil
producer in South Texas. Prior to Kazi Management VI, he served as an
independent analyst for The March Group in St. Thomas, U.S.V.I. from February
2001 to January 2002. Mr. Collins previously held the position of Chief
Financial Officer of Federation Logistics, LLC in the New York metropolitan area
from November 1994 to January 2001. Mr. Collins graduated from Villanova
University in 1990 with a Bachelor's degree in Accountancy. He became a
Certified Public Accountant and began his career in the Financial Services
Division of Ernst and Young in New York City. At Ernst and Young, he performed
audits of Fortune 500 Companies.
GERALD N. AGRANOFF, DIRECTOR
Gerald N. Agranoff joined us as a Director in May 2004. Mr. Agranoff has been
counsel to the firm of Kupferman & Kupferman, L.L.P. in New York since 2004 and
has been a general partner of SES Family Investment and Trading Partnership,
L.P., an investment partnership since 2004. Mr. Agranoff has also been a
member of Inveraray Capital Management L.L.C., the investment manager of
Highlander Fund B.V. and Highlander Partners (USA) L.P since 2002. He is also a
director and the chair of the audit committee of Triple Crown Media Inc (symbol,
TCMI). Active in Wall Street financial transactions for over two decades, his
specialties include taxation, investments and corporate finance. From 1975
through 1981, Mr. Agranoff was engaged exclusively in the private practice of
law in New York and was an adjunct-instructor at New York University's Institute
of Federal Taxation. Previously, he served as attorney-advisor to a Judge of the
United States Tax Court. He holds an L.L.M. degree in Taxation from New York
University and J.D. and B.S. Degrees from Wayne State University.
RICHARD MAJERES, DIRECTOR
Richard Majeres joined us as a Director in May 2004. In December 2000, Mr.
Majeres was one of the founding partners of the Houston public accounting firm
Ubernosky & Majeres, PC, which currently operates as Ubernosky, Passmore &
Majeres, LLP, offering tax, audit, accounting and management consulting
services. Mr. Majeres has served as a partner of this firm since its inception
in December 2000. From January 1999 to November 2000, Mr. Majeres was a partner
at Cox & Lord, PC. Mr. Majeres graduated from Bemidji State University,
Bemidji, Minnesota in 1989 with a bachelor's degree in accounting. Upon
graduation, he served as a field auditor with the Federal Energy Regulatory
Commission of the Department of Energy. Mr. Majeres
Page 41
became a certified public accountant in 1992. He has extensive experience with
oil and gas entities, including exploration and development partnerships and
corporations and currently focuses a majority of his efforts on the Firm's audit
practice.
COMMITTEES OF THE BOARD OF DIRECTORS
We held two in person and four telephonic meetings of the Board of Directors
during the fiscal year ended December 31, 2005, and the Board of Directors took
action at Board meetings or by unanimous written consent eight times during that
period. Mr. Dole is our only Director who is also an Officer. We currently
have an audit committee of the Board of Directors made up of Richard Majeres and
Gerald Agranoff. The Board of Directors is in the process of evaluating the
need for other appropriate committees for our future growth.
We do not currently have a process for security holders to send communications
to the Board of Directors. However, we welcome comments and questions from our
shareholders. Shareholders can direct communications to our Chief Executive
Officer, Richard D. Dole, at our executive offices, 675 Bering Drive, Suite 200,
Houston, Texas 77057. While we appreciate all comments from shareholders, we may
not be able to individually respond to all communications. We attempt to address
shareholder questions and concerns in our press releases and documents filed
with the SEC so that all shareholders have access to information about us at the
same time. Mr. Dole collects and evaluates all shareholder communications. If
the communication is directed to the Board of Directors generally or to a
specific director, Mr. Dole will disseminate the communications to the
appropriate party at the next scheduled Board of Directors meeting. If the
communication requires a more urgent response, Mr. Dole will direct that
communication to the appropriate executive officer. All communications addressed
to our directors and executive officers will be reviewed by those parties unless
the communication is clearly frivolous.
Our Bylaws provide that nominations of persons for election to the Board of
Directors of the corporation may be made at a meeting of stockholders by or at
the direction of the Board of Directors or by any stockholder of the corporation
entitled to vote in the election of directors at the meeting who complies with
the following notice procedures, as set forth in the Bylaws:
Nominations of persons for election to the Board of Directors may be made at a
meeting of the shareholders at which directors are to be elected (a) by or at
the direction of the Board of Directors, or (b) by any shareholder of the
Company who is a shareholder of record at the time of the giving of such
shareholders notice provided for in Paragraph 3.3 (of the Bylaws), who shall be
entitled to vote at such meeting in the election of directors and who complies
with the requirements of Paragraph 3.3 (of the Bylaws). Such nominations, other
than those made by or at the direction of the Board of Directors shall be
preceded by timely advance notice in writing to the Secretary. To be timely, a
shareholder's notice shall be delivered to, or mailed and received at, the
principal executive offices of the Company (1) with respect to an election to be
held at the annual meeting of the shareholders of the Company, not later than
the close of business on the 90th day prior to the first anniversary of the
preceding year's annual meeting; provided, however, in the event that the date
of the annual meeting is more than 30 days before or more than 60 days after
such anniversary date, notice by the shareholder to be timely must be so
delivered not later than the close of business on the later of the 90th day
prior to such annual meeting or the 10th day following the day on which public
announcement of the date of such meeting is first made by the Company; and (2)
with respect to an election to be held at a special
Page 42
meeting of shareholders of the Company for the election of directors not later
than the close of business on the 10th day following the day on which notice of
the date of the special meeting was mailed to shareholders of the Company as
provided in Paragraph 2.4 (of the Bylaws) or public disclosure of the date of
the special meeting was made, whichever first occurs. Any such shareholder's
notice to the Secretary shall set forth (x) as to each person whom the
shareholder proposes to nominate for election or re-election as a director, (i)
the name, age, business address and residence address of such person; (ii) the
principal occupation or employment of such person; (iii) the number of shares of
each class of capital stock of the Company's beneficially owned by such person;
(iv) the written consent of such person to having such person's name placed in
nomination at the meeting and to serve as a director if elected; (v) any other
information relating to such person that is required to be disclosed in
solicitations of proxies for election of directors, or is otherwise required,
pursuant to Regulation 14A under the Exchange Act, and (vi) as to the
shareholder giving the notice, (i) the name and address, as they appear on the
Company's books of such shareholder, and (ii) the number of shares of each class
of voting stock of the Company which are then beneficially owned by such
shareholder. The presiding officer of the meeting of shareholders shall
determine whether the requirements of Paragraph 3.3 (of the Bylaws) have been
met with respect to any nomination or intended nomination. If the presiding
officer determines that any nomination was not made in accordance with the
requirements of Paragraph 3.3 (of the Bylaws), he shall so declare at the
meeting and the defective nomination shall be disregarded. Notwithstanding the
foregoing provisions, a shareholder shall also comply with all applicable
requirements of the Exchange Act and the rules and regulations thereunder with
respect to the matters set forth in Paragraph 3.3 of the Bylaws. For (purposes
of the notice provisions of the Bylaws), public disclosure shall be deemed to
first be given to shareholders when disclosure of such date of the meeting of
shareholders is first made in a press release reported by the Dow Jones News
Services, Associated Press or comparable national news service, or in a document
publicly filed by the Company with the Securities and Exchange Commission
pursuant to Sections 13, 14 or 15(d) of the Exchange Act.
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934 requires our directors and
executive officers, and persons who own beneficially more than ten percent of
our common stock, to file reports of ownership and changes of ownership with the
Securities and Exchange Commission. Based solely on the reports we have
received and on written representations from certain reporting persons, we
believe that the directors, executive officers, and greater than ten percent
beneficial owners have complied with all applicable filing requirements.
CODE OF ETHICS
Effective August 19, 2005, the Board of Directors adopted a Code of Ethics for
our directors, officers and employees. A copy of our Code of Ethics was filed
with our Form SB-2 registration statement on June 6, 2005.
EXECUTIVE COMPENSATION
The following table sets forth certain compensation information for the
following individuals for the three most recently completed fiscal years ended
December 31, 2005. No other compensation was paid to our named executive
officers other than the compensation set forth
Page 43
below. The compensation reflected in this section has been awarded by us and
our predecessor, Petrosearch Texas.
- ------------------------------------------------------------------------------------------------------------
SUMMARY COMPENSATION TABLE
- ------------------------------------------------------------------------------------------------------------
ANNUAL COMPENSATION LONG TERM COMPENSATION
- ---------------------------- --------------------------- -------------------------------------------------
AWARDS PAYOUTS
----------- ----------
OTHER OPTIONS/
ANNUAL RESTRICTED SARS ALL OTHER
COMP- STOCK WARRANTS LTIP COMP-
NAME TITLE YEAR SALARY BONUS ENSATION AWARDED (#) PAYOUTS ($) ENSATION
- ----------- --------- ---- -------- ------- -------- ----------- ---------- ----------- -----------
Richard Chairman, 2005 $180,000 -0- -0- -0- -0- -0- -0-
Dole(1) CEO and 2004 $ 90,000 -0- -0- -0- 3,930,046 -0- -0-
President 2003 -0- -0- -0- -0- 15,385 -0- -0-
- ----------- --------- ---- -------- ------- -------- ----------- ---------- ----------- -----------
Bradley Former 2005 -0- -0- -0- -0- -0- -0- -0-
Simmons(2) Director, 2004 $180,000 $50,000 -0- -0- -0- -0- $110,000(3)
CEO and 2003 $320,370 -0- -0- -0- 730,769 -0- -0-
President
- ----------- --------- ---- -------- ------- -------- ----------- ---------- ----------- -----------
Wayne Chief 2005 $135,417 $25,000 -0- -0- 365,000 -0- -0-
Beninger(4) Operating 2004 -0- -0- -0- -0- -0- -0- -0-
Officer 2003 -0- -0- -0- -0- -0- -0- -0-
- ----------- --------- ---- -------- ------- -------- ----------- ---------- ----------- -----------
David Chief 2005 $180,000 -0- -0- -0- 50,000 -0- -0-
Collins(5) Financial 2004 $165,000 $25,000 -0- $ 15,000 -0- -0- -0-
Officer 2003 -0- -0- -0- $ 45,000 323,077 -0- -0-
- ----------- --------- ---- -------- ------- -------- ----------- ---------- ----------- -----------
Eric Former 2005 $180,000 -0- -0- -0- 500,000 -0- -0-
Brown(6) V.P., 2004 $105,000 -0- -0- -0- 53,846 -0- -0-
Finance 2003 -0- -0- -0- -0- -0- -0- -0-
- ------------------------------------------------------------------------------------------------------------
Notes to Summary Compensation Table:
(1) Mr. Dole was appointed as a Director in July 2004. On December 30,
2004, Mr. Dole assumed the roles of Chairman of our Board of
Directors, President and Chief Executive Officer Mr. Dole entered into
an employment agreement with the Company in November 2004 for a term
of 2 years which called for compensation of $15,000 per month. Mr.
Dole became an employee of the Company as of January 1, 2005.
(2) Mr. Simmons served as a Director and Chief Executive Officer and
President until his resignation on December 30, 2004. Mr. Simmons
entered into a consulting agreement with the Company in December 2004
for a term of one year which calls for compensation of $15,000 per
month. In September 2005 the Company and Mr. Simmons mutually agreed
to terminate his consulting agreement.
(3) During 2004, the Board of Directors approved advances to Mr. Simmons
which were to be evaluated at year-end as possible compensation. The
Board of Directors authorized a portion of the advances as a year-end
performance bonus for 2004; the remaining balance of the advances was
converted to a non-interest bearing receivable to the Company as of
December 31, 2004. The outstanding balance of the loan as of December
31, 2005 was -0-.
(4) Mr. Beninger was appointed Chief Operating Officer in May, 2005.
Mr. Beninger became an employee and entered into an employment
agreement with the Company on May 1, 2005, for a term of 2 years which
calls for compensation of $20,830 per month and a $50,000 annual bonus
each year.
Page 44
(5) Mr. Collins was appointed Chief Financial Officer in September, 2004.
Mr. Collins became an employee of the Company as of January 1, 2005.
Mr. Collins entered into an employment agreement with the Company May
1, 2005, for a term of 2 years which calls for compensation of $15,000
per month.
(6) Mr. Brown was appointed Vice President of Finance on December 30,
2004. Mr. Brown became an employee of the Company as of January 1,
2005. Mr. Brown entered into an employment agreement with the Company
May 1, 2005, which called for compensation of $15,000 per month.
Subsequent to the fiscal year end Mr. Brown tendered his resignation
effective April 1, 2006.
OPTION/SAR/WARRANT GRANTS IN LAST FISCAL YEAR
(Individual Grants)
- -------------------------------------------------------------------------------------------
Number of Percent of Total
Securities Options/SARs/
Underlying Warrants Granted Exercise of Base
Name Warrants/Options/ to Employees in Price ($/Sh) Expiration Date
SARS Granted (#) Fiscal Year (%)
- --------------- ------------------ ----------------- ------------------ ---------------
Richard Dole -0- -0- N/A N/A
- --------------- ------------------ ----------------- ------------------ ---------------
Wayne Beninger 365,000 36.0% $ 1.95 11/15/2008
- --------------- ------------------ ----------------- ------------------ ---------------
David Collins 50,000 4.9% $ 1.95 11/15/2008
- --------------- ------------------ ----------------- ------------------ ---------------
Eric Brown 500,000 49.3% $ 1.95 11/15/2008
- --------------- ------------------ ----------------- ------------------ ---------------
Richard Majeres 50,000 4.9% $ 1.95 11/15/2008
- --------------- ------------------ ----------------- ------------------ ---------------
Gerald Agranoff 50,000 4.9% $ 1.95 11/15/2008
- -------------------------------------------------------------------------------------------
AGGREGATED OPTION/SAR/WARRANT EXERCISES IN
LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
- ----------------------------------------------------------------------------------------------
Number of Value of
Unexercised Unexercised In-The-
Underlying Money
Shares Acquired Options/SARs/ Options/SARs/
Name on Exercise (#) Value Realized ($) Warrants at FY end Warrants at FY end
(#); ($);
Exercisable/ Exercisable/
Unexercisable Unexercisable
- --------------- ---------------- ------------------ ------------------ -------------------
Richard Dole -0- -0- 2,995,430/-0- -0-/-0-
- --------------- ---------------- ------------------ ------------------ -------------------
Wayne Beninger -0- -0- 399,616/-0- -0-/-0-
- --------------- ---------------- ------------------ ------------------ -------------------
David Collins -0- -0- 373,077/-0- -0-/-0-
- --------------- ---------------- ------------------ ------------------ -------------------
Eric Brown -0- -0- 553,847/-0- -0-/-0-
- --------------- ---------------- ------------------ ------------------ -------------------
Richard Majeres -0- -0- 111,538/-0- -0-/-0-
- --------------- ---------------- ------------------ ------------------ -------------------
Gerald Agranoff -0- -0- 111,538/-0- -0-/-0-
- ----------------------------------------------------------------------------------------------
There were no stock options, SAR's or warrants exercised by any of our named
executive officers during our most recent fiscal year ended December 31, 2005.
Other than those awards listed above, we have no long-term incentive plans.
Page 45
DIRECTOR COMPENSATION
In May 2004, as director compensation, Messrs. Agranoff and Majeres each
received 61,538 warrants to purchase shares of our common stock at a strike
price of $6.50 per share which will expire on May 20, 2007. Additionally, in
December 2004, Mr. Agranoff was paid $4,500 for consulting services to us.
From January 1, 2005 until December 31, 2005, Mr. Agranoff received $4,500 per
month for consulting services provided to us including consultation,
participation and review of our restructuring, the private placement transaction
and the SB-2 Registration Statement. These services are no longer provided by
Mr. Agranoff.
On March 25, 2005, the Board of Directors approved compensation to each of
Gerald Agranoff, Richard Majeres and Don Henrich (our former Director) in an
amount of (i) $25,000, which was payable $5,000 in cash and $20,000 in
restricted stock, and (ii) 50,000 warrants to purchase our common stock at a
strike price of $1.95 per share.
EMPLOYMENT AGREEMENTS
As of May 9, 2006, we have employment contracts in existence with officers and
key personnel, including the above-referenced November 15, 2004, contract with
Richard Dole (Chairman, President and CEO), and employment contracts with each
of David Collins (Vice President and Chief Financial Officer) and Wayne
Beninger, our Chief Operating Officer, each dated as of May 1, 2005.
The employment contracts with Messrs. Dole, Collins and Beninger provide for an
employment term of two years. Each of the employment contracts provides for
termination by the Company upon death or disability, with six month severance
payments. Each of the employment contracts permits termination by the Company
for cause, which includes malfeasance, misuse of funds, insubordination, a
material uncured breach or conviction for a felony or crime of moral turpitude.
The agreements may be voluntarily terminated by the employee at any time, with
no severance payment. Additionally, the respective employees may elect to
terminate their employment contract and receive severance pay upon a material
uncured breach by the Company or a change in control, if within forty five days
of the change in control the employee is not offered a position with the
identical salary for a period equal to the then remaining term plus one year.
For purposes of each agreement, a change in control is defined as a change in
the majority of the Board of Director positions accompanying the acquisition of
voting securities by a third party (other than directly from the Company)
equivalent to forty percent of the voting control of the Company (other than a
subsidiary or employee benefit plan), or accompanying a sale of all of the
assets or a merger (other than involving a subsidiary). Upon termination for
cause, the employee is not entitled to severance pay. A termination without
cause while a contract is pending, other than due to a change in control,
entitles the employees other than Mr. Dole to compensation through the end of
the contract term plus an additional three months. A termination without cause
of Mr. Dole or non-renewal of Mr. Dole's agreement gives rise to a severance pay
obligation equal to twelve months. Upon a termination coupled with a change in
control where the particular employee is not offered a position for the
identical salary, and in the case of Messrs. Dole and Beninger, the same
position, the employee is entitled to severance
Page 46
compensation equal to the face period of the employment contract then pending at
termination (e.g. a 1-year contract would give rise to twelve months severance
pay).
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The following table sets forth certain information at May 9, 2006 with respect
to the beneficial ownership of shares of common stock by (i) each person known
to us who owns beneficially more than 5% of the outstanding shares of common
stock, (ii) each of our Directors, (iii) each of our Executive Officers
(including Wayne Beninger who became our Chief Operating Officer on May 16,
2005) and (iv) all of our Executive Officers and Directors as a group. Unless
otherwise indicated, each stockholder has sole voting and investment power with
respect to the shares shown. As of May 9, 2006, we had 31,099,570 shares of
common stock issued and outstanding.
- ------------------------------------------------------------------------------------------------
TITLE OF CLASS NAME AND ADDRESS OF NUMBER OF SHARES PERCENTAGE OF
BENEFICIAL OWNER OF COMMON STOCK COMMON STOCK (1)
- -------------- ------------------------------------------- ----------------- ----------------
Common Stock Richard D. Dole 3,045,430(2) 8.9%
Chairman, President and CEO
675 Bering Drive, Suite 200
Houston, Texas 77057
- -------------- ------------------------------------------- ----------------- ----------------
Common Stock Wayne Beninger 647,308 (3) 2.0%
Chief Operating Officer
675 Bering Drive, Suite 200
Houston, Texas 77057
- -------------- ------------------------------------------- ----------------- ----------------
Common Stock 913,263(4) 2.9%
David J. Collins
Vice President and Chief Financial Officer
675 Bering Drive, Suite 200
Houston, Texas 77057
- -------------- ------------------------------------------- ----------------- ----------------
Common Stock Gerald Agranoff 114,102(5) <1%
Director
675 Bering Drive, Suite 200
Houston, Texas 77057
- -------------- ------------------------------------------- ----------------- ----------------
Common Stock Richard Majeres 203,942(6) <1%
Director
675 Bering Drive, Suite 200
Houston, Texas 77057
- -------------- ------------------------------------------- ----------------- ----------------
- -------------- ------------------------------------------- ----------------- ----------------
ALL OFFICERS AND DIRECTORS 4,924,045(7) 14%
AS A GROUP (TOTAL OF 5)
- -------------- ------------------------------------------- ----------------- ----------------
- -------------- ------------------------------------------- ----------------- ----------------
Common Stock GLG Partners, LP 1,795,098(8) 5.7%
1 Curzon Street
London, XO W1J 5HB
- -------------- ------------------------------------------- ----------------- ----------------
Common Stock North Sound Capital, LLC 2,770,000(9) 8.9%
20 Horseneck Lane
Greenwich, CT 06830
- ------------------------------------------------------------------------------------------------
Page 47
(1) Under Rule 13d-3 promulgated under the Exchange Act, a beneficial owner of a
security includes any person who, directly or indirectly, through any contract,
arrangement, understanding, relationship, or otherwise has or shares: (i) voting
power, which includes the power to vote, or to direct the voting of shares; and
(ii) investment power, which includes the power to dispose or direct the
disposition of shares. Certain shares may be deemed to be beneficially owned by
more than one person (if, for example, persons share the power to vote or the
power to dispose of the shares). In addition, shares are deemed to be
beneficially owned by a person if the person has the right to acquire the shares
(for example, upon exercise of an option) within 60 days of the date as of which
the information is provided. In computing the percentage ownership of any
person, the amount of shares is deemed to include the amount of shares
beneficially owned by such person (and only such person) by reason of these
acquisition rights. As a result, the percentage of outstanding shares of any
person as shown in this table does not necessarily reflect the person's actual
ownership or voting power with respect to the number of shares of common stock
actually outstanding on May 9, 2006. As of May 9, 2006, there were 31,099,570
shares of our common stock issued and outstanding.
(2) Includes 65,385 shares of common stock held directly and 2,980,045 shares
issuable upon the exercise of warrants to purchase shares of our common stock.
Excludes 950,000 warrants issued to Mr. Dole that have been gifted to his
children, to which Mr. Dole disavows beneficial ownership.
(3) Includes 247,692 shares of common stock held directly and 399,616 shares
issuable directly upon the exercise of warrants to purchase shares of our common
stock.
(4) Includes 413,263 shares held indirectly through DC Financial Services,
LLC, 126,923 shares held directly and 373,077 shares issuable directly upon the
exercise of warrants to purchase shares of our common stock.
(5) Includes 10,256 shares held directly and 103,846 shares issuable upon the
exercise of warrants to purchase shares of our common stock.
(6) Includes 92,404 shares held directly by Mr. Majeres and 111,538 shares
issuable upon the exercise of warrants to purchase shares of our common stock.
(7) Includes 3,968,122 shares issuable upon the exercise of warrants to
purchase shares of our common stock.
(8) Includes 1,421,200 shares held by GLG North American Opportunity Fund;
322,308 shares held by GLG North American Equity Fund; 13,000 shares held by
CITI GLG North American Fund Limited; and 38,590 shares held by Lyxor/GLG Pan
European Equity Fund Limited.
(9) Includes 775,600 shares held by North Sound Institutional Fund and
1,994,400 shares held by North Sound International Fund.
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Except as described below, none of the following persons has any direct or
indirect material interest in any transaction to which we were or are a party
during the past two years, or in any proposed transaction to which we propose to
be a party:
(A) any of our directors or executive officers;
Page 48
(B) any nominee for election as one of our directors;
(C) any person who is known by us to beneficially own, directly or indirectly,
shares carrying more than 5% of the voting rights attached to our common
stock; or
(D) any member of the immediate family (including spouse, parents, children,
siblings and in-laws) of any of the foregoing persons named in paragraph
(A), (B) or (C) above.
Mr. Wayne Beninger, who became our Chief Operating Officer on May 16, 2005, is
the owner of Southwest Oil & Gas Management ("SOGMI") which had provided
engineering and geological consulting services for our projects. During the
fiscal year ended December 31, 2004, we paid SOGMI approximately $600,000 for
such services. When Mr. Beninger became our employee, the agreement with SOGMI
was terminated. From January 1, 2005, until the agreement was terminated on May
15, 2005, we paid SOGMI approximately $365,529 for engineering and geological
consulting services. We believe the prices and bids for engineering and
geological consulting services previously paid to SOGMI have been competitive
with those quoted for similar services by unrelated third parties. Mr. Beninger
has an option to purchase for $1.00 a 5% interest (after payout to the company
and our drilling partner) in our subsidiary that holds the Jefferson County,
Mississippi project.
One of our former Directors, Mr. Don Henrich, is a principal officer of Maverick
Drilling Co., Inc., a company which is owned by his wife, with which we
contracted for drilling services in Fort Bend County, Texas. Additionally, Mrs.
Henrich owned a 15-30% working interest in our Fort Bend County Prospect, which
was sold in July, 2005. During the fiscal year ending December 31, 2005, we
paid Maverick Drilling Company approximately $316,000. We believe Maverick's
prices and bids for drilling services have been competitive with those quoted
for similar services by unrelated third parties.
SELLING STOCKHOLDERS
The following is a list of the selling stockholders who own or who have a right
to acquire the 16,108,524 shares of Common Stock covered by this prospectus. Up
to 8,141,814 Shares are issuable upon the exercise of warrants held by certain
of the selling stockholders. As set forth below and elsewhere in this
prospectus, some of these selling stockholders hold, or within the past three
years have held, a position, office or other material relationship with us or
our predecessors or affiliates.
Beneficial ownership is determined in accordance with Rule 13d-3 promulgated by
the Securities and Exchange Commission, and generally includes voting or
investment power with respect to securities. In computing the number of shares
beneficially owned by the holder and the percentage ownership of the holder,
shares of common stock issuable upon exercise of the warrant held by the holder
that are currently exercisable or exercisable within 60 days after the date of
the table are deemed outstanding.
Page 49
The percent of beneficial ownership for the selling stockholders is based on
31,099,570 shares of common stock outstanding as of May 9, 2006. Shares of
common stock subject to warrants, options and other convertible securities that
are currently exercisable or exercisable within 60 days of May 9, 2006, are
considered outstanding and beneficially owned by a selling stockholders who
holds those warrants, options or other convertible securities for the purpose of
computing the percentage ownership of that selling stockholders but are not
treated as outstanding for the purpose of computing the percentage ownership of
any other stockholder.
The shares of common stock being offered under this prospectus may be offered
for sale from time to time during the period the registration statement of which
this prospectus is a part remains effective, by or for the account of the
selling stockholders. After the date of effectiveness of the registration
statement of which this prospectus is a part, the selling stockholder may have
sold or transferred, in transactions covered by this prospectus or in
transactions exempt from the registration requirements of the Securities Act,
some or all of its common stock. Information about the selling stockholders may
change over time. Any changed information will be set forth in an amendment to
the registration statement or supplement to this prospectus, to the extent
required by law.
The following table sets forth information concerning the selling stockholders,
including the number of shares currently held and the number of shares offered
by each selling security holder, to our knowledge as of May 9, 2006. At the
time of acquisition, there were no agreements, understandings or arrangements
between any selling stockholders and any other persons, either directly or
indirectly, to distribute the securities.
- ----------------------------------------------------------------------------------------------------------------------
BEFORE THE AFTER THE
OFFERING OFFERING
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Total
Number of Number of Percentage
Shares of Shares to Number to be
common be Offered of Shares Beneficially
Position, stock for the to be Owned
Office or Beneficially Account of Owned after this
Other Owned Prior to the Selling after this Offering
Material the Offering Stockholder Offering (3)
Name of Selling Stockholder Relationship (1) (2) (3) (4)
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
COMMON STOCK
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
North Sound Legacy Institutional
Fund LLC (7) None 775,600 775,600(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
North Sound Legacy International
Ltd. (7) None 1,994,400 1,994,400(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
A/C #038C6339 of Compass SAV
LLC(8) None 319,800 319,800(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Corsair Capital Partners, L.P. (9) None 140,946 140,946(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Corsair Capital Investors, Ltd. (9) None 17,761 17,761(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Corsair Capital Partners 100, LP (9) None 3,605 3,605(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Braeburn Special Opportunities
Fund, LLC (10) None 481,018 230,769(5) 151,250 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Page 50
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
GLG North American Opportunity
Fund (15) None 1,600,000 1,600,000(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
GLG Investments PLC: Sub-Fund:
GLG North American Equity Fund
(15) None 322,308 322,308(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
S&S Partners, LP (16) None 400,000 200,000(5) 200,000 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
CBarney Investments (18) None 1,076,926 1,076,926(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Mark X Energy Company (18) None 461,538 461,538(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
7,143,653
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Baird, Gary (Jr.) None 3,078 3,078(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Bankston, Colleen R. None 2,052 2,052(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Blum, Gary None 10,258 10,258(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Bowden, David None 4,104 4,104(5) -0- -0
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Bowen, William G. (Jr.) None 4,616 4,616(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Bornham, John Preston (III) None 6,154 6,154(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Brown, Gregory L. None 24,412 24,412(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Brown, Carson E. (Trust) None 10,258 10,258(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Brown, Kathryne Taylor (Trust) None 10,258 10,258(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Brown, Kristin Lee (Trust) None 10,258 10,258(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
CHLG Funding (20) None 100,000 100,000(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Claimworks, Inc. (21) None 2,052 2,052(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Clay, Robert and Emily None 7,694 7,694(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Crowder, Brent & Deborah None 10,258 10,258(5) 0 <1%0
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Crown Financial, LLC (22) None 40,006 16,308(5) 23,698 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Dennis, Mark and Cari None 20,514 20,514(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Dole, Richard D. CEO &
President 3,045,430(23) 15,385 3,030,045 8.8%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Famco of Maryland (24) 233,334 41,026(5) 192,308 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Fetter, R. Keith None 4,104 4,104(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Frishman, Ben & Mary Ann None 2,062 2,062(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Grimes, David Link None 2,052 2,052(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Grisebaum, Andrew M. None 92,308 92,308(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Grisebaum, Andrew M. (IRA) None 23,078 23,078(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Grisebaum, Andrew P. (Minor) None 6,462 6,462(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Grisebaum, Frances B. (Minor) None 6,462 6,462(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Grisebaum, James D. None 15,386 15,386(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Grisebaum, Meredith (IRA) None 23,078 23,078(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Hamilton, William M. None 6,231 6,231(5) -0- 0
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Johnson, Arlen & Nancy None 4,104 4,104(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
King, Michael S. None 308 308(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Lam, Jeffrey None 7,694 7,694(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Lanza, Nick & Judy None 308 308(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Lee, Scott T. None 7,616 7,616(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Lovell, Cliff None 3,283 2,770(5) -513- <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Martinez, Andrew None 1,026 1,026(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
McMahon, Michael & Judith None 7,694 7,694(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
McNulty, David None 4,104 4,104(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Meredith, Robert Matthew None 38,976 8,206(5) 30,770 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Page 51
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Milford Street Partnership None 4,616 4,616(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Modesett, Jack (Jr.) None 41,026 41,026(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Mooneyham, Howard & Janie None 3,078 3,078(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Pagano, Tony None 61,540 30,770(5) 30,770 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Page, John None 2,462 2,462(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Pfeffer, Blake & Jeanne None 41,026 41,026(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Phifer Johnston Assoc. Inc. None 7,694 7,694(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Piedmont Consulting(30) Consultant 15,385 15,385(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Pollak, Michael None 24,616 24,616(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Schnitker, Kevin None 944 944(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Scully, Stephen M. None 15,386 15,386(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Siegfried, Winston & Sandra None 6,462 6,462(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Stetzel, Charles None 12,308 12,308(5) -0- 0
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Tomjanovich, Rudy (IRA) None 185,220 41,026(5) 144,194 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Ulak, Dennis & Deborah None 9,232 9,232(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Vowles, Duanne None 2,052 2,052(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Vowles, Patrick None 4,104 4,104(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Wallace, Michael & Leslyn None 12,308 12,308(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Walters, Cynthia D. None 1,026 1,026(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Williams, A. Kelly None 20,514 20,514(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Zepeda, Zacharia Nazario None 3,284 3,284(5) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
823,057
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
WARRANTS FOR COMMON STOCK
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Koen, A.D. Former
Advisory
Board 76,925 15,385(6) 61,540 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Dole, Alyssa (25) 225,000 225,000 -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Gregarek, David Former
Advisory
Board 7,693 7,693 -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Huttner, Frederick Former
Advisory
Board 7,692 7,692 -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Linck, Ashlee Dole (25) 225,000 225,000 -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Clark, Bill Former
Subsidiary
president 38,462 38,462(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Leer, Bill Former
Subsidiary
president 38,462 38,462(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Simmons, Bradley Former
Director/CEO 192,749 192,308(6) 441 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
The Simmons Grandchildren
2005 Irrevocable Trust (26) 384,615 384,615 -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Dole, Brant Richard (27) 225,000 225,000 -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Brooks, Britt Former
director 153,785 76,923(6) 76,862 <1%%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Roemer, Charles (III) Former
Advisory
Board 15,385 15,385(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Johns, Charlie Former
Subsidiary
president 38,462 38,462(6) 0 0
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Marsh, Christine None 7,692 7,692(29) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Page 52
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Scully, Christopher Former
Subsidiary
president 238,464 38,462(6) 200,002 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Denton, Dan Former
Officer 384,615 384,615(6) 0 0
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Collins, David Officer 913,263 323,070(6) 590,193 1.9%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Henrich, Don Director 419,232 357,692(6) 61,540 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Brown, Eric Officer 696,359 553,846(6) 142,513 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Laguda, Fernando Former
Subsidiary
president 38,462 38,462(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Agranoff, Gerald Director 114,102 103,846(6) 10,256 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Noble, Greg Officer 718,101 307,692(6) 410,409 1.3%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Schulle, Henry Former
director 396,618 76,923(6) 319,695 1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Landis, James Former
Subsidiary
president 38,462 38,462(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Cox, J.B. Former
Advisory
Board 15,385 15,385(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Pfeffer, Jimmy (Jr.) Former
Subsidiary
president 38,462 38,462(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Shepperd, Joe Former
Advisory
Board 15,385 15,385(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Rodgers, Johnny Former
Advisory
Board 53,846 53,846(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Erwin, Kelly Former
Subsidiary
president 76,923 76,923(6) 0 0
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Bachelet, Kelli Dole (25) 225,000 225,000 -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Ferrante, Linda Patas None 50,000 50,000(28) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Crawford, Marshall Former
- ------------------------------------ ---------------------
Subsidiary
president 38,462 38,462(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Wallace, Michael Former
Advisory
Board 150,770 15,385(6) 135,385 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Heberling, Peter Former
Advisory
Board 15,385 15,385(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Thomas, Randy Subsidiary
president 38,462 38,462(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Lunsford, Raymond Subsidiary
president 107,693 67,923(6) 30,770 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Dole, Richard D. CEO/
Chairman 3,045,430(23) 2,980,045(6) 65,385 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Majeres, Richard Director 203,942 111,538(6) 92,404 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Barr, Robert Former
Advisory
Board 161,539 38,462(6) 123,077 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Haag, Andrew Former
Advisory
Board 15,385 15,385 -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Page 53
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Tomjanovich, Rudy Former
Advisory
Board 200,605 15,385(6) 185,220 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Eicke, Scott Former
Advisory
Board 15,385 15,385(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Weddle, Tim Former
Advisory
Board 138,462 15,385(6) 123,077 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Beninger, Wayne Officer 647,307 399,615(6) 247,692 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Barbee, William Former
Advisory
Board 27,693 15,385(6) 12,308 <1%
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Chesser, William Former
Subsidiary
president 38,462 38,462(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
David Arndt Employee 50,000 50,000(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
John Sobehrad Employee 40,000 40,000(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Jon Benken Employee 5,000 5,000(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
Shellie Hayes Employee 30,000 30,000(6) -0- -0-
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
TOTAL WARRANTS 8,141,814
- ------------------------------------ --------------------- --------------- ------------ ----------- -------------
(1) Includes shares of common stock for which the selling security holder has
the right to acquire beneficial ownership within 60 days.
(2) This table assumes that each selling security holder will sell all shares
offered for sale by it under this registration statement. Security holders
are not required to sell their shares.
(3) Assumes that all shares of Common Stock registered for resale by this
prospectus have been sold.
(4) Based on 31,099,570 shares of Common stock issued and outstanding as of May
9, 2006.
(5) The selling stockholder acquired these securities for cash.
(6) The selling stockholder acquired these securities as compensation for
services to the Company.
(7) The Managing Member (Thomas McAuley) of North Sound Capital LLC (Investment
Manager for the selling stockholder) holds the investment decision and
voting powers for this non-natural entity.
(8) Scott Johnston (Sterling Johnston Capital Management, L.P.) has investment
decision and voting power for this non-natural entity.
(9) Jay Petschek and Steve Major are the individuals with investment decision
and voting power for this non-natural entity. Messrs. Petschek and Major
are employees of a broker-dealer, C.E. Unterberg Towbin, which has no
relationship to the selling stockholder. The broker-dealer has no
investment decision or voting power on behalf of the selling stockholder.
The selling stockholder acquired the securities for cash in the ordinary
course of business for investment purposes.
(10) Lee Canaan is the portfolio manager of this hedge fund and has investment
decision and voting power for this non-natural entity.
(11) [Intentionally left blank.]
(12) [Intentionally left blank.]
Page 54
(13) [Intentionally left blank.]
(14) [Intentionally left blank.]
(15) The Managing Directors of GLG Partners, LP (Investment Manager for the
selling stockholder) hold the investment decision and voting power for this
non-natural entity. These persons are: Noam Gottesman, Pierre Lagrange and
Phillippe Jabre. GLG Partners, LP is approximately 20% owned by Lehman
Brothers International. Lehman Brothers International has no investment
decision or voting power on behalf of the selling stockholder. The shares
were acquired by the selling stockholder for cash in the normal course of
business for investment purposes.
(16) Dan Springfield is the individual with investment decision and voting power
for this non-natural entity.
(17) [Intentionally left blank.]
(18) Charles Barney holds the investment decision and voting power for this
non-natural entity.
(19) [Intentionally left blank.]
(20) Ike Claypool and Allen Crosswell are the individuals with investment
decision and voting power for this non-natural entity.
(21) Thomas Coonrod is the individual with investment decision and voting power
for this non-natural entity.
(22) Richard D. Tribe is the individual with investment decision and voting
power for this non-natural entity.
(23) Includes 65,385 shares of common stock held directly and 2,980,045 shares
of common stock issuable upon the exercise of warrants to purchase shares
of our common stock.
(24) Limited Partnership owned in part by Eric Brown, our Vice President of
Finance. Eric Brown and his father (G. Stephen Brown) are the individuals
with investment decision and voting power for this non-natural entity.
(25) Daughter of Richard D. Dole, our Chief Executive Officer. The selling
stockholder acquired the securities as a result of a gift from her father.
(26) Trust established for the benefit of the grandchildren of Bradley Simmons,
our former CEO, for which Mr. Simmons is not a Trustee and for which Mr.
Simmons disavows beneficial ownership. The selling stockholder acquired the
securities as a result of a gift from Mr. Simmons.
(27) Son of Richard D. Dole, our Chief Executive Officer. The selling
stockholder acquired the securities as a result of a gift from his father.
(28) The selling stockholder acquired the securities as a result of a gift from
Richard D. Dole, our Chief Executive Officer.
(29) The selling stockholder acquired the securities as a result of a gift from
Gerald Agranoff, one of our Directors
(30) Keith Fetter and Darren Bankston are the individuals with investment
decision and voting power for this non-natural entity.
PLAN OF DISTRIBUTION
Shares owned by the selling stockholders, or by their partners, pledgees,
donees (including charitable organizations), transferees or other successors in
interest, may from time to time be offered for sale either directly by such
individual, or through underwriters, dealers or agents or on any exchange on
which the shares may from time to time be traded, in the over-the-
Page 55
counter market, or in independently negotiated transactions or otherwise. The
methods by which the shares may be sold include:
- a block trade (which may involve crosses) in which the broker or
dealer so engaged will attempt to sell the securities as agent but may
position and resell a portion of the block as principal to facilitate
the transaction;
- purchases by a broker or dealer as principal and resale by such broker
or dealer for its own account pursuant to this prospectus;
- exchange distributions and/or secondary distributions;
- sales in the over-the-counter market;
- underwritten transactions;
- ordinary brokerage transactions and transactions in which the broker
solicits purchasers; and
- privately negotiated transactions.
Such transactions may be effected by the selling stockholders at market
prices prevailing at the time of sale or at negotiated prices. The selling
stockholders may effect such transactions by selling the common stock to
underwriters or to or through broker-dealers, and such underwriters or
broker-dealers may receive compensations in the form of discounts or commissions
from the selling stockholders and may receive commissions from the purchasers of
the common stock for whom they may act as agent. The selling stockholders may
agree to indemnify any underwriter, broker-dealer or agent that participates in
transactions involving sales of the shares against certain liabilities,
including liabilities arising under the Securities Act. We have agreed to
register the shares for sale under the Securities Act and to indemnify the
selling stockholders, certain representatives of the selling stockholders and
each person who participates as an underwriter in the offering of the shares
against certain civil liabilities, including certain liabilities under the
Securities Act. We are required to pay certain fees and expenses incurred by us
incident to the registration of the shares.
Because selling stockholders may be deemed to be statutory "underwriters"
within the meaning of the Securities Act, they will be subject to the prospectus
delivery requirements of the Securities Act. The selling stockholders are
subject to the applicable provisions of the Exchange Act, and the rules and
regulations thereunder which may restrict certain activities of, and limit the
timing of purchases and sales of securities by, selling stockholders and other
persons participating in a distribution of securities. The selling stockholders
may also sell shares under Rule 144 of the Securities Act, if available, rather
than under this prospectus. There is no underwriter or coordinating broker
acting in connection with the proposed sale of the shares by the selling
stockholders.
In connection with sales of the common stock under this prospectus, the
selling stockholders, upon effectiveness of the Post-Effective Amendment No. 1
to our Form SB-2 Registration Statement, may enter into hedging transactions
with broker-dealers, who may in turn engage in short sales of the common stock
in the course of hedging the positions they assume. The selling stockholders
also may sell shares of common stock short and deliver them to close out the
short positions, or loan or pledge the shares of common stock to broker-dealers
that in turn may sell them.
Page 56
The selling stockholders and any underwriters, dealers or agents that
participate in distribution of the shares may be deemed to be underwriters, and
any profit on sale of the shares by them and any discounts, commissions or
concessions received by any underwriter, dealer or agent may be deemed to be
underwriting discounts and commissions under the Securities Act. The selling
stockholders do not expect these commissions and discounts to exceed what is
customary in the types of transactions involved.
We agreed to keep this prospectus effective until the earlier of (i) April
19, 2007, or (ii) the time that all of the shares have been sold pursuant to the
prospectus or Rule 144 under the Securities Act or any other rule of similar
effect.
There can be no assurances that the selling stockholders will sell any or
all of the shares offered under this prospectus.
DESCRIPTION OF SECURITIES
-------------------------
GENERAL
The following description of our capital stock is subject to and qualified in
its entirety by our certificate of incorporation and bylaws, which are included
as exhibits to the registration statement of which this prospectus forms a part,
and by the applicable provisions of Nevada law.
Our authorized capital stock consists of 100,000,000 shares of common stock, par
value $.001 per share, and 20,000,000 shares of preferred stock, par value $1.00
per share.
COMMON STOCK
As of May 9, 2006, there were 31,099,570 shares of common stock outstanding.
The rights of all holders of the common stock are identical in all respects.
The holders of the common stock are entitled to receive ratably such dividends,
if any, as may be declared by the Board of Directors out of legally available
funds. The current policy of the Board of Directors, however, is to retain
earnings, if any, for reinvestment in drilling ventures to maximize development
of reserves.
Upon liquidation, dissolution or winding up of the Company, the holders of the
common stock are entitled to share ratably in all aspects of the Company that
are legally available for distribution, after payment of or provision for all
debts and liabilities and after preferences are afforded to the holders of the
preferred shares. The Series A preferred shares have preference over the common
stock in payment of declared dividends. Both the Series A and B preferred
shares have preference over the common stock in the event of liquidation of the
Company.
The holders of the common stock do not have preemptive subscription, redemption
or conversion rights under our Articles of Incorporation. Cumulative voting in
the election of Directors is not permitted. The rights, preferences and
privileges of holders of common stock will be subject to, and may be adversely
affected by, the rights of holders of shares of any series of preferred stock
that are presently outstanding or that may be designated and issued by us in the
future.
Page 57
PREFERRED STOCK
Our Articles of Incorporation authorize the issuance of up to 20,000,000 shares
of preferred stock with such rights, designations and preferences as are
determined by our Board of Directors. Our Articles of Incorporation provide for
a Series A 8% Convertible Preferred Stock of 1,000,000 shares with a stated
value of $1.00 per share and an initial conversion price of $6.50, a Series B
Convertible Preferred Stock of 100,000 shares with a stated value of $1.00 and
an initial conversion price of $2.14, a Series C 8% Convertible Preferred Stock
of 100,000 shares with a stated value of $1.00 and an initial conversion price
of $2.14, and a Series D 8% Convertible Preferred Stock of 600,000 shares with a
stated value of $1.00 and an initial conversion price of $1.62.
As of May 9, 2006, there were 483,416 Series A 8% Convertible Preferred Shares
outstanding. Dividends are to be paid quarterly in cash or in common stock to
the holders of the Series A Preferred Shares at the discretion of the Board of
Directors. The Series A Preferred Shares rank senior to the common stock with
respect to payment of dividends and with respect to liquidation preference. The
Series A Preferred Shares are convertible into common stock at an initial
conversion price of $6.50 per share. Beginning August 19, 2003, we had the
right to redeem all or part of the Series A Preferred Shares for cash at a
redemption price of $6.50 per share plus all accrued and unpaid dividends on the
shares to be redeemed. The Series A Preferred Shares are entitled to cast the
number of votes equal to the number of shares of common stock into which such
shares could be converted and have full voting rights and powers equal to the
voting rights and powers of the common stock on all matters submitted to the
shareholders. As of May 9, 2006, no dividends have been declared or paid and no
dividends are anticipated to be declared or paid in the foreseeable future.
As of May 9, 2006, there were 43,000 Series B Convertible Preferred Shares
outstanding. These shares have a par and stated value of $1.00. The Series B
Preferred Shares rank senior to the common stock with respect to liquidation
preference. The Series B Preferred Shares are convertible into common stock at
an initial conversion price of $2.14 per share at the option of the holder.
Beginning October 1, 2003, we had the right to redeem all or part of the Series
B Preferred Shares for cash at a redemption price of $2.14 per share. The
Series B Preferred Shares are entitled to cast the number of votes equal to the
number of shares of common stock into which such shares could be converted and
have full voting rights and powers equal to the voting rights and powers of the
common stock on all matters submitted to the shareholders.
As of May 9, 2006, no Series C or Series D Preferred Shares were outstanding.
SCHEDULE OF WARRANTS
Page 58
A summary of outstanding stock warrants at March 31, 2006 is as follows:
WEIGHTED
NUMBER OF REMAINING AVERAGE
COMMON STOCK CONTRACTED EXERCISE EXERCISE
EQUIVALENTS EXPIRATION DATE LIFE (YEARS) PRICE PRICE
- ------------ ---------------- ------------ ----------- ---------
488,312 August 2006 .42 $ 0.98 $ 0.98
92,308 November 2008 2.67 $ 0.98 $ 0.98
615,385 September 2006 .44 $ 1.63 $ 1.63
76,923 November 2008 2.67 $ 1.63 $ 1.63
1,076,923 November 2006 .67 $ 9.75 $ 9.75
211,538 February 2007 1.92 $ 9.75 $ 9.75
30,769 March 2007 1.00 $ 9.75 $ 9.75
300,000 April 2007 1.09 $ 9.75 $ 9.75
161,538 May 2007 1.17 $6.50-$9.75 $ 7.27
76,923 July 2007 1.25 $5.20-$6.50 $ 6.24
269,231 September 2007 1.42 $4.88-$5.20 $ 5.15
100,000 November 2007 1.67 $ 2.00 $ 2.00
20,000 August 2008 2.37 $ 1.95 $ 1.95
4,832,733 November 2008 2.67 $ 1.95 $ 1.93
1,060,715 February 2009 3.91 $ 2.00 $ 2.00
- ------------
9,413,298
============
ANTI-TAKEOVER PROVISIONS
Certain anti-takeover provisions in our Certificate of Incorporation may make a
change in control of the Company more difficult, even if a change in control
would be beneficial to our stockholders. In particular, our board of directors
will be able to issue a total of up to 20,000,000 shares of preferred stock with
rights and privileges that might be senior to our Common Stock, without the
consent of the holders of our Common Stock, and has the authority to determine
the price, rights, preferences, privileges and restrictions of the preferred
stock. Although the ability to issue preferred stock may provide us with
flexibility in connection with possible acquisitions and other corporate
purposes, this issuance may make it more difficult for a third party to acquire
a majority of our outstanding voting stock.
TRANSFER AGENT
The transfer agent for our Common Stock is Corporate Stock Transfer located at
3200 Cherry Creek Drive South, Suite 430, Denver, Colorado 80209. Their
telephone number is 303-282-4800.
INTEREST OF NAMED EXPERTS AND COUNSEL
-------------------------------------
Axelrod, Smith & Kirshbaum, P.C., who has prepared this Registration Statement
and Opinion regarding the authorization, issuance and fully-paid and
non-assessable status of the securities covered by this Registration Statement,
has represented us in the past on certain legal matters. Mr. Robert D. Axelrod
does not presently own any of our common stock. His entire relationship with us
has been as legal counsel, and there are no arrangements or understandings which
would
Page 59
in any way cause him to be deemed an affiliate of the Registrant or a person
associated with an affiliate of the Registrant.
EXPERTS
-------
The financial statements of Petrosearch Energy Corporation at December 31, 2005
and 2004 included in and made a part of this document have been audited by Ham,
Langston & Brezina, P.C., independent auditors, as set forth in their report
appearing elsewhere herein, and are included in reliance upon such report given
on the authority of such firm as experts in accounting and auditing.
RESERVE ENGINEERS
Certain information incorporated by reference in this prospectus regarding
estimated quantities of oil and natural gas reserves associated with our oil and
gas properties, the future net revenues from those reserves and their present
value is based on estimates of the reserves and present values prepared by or
derived from estimates prepared by McCartney Engineering, LLC, Consulting
Petroleum Engineers or Ryder Scott Company, Petroleum Consultants, independent
reserve engineers. The reserve information is incorporated by reference herein
in reliance upon the authority of said firms as experts with respect to such
reports.
COMMISSION POSITION ON
INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
----------------------------------------------
Our certificate of incorporation provides that we shall indemnify our directors
and officers to the fullest extent permitted by Nevada law and that none of our
directors will be personally liable to the Company or its stockholders for
monetary damages for breach of fiduciary duty as a director, except for
liability:
- for any breach of the director's duty of loyalty to the Company or its
stockholders;
- for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of the law;
- under Nevada General Corporation Law for the unlawful payment of
dividends; or
- for any transaction from which the director derives an improper
personal benefit.
These provisions require us to indemnify our directors and officers unless
restricted by Nevada law and eliminate our rights and those of our stockholders
to recover monetary damages from a director for breach of his fiduciary duty of
care as a director except in the situations described above. The limitations
summarized above, however, do not affect our ability or that of our stockholders
to seek non-monetary remedies, such as an injunction or rescission, against a
director for breach of his fiduciary duty.
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to our directors, officers and controlling persons pursuant to the
foregoing provisions, we have been advised that in the opinion of the Securities
and Exchange Commission, such indemnification is against public policy as
expressed in the Securities Act and is therefore unenforceable.
Page 60
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form SB-2 under the
Securities Act, and the rules and regulations promulgated thereunder, with
respect to the common stock offered hereby. This prospectus, which constitutes a
part of the registration statement, does not contain all of the information set
forth in the registration statement and the exhibits thereto. Statements
contained in this prospectus as to the contents of any contract or other
document that is filed as an exhibit to the registration statement are not
necessarily complete and each such statement is qualified in all respects by
reference to the full text of such contract or document. For further information
with respect to us and the common stock, reference is hereby made to the
registration statement and the exhibits thereto, which may be inspected and
copied at the principal office of the SEC, 450 Fifth Street, N.W., Washington,
D.C. 20549, and copies of all or any part thereof may be obtained at prescribed
rates from the Commission's Public Reference Section at such addresses. Also,
the SEC maintains a World Wide Web site on the Internet at http://www.sec.gov
------------------
that contains reports, proxy and information statements and other information
regarding registrants that file electronically with the SEC. Additional
information can also be obtained through our website at www.petrosearch.com. We
-------------------
also make available free of charge our annual, quarterly and current reports,
proxy statements and other information upon request. To request such materials,
please contact Mr. Richard D. Dole, our President and Chief Executive Officer,
675 Bering Drive, Suite 200, Houston, Texas 77057.
We are in compliance with the information and periodic reporting
requirements of the Exchange Act and, in accordance therewith, will file
periodic reports, proxy and information statements and other information with
the SEC. Such periodic reports, proxy and information statements and other
information will be available for inspection and copying at the principal
office, public reference facilities and Web site of the SEC referred to above.
Page 61
PETROSEARCH ENERGY CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005 and 2004
TABLE OF CONTENTS
Report of Independent Registered Public Accounting Firm. . . . . . . . F-2
Audited Consolidated Financial Statements:
Consolidated Balance Sheets. . . . . . . . . . . . . . . . . . F-3
Consolidated Statements of Operations. . . . . . . . . . . . . F-4
Consolidated Statements of Changes in Stockholders' Equity . . F-5
Consolidated Statements of Cash Flows. . . . . . . . . . . . . F-6
Notes to Consolidated Financial Statements . . . . . . . . . . F-8
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
-------------------------------------------------------
To the Board of Directors and Stockholders
Petrosearch Energy Corporation
We have audited the accompanying consolidated balance sheets of Petrosearch
Energy Corporation and subsidiaries as of December 31, 2005 and 2004 and the
related consolidated statements of operations, stockholders' equity and cash
flows for the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Petrosearch Energy Corporation and subsidiaries as of December 31, 2005 and
2004, and the results of their operations and their cash flows for the years
then ended, in conformity with accounting principles generally accepted in the
United States of America.
/s/ Ham, Langston & Brezina, L.L.P.
Houston, Texas
March 29, 2006
F-2
PETROSEARCH ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005 AND 2004
ASSETS 2005 2004
------ ------------ ------------
Current assets:
Cash $ 4,052,844 $ 1,100,568
Accounts receivable:
Joint owners-billed, net of allowance of $83,073 at 1,342,386 935,622
December 31, 2005
Joint owners-unbilled 1,958 624,541
Oil and gas production sales 9,345 264,623
Prepaid expenses and other current assets 517,482 389,048
------------ ------------
Total current assets 5,924,015 3,314,402
------------ ------------
Property and equipment:
Oil and gas properties, full cost method of accounting:
Properties subject to amortization 11,849,520 5,490,447
Properties not subject to amortization 3,513,597 3,548,812
Other property and equipment 147,047 69,136
------------ ------------
Total 15,510,164 9,108,395
Less accumulated depreciation, depletion and amortization (1,966,000) (2,164,936)
------------ ------------
Total property and equipment, net 13,544,164 6,943,459
Prepaid oil and gas costs 81,603 82,280
Other assets 66,462 65,901
------------ ------------
Total assets $19,616,244 $10,406,042
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Current portion of long-term debt $ 908,168 $ 2,890,000
Accounts payable 561,546 847,332
Accrued liabilities 750,036 1,338,641
------------ ------------
Total current liabilities 2,219,750 5,075,973
------------ ------------
Long-term debt, net of current portion 2,537,251 -
Other long-term obligations 670,456 -
Stockholders' equity:
Preferred stock, par value $1.00 per share, 20,000,000 shares
authorized:
Series A 8% convertible preferred stock, 1,000,000 shares 483,416 483,416
authorized; 483,416 shares issued and outstanding
Series B convertible preferred stock, 100,000 shares authorized; 43,000 43,000
43,000 shares issued and outstanding
Common stock, par value $0.001 per share, 100,000,000 shares 28,497 18,792
Authorized; 28,497,761 and 18,792,120 shares issued and
outstanding at December 31, 2005 and 2004, respectively
Additional paid-in capital 18,089,828 6,884,784
Unissued common stock 545,000 -
Accumulated deficit (5,000,954) (2,099,923)
------------ ------------
Total stockholders' equity 14,188,787 5,330,069
------------ ------------
Total liabilities and stockholders' equity $19,616,244 $10,406,042
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
PETROSEARCH ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
2005 2004
------------ ------------
Oil and gas production revenues $ 1,701,043 $ 4,718,313
------------ ------------
Operating costs and expenses:
Lease operating and production taxes 581,313 773,723
Depreciation, depletion and amortization 563,252 2,219,998
General and administrative 3,268,088 3,239,184
------------ ------------
Total costs and expenses 4,412,653 6,232,905
------------ ------------
Operating loss (2,711,610) (1,514,592)
------------ ------------
Other income (expense):
Interest income 51,031 7,754
Interest expense (240,452) (64,282)
------------ ------------
Total other income (expense) (189,421) (56,528)
------------ ------------
Net loss $(2,901,031) $(1,571,120)
============ ============
Basic and diluted net loss per common share $ (0.11) $ (0.09)
============ ============
Weighted average common shares 25,409,348 17,576,294
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
PETROSEARCH ENERGY CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
SERIES A SERIES B SERIES C SERIES D
COMMON STOCK PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
----------- -------- ---------- ----------- -------- -------- ---------- --------- ---------- ---------
Balance at
December 31, 16,836,861 $16,837 1,000,000 $1,000,000 43,000 $ 43,000 75,000 $ 75,000 37,500 $ 37,500
2003
Common stock
issued for
cashless 85,537 86 - - - - - - - -
exercise of
warrants
Common stock
issued for 1,374,338 1,374 - - - - - - - -
cash
Common stock
issued for 12,308 12 - - - - - - - -
property costs
Common stock
issued for 16,923 17 - - - - - - - -
services
Issuance of
committed stock 535,349 535 - - - - - - - -
Collection of
subscription - - - - - - - - - -
receivable
Reduction of
subscription
receivable in - - - - - - - - - -
lieu of
compensation
Exchange of
Series A
preferred stock 79,474 79 (516,584) (516,584) - - - - - -
for common
stock
Exchange of
Series C
preferred stock 34,615 35 - - - - (75,000) (75,000) - -
for common
stock
Exchange of
Series D
preferred stock 23,077 23 - - - - - - (37,500) (37,500)
for common
stock
Cancellation of
common stock
for payment of (206,362) (206) - - - - - - - -
receivables
Issuance of
warrants for - - - - - - - - - -
services
Net loss - - - - - - - - - -
----------- -------- ---------- ----------- -------- -------- ---------- --------- ---------- ---------
Balance at
December 31 18,792,120 $18,792 483,416 $ 483,416 43,000 $ 43,000 - $ - - $ -
2004 =========== ======== ========== =========== ======== ======== ========== ========= ========== =========
TOTAL
ADDITIONAL UNISSUED STOCK STOCK
PAID-IN COMMON SUBSCRIPTIONS ACCUMULATED HOLDERS
CAPITAL STOCK RECEIVABLE DEFICIT EQUITY
------------ ------------ --------------- ------------- ------------
Balance at
December 31, $ 1,695,830 $ 2,618,076 $ (329,410) $ (528,803) $ 4,628,030
2003
Common stock
issued for
cashless (86) - - - -
exercise of
warrants
Common stock
issued for 1,852,106 - - - 1,853,480
cash
Common stock
issued for 51,908 - - - 51,920
property costs
Common stock
issued for 80,463 - - - 80,480
services
Issuance of
committed stock 2,617,541 (2,618,076) - - -
Collection of
subscription - - 35,000 - 35,000
receivable
Reduction of
subscription
receivable in - - 45,000 - 45,000
lieu of
compensation
Exchange of
Series A
preferred stock 516,505 - - - -
for common
stock
Exchange of
Series C
preferred stock 74,965 - - - -
for common
stock
Exchange of
Series D
preferred stock 37,477 - - - -
for common
stock
Cancellation of
common stock
for payment of (321,804) - 249,410 - (72,600)
receivables
Issuance of
warrants for 279,879 - - - 279,879
services
Net loss - - - (1,571,120) (1,571,120)
------------ ------------ --------------- ------------- ------------
Balance at
December 31 $ 6,884,784 $ - $ - $ (2,099,923) $ 5,330,069
2004 ============ ============ =============== ============= ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
PETROSEARCH ENERGY CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
SERIES A SERIES B SERIES C SERIES D
COMMON STOCK PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------------ ------- ------- -------- ------ ------- -------- --------- -------- --------
Balance at
December 31, 18,792,1200 $18,792 483,416 $483,416 43,000 $43,000 - $ - - $ -
2004
Common Stock
issued for cash 9,174,873 9,174 - - - - - - - -
Common stock
issued and
committed for 500,000 500 - - - - - - - -
oil and gas
properties
Compensation
awarded to
Board of 30,768 31 - - - - - - - -
Directors
Issuances of
warrants with - - - - - - - - - -
debt
Cancellation of
warrants - - - - - - - - - -
Net loss - - - - - - - - - -
------------ ------- ------- -------- ------ ------- -------- --------- -------- --------
28,497.761 $28,497 483,416 $483,416 43,000 $43,000 - $ - - $ -
============ ======= ======= ======== ====== ======= ======== ========= ======== ========
ADDITIONAL UNISSUED STOCK STOCK
PAID-IN COMMON SUBSCRIPTIONS ACCUMULATED HOLDERS
CAPITAL STOCK RECEIVABLE DEFICIT EQUITY
------------ ------------ ------------- ------------- -----------
Balance at
December 31, $ 6,884,784 $ - $ - $ (2,099,923) $5,330,069
2004
Common Stock
issued for cash 10,600,545 - - - 10,609,719
Common stock
issued and
committed for 544,500 545,000 - - 1,090,000
oil and gas
properties
Compensation
awarded to
Board of 59,969 - - - 60,000
Directors
Issuances of
warrants with 88,422 - - - 88,422
debt
Cancellation of
warrants (88,392) - - - (88,392)
Net loss - - - (2,901,031) (2,901,031)
------------ ------------ ------------- ------------- -----------
$18,089,828 $ 545,000 $ - $ (5,000,954) $14,188,787
============ ============ ============= ============= ===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
PETROSEARCH ENERGY CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
2005 2004
------------ ------------
Cash flows from operating activities:
Net loss $(2,901,031) $(1,571,120)
Adjustments to reconcile net loss to net cash used in operating activities:
Depletion, depreciation and amortization expense 563,252 2,219,998
Write off of prepaid oil and gas costs 60,000 32,219
Reduction in subscription receivable in lieu of compensation - 45,000
Common stock and warrants issued as compensation for services 60,000 360,359
Amortization of deferred rent 77 -
Amortization of debt discount and financing costs 48,283 -
Bad debt expense 145,443
Changes in operating assets and liabilities:
Accounts receivable 368,664 (1,330,588)
Related party receivable - (16,926)
Prepaid expenses and other assets (235,055) (284,360)
Accounts payable and accrued liabilities (599,672) 248,926
------------ ------------
Net cash used in operating activities (2,490,039) (296,492)
------------ ------------
Cash flows from investing activities:
Capital expenditures, including purchases and development of properties (7,815,083) (6,356,134)
Purchase of prepaid credits for oil and gas properties, net (59,323)
Proceeds from sale of overriding royalty interest - 100,000
Proceeds from sale of property 2,072,002 18,000
------------ ------------
Net cash used in investing activities (5,802,404) (6,238,134)
------------ ------------
Cash flows from financing activities:
Proceeds from the sale of common stock 10,609,719 1,853,480
Proceeds from collection of stock subscription receivable - 1,231,250
Proceeds from notes payable 3,950,000 3,100,000
Repayment of bonds payable (200,000)
Repayment of notes payable (3,315,000) (210,000)
------------ ------------
Net cash provided by financing activities 11,244,719 5,774,730
------------ ------------
Net increase (decrease) in cash and cash equivalents 2,952,276 (759,896)
Cash and cash equivalents at beginning of year 1,100,568 1,860,464
------------ ------------
Cash and cash equivalents at end of year $ 4,052,844 $ 1,100,568
============ ============
Supplemental disclosures of cash flow information:
Interest paid $ 227,192 $ 40,470
============ ============
Income taxes paid $ - $ -
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
PETROSEARCH ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------------
ORGANIZATION
------------
Petrosearch Energy Corporation (the "Company"), a Nevada Corporation formed
in November 2004, is an independent oil and gas company based in Houston,
Texas, with a second office in Dallas, Texas. The Company is engaged in the
exploration for and the acquisition, development and production of crude
oil and natural gas. The Company has established production in North
Dakota, Oklahoma and Texas and is currently engaged in exploration and
development activities, including direct operator activities, through its
subsidiary, Petrosearch Operating Company, L.L.C., in North Dakota,
Louisiana, Texas, Oklahoma, and Mississippi. The Company identifies high
quality prospects and projects and provides the capital, technical support
and business resources needed to develop the projects. The Company also
pursues ventures with other independent companies when targets of
exceptional potential are available and considers acquisition of producing
properties with additional development potential. The Company is the
successor of Petrosearch Corporation ("Petrosearch Texas") which was formed
in August 2003 in the state of Texas pursuant to a reverse merger agreement
with Texas Commercial Resources, Inc. ("TCRI"). In November 2004,
shareholders of Petrosearch Texas approved a 6.5-to-1 reverse stock split
which took effect immediately prior to its merger with the Company on
December 30, 2004 (the "Merger"). Upon completion of the Merger,
shareholders of Petrosearch Texas were issued common shares of Petrosearch
Energy Corporation representing 100% of the then issued and outstanding
common shares.
The consolidated financial statements presented herein include the accounts
of the Company and its wholly-owned subsidiaries. All significant
inter-company accounts and transactions have been eliminated.
ACCOUNTING ESTIMATES
--------------------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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 revenue and expenses during the reporting
period. Actual results could differ from those estimates. These estimates
primarily involve the useful lives of property and equipment, the
impairment of unproved oil and gas properties, the valuation of deferred
tax assets and the realization of accounts receivable.
OIL AND GAS PROPERTIES
----------------------
The Company follows the full cost method of accounting for crude oil and
natural gas properties. Under this method, all direct costs and certain
directly related internal costs associated with acquisition of properties
and successful, as well as unsuccessful, exploration and development
activities are capitalized. Depreciation, depletion and amortization of
capitalized crude oil and natural gas properties and estimated future
development costs, excluding unproved properties, are based on the
unit-of-production method based on proved reserves. Net capitalized costs
of crude oil and natural gas properties, as adjusted for asset retirement
obligations, net of salvage value, are limited, by country, to the lower of
unamortized cost or the cost ceiling, defined as the sum of the present
value of estimated future net revenues from proved reserves based on
unescalated prices discounted at 10 percent, plus the cost of properties
not being amortized, if any, plus the lower of cost or estimated fair value
of unproved properties included in the costs being amortized, if any, less
related income taxes. Excess costs are charged to proved property
impairment expense. No gain or loss is recognized upon sale or disposition
of crude oil and natural gas properties, except in unusual circumstances.
F-8
The following table reflects the depletion expense incurred from oil and
gas properties during the years ended December 31, 2005 and 2004:
2005 2004
-------- ----------
Depletion Expense $543,654 $2,207,949
======== ==========
Depletion expense per bbl produced $ 15.24 $ 16.83
======== ==========
At December 31, 2005 and 2004, unproved oil and gas properties not subject
to amortization included $3,513,597 and $3,548,812, respectively, of
property acquisition, exploration and development costs that are not being
amortized. These costs will begin to be amortized when they are evaluated
and proved, reserves are discovered, impairment is indicated or when the
lease terms expire. Unproved leasehold costs consist of interest in leases
located in Mississippi, Oklahoma and Texas.
The following table reflects the periods when costs were incurred for
unproved oil and gas properties costs:
2004 2005 TOTAL
---------- ---------- ----------
Property acquisition costs $1,185,625 $1,678,257 $2,863,882
Exploration costs - 649,715 649,715
----------------------------------
Total $1,185,625 $2,327,972 $3,513,597
========== ========== ==========
Unproved properties represent costs associated with properties on which the
Company is performing exploration activities or intends to commence such
activities. These costs are reviewed periodically for possible impairments
or reduction in value based on geological and geophysical data. If a
reduction in value has occurred, costs being amortized are increased.
OTHER PROPERTY AND EQUIPMENT
----------------------------
Property and equipment is stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of 3 to 5 years
for office furniture and equipment and transportation and other equipment.
Additions or improvements that increase the value or extend the life of an
asset are capitalized. Expenditures for normal maintenance and repairs are
expensed as incurred. Disposals are removed from the accounts at cost less
accumulated depreciation and any gain or loss from disposition is reflected
in operations. Depreciation expense for other property and equipment for
the years ended December 31, 2005 and 2004 was $19,598 and $12,049,
respectively.
ASSET RETIREMENT OBLIGATIONS
----------------------------
Effective January 1, 2003, the Company adopted Statement of Financial
Accounting Standards No. 143, Accounting for Asset Retirement Obligations
("SFAS 143"). This statement applies to obligations associated with the
retirement of tangible long-lived assets that result from the acquisition,
construction and development of the assets. SFAS 143 requires that the fair
value of a liability for a retirement obligation be recognized in the
period in which the liability is incurred. For oil and gas properties, this
is the period in which an oil or gas well is acquired or drilled. The asset
retirement obligation is capitalized as part of the carrying amount of our
oil and gas properties at its discounted fair value. The liability is then
accreted each period until the liability is settled or the well is sold, at
which time the liability is reversed.
Prior to 2005, the discounted fair value of the Company's expected future
obligation was estimated to approximate salvage value, and, thus, no
obligation was recorded. The estimated asset
F-9
retirement obligation as of December 31, 2005, of $633,455 is attributable
to property additions in 2005 and as been recognized as a long-term
obligation in the accompanying balance sheet as of December 31, 2005.
CASH AND CASH EQUIVALENTS
-------------------------
For purposes of reporting cash flows, the Company considers all short-term
investments with an original maturity of three months or less when
purchased to be cash equivalents.
RECEIVABLES
-----------
The Company routinely assesses the recoverability of all material trade and
other receivables to determine their collectibility. Many of the Company's
receivables are from joint interest owners on properties of which the
Company is the operator. Thus, the Company may have the ability to withhold
future revenue disbursements to recover any non-payment of joint interest
billings. Generally, the Company's crude oil and natural gas receivables
are collected within two months. The Company accrues a reserve on a
receivable when, based on the judgment of management, it is probable that a
receivable will not be collected and the amount of any reserve may be
reasonably estimated. As of December 31, 2005 and 2004, the Company
provided an allowance of $83,073 and $ -0- for doubtful accounts for trade
receivables or joint interest owner receivables.
FAIR VALUE OF FINANCIAL INSTRUMENTS
-----------------------------------
The Company includes fair value information in the notes to financial
statements when the fair value of its financial instruments is different
from the book value. When the book value approximates fair value, no
additional disclosure is made. The Company assumes the book value of those
financial instruments that are classified as current approximates fair
value because of the short maturity of these instruments. For non-current
financial instruments, the Company uses quoted market prices or, to the
extent that there are no available quoted market prices, market prices for
similar instruments.
RESTORATION, REMOVAL AND ENVIRONMENTAL LIABILITIES
--------------------------------------------------
The Company is subject to extensive federal, state and local environmental
laws and regulations. These laws regulate the discharge of materials into
the environment and may require the Company to remove or mitigate the
environmental effects of the disposal or release of petroleum substances at
various sites. Environmental expenditures are expensed or capitalized
depending on their future economic benefit. Expenditures that relate to an
existing condition caused by past operations and that have no future
economic benefit are expensed.
Liabilities for expenditures of a noncapital nature are recorded when
environmental assessments and/or remediation is probable, and the costs can
be reasonably estimated. Such liabilities are generally undiscounted unless
the timing of cash payments for the liability or component are fixed or
reliably determinable. As of December 31, 2005, the Company believes it has
no such liabilities.
CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS
------------------------------------------------
Financial instruments which subject the Company to concentrations of credit
risk include cash and cash equivalents and accounts receivable. The Company
maintains its cash and cash equivalents with major financial institutions
selected based upon management's assessment of the banks' financial
stability. Balances regularly exceed the $100,000 federal depository
insurance limit. The Company has not experienced any losses on deposits.
The Company performs ongoing credit evaluations and, generally, requires no
collateral from its customers or other joint interest owners. As of
December 31, 2005, 98% of accounts receivable from oil and gas sales was
from one customer and 86% of accounts receivable from joint interest owners
was from one joint interest owner. During the years ended December 31, 2005
and 2004, respectively, 98% and 100% of the Company's revenue was received
from four and three customers as follows:
F-10
2005 2004
---------- ----------
Customer A $ 879,542 $3,114,087
Customer B 552,998 1,321,128
Customer C 172,540 283,098
Customer D 69,622 -
Others 26,341 -
----------------------
Total $1,701,043 $4,718,313
========== ==========
REVENUE RECOGNITION
-------------------
The Company recognizes crude oil and natural gas revenue from its interest
in producing wells as crude oil and natural gas is sold from those wells,
net of royalties.
EARNINGS (LOSS) PER SHARE
-------------------------
The Company provides basic and dilutive earnings (loss) per common share
information for each year presented. The basic net loss per common share is
computed by dividing the net loss by the weighted average number of common
shares outstanding. Diluted net loss per common share is computed by
dividing the net loss, adjusted on an "as if converted" basis, by the
weighted average number of common shares outstanding plus potential
dilutive securities. For the years ended December 31, 2005 and 2004,
potential dilutive securities, assuming the Company had net income, that
had an anti-dilutive effect and were not included in the calculation of
diluted net loss per common share consisted of warrants for the purchase of
651,281 and 5,207,070 common shares, respectively, and convertible
preferred stock convertible into 94,218 and 612,416 common shares,
respectively. Per share calculations reflect the effects of the
recapitalization and reverse stock split for all periods presented.
STOCK BASED COMPENSATION
------------------------
SFAS No. 123, "Accounting for Stock-Based Compensation" established
financial accounting and reporting standards for stock-based employee
compensation plans. It defined a fair value based method of accounting for
an employee stock option or similar equity instrument and encouraged all
entities to adopt that method of accounting for all of their employee stock
compensation plans and include the cost in the income statement as
compensation expense. However, it also allows an entity to continue to
measure compensation cost for those plans using the intrinsic value based
method of accounting prescribed by Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees". The Company
accounts for compensation cost for stock option plans in accordance with
APB Opinion No. 25. See "New Accounting Pronouncements" below for
information regarding the Company's adoption of SFAS No. 123 (revised
2004), "Share-Based Payment" ("SFAS 123(R)") on January 1, 2006.
CAPITALIZED INTEREST
--------------------
The Company capitalizes interest ($46,630 in 2005 and $ -0- in 2004) on
expenditures made in connection with exploration and development projects
that are not subject to current amortization. Interest is capitalized only
for the period that activities are in progress to bring these projects to
their intended use.
INCOME TAXES
------------
The Company uses the liability method in accounting for income taxes. Under
this method, deferred tax assets and liabilities are determined based on
differences between financial reporting and income tax carrying amounts of
assets and liabilities and are measured using the enacted tax rates and
laws that will be in effect when the differences are expected to reverse. A
valuation allowance, if necessary, is provided against deferred tax assets,
based upon management's
F-11
assessment as to their realization.
NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------
The following discussions provide information about new accounting
pronouncements that have been issued by the FASB:
In December 2004, the FASB issued SFAS 123(R), which is a revision of SFAS
123. SFAS 123(R) supersedes APB 25 and amends SFAS No. 95, "Statement of
Cash Flows". Generally, the approach in SFAS 123(R) is similar to the
approach described in SFAS 123. However, SFAS 123(R) will require all
share-based payments to employees, including grants of employee stock
options, to be recognized as stock-based compensation expense in the
Company's Consolidated Statements of Operations based on their fair values.
Proforma disclosure is no longer an alternative.
SFAS 123(R) must be adopted no later than January 1, 2006 and permits
public companies to adopt its requirements using one of two methods:
- A "modified prospective" method in which compensation cost is
recognized beginning with the effective date based on the requirements
of SFAS 123(R) for all share-based payments granted after the adoption
date and based on the requirements of SFAS 123 for all awards granted
to employees prior to the effective date of SFAS 123(R) that remain
unvested on the adoption date.
- A "modified retrospective" method which includes the requirements of
the modified prospective method described above, but also permits
entities to restate either all prior periods presented or prior
interim periods of the year of adoption based on the amounts
previously recognized under SFAS 123 for purposes of proforma
disclosures.
The Company adopted the provisions of SFAS 123(R) on January 1, 2006 using
the modified prospective method.
As permitted by SFAS 123, the Company accounted for share-based payments to
employees prior to January 1, 2006 using the intrinsic value method
prescribed by APB 25 and related interpretations. As such, the Company
generally did not recognize compensation expense associated with employee
stock option grants. Currently, the Company has no plans to issue stock
warrants to any parties other than in financing arrangements with third
parties. Consequently, based on current plans, the adoption of SFAS
123(R)'s fair value method will not have a significant impact on the
Company's future results of operations or financial position. Had the
Company adopted SFAS 123(R) in prior periods, the impact would have
approximated the impact of SFAS 123 as described in the proforma
disclosures. The adoption of SFAS 123(R) will not result in any
compensation charges in 2006 related to options outstanding at December 31,
2005, because all employee stock options were vested as of December 31,
2005.
SFAS 123(R) also requires that tax benefits in excess of recognized
compensation expenses be reported as a financing cash flow, rather than an
operating cash flow as required under prior literature. This requirement
may serve to reduce the Company's future cash flows from operating
activities and increase future cash flows from financing activities, to the
extent of associated tax benefits that may be realized in the future.
In June 2005, the Financial Accounting Standards Board (FASB) issued FASB
Statement No. 154, "Accounting Changes and Error Corrections - a
replacement of APB Opinion No. 20 and FASB Statement No. 3". This Statement
provides guidance on the accounting for and reporting of accounting changes
and error corrections. It establishes, unless impracticable, retrospective
application as the required method for reporting a change in accounting
principle in the absence of explicit transition requirements specific to
the newly adopted accounting principle. This Statement also provides
guidance for determining whether retrospective application of a change in
accounting principle is impracticable and for reporting a change when
retrospective application is
F-12
impracticable. The correction of an error in previously issued financial
statements is not an accounting change. However, the reporting of an error
correction involves adjustments to previously issued financial statements
similar to those generally applicable to reporting an accounting change
retrospectively. Therefore, the reporting of a correction of an error by
restating previously issued financial statements is also addressed by this
Statement. This Statement shall be effective for accounting changes and
correction of errors made in fiscal years beginning after December 15,
2005. At this time, the Company has no plans to adopt a change in
accounting principle; however, this guidance could have a significant
impact on the Company in the event that an accounting change is made in the
future.
In March 2005, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation (FIN) 47, "Accounting for Conditional Asset Retirement
Obligations, an interpretation of FASB Statement No. 143". This
interpretation clarifies that the term, conditional asset retirement
obligation, as used in FASB Statement No. 143, refers to a legal obligation
to perform an asset retirement activity in which the timing and/or method
of settlement are conditional on a future event that may or may not be
within the control of the entity. The obligation to perform the asset
retirement activity is unconditional even though uncertainty exists about
the timing and/or method of settlement. Thus, the timing and/or method of
settlement may be conditional on a future event. Accordingly, an entity is
required to recognize a liability for the fair value of a conditional asset
retirement obligation if the fair value of the liability can be reasonably
estimated. The fair value of a liability for the conditional asset
retirement obligation should be recognized when incurred, generally upon
acquisition, construction, or development and/or through the normal
operation of the asset. Uncertainty about the timing and/or method of
settlement of a conditional asset retirement obligation should be factored
into the measurement of the liability when sufficient information exists.
SFAS No. 143 acknowledges that, in some cases, sufficient information may
not be available to reasonably estimate the fair value of an asset
retirement obligation. We do not expect this guidance to have a significant
impact on the Company.
2. SALE OF OIL AND GAS PROPERTIES
------------------------------
Effective July 1, 2005, the Company's wholly owned subsidiary, TK
Petrosearch, L.L.C., sold its interest in the Blue Ridge Salt Dome Field
for $2,072,002 to the individual who has managed the TK PetroSearch, LLC
subsidiary. The assets sold accounted for $1,370,110 of the Company's PV-10
of proved reserves as of December 31, 2004, or approximately 10% of the
Company's total PV-10 value. The property had an estimated remaining 68,700
barrels of proved oil reserves at the time of the sale. The transaction has
been reflected in the accompanying financial statements as a reduction of
capitalized oil and gas properties as required by accounting principles
generally accepted in the United States of America. The following
represents the unaudited proforma effect on the consolidated statement of
operations for the year ended December 31, 2005 as if the transaction
occurred on January 1, 2005. The sale represents $30.16 per barrel of oil
of the proved reserves sold.
PROFORMA PROFORMA
AS REPORTED ADJUSTMENTS (UNAUDITED)
------------- ------------- -------------
Oil and gas production
revenues $ 1,701,043 $ (552,998) $ 1,148,045
Costs and expenses 4,412,653 359,162 4,053,491
------------- ------------- -------------
Operating loss (2,711,610) (193,836) (2,905,446)
Other expenses (189,421) - (189,421)
------------- ------------- -------------
Net loss $ (2,901,031) $ (193,836) $( 3,094,867)
============= ============= =============
Basic and diluted net loss per
common share $ (0.11) $ (0.01) $ (0.12)
============= ============= =============
F-13
3. PURCHASE OF OIL AND GAS PROPERTIES
----------------------------------
Effective September 28, 2005, the Company purchased an additional 21.25%
working interest in the Gruman #18-1 Well and Gruman Leases for $637,500,
increasing the Company's working interest in the properties to 85%. As of
the time of the closing, the purchase provided additional PV-10 value of
approximately $3,500,000 (based upon independent engineering report as of
July 1, 2005), made up of additional proved reserves of 89,755 barrels of
oil and 25,672 MCF of gas. The purchase price represents $6.67 per barrel
of oil equivalent of the proved reserves purchased.
Effective November 15, 2005, the Company entered into an agreement to
purchase a 100% working interest in 1780 acres of leases in the Quinduno
Field located in Roberts County, Texas from Quinduno Energy, L.L.C. The
agreement provides for the payment of the purchase price of $2,000,000 cash
and 3,000,000 shares of unregistered common shares of the Company to occur
in three phases as the project progresses. Should the project not proceed
past the first phase, Petrosearch's maximum obligation would be $750,000 in
cash and 1,000,000 unregistered common shares plus the cost of capital
expenditures for the first phase which are estimated to be $2,900,000. Upon
completion of the entire project, the seller will back in for a 10% working
interest after Petrosearch has been repaid all capital expenditure costs
plus $9.5 million. Based on the valuation of the acquisition of $9.5
million on November 15, 2005, this purchase represents $3.37 per barrel of
oil equivalent of the proved reserves purchased.
At any time after completion of the first phase of the project, should the
Company, in the Company's sole discretion, determine to terminate further
operations, then the Company must offer Quinduno the Company's interest in
the leases for a purchase price equal to an internal rate of return to the
Company of twenty-two and one half percent (22.5%), calculated monthly,
using the closing date under the Agreement as the commencement date and,
taking into account all acquisition cash, all capital expenditures, plus a
sum of $7,500,000 and the net income received from the project. Quinduno
will have 45 days to exercise its right of refusal to repurchase the
leases, at which time, upon Quinduno's refusal to repurchase, the Company
may sell the Company's interest in the leases to a third party.
4. PREPAID EXPENSES AND OTHER CURRENT ASSETS
-----------------------------------------
Prepaid expenses and other current assets consist of the following at
December 31, 2005 and 2004:
2005 2004
----------- ----------
Prepaid expenses $ 152,386 $ 90,207
Note receivable - 110,000
Prepaid bonds 277,000 177,000
Current portion of financing costs 42,890 -
Other receivables 45,206 -
Other assets - 11,841
-----------------------
$ 517,482 $ 389,048
=========== ==========
F-14
5. ACCRUED LIABILITIES
-------------------
Accrued liabilities consist of the following at December 31, 2005 and 2004:
2005 2004
-------- ----------
Revenue payable and operated prepayment liability $ 21,297 $ 139,270
Accrued interest payable 36,794 25,187
Accrued liabilities for capital additions 500,000 1,017,058
Accrued liability for Professional Fees 50,000 -
Other accrued expenses 141,945 157,126
--------------------
$750,036 $1,338,641
======== ==========
6. REVOLVING CREDIT AGREEMENT
--------------------------
On October 1, 2004, the Company entered into a revolving credit agreement
to borrow up to $18,000,000 over a one-year period from a company whose
managing partner is a shareholder of the Company. Draws under the agreement
were subject to limits after the initial draw at a maximum rate of
$4,500,000 for each three-month period following the initial draw date with
undrawn funds to be carried forward to the succeeding draw period. Draws
were also limited based on the Company's actual cost of oil and gas leases
and the amount of the Company's proved producing reserves. Advances under
the revolving credit agreement bear interest at a rate of six percent (6%)
per year which was payable each quarter, and were collateralized by the
Company's oil and gas properties. The agreement stipulates that, after 60
days of each particular draw, the Company repay the outstanding principal
in monthly installments equal to 10% of the original amount of the
particular draw and continue on the same calendar date of each succeeding
month thereafter. The outstanding principal and interest balance matures
two years from the date of the initial draw, which is October 2006. The
Company was assessed a one quarter of one percent (0.25%) standby fee on
available undrawn principal each quarter.
As additional consideration for this agreement, the Company assigned the
lender a one percent (1%) overriding royalty interest in certain producing
wells in Oklahoma and Texas and a commitment to provide a one percent (1%)
overriding royalty interest in all future leases acquired using funds from
this agreement. Per the agreement, this overriding royalty interest is
earned by the lender upon funding and is not subject to revision or
reassignment upon repayment or termination of the loan. As a result, the
Company capitalized the net present value of this overriding royalty
interest of $24,825, plus additional loan costs of $38,743, as deferred
loan cost in the consolidated balance sheet as of December 31, 2004. These
loan costs were being amortized into interest expense over the two-year
life of the agreement.
On September 29, 2005, the Company entered into an amended and restated
revolving credit agreement to borrow up to $10,000,000 over a two-year
period to October 1, 2007, from a private, non-public entity. The
outstanding loan balance under the original revolving credit agreement
dated October 1, 2004, of $825,000 and accrued interest through the date of
the amended agreement, were deemed to be principal and interest outstanding
under the amended and restated revolving credit agreement. Proceeds of the
credit line are to be used to finance activity related to eight new
prospects including costs associated with acquisitions of oil and gas
leases, oil and gas drilling, reworking, production, transportation,
marketing and plugging activities under the leases, and all lender charges
and fees. Advances under the amended and restated revolving credit
agreement bear interest at a rate of the Wall Street Journal Prime Rate
plus three percent (3%) per year. Each advance of principal under the
amended facility is treated as a separate loan and is repayable in six (6)
interest only installments followed by up to twenty four (24) principal and
interest installments based upon a 30-month amortization. The Company will
be assessed a one quarter of one percent (.25%) standby fee on available
undrawn principal each quarter. The note matures on April 1, 2008. As of
December 31, 2005, the balance outstanding under the line of credit
agreement was $3,525,000, $940,000 of which is due in the next twelve
months, $1,410,000 of which is due in
F-15
2007, and $1,175,000 of which is due in 2008.
The loan is collateralized by a first lien on the particular oil and gas
leases acquired with the funds, but the Company is entitled to obtain
partial releases if the ratio of proved developed and proved undeveloped
reserves underlying the collateral base meets certain criteria. According
to the terms of the agreement, the unused available funds under the line of
credit will only be available for draw by the Company if at all times the
Company's proved developed reserves equal or exceed twenty-five percent
(25%) of the outstanding principal and interest indebtedness under the
agreement and if the principal balance of the note outstanding after the
requested draw is less than the sum of 1) the actual costs of the oil and
gas lease purchased and or funded, and 2) the sum of 75% of the Company's
proved developed reserves and 50% of the Company's proved undeveloped
reserves from all sources pledged as collateral.
Because the lender obtains its funds from the private capital markets and
or individuals who desire to participate in the lenders investment bank
activities, the lender does not have a guaranteed source of money in which
to fund this transaction with the Company. As a result, the lender has not
guaranteed that all proposed funding under this agreement will be available
if and when the Company elects to make draw requests.
As consideration for entering into the agreement, the lender will receive
an overriding royalty in each oil and gas lease acquired with facility
funds equal to 2% of the Company's acquired net revenue interest in the
lease. The overriding royalty interests are earned when the lender funds
have been utilized by the Company for direct and or indirect acquisition
expenses or drilling expenses. In addition, the lender received 100,000
warrants to purchase common stock of the Company at an exercise price of
$2.00 per share and an expiration date of November 1, 2007.
Under the terms of the credit facility, the Company is required to offer to
the lender the opportunity to participate in up to a minimum of 33.3% and
up to 100% based on the sole discretion of the Company.
The Company allocates the proceeds received from debt with detachable
warrants using the relative fair value of the individual elements at the
time of issuance. The amount allocated to the warrants as a debt discount
was calculated at $88,422 and was $79,581 at December 31, 2005. The debt
discount is recognized as interest expense over the period until the notes
mature. In the event the debt is settled prior to the maturity date, an
expense will be recognized based on the difference between the carrying
amount and the amount of the payment.
7. INCOME TAXES
------------
Through December 31, 2005, the Company has incurred losses since its
inception and, therefore, has not been subject to federal income taxes. As
of December 31, 2005, the Company had net operating loss ("NOL")
carryforwards for income tax purposes of approximately $11,400,000 which
expire in various tax years through 2025. Under the provisions of Section
382 of the Internal Revenue Code, the ownership change in the Company that
resulted from the recapitalization of the Company could limit the Company's
ability to utilize its NOL carryforward to reduce future taxable income and
related tax liabilities. Additionally, because United States tax laws limit
the time during which NOL carryforwards may be applied against future
taxable income, the Company may be unable to take full advantage of its NOL
for federal income tax purposes should the Company generate taxable income.
The composition of deferred tax assets and the related tax effects at
December 31, 2005 and 2004 are as follows:
F-16
2005 2004
------------ ----------
Deferred tax assets:
Net operating loss carry-forward $ 3,874,325 $1,327,265
Allowance for doubtful accounts 42,868 -
Contribution carryover 2,346 2,346
------------------------
Total deferred tax assets 3,919,539 1,329,611
Less valuation allowance (1,628,636) (647,632)
------------------------
Net deferred tax asset 2,290,903 681,979
------------------------
Deferred tax liabilities:
Book/tax basis difference in oil and
gas properties (2,277,366) (671,268)
Book/tax basis difference in property
and equipment (13,537) (10,711)
------------------------
Total deferred tax liability (2,290,903) (681,979)
------------------------
Net deferred tax $ - $ -
============ ==========
The difference between the income tax benefit in the accompanying statement
of operations and the amount that would result if the U.S. Federal
statutory rate of 34% were applied to pre-tax loss for the years ended
December 31, 2005 and 2004 is as follows:
2005 2004
AMOUNT % AMOUNT %
---------- ------- ---------- -------
Benefit for income tax at federal $(986,351) (34.0)% $(534,180) (34.0)%
statutory rate
Non-deductible expenses 5,347 0.0 159,654 10.1
Increase in valuation allowance 981,004 28.0 374,526 23.9
----------------------------------------
$ - -% $ - -%
========== ======= ========== =======
8. RIGHT OF FIRST REFUSAL AGREEMENT
--------------------------------
Effective December 30, 2005, Petrosearch Energy Corporation, joined by six
of its subsidiaries, entered into an Agreement with Rock Energy Partners
Operating, L.P. and Rock Energy Partners, L.P. (collectively referred to
herein as "Rock"). The Agreement generally covers the geographic areas of
current operations in Jefferson County, Mississippi and Colorado County,
Texas affecting the Company and Rock, including agreements and stipulations
regarding future operations in those geographic areas, the terms under
which future exploration and development participation opportunities will
be offered by the Company to Rock, and agreed procedures for conducting
internal audits and accounting reconciliations. As part of the transaction
with Rock, the parties have executed an Amended Right of First Refusal
Agreement (the "Amended ROFR") which replaces the previous Right of First
Refusal Agreement between the Company and Rock which was entered in March
2004 (the "ROFR").
The Amended ROFR has more limited applicability to the Company's various
projects than the ROFR. While the original agreement required all Company
prospects to be presented to Rock for consideration by Rock, the Amended
ROFR does not require that all Company prospects be offered to Rock for
participation. The Amended ROFR also does not require that the Company
offer to Rock prospects in any specified area, although the parties have
separately stipulated to certain specified areas of mutual interest in the
Mississippi and Colorado County areas based upon historical operations in
those areas. The Amended ROFR permits the Company to decide which projects
will be offered to Rock, so long as the projects actually presented are
projects in which the Company owns or intends to retain a minimum of ten
percent (10%) of the project interest available to the Company.
F-17
Under the Amended ROFR, Rock's percentage participation is limited to the
range between ten percent (10%) minimum participation and forty percent
(40%) maximum participation, while the ROFR permitted Rock to take up to
100% of a prospect, if desired. All of the above participation interests
are fractions of the interest available to the Company.
The Amended ROFR also calls for a minimum funding commitment required from
Rock equal to $3,000,000 per year, without the right to carry over to any
subsequent year as a credit excess expenditures above the minimum required
commitment for that year. The term of the Amended ROFR will automatically
renew from December 31 of a given year to December 31 of the following
year: 1) if Rock meets its funding minimum in a calendar year, 2) if the
funding minimum is not met, but the Company otherwise has failed to offer a
sufficient number of projects to Rock such that theoretical participation
by Rock in one-half of the offered prospects to the extent of twenty five
percent (25%) would have resulted in Rock achieving the funding minimum; or
3) if more than one-half of the prospects offered to Rock are offered
during October, November or December of a calendar year.
The Amended ROFR provides that the reversionary interest to be retained by
the Company in each prospect which is accepted by Rock shall be a
twenty-five percent (25%) reversionary interest in each interest assigned
to Rock, with the reversion to take effect upon "payout" or recoupment of
Rock's development costs net to that interest. Under the Amended ROFR, if
the particular prospect is a drilling project without existing oil and gas
production, then payout will be computed on a well-by-well basis. However,
if the prospect includes existing oil and gas production acquired by the
parties, then payout will be computed on a prospect-wide basis, inclusive
of drilling costs expended after acquisition on reworked and new wells.
Under the Amended ROFR, the Company has agreed to reduce its after payout
reversionary interest in an accepted project in the event the Company gives
better after-payout terms to a third party in the same prospect, thereby
providing Rock the same benefits of the terms offered to any such third
party.
The Company's Jefferson County, Mississippi operations have, to date, been
conducted by the Company's operating subsidiary, Petrosearch Operating
Company, L.L.C. ("POC"). Prior to this transaction, one hundred percent
(100%) of the applicable oil and gas leases on which drilling of the
Phillips-Burkley No. 1 well have occurred were assigned to Rock subject to
a reversionary interest retained and owned by the Company's subsidiary,
Buena Vista Petrosearch, L.L.C. ("BVPS"), which was to take effect when
Rock recouped 100% of its development costs.
As part of the transaction, the Company may fund all exploration costs of
the Phillips-Burkley No. 1 well going forward pursuant to a new operating
agreement between POC and BVPS. Further, as part of the transaction, Rock
will be assigned a 50% net revenue interest in the BVPS once the company
has recouped its investment in the subsidiary. Rock will retain its
ownership of the gas pipeline associated with the project but will grant us
the right to transport gas through the pipeline at the rate of ten cents
per Mcf through December 31, 2006 and five cents per Mcf thereafter. Rock
has executed a promissory note in favor of the Company in the principal
amount of $825,449 to repay the outstanding acquisition and development
costs of the project which accrued prior to September 30, 2005. The balance
of this note has been included in accounts receivable-joint owners as of
December 31, 2005. This note bears interest at the rate of 6% and is
payable in four equal monthly installments expected to begin June 1, 2006.
The sharing of production proceeds, if any, derived from the
Phillips-Burkley No. 1 well will be staged. Beginning with the effective
date of the agreement until the Company recoups from production all sums
paid by the Company toward Phillips-Burkley #1 operations after September
30, 2005 (the "Stage 1 Payout"), the Company will retain all of the net
profits, if any, as a production payment. After the Stage 1 Payout event
occurs, the Company and Rock shall share equally in the production payment.
At such time during this sharing period, the Company and Rock will each
receive $3,905,505 (the "Stage 2 Payout"). Subsequent to the Stage 2
Payout, certain persons vested with a collective 20% reversionary interest
in BVPS (one of whom is the Company's chief operating officer who owns a 5%
reversionary interest) will be entitled to receive their limited liability
company interest which will decrease the collective interests of the
Company and Rock in BVPS to 80% of profits from leasehold revenues. At the
point of the Stage 2 Payout, Rock's 40% interest as the owner of one-half
of BVPS shall be
F-18
assigned to it by BVPS, thereby eliminating Rock's interest in BVPS in
favor of a direct working interest ownership. However, Rock has the right
to waive this automatic conversion to direct ownership after Stage 2 Payout
if it desires.
As part of the transaction, if either the Company or Rock acquires an oil
and gas lease within the area of mutual interest designated by the parties,
then the acquiring party shall offer to the other the right to acquire at
cost a 50% interest in the acquired oil and gas lease within the
Mississippi AMI leases.
Under the prior agreements between the parties, one hundred percent (100%)
of the Colorado County "Garwood" Prospect was assigned by the Company to
Rock subject to a reversionary interest retained and owned by Pursuit
Petrosearch, L.L.C. ("Pursuit"), the Company's subsidiary, which was to
take effect when Rock recouped 100% of its development costs on a
well-by-well basis. As in the case of the Jefferson County, Mississippi
operations, the operator for the "Garwood" Prospect to date has been POC.
Under the terms of the transaction, the parties have divided this
geographic region into three (3) parts, the Garwood North Leases, the
Garwood South Leases and the Garwood Area of Mutual Interest or "AMI"
Leases. As to the Garwood North area, POC will remain the operator. As to
the Garwood South and Garwood AMI Leases, Rock will be the operator.
However, Rock has engaged POC as a contract operator for a term which is
yet to be determined in order to take advantage of POC's existing
regulatory registrations and bonding status.
The ROFR provided for a reversionary interest equal to thirty-three and
one-third percent (33.33%) of the interest assigned to Rock which interest
would take effect upon Rock recouping 100% of its acquisition and
development costs. Under the terms of the transaction, the Company's after
payout reversionary interest has been adjusted to 21.5% as to Garwood South
Leases and will be computed on a the well-by-well basis. The Company's
after payout reversionary interest will remain 33.33% as to the wells
drilled on Garwood North Leases, likewise on a well-by-well basis. For
purposes of calculating "payout", the parties have stipulated to certain
existing balances outstanding which are owed by Rock to the Company,
subject to completion of an audit. These sums will be applied as payout
calculation deficits in the payout formulae as more fully described in the
transaction documents.
Rock agreed to expend net to its interests during calendar year 2006 not
less than $8,000,000 toward development of the Garwood North and Garwood
South leases. The parties contemplate that this commitment will be met by
Rock's participation in two projects contemplated in 2006, being a new well
in the Garwood North area and a recompletion of an existing wellbore known
as the Kallina #2 well. The timing of the 2006 projects will not be
overlapped so that costs may be closely monitored. Rock is not obligated to
commit to operations exceeding $8,800,000, should the proposed projects
exceed $8,000,000 in the aggregate.
For five (5) years from the date of the Agreement, the Company and Rock
have agreed that as to oil and gas leases in the Garwood prospect, which
one or the other has acquired prior to consummation of the Agreement which
are neither in the Garwood North nor Garwood South area, the party which
has acquired the particular lease shall offer the other the right to
acquire percentage ownership in the lease, being 80% if the offer is made
to Rock and 20% if the offer is made to the Company.
9. COMMITMENTS AND CONTINGENCIES
-----------------------------
OPERATING LEASE
---------------
The Company rents office space under long-term office leases that expire
through 2010. The future minimum lease payments required under the
operating leases that have initial non-cancelable lease terms in excess of
one year amount to $493,077 of which $94,196 is to be paid in 2006, $96,234
is to be paid in 2007, $99,989 is to be paid in 2008, $101,888 is to be
paid in 2009, and $100,770 is to be paid in 2010. Rent expense incurred
under operating leases during the years ended December 31, 2005 and 2004
was $101,321 and $85,172, respectively.
LEGAL PROCEEDINGS
-----------------
We are currently not a party to any material legal proceedings.
F-19
10. STOCKHOLDERS' EQUITY
--------------------
COMMON STOCK
-------------
Effective April 23, 2004, the Company amended its articles of incorporation
to increase the total number of shares of stock that the Company has the
authority to issue to 1,020,000,000, consisting of 1,000,000,000 shares of
common stock, par value $.001 per share, and 20,000,000 shares of preferred
stock, par value $1.00 per share.
Upon the merger on December 30, 2004, the Company's authorized shares of
common stock decreased to 100,000,000 from 1,000,000,000. The authorized
preferred stock of 20,000,000 remained the same.
PREFERRED STOCK
---------------
The Company's articles of incorporation authorize the issuance of up to
20,000,000 shares of preferred stock with characteristics determined by the
Company's board of directors. As a result of the recapitalization of the
Company in 2003, effective November 5, 2003, the Company had 1,000,000
shares of Series A 8% Convertible Preferred Stock ("Series A Preferred")
authorized, issued and outstanding as of December 31, 2003. The shares have
a par and stated value of $1.00 per share. If declared by the Board of
Directors, dividends are to be paid quarterly in cash or in common stock of
the Company to the holders of shares of the Series A Preferred. The shares
of the Series A Preferred rank senior to the common stock both in payment
of dividends and liquidation preference. The Series A Preferred is
convertible into common stock of the Company at a conversion price of $6.50
per share (post-reverse split). Beginning August 19, 2003, the Company had
the right to redeem all or part of the shares of Series A Preferred for
cash at a redemption price equal to $6.50 per share plus all accrued and
unpaid dividends on the shares to be redeemed. During 2004, 516,584 shares
of Series A Preferred were converted to 79,474 shares of the Company's
common stock. As of December 31, 2005, no dividends have been declared and
approximately $131,000 of dividends were in arrears related to the Series A
Preferred if the Company decided to declare dividends.
As a result of the recapitalization of the Company, effective November 5,
2003, the Company has 100,000 shares authorized and 43,000 shares issued
and outstanding of Series B Convertible Preferred Stock ("Series B
Preferred") as of December 31, 2005 and 2004. The shares have a par and
stated value of $1.00 per share. The shares of the Series B Preferred rank
senior to the common stock in liquidation preference. The Series B
Preferred is convertible into common stock of the Company at an initial
conversion price of $2.14 per share (post-reverse split) at the option of
the holder. Beginning October 1, 2003, the Company had the right to redeem
all or part of the shares of Series B Preferred for cash at a redemption
price equal to $6.50 per share.
As a result of the recapitalization of the Company, effective November 5,
2003, the Company had 100,000 shares authorized and 75,000 shares issued
and outstanding of Series C Convertible Preferred Stock ("Series C
Preferred") as of December 31, 2003. The shares had a par and stated value
of $1.00 per share. The shares of the Series C Preferred ranked senior to
the common stock in liquidation preference. The Series C Preferred was
convertible into common stock of the Company at an initial conversion price
of $2.14 per share (post-reverse split) at the option of the holder.
Beginning December 13, 2003, the Company had the right to redeem all or
part of the shares of Series C Preferred for cash at a redemption price
equal to the stated value of $1.00 per share. During 2004 all 75,000 shares
of Series C Preferred were converted to 34,615 shares (post-reverse split)
of the Company's common stock.
As a result of the recapitalization of the Company, effective November 5,
2003, the Company had 600,000 shares authorized and 37,500 shares issued
and outstanding of Series D 8% Convertible Preferred Stock ("Series D
Preferred") as of December 31, 2003. The shares had a par and stated value
of $1.00 per share. If declared by the Board of Directors, dividends were
to be paid quarterly in cash or in common stock of the Company to the
holders of shares of the Series D Preferred. The shares of the Series D
Preferred ranked senior to the common stock both in payment of dividends
F-20
and liquidation preference. The Series D Preferred was convertible into
common stock of the Company at a conversion price of $1.62 per share
(post-reverse split) at the option of the holder. Beginning March 10, 2004,
the Company had the right to redeem all or part of the shares of Series D
Preferred for cash at a redemption price equal to the stated value of $1.00
per share plus all accrued and unpaid dividends on the shares to be
redeemed. During 2004 all 37,500 Series D Preferred were converted to
23,077 shares (post-reverse split) of the Company's common stock.
STOCK WARRANTS
--------------
The Company periodically issues incentive stock warrants to executives,
officers, directors and employees to provide additional incentives to
promote the success of the Company's business and to enhance the ability to
attract and retain the services of qualified persons. The issuance of such
warrants are approved by the Board of Directors. The exercise price of a
warrant granted is determined by the fair market value of the stock on the
date of grant. For purposes of determining compensation expense associated
with stock warrants, the intrinsic value of the Company's stock was
determined based upon the quoted market price of the Company's common stock
for executives, officers and directors and fair value of the Company's
stock was determined based upon the Black-Scholes option pricing model for
non-employees.
During 2004, the Company granted warrants to purchase 973,082 shares of
common stock (post-reverse split) at prices ranging from $5.20 per share to
$9.75 per share. All warrants were granted at an exercise price equal to or
greater than the fair market value at the date of grant and, thus, no
compensation cost was recorded. All of these warrants are immediately
exercisable except for 115,384 that vest one year from the date of grant.
These warrants expire in 2007.
During November 2004, the Company, prior to its merger with Petrosearch
Texas, entered into a two-year employment agreement with its new chief
executive officer ("CEO") for which the CEO was granted warrants to
purchase 3,637,738 shares of the Company's common stock at $1.95 per share,
which was the fair market value of the common stock at the date of grant
and, thus, no compensation cost was recorded. The warrants expire four
years from the date of grant.
During 2004, the Company granted warrants to purchase 76,923 shares of
common stock at a price range of $5.20 to $9.75 per share to certain of its
advisory board members. These warrants were exercisable immediately and
expire three years from the date of grant. Using the Black Scholes Option
Pricing Model, the issuance of the warrants resulted in $279,879 of
additional compensation expense included in the accompanying statement of
operations for the year ended December 31, 2004. The Company no longer has
an advisory board.
During 2005, the Company granted warrants to purchase 1,215,000 shares of
common stock of the Company to board of directors and employees for
services performed during 2005. The warrants expire in 2008 and have an
exercise price of $1.95, which exceeded the fair market value of the common
stock at the date of grant and, thus, no compensation cost was recorded.
In September, 2005, the Company granted warrants to purchase 100,000 shares
of common stock of the Company with an exercise price of $2.00 and an
expiration date in 2007 to a lender for financing costs associated with the
Company's amended credit facility with the lender (Note 6). The value
allocated to the warrants as a debt discount was $88,422.
During December, 2005, the Company extended the expiration date of warrants
held by an officer of the Company to purchase 92,308 shares of common stock
of the Company at an exercise price of $0.98 per share from August 28,
2006, to November 15, 2008.
During 2005, the Company cancelled warrants to purchase 153,847 shares of
common stock of the Company valued at $88,392 to reduce a note receivable
from a former officer of the Company.
Until the Company's adoption of the provisions of SFAS 123(R) on January 1,
2006 (See Note 1), the Company 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
F-21
warrants because, as discussed below, the alternative fair value accounting
provided for under FASB Statement No. 123, "Accounting for Stock-Based
Compensation", requires use of option valuation models that were not
developed for use in valuing employee stock options/warrants. Under APB 25,
if the exercise price of the Company's employee stock options is greater
than or equal to the market price of the underlying stock on the date of
grant, no compensation expense is recognized.
Proforma information regarding net income (loss) and earnings (loss) per
share is required by Statements 123 and 148, and has been determined as if
the Company had accounted for its employee stock warrants under the fair
value method of these Statements. For warrants granted during the years
ended December 31, 2005 and 2004, the fair value for such warrants was
estimated at the date of grant using a Black-Scholes option-pricing model
with the following assumptions:
2005 2004
---------- ----------
Dividend yield -0- -0-
Expected volatility 70% 135%
Risk free interest 3.00% 2.25%
Expected lives 2-4 years 3-4 years
The Black-Scholes option valuation model was developed for use in
estimating fair value of traded options or warrants that have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's employee stock
warrants have characteristics significantly different from those of traded
options/warrants, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock warrants.
For purposes of proforma disclosures, the estimated fair value of the
warrants is included in expense over the vesting period or expected life of
the warrant.
2005 2004
------------ ------------
Net loss as reported $(2,901,031) $(1,571,120)
Add: Stock-based employee compensation expense - -
included in reported net loss, net of tax
Deduct: Stock-based employee compensation expense (833,855) (6,619,962)
determined under the fair value method, net of tax ------------ ------------
Proforma net loss $(3,734,886) $(8,191,082)
============ ============
Basic and diluted net loss per common share, as reported $ (0.11) $ (0.09)
============ ============
Proforma basic and diluted net loss per common share $ (0.15) $ (0.47)
============ ============
No tax effects were included in the determination of proforma net loss
because the deferred tax asset resulting from stock-based employee
compensation would be offset by an additional valuation allowance for
deferred tax assets.
A summary of the Company's stock warrant activity (reverse split adjusted)
and related information
F-22
for the years ended December 31, 2005 and 2004 follows:
WEIGHTED
NUMBER OF AVERAGE
SHARES UNDER EXERCISE EXERCISE
WARRANT PRICE PRICE
------------- ----------- ---------
Balance outstanding at
December 31, 2003 2,761,539 $0.98-$9.75 $ 4.62
Issued 1,050,000 $4.88-$9.75 $ 4.62
Effect of merger 3,637,738 $ 1.95 $ 1.95
Exercised (115,385) $ 2.60 $ 2.60
-------------
Balance outstanding at
December 31, 2004 7,333,892 $0.98-$9.75 $ 3.77
Issued 1,407,308 $0.98-$2.00 $ 1.89
Cancelled (246,155) $ 0.98 $ 0.98
-------------
Balance outstanding at
December 31, 2005 8,495,045 $0.98-$9.75 $ 3.57
=============
All outstanding stock warrants are exercisable at December 31, 2005. A
summary of outstanding stock warrants at December 31, 2005 follows:
WEIGHTED
NUMBER OF REMAINING AVERAGE
COMMON STOCK CONTRACTED EXERCISE EXERCISE
EQUIVALENTS EXPIRATION DATE LIFE (YEARS) PRICE PRICE
------------ --------------- ------------ ----------- ---------
630,769 August 2006 .67 $0.98 $0.98
692,308 September 2006 .68 $1.63 $1.63
1,076,923 November 2006 .92 $9.75 $9.75
211,538 February 2007 1.17 $9.75 $9.75
30,769 March 2007 1.25 $9.75 $9.75
300,000 April 2007 1.34 $9.75 $9.75
161,538 May 2007 1.42 $6.50-$9.75 $7.27
76,923 July 2007 1.50 $5.20-$6.50 $6.24
269,231 September 2007 1.67 $4.88-$5.20 $5.15
100,000 November 2007 1.92 $2.00 $2.00
150,000 March 2008 2.25 $1.95 $1.95
20,000 August 2008 2.62 $1.95 $1.95
4,775,046 November 2008 2.92 $1.95 $1.93
- -----------------
8,945,045
=================
11. RELATED PARTY TRANSACTIONS
--------------------------
During the years ended December 31, 2005 and 2004, the Company was engaged
in various transactions with related parties as follows:
During the years ended December 31, 2005 and 2004, a vendor owned by the
spouse of a director of the Company through December 8, 2005, at which time
he resigned as director, provided drilling services totaling $485,570 and
$280,457, respectively. The balance owed to this vendor was $-0- and
$45,705 at December 31, 2005 and 2004, respectively. The director's spouse
was also a 15 - 30% working interest owner in the Fort Bend County Prospect
(Blue Ridge) which the Company sold in 2005. Accounts receivable from the
spouse for joint interest billings was $-0- and $268,973 as of December 31,
2005 and 2004, respectively.
F-23
Mr. Wayne Beninger, who became the Company's Chief Operating Officer on May
16, 2005, is the owner of Southwest Oil & Gas Management (Southwest) which
has provided engineering and geological consulting services for the
Company's projects. During the fiscal year ended December 31, 2004, the
Company paid Southwest approximately $600,000 for such services. When Mr.
Beninger became an employee of the Company, the agreement with Southwest
was terminated. From January 1, 2005, until the agreement was terminated on
May 15, 2005, the Company paid Southwest approximately $365,000 for
engineering and geological consulting services. Mr. Beninger has an option
to purchase for $1.00 a 5% interest (after payout to the Company and its
drilling partner) in the Company's subsidiary that holds the Jefferson
County, Mississippi project.
During 2004, the Company's board of directors provided executives an option
to repay the $149,410 of notes receivable that were outstanding on December
1, 2004, in cash or a return of shares of common stock at $1.56 per share,
when the current fair market value of the common stock was $1.95 per share,
resulting in the executives having to return 20% more shares to the Company
rather than what would have been returned based on the fair market value of
the common stock. The principal of $149,410 and interest balance of $9,366
were repaid by all officers in December 2004 through the return of 95,776
and 6,004 shares of the Company's common stock, respectively, held by the
executives.
As of December 1, 2004, $145,000 was recorded in stock subscription
receivable from executives of the Company. The stock subscription
receivables of $100,000 were repaid in 2004 through the return of 64,103
shares of the Company's common stock under the terms described in the
previous paragraph. The stock subscription receivable of $45,000 was repaid
in lieu of compensation in 2004.
The related party receivable balance from executives increased from $51,900
at December 1, 2004, to $63,234 in 2004 as a result of advances to two
officers of the Company. The total balance was repaid to the Company in
2004 through the return and cancellation of 40,480 shares of common stock
of the Company personally held by the two officers.
12. EARNINGS PER SHARE
------------------
Following is a reconciliation of the numerators and denominators of the
basic and diluted EPS computations for the years ended December 31, 2005
and 2004:
2005 2004
------------ ------------
Net loss $(2,901,031) $(1,571,120)
Less: Preferred stock dividends (38,673) (38,673)
------------ ------------
Net loss available to common
stockholders (numerator) $(2,939,704) $(1,609,793)
============ ============
Weighted average shares of common stock
(denominator) 25,409,348 17,576,294
============ ============
Basic and diluted net loss per share $ (0.12) $ (0.09)
============ ============
13. NON-CASH INVESTING AND FINANCING ACTIVITIES
-------------------------------------------
During the years ended December 31, 2005 and 2004, the Company engaged in
various non-cash financing and investing activities as follows:
F-24
2005 2004
---------- ---------
Transfer of overriding royalty interest for debt issuance costs $ 64,784 $ -
========== =========
Reduction of prepaid services for development
of oil and gas properties $ - $ 333,765
========== =========
Issuance of common stock for acquisition of
Property $1,090,000 $ 51,920
========== =========
Cancellation of common stock for reduction in
subscription receivable $ - $ 249,410
========== =========
Cancellation of common stock for reduction in
related party receivable $ - $ 72,600
========== =========
Increase in accounts payable and accrued
liabilities for property costs $ 500,000 $ 429,069
========== =========
Increase in property costs for asset retirement obligation accrual $ 633,455 $ -
========== =========
Issuance of warrants with debt $ 88,422 $ -
========== =========
Cancellation of warrants for reduction in note receivable $ 88,392 $ -
========== =========
Transfer of automobile for reduction in liability $ 15,346 $ -
========== =========
14. IMPAIRMENT AND SALE OF OIL AND GAS PROPERTIES
---------------------------------------------
At December 31, 2005 and 2004, the net capitalized costs of crude oil and
natural gas properties did not exceed the present value of the estimated
reserves; as such, no write-down was recorded.
15. BUSINESS SEGMENTS
-----------------
The Company believes that all of its material operations are conducted in
the exploration and production of oil and gas in the United States and
currently reports as a single segment.
16. SUPPLEMENTAL OIL AND GAS INFORMATION - UNAUDITED
------------------------------------------------
The following supplemental information regarding the oil and gas activities
of the Company is presented pursuant to the disclosure requirements
promulgated by the Securities and Exchange Commission ("SEC") and SFAS No.
69, Disclosures About Oil and Gas Producing Activities (`Statement 69").
ESTIMATED QUANTITIES OF PROVED OIL AND GAS RESERVES
---------------------------------------------------
Set forth below is a summary of the changes in the estimated quantities of
the Company's crude oil and condensate, and gas reserves for the periods
indicated, as estimated by the Company as of December 31, 2005. All of the
Company's reserves are located within the United States. Proved reserves
cannot be measured exactly because the estimation of reserves involves
numerous judgmental determinations. Accordingly, reserve estimates must be
continually revised as a result of new information obtained from drilling
and production history, new geological and geophysical data and changes in
economic conditions.
Proved reserves are estimated quantities of gas, crude oil, and condensate,
which geological and engineering data demonstrate, with reasonable
certainty, to be recoverable in future years from known reservoirs under
existing economic and operating conditions. Proved developed reserves are
proved reserves that can be expected to be recovered through existing wells
with existing equipment and operating methods.
F-25
OIL GAS
---------- ----------
QUANTITY OF OIL AND GAS RESERVES (BBLS) (MCF)
-------------------------------------------- ---------- ----------
Total proved reserves at December 31, 2003 460,654 177,438
Extensions and discoveries 25,856 1,158,000
Production (120,525) (64,009)
Revisions to previous estimate 7,812 (24,392)
---------- ----------
Total proved reserves at December 31, 2004 373,797 1,247,037
Extensions and discoveries 2,033,869 1,121,000
Production (33,676) (4,725)
Sale of Assets (64,771) - 0 -
Revisions to previous estimate 36,575 (519,565)
Total proved reserves at December 31, 2005 2,345,794 1,843,747
========== ==========
PROVED DEVELOPED RESERVES:
December 31, 2005 330,838 229,747
========== ==========
December 31, 2004 181,945 94,075
========== ==========
CAPITALIZED COSTS OF OIL AND GAS PRODUCING ACTIVITIES
-----------------------------------------------------
The following table sets forth the aggregate amounts of capitalized costs
relating to the Company's oil and gas producing activities and the
aggregate amount of related accumulated depletion, depreciation and
amortization as of December 31, 2005 and 2004:
2005 2004
------------ ------------
Unproved oil and gas properties $ 3,513,597 $ 3,548,812
Proved oil and gas properties 11,849,520 5,490,447
------------ ------------
Total 15,363,117 9,039,259
Less accumulated depletion, depreciation
and amortization (1,929,727) (2,152,511)
------------ ------------
Net capitalized costs $13,433,390 $ 6,886,748
============ ============
COSTS INCURRED IN OIL AND GAS PRODUCING ACTIVITIES
--------------------------------------------------
The following table reflects the costs incurred in oil and gas property
acquisition, exploration and development activities during the years ended
December 31, 2005 and 2004:
2005 2004
---------- ----------
Acquisition costs $4,079,919 $3,298,830
========== ==========
Exploration costs $1,147,816 $2,288,195
========== ==========
Development costs $1,096,124 $1,397,403
========== ==========
F-26
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
--------------------------------------------------------
The following table reflects the Standardized Measure of Discounted Future
Net Cash Flows relating to the Company's interest in proved oil and gas
reserves as of December 31, 2005 and 2004:
2005 2004
------------- ------------
Future cash inflows $158,565,979 $23,742,174
Future development and production costs (59,263,004) (6,250,065)
------------- ------------
Future net cash inflows before income taxes 99,302,975 17,492,109
Future income taxes (27,804,833) (4,961,317)
------------- ------------
Future net cash flows 71,498,142 12,530,792
10% discount factor (36,654,786) (2,704,002)
------------- ------------
Standardized measure of discounted future net
cash inflow $ 34,843,356 $ 9,826,790
============= ============
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
--------------------------------------------------------
Future net cash flows at each year end, as reported in the above schedule,
were determined by summing the estimated annual net cash flows computed by:
(1) multiplying estimated quantities of proved reserves to be produced
during each year by current prices, and (2) deducting estimated
expenditures to be incurred during each year to develop and produce the
proved reserves (based on current costs).
Income taxes were computed by applying year-end statutory rates to pretax
net cash flows, reduced by the tax basis of the properties and available
net operating loss carryforwards. The annual future net cash flows were
discounted, using a prescribed 10% rate, and summed to determine the
standardized measure of discounted future net cash flow.
The Company cautions readers that the standardized measure information
which places a value on proved reserves is not indicative of either fair
market value or present value of future cash flows. Other logical
assumptions could have been used for this computation which would likely
have resulted in significantly different amounts. Such information is
disclosed solely in accordance with Statement 69 and the requirements
promulgated by the SEC to provide readers with a common base for use in
preparing their own estimates of future cash flows and for comparing
reserves among companies. Management of the Company does not rely on these
computations when making investment and operating decisions.
17. SUBSEQUENT EVENTS
-----------------
CAPITAL RAISE
On February 8, 2006, Petrosearch Energy Corporation completed a private
placement of equity securities solely to accredited investors for total
proceeds of $2,700,000 (the "Offering"). Pursuant to the Offering, the
Company issued 1,928,572 shares of the Company's common stock at a price of
$1.40 per share and 964,286 three year warrants to purchase shares of the
Company's common stock with an exercise price of $2.00 per share to the
accredited investors. On February 3, 2006, the Company engaged a placement
agent to handle the Offering. At the time of closing, the Company paid a
placement fee of 5% of the gross proceeds of the Offering. Additionally, at
the time of closing, the placement agent received 96,429 warrants to
purchase shares of the Company's common stock equal to 5% of the number of
shares of common stock issued to the
F-27
accredited investors at the time of closing of the Offering. The warrants
issued to the placement agent are exercisable for three years and have an
exercise price of $2.00 per share. The shares of common stock and the
shares of common stock underlying the warrants have piggyback registration
rights. The Company intends to use the proceeds of the Offering for working
capital and general corporate purposes.
BARNETT SHALE AGREEMENT
On March 30, 2006, we entered into an Extension Agreement with
ExxonMobil Corporation, Harding Company ("Harding"), Eagle Oil & Gas Co.,
PS Gas Partners, LLC, and Gas Partners, L.P. (the "Extension Agreement"),
under which the parties have agreed to extend until May 2, 2006,
ExxonMobil's preferential purchase rights related to the separate sale
agreements between Harding Company and each of the other parties relating
to the Barnett Shale project, including our February 6, 2006, First Amended
and Restated Program Agreement with Harding Company (the "First Amended and
Restated Program Agreement") previously announced in our Form 8-K filing on
February 6, 2006.
The First Amended and Restated Program Agreement followed a June 29,
2005 Lease Acquisition and Development Agreement between ExxonMobil
Corporation and Harding Company and a Memorandum of Understanding Regarding
Gas Evacuation from ExxonMobil and Harding Barnett Shale E&P Venture
covering the project (the "ExxonMobil/Harding Agreements"). Under the
ExxonMobil/Harding Agreements, Harding is responsible to serve as operator
for a significant portion of the area of mutual interest and to acquire and
develop the leases in the area of mutual interest. ExxonMobil is
responsible for the operation and construction of the gathering and
evacuation system associated with the area of mutual interest and will
serve as operator for the balance of the area of mutual interest.
At the time of the execution of the First Amended and Restated Program
Agreement, Harding had not obtained from ExxonMobil a consent to transfer
and a waiver of Exxon/Mobil's a preferential purchase right set forth in
the ExxonMobil/Harding agreement. At the time of our execution of and
initial funding under the First Amended and Restated Program Agreement, we
did not have a direct contractual relationship with ExxonMobil. We believed
that all conditions necessary to assign and convey the working interest
from Harding had been met. We subsequently learned that ExxonMobil had not
waived the contingencies and that ExxonMobil desired to explore possible
alternative ownership structures beneficial to all concerned before making
a determination with respect to the preferential right to purchase.
The purpose of the Extension Agreement is to give all the parties
involved the ability to explore possible alternative structures with the
goal to form an integrated venture which would include both upstream and
pipeline assets and activities, which would better align each party's
interest, and which would enhance the ability of the venture to assure that
adequate pipeline capacity would be available to move natural gas to
market. The opportunity to participate in an integrated venture which
includes the gathering and evacuation system was not present in the First
Amended and Restated Program Agreement. The potential alternative structure
has potential positive features. The Extension Agreement likewise preserves
to the parties all of their respective rights and claims as they existed
prior to the execution of the Extension Agreement.
In the event that the parties cannot achieve a mutually agreed
alternative structure on or before May 2, 2006, ExxonMobil could exercise
its preferential purchase right which, if exercised, would prevent our
participation in the project. In the event of such a loss of this
opportunity to participate in the project, our legal rights are not
prejudiced by the Extension Agreement and we would then expect to pursue
all potential remedies available to us relating to the factual
circumstances surrounding these agreements.
F-28
PETROSEARCH ENERGY CORPORATION
TABLE OF CONTENTS
-----------------
Consolidated Balance Sheets as of March 31, 2006 (unaudited)
and December 31, 2005 (audited) F - 30
Consolidated Statements of Operations for the three months
ended March 31, 2006 and 2005 (unaudited) F - 31
Consolidated Statements of Stockholders' Equity for the three
months ended March 31, 2006 and 2005 (unaudited) F - 32
Consolidated Statements of Cash Flows for the three months
ended March 31, 2006 and 2005 (unaudited) F - 33
Notes to Consolidated Financial Statements F - 34
F - 29
PETROSEARCH ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2006 AND DECEMBER 31, 2005
ASSETS MARCH 31, DECEMBER 31,
----- ---------- ------------
2006 2005
---- ----
(UNAUDITED) (SEE NOTE)
----------- ----------
Current assets:
Cash $ 1,960,093 $ 4,052,844
Accounts receivable:
Joint owners, net of allowance of $83,073 1,164,932 1,344,344
Oil and gas production sales 60,335 9,345
Prepaid expenses 548,099 517,482
----------------------------
Total current assets 3,733,459 5,924,015
----------------------------
Property and equipment:
Oil and gas properties, full cost method of accounting:
Properties subject to amortization 12,494,824 11,849,520
Properties not subject to amortization 6,617,580 3,513,597
Other property and equipment 147,047 147,047
----------------------------
Total property and equipment 19,259,451 15,510,164
Less accumulated depreciation, depletion and amortization (2,003,380) (1,966,000)
----------------------------
Property and equipment, net 17,256,071 13,544,164
Prepaid oil and gas costs 241,189 81,603
Other assets 12,731 66,462
----------------------------
Total assets $21,243,450 $ 19,616,244
============ ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Current portion of long-term debt $ 1,264,204 $ 908,168
Accounts payable 710,694 561,546
Accrued liabilities 373,012 750,036
----------------------------
Total current liabilities 2,347,910 2,219,750
----------------------------
Long-term debt, net of current portion 2,190,056 2,537,251
Other long-term obligations 669,229 670,456
----------------------------
Total liabilities 5,207,195 5,427,457
Stockholders' equity:
Preferred stock, par value $1.00 per share, 20,000,000 shares
authorized:
Series A 8% convertible preferred stock, 1,000,000 shares authorized; 483,416
shares issued and outstanding at March 31, 2006 and December 31, 2005,
respectively 483,416 483,416
Series B convertible preferred stock, 100,000 shares authorized; 43,000 43,000
43,000 shares issued and outstanding
Common stock, par value $0.001 per share, 100,000,000 shares 31,068 28,497
Authorized; 31,068,300 and 28,497,761 shares issued and outstanding at March
31, 2006 and December 31, 2005, respectively.
Additional paid-in capital 21,324,355 18,089,828
Unissued common stock - 545,000
Accumulated deficit (5,845,584) (5,000,954)
----------------------------
Total stockholders' equity 16,036,255 14,188,787
----------------------------
Total liabilities and stockholders' equity $21,243,450 $ 19,616,244
============ ==============
<FN>
Note: The balance sheet at December 31, 2005 has been derived from the audited financial statements at that
date but does not include all of the information and footnotes required by generally accepted accounting
principles for complete financial statements.
See accompanying notes to unaudited condensed
consolidated financial statements
F-30
PETROSEARCH ENERGY CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
2006 2005
------------ ------------
Oil and gas production revenues $ 121,914 $ 654,164
--------------------------
Operating costs and expenses:
Lease operating and production taxes 161,690 177,060
Depreciation, depletion and amortization 37,381 334,459
General and administrative 722,548 638,080
--------------------------
Total costs and expenses 921,619 1,149,599
--------------------------
Operating loss (799,705) (495,435)
--------------------------
Other income (expense):
Interest income 19,592 416
Interest expense (64,517) (49,303)
--------------------------
Total other income (expense) (44,925) (48,887)
Net loss $ (844,630) $ (544,322)
============ ============
Basic and diluted net loss per common share $ (0.03) $ (0.03)
============ ============
Weighted average common shares 29,327,487 18,144,067
============ ============
<FN>
See accompanying notes to unaudited condensed
consolidated financial statements
F-31
PETROSEARCH ENERGY CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2006
SERIES A SERIES B
----------------- --------------- TOTAL
COMMON STOCK PREFERRED STOCK PREFERRED STOCK ADDITIONAL UNISSUED ACCUM- STOCK
------------------- ----------------- --------------- PAID-IN COMMON ULATED HOLDERS
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL STOCK DEFICIT EQUITY
---------- ------- ------- -------- ------ ------- ------------ ---------- ------------ ------------
Balance at
December 31, 28,497,761 $28,497 483,416 $483,416 43,000 $43,000 $18,089,828 $ 545,000 $(5,000,954) $14,188,787
2005
Common Stock
issued for cash 1,928,576 1,929 2,698,078 2,700,007
Common stock
issued for oil and 500,000 500 544,500 (545,000) -0-
gas properties
Common Stock
issued - exercise 141,963 142 138,982 139,124
of warrants
Offering costs
related to private (147,033) (147,033)
placement
Net loss (844,630) (844,630)
---------- ------- ------- -------- ------ ------- ------------ ---------- ------------ ------------
Balance at March
31, 2006 31,068,300 $31,068 483,416 $483,418 43,000 $43,000 $21,324,355 $ 0 $(5,845,584) $16,036,255
========== ======= ======= ======== ====== ======= ============ ========== ============ ============
F-32
PETROSEARCH ENERGY CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
2006 2005
------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
NET LOSS $ (844,630) $ (544,322)
ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH USED IN OPERATING ACTIVITIES:
Depletion, depreciation and amortization expense 37,380 334,459
Amortization of deferred compensation - 18,750
Amortization of deferred rent (1,227) -
Amortization of debt discount and financing costs 8,841 -
CHANGES IN OPERATING ASSETS AND LIABILITIES:
Accounts receivable 128,422 (229,266)
Amortization of financing costs 10,722 -
Prepaid expenses and other assets 12,392 (360,740)
Accounts payable and accrued liabilities (32,617) (91,993)
-------------------------
NET CASH USED IN OPERATING ACTIVITIES (680,717) (873,112)
-------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, including purchases and development of properties (3,749,286) (184,616)
Prepayments for oil and gas properties, net (159,586) -
Payments of accounts payable for property (195,259) -
-------------------------
NET CASH USED IN INVESTING ACTIVITIES (4,104,131) (184,616)
-------------------------
Cash flows from financing activities:
Proceeds from the sale of common stock 2,692,097 620,812
Proceeds from notes payable 1,250,000
Repayment of notes payable (830,000)
-------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 2,692,097 1,040,812
-------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,092,751) (16,916)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,052,844 1,100,568
============ ===========
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,960,093 $1,083,652
============ ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 90,695 $ 24,885
============ ===========
Income taxes paid $ - $ -
============ ===========
<FN>
See accompanying notes to unaudited condensed consolidated financial statements
F-33
PETROSEARCH ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. INTERIM FINANCIAL STATEMENTS
------------------------------
The accompanying un-audited interim financial statements have been prepared
without audit pursuant to the rules and regulations of the U.S. Securities
and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States of America
have been condensed or omitted, pursuant to such rules and regulations.
These unaudited consolidated condensed financial statements should be read
in conjunction with the audited financial statements and notes thereto of
Petrosearch Energy Corporation (the "Company") for the year ended December
31, 2005. In the opinion of management, all adjustments (consisting of
normal recurring adjustments) considered necessary for a fair presentation
of financial position, results of operations and cash flows for the interim
periods presented have been included. Operating results for the interim
periods are not necessarily indicative of the results that may be expected
for the respective full year.
2. INCOME TAXES
-------------
The Company uses the liability method in accounting for income taxes. Under
this method, deferred tax assets and liabilities are determined based on
differences between financial reporting and income tax carrying amounts of
assets and liabilities and are measured using the enacted tax rates and
laws that will be in effect when the differences are expected to reverse. A
valuation allowance, if necessary, is provided against deferred tax assets,
based upon management's assessment as to their realization.
The difference between the 34% federal statutory income tax rate and
amounts shown in the accompanying interim financial statements is primarily
attributable to the utilization of net operating loss carry-forwards and a
valuation allowance recorded against net deferred tax assets.
3. CAPITAL RAISE
--------------
On February 8, 2006, Petrosearch Energy Corporation completed a private
placement of equity securities solely to accredited investors for total
proceeds of $2,700,000 (the "Offering"). Pursuant to the Offering, the
Company issued 1,928,572 shares of the Company's common stock at a price of
$1.40 per share and 964,286 three year warrants to purchase shares of the
Company's common stock with an exercise price of $2.00 per share to the
accredited investors. On February 3, 2006, the Company engaged a placement
agent to handle the Offering. At the time of closing, the Company paid a
placement fee of 5% of the gross proceeds of the Offering. Additionally, at
the time of closing, the placement agent received 96,429 warrants to
purchase shares of the Company's common stock equal to 5% of the number of
shares of common stock issued to the accredited investors at the time of
closing of the Offering. The warrants issued to the placement agent are
exercisable for three years and have an exercise price of $2.00 per share.
The shares of common stock and the shares of common stock underlying the
warrants have piggyback registration rights. The Company intends to use the
proceeds of the Offering for working capital and general corporate
purposes.
4. PURCHASE OF INTERESTS IN OIL AND GAS PROPERTIES
------------------------------------------------------
BARNETT SHALE, 5 COUNTIES, TEXAS
On May 9, 2006, the Company entered into a Heads of Agreement
("ExxonMobil/Harding Agreement") with Exxon Mobil Corporation, Harding
Company, Eagle Oil & Gas Co., PS Gas Partners, LLC, and Gas Partners, L.P.
The ExxonMobil/Harding Agreement addresses the economic terms of the
project, provides the alternative structure under which the new integrated
venture in the Barnett Shale Project will operate, and provides the
structure within which the parties will negotiate definitive agreements.
Formation of the new integrated venture is conditioned upon execution of
definitive agreements. The ExxonMobil/Harding Agreement also extends for 60
days Exxon Mobil Corporation's preferential purchase rights and preserves
all Petrosearch's legal rights under the Amended and Restated Program
Agreement.
The First Amended and Restated Program Agreement followed a June 29, 2005
Lease Acquisition and Development Agreement between Exxon Mobil Corporation
and Harding Company and a Memorandum of Understanding Regarding Gas
Evacuation from ExxonMobil and Harding Barnett Shale E&P Venture covering
the project (the "ExxonMobil/Harding Agreements").
F-34
At the time of the execution of the First Amended and Restated Program
Agreement, Harding had not obtained from ExxonMobil consent to transfer and
a waiver of Exxon/Mobil's a preferential purchase right set forth in the
ExxonMobil/Harding agreement. At the time of the Company's execution of and
initial funding under the First Amended and Restated Program Agreement, the
Company did not have a direct contractual relationship with ExxonMobil. The
Company believed that all conditions necessary to assign and convey the
working interest from Harding had been met. The Company subsequently
learned that ExxonMobil had not waived the contingencies and that
ExxonMobil desired to explore possible alternative ownership structures
beneficial to all concerned before making a determination with respect to
the preferential right to purchase.
In the event that the parties cannot formulate the Definitive project
agreements before 60 days from May 9, 2006, Exxon Mobil could exercise its
preferential purchase right which, if exercised, would prevent the
Company's participation in the project. In the event of such a loss of this
opportunity to participate in the project, the Company's legal rights are
not prejudiced by the Heads of Agreement and the Company would then expect
to pursue all potential remedies available to us relating to the factual
circumstances surrounding these agreements.
We also signed a letter agreement ("Letter Agreement") on May 7, 2006 with
Harding Company that defines the terms of participation and interest
between Harding Company and Petrosearch in the formation of a new venture
entity. The terms of the Letter Agreement are subject to the completion of
the definitive agreements as outlined in the ExxonMobil/Harding Agreement.
QUINDUNO FIELD, ROBERTS COUNTY, TEXAS
On November 15, 2005, the Company closed on an agreement to purchase a 100%
working interest in 1780 acres of leases in the Quinduno Field located in
Roberts County, Texas from Quinduno Energy, L.L.C. The agreement provided
for the payment of the purchase price of $2,000,000 cash and 3,000,000
shares of unregistered common shares of the Company to occur in three
phases as the project progresses. Should the project not proceed past the
first phase, Petrosearch's maximum obligation would be $750,000 in cash and
1,000,000 unregistered common shares plus the cost of capital expenditures
for the first phase which are estimated to be $2,900,000. The project is in
the first phase of the water flood. Upon completion of the entire project,
the seller will back in for a 10% working interest after Petrosearch has
been repaid all capital expenditure costs plus $9.5 million.
LODGEPOLE REEF, STARK COUNTY, NORTH DAKOTA
Effective September 28, 2005, the Company purchased a 21.25% working
interest in the Gruman #18-1 Well and Gruman Leases for $637,500 increasing
the Company's working interest in the properties to 85%.
5. AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT
----------------------------------------------------
On September 29, 2005, the Company entered into an amended and restated
revolving credit agreement to borrow up to $10,000,000 over a two-year
period to October 1, 2007, from a private, non-public entity. The note
matures on April 1, 2008. As of March 31, 2006, the balance outstanding
under the line of credit agreement was $3,525,000, $1,264,204 of which is
due in the next twelve months.
6. STOCK WARRANTS
---------------
In the past, the Company has periodically issued incentive stock warrants
to officers, executives, directors, and consultants to provide additional
incentives to promote the success of the Company's business and to enhance
the ability to attract and retain the services of qualified persons. The
issuance of such warrants has been approved by the Board of Directors. The
exercise price of a warrant granted is determined by the fair market value
of the stock on the date of grant.
F-35
In December 2004, the FASB issued SFAS 123(R), which is a revision of SFAS
123. SFAS 123(R) requires all share-based payments to employees, including
grants of employee stock options, to be recognized as stock-based
compensation expense in the Company's Consolidated Statements of Operations
based on their fair values. Proforma disclosure is no longer an
alternative, as was permitted by SFAS 123. Until the adoption of the
provisions of SFAS 123(R) on January 1, 2006, the Company 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 and warrants because the alternative fair value
accounting provided for under FASB Statement No. 123, "Accounting for
Stock-Based Compensation", required use of option valuation models that
were not developed for use in valuing employee stock options or warrants.
Under APB 25, if the exercise price of the Company's employee stock options
is greater than or equal to the market price of the underlying stock on the
date of grant, no compensation expense was recognized.
Currently, the Company has no plans to issue stock warrants to any parties
other than in financing arrangements with third parties. Consequently,
based on current plans, the adoption of SFAS 123(R)'s fair value method
will not have a significant impact on the Company's future results of
operations or financial position. The adoption of SFAS 123(R) will not
result in any compensation charges in 2006 related to options outstanding
at December 31, 2005, because all employee stock options were vested as of
December 31, 2005. There was no compensation expense related to warrants
during the three month periods ended March 31, 2006 and 2005.
Although it is no longer required, due to the adoption of SFAS 123(R),
proforma information regarding net income and earnings per share was
required by Statement 123 and 148 (included for purposes of 2005 proforma
comparison), and has been determined as if the Company had accounted for
its employee stock warrants under the fair value method of these
Statements. For warrants granted to employees or directors during the three
months ended March 31, 2006 and 2005, the fair value of such warrants was
estimated at the date of grant using a Black-Scholes option-pricing model
with the following assumptions:
MARCH MARCH
31, 2006 31, 2005
----------------- --------------
Dividend yield - 0 - - 0 -
Expected volatility 70% 180 %
Risk free interest 3.00% 2.25%
Expected lives 2 - 4 years 3 years
The Black-Scholes option valuation model was developed for use in
estimating fair value of traded options or warrants that have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's employee stock
warrants have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock warrants.
For purposes of proforma disclosures, the estimated fair value of the
warrants is included in expense over the vesting period or expected life of
the warrant.
F-36
THREE MONTHS ENDED
MARCH 31,
2005
--------------------
Net income (loss), as reported $ (544,322)
Less stock-based compensation calculated in
accordance with SFAS 123 (540,000)
--------------------
Proforma net loss (1,084,322)
====================
Basic and fully diluted net income (loss) per
common share, as reported $ (0.03)
====================
Basic and fully diluted proforma net loss per
common share $ (0.06)
====================
A summary of the Company's warrant activity and related information for the
three months ended March 31, 2006 follows:
WEIGHTED
NUMBER OF AVERAGE
SHARES UNDER EXERCISE EXERCISE
WARRANT PRICE PRICE
------------- ----------- ---------
Balance outstanding at
December 31, 2005 8,495,045 $0.98-$9.75 $ 3.57
Issued 1,060,715 $ 2.00 $ 2.00
Exercised (142,462) $ 0.98 $ 0.98
-------------
Balance outstanding at
March 31, 2006 9,413,298 $0.98-$9.75 $ 3.43
=============
F-37
A summary of outstanding stock warrants at March 31, 2006 is as follows:
WEIGHTED
NUMBER OF REMAINING AVERAGE
COMMON STOCK CONTRACTED EXERCISE EXERCISE
EQUIVALENTS EXPIRATION DATE LIFE (YEARS) PRICE PRICE
------------ --------------- ------------ ----------- ---------
488,312 August 2006 .42 $ 0.98 $ 0.98
92,308 November 2008 2.67 $ 0.98 $ 0.98
615,385 September 2006 .44 $ 1.63 $ 1.63
76,923 November 2008 2.67 $ 1.63 $ 1.63
1,076,923 November 2006 .67 $ 9.75 $ 9.75
211,538 February 2007 1.92 $ 9.75 $ 9.75
30,769 March 2007 1.00 $ 9.75 $ 9.75
300,000 April 2007 1.09 $ 9.75 $ 9.75
161,538 May 2007 1.17 $6.50-$9.75 $ 7.27
76,923 July 2007 1.25 $5.20-$6.50 $ 6.24
269,231 September 2007 1.42 $4.88-$5.20 $ 5.15
100,000 November 2007 1.67 $ 2.00 $ 2.00
20,000 August 2008 2.37 $ 1.95 $ 1.95
4,832,733 November 2008 2.67 $ 1.95 $ 1.93
1,060,715 February 2009 3.91 $ 2.00 $ 2.00
------------
9,413,298
============
7. RELATED PARTY TRANSACTIONS
----------------------------
During the three months ended March 31, 2006 there were no related party
transactions.
8. NON-CASH INVESTING AND FINANCING ACTIVITIES
-----------------------------------------------
During the three months ended March 31, 2006 and 2005, the Company engaged
in non-cash financing and investing activities as follows:
2006 2005
-------- --------
Reduction of prepaid services for development
of oil and gas properties $ - $ 4,476
======== ========
Increase in accounts payable for property costs $ - $956,895
======== ========
Purchase of property for stock $545,000 $ -
======== ========
9. EARNINGS PER SHARE
--------------------
The Company has adopted SFAS No. 128, which provides for calculation of
"Basic" and "Diluted" earnings per share. Basic earnings per share includes
no dilution and is computed by dividing net income available to common
shareholders by the weighted average common shares outstanding for the
period. Diluted earnings per share reflect the potential dilution of
securities that could share in the earnings of an entity similar to fully
diluted earnings per share.
Following is a reconciliation of the numerators and denominators of the
basic and diluted EPS computations for the three months ended March 31,
2006 and 2005:
F-38
2006 2005
-------------- --------------
Net loss $ (844,630) $ (544,322)
Less: Preferred stock dividends (9,668) (9,668)
------------------------------
Net loss available to common
stockholders (numerator) $ (854,298) $ (553,990)
============== ==============
Weighted average shares of common stock
(denominator) 29,327,487 18,144,067
============== ==============
Basic and diluted net loss per share $ (0.03) $ (0.03)
============== ==============
10. SUBSEQUENT EVENTS
------------------
On April 7, 2006 the Company drew down $1,800,000 from its revolving credit
facility. Proceeds of the credit line are to be used to finance activity
related to the designated eight prospects including costs associated with
acquisitions of oil and gas leases, oil and gas drilling, reworking,
production, transportation, marketing and plugging activities under the
leases, and all lender charges and fees. Advances under the amended and
restated revolving credit agreement bear interest at a rate of the Wall
Street Journal Prime Rate plus three percent (3%) per year. Each advance of
principal under the amended facility is treated as a separate loan and is
repayable in six (6) interest only installments followed by up to twenty
four (24) principal and interest installments based upon a 30-month
amortization. The principal balance outstanding on the credit facility as
of May 9, 2006 is $5,207,500.
On May 5, 2006 the Company sold its 1,500,000 shares of Texcomm Stock for a
total of $1,000,000. The Company acquired the shares in November 2003
pursuant to a merger and a sale of a subsidiary.
On May 9, 2006, the Company entered into a Heads of Agreement
("ExxonMobil/Harding Agreement") with Exxon Mobil Corporation, Harding
Company, Eagle Oil & Gas Co., PS Gas Partners, LLC, and Gas Partners, L.P.
The ExxonMobil/Harding Agreement addresses the economic terms of the
project, provides the alternative structure under which the new integrated
venture in the Barnett Shale Project will operate, and provides the
structure within which the parties will negotiate definitive agreements.
Formation of the new integrated venture is conditioned upon execution of
definitive agreements. The ExxonMobil/Harding Agreement also extends for 60
days Exxon Mobil Corporation's preferential purchase rights and preserves
all Petrosearch's legal rights under the Amended and Restated Program
Agreement.
We signed a letter agreement ("Letter Agreement") on May 7, 2006 with
Harding Company that defines the terms of participation and interest
between Harding Company and Petrosearch in the formation of a new venture
entity. The terms of the Letter Agreement are subject to the completion of
the definitive agreements as outlined in the ExxonMobil/Harding Agreement.
F-39