UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB
|X| Quarterly report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the quarterly period ended: SEPTEMBER 30, 2004
|_| Transition report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the transition period from _______ to _______
Commission file no. 000-50228
TOUCHSTONE RESOURCES USA, INC.
-----------------------------------------------------------------
(Exact Name of Small Business Issuer as Specified in Its Charter)
DELAWARE 33-0967974
- ------------------------------- -------------------
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
111 PRESIDENTIAL BOULEVARD,
SUITE 165
BALA CYNWYD, PA 19004
----------------------------------------
(Address of Principal Executive Offices)
(610) 771-0680
------------------------------------------------
(Issuer's Telephone Number, including Area Code)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes |X| No |_|
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: There were 59,919,053 issued
and outstanding shares of the registrant's common stock, par value $.001 per
share, as of November 12, 2004.
Transitional Small Business Disclosure Format (check one):
Yes|_| No |X|
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - (Unaudited) 2
Condensed Consolidated Statements of Operations - (Unaudited) 3
Condensed Consolidated Statements of Cash Flows - (Unaudited) 4
Notes to Financial Statements - (Unaudited) 5
Item 2. Mamangements Discussion and Analysis 30
Item 3. Controls and Procedures 39
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 39
Item 5. Other Information 39
Item 6. Exhibits and Reports on Form 8-k 40
1
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Condensed Consolidated Balance Sheets
ASSETS
September 30, December 31,
2004 2003
------------ ---------
(Unaudited) (Audited)
Current assets
Cash and cash equivalents $ 797,883 $ 91,578
Restricted cash 81,133 --
Restricted cash - joint interest 602,837 --
Accounts receivable - joint interest 1,654,531 --
Accounts receivable - joint interest - related party 438,094
Notes and interest receivable 51,087 --
Due from related party 201,199 --
Prepaid expenses and advances to operators 1,721,846 741
------------ ---------
Total current assets 5,548,610 92,319
Undeveloped oil and gas interests, using successful efforts 5,049,787 --
Investment in limited partnerships and liability companies 8,665,328 --
Goodwill 751,482 --
Fixed assets, net 35,637 --
------------ ---------
$ 20,050,844 $ 92,319
============ =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Accounts payable and accrued expenses $ 1,032,576 $ 31,247
Accounts payable and accrued expenses - related party 2,259 --
Accounts payable - joint interest 2,959,080 --
Accounts payable - joint interest - related party 552,140 --
Notes payable 982,087 --
Notes payable - related party 216,541 --
Limited partnership subscriptions payable 550,000 --
Convertible debentures 2,625,136 100,000
------------ ---------
Total current liabilities 8,919,819 131,247
------------ ---------
Note payable - noncurrent 1,458,000 --
Total liabilities 10,377,819 131,247
------------ ---------
Commitment and contingencies
Minority interest 3,203,831 --
Stockholders' equity
Preferred stock; $.001 par value; authorized - 5,000,000 shares; shares
issued and outstanding - 0 at September 30, 2004 and December 31, 2003 -- --
Common stock; $.001 par value; authorized - 150,000,000 shares; shares
issued and outstanding - 59,919,053 and 285,000 issuable at
September 30, 2004 and 166,775,000 at December 31, 2003 60,204 166,775
Additional paid-in capital 16,908,452 --
Discount on common stock from stock split -- (120,075)
Deferred compensation (20,700) --
Deficit accumulated during the development stage (10,478,762) (85,628)
------------ ---------
Total stockholders' equity (deficit) 6,469,194 (38,928)
------------ ---------
$ 20,050,844 $ 92,319
============ =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Condensed Consolidated Statements of Operations
(Unaudited)
For the Three Months For the Nine Months March 5, 2001
Ended September 30, Ended September 30, (Inception) to
----------------------------- ----------------------------- September 30,
2004 2003 2004 2003 2004
------------ ------------- ------------ ------------- -------------
Operator revenues $ 60,316 $ -- $ 144,253 $ -- $ 144,253
------------ ------------- ------------ ------------- -------------
Expenses:
Exploration expenses -- -- 112,748 -- 112,748
Impairment of oil and gas properties 20,221 -- 1,333,466 -- 1,333,466
Bad debt expense -- -- 15,454 -- 15,454
General and administrative 835,838 5,860 1,804,336 11,109 1,883,717
Rent - related party 1,669 -- 1,669 -- 1,669
------------ ------------- ------------ ------------- -------------
Total expenses 857,728 5,860 3,267,673 11,109 3,347,054
------------ ------------- ------------ ------------- -------------
Loss from operations (797,412) (5,860) (3,123,420) (11,109) (3,202,801)
------------ ------------- ------------ ------------- -------------
Other (income) expense
Loss from limited partnerships
and limited liability companies 604,276 -- 717,760 -- 717,760
Interest income (687) -- (8,301) -- (8,301)
Interest expense 288,510 -- 7,252,307 -- 7,258,554
------------ ------------- ------------ ------------- -------------
Total other expense 892,099 -- 7,961,766 -- 7,968,013
------------ ------------- ------------ ------------- -------------
Loss before minority interest and
pre-acquisition losses (1,689,511) (5,860) (11,085,186) (11,109) (11,170,814)
------------ ------------- ------------ ------------- -------------
Minority interest and
pre-acquisition losses 106,013 -- 692,052 -- 692,052
------------ ------------- ------------ ------------- -------------
Net loss to common stockholders $ (1,583,498) $ (5,860) $(10,393,134) $ (11,109) $ (10,478,762)
============ ============= ============ ============= =============
Net loss per common share -
basic and diluted $ (0.03) $ (0.00) $ (0.12) $ (0.00) $ (0.08)
============ ============= ============ ============= =============
Weighted average number of common
shares outstanding - basic and diluted 59,531,635 166,775,000 85,799,555 166,775,000 139,676,324
============ ============= ============ ============= =============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended March 5, 2001
September 30, (Inception) to
------------------------- September 30,
2004 2003 2004
------------ --------- ------------
Cash flows from operating activities
Net cash used in operating activities $ (595,811) $ (13,989) $ (645,283)
------------ --------- ------------
Cash flows from investing activities
Cash acquired from acquisition of wholly-owned subsidiary
and limited partnership interest 510,273 -- 510,273
Repayment of note receivable - related party 6,250 -- 6,250
Notes receivable (30,000) -- (30,000)
Notes receivable - related party (184,549) -- (184,549)
Purchase of oil and gas interests and drilling costs (2,548,420) -- (2,548,420)
Investment in limited partnership interests (7,319,654) -- (7,319,654)
Purchase of fixed assets 10,835 -- 10,835
------------ --------- ------------
Net cash used in investing activities (9,555,265) -- (9,555,265)
------------ --------- ------------
Cash flows from financing activities
Advances from stockholder -- -- 10,000
Repayments to stockholder -- -- (10,000)
Proceeds from notes payable 925,100 -- 925,100
Proceeds from notes payable - related party 146,468 -- 146,468
Repayment of notes payable (5,253,600) -- (5,253,600)
Repayment of notes payable - related party (76,000) -- (76,000)
Proceeds from issuance of convertible debt 9,990,000 100,000 10,090,000
Repayment of convertible debt (150,000) -- (150,000)
Loan costs (121,500) -- (121,500)
Capital contributed by sole officer 15,000 -- 15,000
Minority contributions 3,425,500 -- 3,425,500
Proceeds from issuance of common stock, net of issuance costs 2,559,250 -- 2,600,300
------------ --------- ------------
Net cash provided by financing activities 11,460,218 100,000 11,601,268
------------ --------- ------------
Net increase in cash and cash equivalents 1,309,142 86,011 1,400,720
Cash and cash equivalents at beginning of year 91,578 9,401 --
------------ --------- ------------
Cash and cash equivalents, end of period $ 1,400,720 $ 95,412 $ 1,400,720
============ ========= ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 1 - BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements included herein have
been prepared by Touchstone Resources USA, Inc. (the "Company"), without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission.
The financial statements reflect all adjustments that are, in the opinion of
management, necessary to fairly present such information. All such adjustments
are of a normal recurring nature except for the adjustment to goodwill in
connection with the Company's acquisition of Touchstone Texas (see Note 5) and
impairment on certain oil and gas properties (see Note 7). Although the Company
believes that the disclosures are adequate to make the information presented not
misleading, certain information and footnote disclosures, including a
description of significant accounting policies normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America ("US GAAP"), have been condensed or omitted
pursuant to such rules and regulations.
These financial statements should be read in conjunction with the financial
statements and the notes thereto included in the Company's 2003 Annual Report on
Form 10-KSB filed with the Securities and Exchange Commission. The results of
operations for interim periods are not necessarily indicative of the results for
any subsequent quarter or the entire fiscal year ending December 31, 2004.
The Company is a Development Stage Enterprise, as defined in Statement of
Financial Accounting Standards ("SFAS") No. 7 "Accounting and Reporting for
Development Stage Enterprises." Under SFAS No. 7, certain additional financial
information is required to be included in the financial statements for the
period from inception of the Company to the current balance sheet date.
NOTE 2 - DESCRIPTION OF BUSINESS
Touchstone Resources USA, Inc. (formerly The Coffee Exchange, Inc.) was
incorporated under the laws of Delaware on March 5, 2001. The Company was
organized to develop Internet coffee cafes in Orange County, California.
On March 15, 2004, the Company experienced a change in management when all of
its directors and officers resigned from their positions and it appointed a new
officer and director. The Company's new management implemented a new business
plan and completed a series of material transactions and the Company became
engaged in oil and gas exploration, development and production and the
acquisition of producing properties focusing on projects located in Texas,
Mississippi, Louisiana and other traditional oil and gas producing states in the
Southern United States, as well as in New Zealand.
Effective March 18, 2004, the Company changed its name from "The Coffee
Exchange, Inc." to "Touchstone Resources USA, Inc."
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ADOPTED IN 2004
Consolidated Financial Statements
The accompanying consolidated financial statements include all of the accounts
of Touchstone Resources USA, Inc. and its eight subsidiaries consisting of
Touchstone Resources USA, Inc. ("Touchstone Texas"), a wholly-owned Texas
corporation incorporated in May 2000, Touchstone Awakino, Inc. ("Touchstone
`Awakino"), a wholly-owned Delaware corporation incorporated in March 2004,
5
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ADOPTED IN 2004 -
(Continued)
Touchstone Louisiana, Inc. ("Touchstone Louisiana"), a wholly-owned Delaware
corporation incorporated in March 2004, Touchstone Vicksburg, Inc. ("Touchstone
Vicksburg"), a wholly-owned Delaware corporation incorporated in March 2004,
Knox Gas, LLC ("Knox Gas"), a 68.18% owned Delaware limited liability company
formed in February 2004, PHT West Pleito Gas, LLC ("PHT West"), a 86% owned
Delaware limited liability company formed in April 2004, Touchstone Pierce
Exploration, LLC, ("Touchstone Pierce"), a wholly-owned Delaware limited
liability company formed in June 2004, and PF Louisiana, LLC ("PF Louisiana"), a
wholly-owned Delaware limited liability company formed in August 2004. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Equity Method
Under the guidance of Emerging Issues Task Force D-46, "Accounting for Limited
Partnership Investments" the Company uses the equity method to account for all
of its limited partnership and membership interests that represent an ownership
interest that exceeds 5% of the applicable entity, but is less than 50% of the
applicable entity. Under the equity method of accounting, the Company's
proportionate share of the investees' net income or loss is included in "Loss
from limited partnerships and limited liability companies" in the condensed
consolidated statements of operations. Any excess investment is evaluated each
reporting period for impairment.
Use of Estimates
The preparation of financial statements in conformity with US GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Management believes that it is reasonably possible that the following material
estimates affecting the financial statements could significantly change in the
coming years (1) estimates of any proved oil and gas reserves, (2) estimates as
to the expected future cash flow from any proved oil and gas properties, and (3)
estimates of future dismantlement and restoration costs.
The Company's business makes it vulnerable to changes in wellhead prices of
crude oil and natural gas. Such prices have been volatile in the past and can be
expected to be volatile in the future.
By definition, proved reserves are based on current oil and gas prices. Price
declines reduce the estimated quantity of proved reserves and increase annual
amortization expense (which is based on proved reserves).
Oil and Gas Accounting
The Company uses the successful efforts method of accounting for oil and gas
producing activities. Costs to acquire mineral interests in oil and gas
properties, to drill and equip exploratory wells that find proved reserves, and
to drill and equip development wells are capitalized. Costs to drill exploratory
wells that do not find proved reserves, geological and geophysical costs, and
costs of carrying and retaining unproved properties, are expensed.
Unproved oil and gas properties that are individually significant are
periodically assessed for impairment of value, and a loss is recognized at the
time of impairment by providing an impairment allowance. Capitalized costs of
producing oil and gas properties, after considering estimated salvage values,
are depreciated and depleted by the unit-of-production method. Support equipment
and other property and equipment are depreciated over their estimated useful
lives.
6
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ADOPTED IN 2004 -
(Continued)
The Company reviews the carrying values of its long-lived assets whenever events
or changes in circumstances indicate that such carrying values may not be
recoverable. If, upon review, the sum of the undiscounted pretax cash flows is
less than the carrying value of the asset group, the carrying value is written
down to estimated fair value. Individual assets are grouped for impairment
purposes at the lowest level for which there are identifiable cash flows that
are largely independent of the cash flows of other groups of assets, generally
on a field-by-field basis. The fair value of impaired assets is determined based
on quoted market prices in active markets, if available, or upon the present
values of expected future cash flows using discount rates commensurate with the
risks involved in the asset group. The long-lived assets of the Company, which
are subject to evaluation, consist primarily of oil and gas properties.
Impairments are provided if the net capitalized costs of gas and oil properties
at the field level exceed their realizable values based upon expected future
cash flows.
Upon the sale or retirement of a complete unit of a proved property, the cost
and related accumulated depreciation, depletion, and amortization are eliminated
from the property accounts, and the resultant gain or loss is recognized. Upon
the retirement or sale of a partial unit of proved property, the cost is charged
to accumulated depreciation, depletion, and amortization with a resulting gain
or loss recognized in income.
On the sale of an entire interest in an unproved property for cash or cash
equivalent, gain or loss on the sale is recognized, taking into consideration
the amount of any recorded impairment as if the property had been assessed
individually. If a partial interest in an unproved property is sold, the amount
received is treated as a reduction of the cost of the interest retained.
Revenue Recognition
Revenue is recognized at the time title passes on oil and gas quantities, less
any royalties due. Revenues related to natural gas are recognized using the
entitlement method of accounting for gas imbalances. Any quantities that are in
excess of sales quantities are recorded as a receivable at the lower of the
current market price or the market price at the time the imbalance occurred. Any
quantities that are lower than the sales quantities are recorded as deferred
revenue at the market price at the time the imbalance occurred. There were no
imbalances as of September 30, 2004.
Capitalized Interest
The Company's policy is to capitalize interest on expenditures for significant
exploration and development projects while activities are in progress to bring
the assets to their intended use. There was no capitalized interest as of
September 30, 2004.
Segment Information
Under SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," the Company has determined it has one reportable operating segment
which is the acquisition, exploration and development of natural gas and oil
properties. The company's operations are conducted in two geographic areas as
follows:
Operating revenues for the nine month periods ended September 30, 2004 and 2003
by geographical area were as follows:
September 30,
---------------------------
2004 2003
----------- -----------
United States $ 144,253 $ --
New Zealand -- --
----------- -----------
$ 144,253 $ --
=========== ===========
7
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ADOPTED IN 2004 -
(Continued)
Operating revenues for the three month periods ended September 30, 2004 and 2003
be geographical area were as follows:
September 30,
---------------------------
2004 2003
----------- -----------
United States $ 60,316 $ --
New Zealand -- --
----------- -----------
$ 60,316 $ --
=========== ===========
Long-lived assets as of September 30, 2004 and December 31, 2003 by geographical
area were as follows:
September 30, December 31,
2004 2003
----------- -----------
United States $13,109,700 $ --
New Zealand 641,052 --
----------- -----------
$13,750,752 $ --
=========== ===========
Fixed Assets
Fixed assets are recorded at cost, less accumulated depreciation and are
depreciated using the straight-line method over the estimated useful life of the
assets which ranges from five to seven years.
Goodwill
The Company has adopted Statement of Financial Accounting Standards ("SFAS") No.
142, "Goodwill and Other Intangible Assets," which addresses the financial
accounting and reporting standards for the acquisition of intangible assets
outside of a business combination and for goodwill and other intangible assets
subsequent to their acquisition. This accounting standard requires that goodwill
be separately disclosed from other intangible assets on the balance sheet, and
no longer be amortized, but tested for impairment on at least an annual basis.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of cash deposits at financial institutions,
trade receivables and unsecured related party advances. As of September 30,
2004, the cash balance exceeded the federally insured limits. To mitigate this
risk, the Company places its cash deposits only with high credit quality
institutions. Management believes the risk of loss is minimal.
NOTE 4 - GOING CONCERN
The Company is in the development stage and has incurred losses since its
inception. Also, its current liabilities exceed its current assets. There are no
assurances the Company will receive funding necessary to implement its business
plan. This raises substantial doubt about the ability of the Company to continue
as a going concern.
8
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 4 - GOING CONCERN - (Continued)
The Company believes that the proceeds received from its private offerings of
securities and its current and projected revenues from oil and gas operations
will be sufficient to fund its operations through September 2005. The Company
may need to raise additional funds in the event it locates additional prospects
for acquisition, experiences cost overruns at its current prospects or fails to
generate projected revenues.
The Company's ability to continue as a going concern is dependent upon the
Company raising additional financing on terms desirable to the Company. If the
Company is unable to obtain additional funds when they are required or if the
funds cannot be obtained on terms favorable to the Company, management may be
required to delay, scale back or eliminate its well development program or
license third parties to develop or market products that the Company would
otherwise seek to develop or market itself, or even be required to relinquish
its interest in one or more properties or in the extreme situation, cease
operations. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
NOTE 5 - BUSINESS COMBINATIONS
In accordance with accounting Research Bulletin No. 51 "Consolidated Financial
Statements," the financial operations of the acquired subsidiaries have been
reflected in the financial statements as if they had been acquired as of January
1, 2004, with the related pre-acquisition losses being deducted at the bottom of
the condensed consolidated statement of operations.
Acquisition of Touchstone Texas
On March 23, 2004, the Company acquired 100% of the issued and outstanding
shares of common stock of Touchstone Texas from Touchstone Resources, Ltd.
("Touchstone Canada"), a related party, in consideration for which the Company
issued 7,000,000 shares of its common stock to Touchstone Canada. The 7,000,000
shares were valued by an independent valuation consultant at $70,000. The
purchase price was allocated to the assets and liabilities in accordance with
SFAS No. 141 "Business Combinations." In connection with this acquisition, the
Company issued 280,000 shares of its common stock to an investment advisor
valued at $2,800. On March 23, 2004, Touchstone Texas had a deficit of
$1,176,630, which consisted of the following components:
Cash $ 506,261
Accounts receivable 2,393,596
Other current assets 31,185
Fixed assets 35,687
-----------
Total Assets $ 2,966,729
===========
Accounts and notes payable $ 4,122,709
Other liabilities 20,650
-----------
Total Liabilities $ 4,143,359
===========
Net Deficit Acquired $(1,176,630)
===========
The excess purchase price of $1,249,430 was recognized as goodwill, which will
be subject to period impairment assessment under SFAS No. 142 "Goodwill and
Other Intangible Assets."
9
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 5 - BUSINESS COMBINATIONS - (Continued)
During the second quarter of 2004, the Company recorded a post closing
acquisition adjustment to the balance of accounts payable of Touchstone Texas
assumed at March 23, 2004, as a result of which goodwill which was originally
recognized was reduced to $751,482.
Acquisition of Knox Gas
On March 24, 2004 the Company purchased from FEQ Gas, LLC, ("FEQ Gas"), a 75%
membership interest in Knox Gas, which owns a 99% limited partnership interest
in Knox Miss Partners, L.P., ("Knox Miss LP"), and a 1% membership interest on
Knox Miss, LLC ("Knox Miss LLC"), a Delaware limited liability company and the
general partner in Knox Miss LP. The Company agreed to assume FEQ Gas'
obligation to make capital contributions to Knox Gas in the amount of $5
million, which was subsequently reduced per the August 2004 amendment to the
operating agreement described below. As of September 30, 2004 the Company has
contributed $2,877,500 to Knox Gas.
Following is the condensed consolidated balance sheet of Knox Gas on March 24,
2004:
Notes and interest receivable $ 32,335
Advance payments to operators 884,191
Unproved oil and gas property 4,079,702
Subscription receivable 4,500,000
Miscellaneous (83)
-----------
Total Assets $ 9,496,145
===========
Accrued expenses $ 41,314
Notes payable 4,504,500
Minority interest 8,151
-----------
Total Liabilities and Minority Interest $ 4,553,965
===========
Net Assets Acquired $ 4,942,180
===========
The excess purchase price of Knox Gas in the amount of $57,820 was allocated to
unproved oil and gas property.
In August 2004, Knox Gas amended its operating agreement to admit a new member
which reduced Touchstone's membership interest in Knox Gas from 75% to 68.18%.
The amendment resulted in the new member becoming the sole Class B Member and
all other members as Class A Members.
Available cash will be distributed among the members of Knox Gas in proportion
to their respective percentage interests. Profits and losses of Knox gas will be
allocated, after giving effect to certain regulatory allocations and cumulative
prior allocations, to the members in proportion to their percentage interests.
Knox Gas' Acquisition of Knox Miss Partners, L.P.
On February 26, 2004, Knox Gas acquired 99% limited partnership interest in Knox
Miss L.P. and 1% membership interest in Knox Miss LLC from Endeavour, in
consideration of which Knox Gas paid $500,000 in cash and issued a secured
promissory note of $4,500,000 to Endeavour. (See Note 9)
10
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 5 - BUSINESS COMBINATIONS - (Continued)
The following is the condensed balance sheet of Knox Miss LP on February 26,
2004:
Cash $ 3,404
Notes and interest receivable 45,368
Advance payments to operators 905,024
Unproved oil and gas property 2,766,623
----------
Total Assets $3,720,419
==========
Accrued expenses $ 23,687
Notes payable 1,250
Minority interest 8,562
----------
Total Liabilities and Minority Interest $ 33,499
==========
Net Assets Acquired $3,686,920
==========
The excess purchase price of $1,313,080 was allocated to unproved oil and gas
property.
The following pro forma presentation assumes the Company's acquisition of
Touchstone Texas and Knox Gas, and Knox Gas' acquisition of Knox Miss LP took
place on January 1, 2003 and shows the pro forma effect on loss from operations.
The historical column presents the unaudited financial information of the
Company for the periods indicated.
Nine Months Ending Nine Months Ending
September 30, 2004 (unaudited) September 30, 2003 (unaudited)
--------------------------------- -----------------------------------
Historical Pro Forma Historical Pro Forma
------------ ------------ ------------- -------------
Revenue $ 144,253 $ 144,253 $ -- $ 122,150
Operating expenses 3,267,673 3,267,673 11,109 12,338,318
Loss from operations (3,123,420) (3,123,420) (11,109) (12,216,168)
Other (income) loss 7,961,766 7,961,766 -- 1,505,780
Net loss before minority
interest and pre-acquisition losses (11,085,186) (11,085,186) (11,109) (13,721,948)
Minority interest and pre-acquisition
losses 692,052 230,781 -- 13,399
Net loss to common
Stockholders (10,393,134) (10,854,405) (11,109) (13,708,549)
Net loss per common share -
basic and diluted (0.12) (0.13) -- (0.08)
Weighted average number of
common shares outstanding -
basic and diluted 85,799,555 85,799,555 166,775,000 166,775,000
11
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 5 - BUSINESS COMBINATIONS - (Continued)
Three Months Ending Three Months Ending
September 30, 2004 (unaudited) September 30, 2003 (unaudited)
--------------------------------- -----------------------------------
Historical Pro Forma Historical Pro Forma
------------ ------------ ------------- -------------
Revenue $ 60,316 $ 60,316 $ -- $ 101,581
Operating expenses 857,728 857,728 5,860 10,896,541
Loss from operations (797,412) (797,412) (5,860) (10,794,960)
Other (income) loss 892,099 892,099 -- 1,095,011
Net loss before minority
interest and pre-acquisition losses (1,689,511) (1,689,511) (5,860) (11,889,971)
Minority interest and pre-acquisition
losses 106,013 130,781 -- 23
Net loss to common
Stockholders (1,583,498) (1,558,730) (5,860) (11,889,948)
Net loss per common share -
basic and diluted (0.03) (0.03) -- (0.07)
Weighted average number of
common shares outstanding -
basic and diluted 59,531,635 59,531,635 166,775,000 166,775,000
NOTE 6 - RECEIVABLES - RELATED PARTY
As of September 30, 2004, the Company had advanced $50,975 to PHT Vicksburg and
$35,000 to Touchstone Canada, respectively. The president of Touchstone Canada
was the former president of Touchstone Texas until June 2, 2004 when he
resigned. In addition, the Company was owed $115,224 from Touchstone Canada for
payment of accounts payable, which Touchstone Canada had agreed to assume prior
to the Company's acquisition of Touchstone Texas.
NOTE 7 - OIL AND GAS PROSPECTS
Knox Miss LP
During 2002, Knox Miss LP entered into exploration agreements (Exploration
Agreements) with SKH Exploration, Inc. ("SKH Exploration") and SKH Energy
Partners II, LP ("SKH Energy Partners") to jointly cooperate and participate in
the exploration and development of oil, gas and mineral leases in the Livingston
Transform Area, Longview and Osborn prospects which cover several counties in
Mississippi. Pursuant to the Exploration Agreements, Knox Miss LP purchased
various leasehold interests from SKH Exploration and SKH Energy Partners for an
aggregate purchase price of $2,646,184. Upon any joint sale by the parties of
any ownership interests in the Livingston Transform Area prospect, Knox Miss LP
will be entitled to receive the first $850,000 of the proceeds. Knox Miss LP
paid KAB Investments, Inc. $185,000 fee for services rendered in connection with
the acquisition from SKH Exploration.
12
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 7 - OIL AND GAS PROSPECTS - (Continued)
All operations in the Livingston Transform Area, Longview and Osborn Prospects
will be conducted in accordance with the provisions of Joint Operating
Agreements between the parties. The Joint Operating Agreements are to be in a
standard industry form with minor modifications as agreed to by the parties.
Knox Miss LP is to be named as the operator in each of the Joint Operating
Agreements. Subsequent to one year after the date of the exploration agreements,
if either party to the relevant exploration agreement elects to drill an initial
prospect exploratory well, then, depending on the results of the drilling
activities, if the other party to the Exploration Agreement elects not to
participate in the drilling activities, it may be obligated to relinquish to the
participating party: (i) its interest or right to earn or acquire an interest in
the producing unit established for the initial prospect exploratory well, and
(ii) a portion of its interest or right to earn or acquire an interest in the
remainder of the Prospect Area depending on the results of the drilling
activities.
On May 23, 2002, Knox Miss LP entered into an Exploration and Development
Agreement (the "Agreement") with Clayton Williams Energy, Inc. ("Clayton
Williams") to jointly cooperate and participate in the exploration and
development of oil, gas and mineral leases in certain prospects which cover
several counties in Mississippi. Pursuant to the Agreement, Knox Miss LP was
required to pay Clayton Williams a management fee in the aggregate amount of
$500,000 payable in twenty-four monthly installments. During 2003 and 2002, Knox
Miss LP had purchased 50% working interest in various oil, gas and mineral
leases. As a result of the settlement of Knox Miss LP's lawsuit with Clayton
Williams on May 26, 2004, Knox Miss LP assigned all of its leasehold interests
it acquired from May 23, 2002 through April 30, 2004 in the original area of
mutual interest back to Clayton Williams, except for the School Board Lease,
which Knox Miss LP acquired in August 2002 for $136,644.
In addition, Knox Miss LP assigned all of its leasehold interests in the
Savannah Lake prospect it acquired from SKH Energy during 2002 to Clayton
Williams, the value of which was approximately $261,474.
During 2003 and 2002, Knox Miss LP acquired various leasehold interests in
Noxubee County, Mississippi. As a result of Knox Miss LP's lawsuit settlement
with Clayton Williams, Knox Miss LP assigned half of its leasehold interests in
Noxubee County to Clayton Williams in the amount of $45,124. See Note 14 for a
detailed explanation of the Knox Miss LP's settlement with Clayton Williams.
Touchstone Pierce Exploration, LLC
On June 28, 2004, the Company formed Touchstone Pierce Exploration, LLC as the
sole managing member. Pursuant to the operating agreement of Touchstone Pierce,
the Company may be called upon from time to time for contributions so as to meet
the reasonable capital requirements of Touchstone Pierce.
In July 2004, Touchstone Pierce acquired various leases on the Pierce Ranch in
Matagorda County, Texas from South Oil, Inc. ("South Oil").
At the discretion of the Company, the managing member of Touchstone Pierce,
available cash will be distributed based on the value of aggregate capital
contributions.
PHT West Pleito Gas, LLC
On April 22, 2004, the Company made an initial capital contribution of $373,500
to PHT West Pleito Gas, LLC, in exchange for an 83.4% membership interest in PHT
West. In July 2004, the Company made an additional capital contribution of
$500,000 to PHT West. Pursuant to operating agreement of PHT West, the Company
and the other non-managing members in PHT West may be called upon from time to
time for additional contributions to meet the reasonable capital requirements of
PHT West. PHT West owned a 35% working interest in approximately 1,800 acres of
leases in Kern County, California, for which Touchstone Texas was the operator.
13
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 7 - OIL AND GAS PROSPECTS - (Continued)
In May and June 2004, the operating agreement of PHT West was amended to reflect
the addition of another member, which reduced the Company's membership interest
to 71.5%.
At the discretion of PHT Gas, LLC, the managing member of PHT West, available
cash will be distributed based on the value of aggregate capital contributions.
In the third quarter 2004, the Company made an additional capital contribution
of $749,000 to PHT West Pleito which increased the Company's membership interest
to 86%.
During the third quarter of 2004, due to certain drilling difficulties,
Touchstone Texas resigned as the operator in the West Pleito Fan and PHT West
notified the other non-operators that it decided to surrender its entire working
interest in the prospect to the remaining non-operators. As a result, PHT West
has impaired all of the leasehold acquisition and drilling costs incurred as of
September 30, 2004 and recorded an impairment charge of $1,333,466.
PF Louisiana LLC
On August 13, 2004, the Company made an initial capital contribution of $150,000
to PF Louisiana, in exchange for a 100% membership interest in PF Louisiana.
Pursuant to the operating agreement of PF Louisiana, the Company may be called
upon from time to time for additional contributions to meet the reasonable
capital requirements of PF Louisiana. On August 13, 2004, PF Louisiana acquired
1,030.54 acres in the Iberia Parish, Louisiana.
At the discretion of the Company, the managing member of PF Louisiana, available
cash will be distributed based on the value of the aggregate capital
contributions.
Summary
Oil and gas properties consisted of the following at September 30, 2004:
Touchstone
Knox Miss, LP Pierce PF Louisiana Total
------------- ------ ------------ -----
Unproved properties acquisition costs $2,661,712 $304,000 $444,000 $3,409,712
Drilling in Progress 5,803 -- -- 5,803
Other capitalized costs 263,372 -- -- 263,372
Excess purchase price for Knox Gas' acquisition
of Knox Miss LP that was allocated to unproved
oil and gas property (See Note 5) 1,313,080 -- -- 1,313,080
Excess purchase price for the Company's acquisition
of Knox Gas that was allocated to unproved
oil and gas property (See Note 5) 57,820 -- -- 57,820
---------- -------- -------- ----------
Net capitalized oil and gas properties $4,301,787 $304,000 $444,000 $5,049,787
========== ======== ======== ==========
NOTE 8 - EQUITY INTERESTS IN OIL AND GAS PROPERTIES
PHT Vicksburg Partners, L.P.
On March 23, 2004, Touchstone Vicksburg purchased a 9.9% limited partnership
interest in PHT Vicksburg Partners, LP ("PHT Vicksburg"), a Delaware limited
partnership from Montex Exploration, Inc. ("Montex"), a Delaware corporation,
for $48,000. The Company, subsequent to the purchase, invested an additional
$277,000 in PHT Vicksburg. On April 1, 2004, the limited partnership agreement
was amended to remove seven limited partners, which increased Touchstone
Vicksburg's limited partnership interest to 27.50%. As of September 30, 2004,
PHT Vicksburg has acquired various leasehold interests in East Coastal Field
Prospect and Sullivan City Prospect located in Starr and Hidalgo Counties,
Texas.
14
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 8 - EQUITY INTERESTS IN OIL AND GAS PROPERTIES - (Continued)
At the discretion of PHT Gas, LLC, the general partner of PHT Vicksburg,
available cash will be distributed 99% to the limited partner to the extent of
its unreturned capital balance and 1% to PHT Gas, LLC until all unreturned
capital balances have been returned, and then 75% to the limited partners in
proportion to their respective percentage interests and 25% to PHT Gas, LLC.
Distributions in liquidation of the partnership will be made in accordance with
the capital accounts subject to the above distributions. In general, profits
will be allocated, after giving effect to certain regulatory allocations and
cumulative prior allocations, 75% to the limited partner and 25% to PHT Gas,
LLC. Losses in general will be allocated, after giving effect to regulatory
allocations and certain proportionate allocations, to all partners with a
positive capital account in proportion to the extent of their balances and then
entirely to PHT Gas, LLC.
Awakino South Exploration, LLC
On March 23, 2004, Touchstone Awakino purchased a 4.6% Class B membership
interest in Awakino South Exploration, LLC ("Awakino South"), a Delaware limited
liability company, from Montex for $150,000. Touchstone Awakino, subsequent to
the purchase, invested an additional $196,154 in Awakino South, and received an
additional 4.54% membership interest. During 2003, Awakino South acquired a 75%
working interest in the Petroleum Exploration Permit No. PEP38479 oil and gas
prospect located in New Zealand for $3,000,000.
In August 2004, the operating agreement of Awakino South was amended to reflect
the addition of two other members, which reduced the Company's membership
interest to 7.93%.
At the discretion of PHT Gas, LLC, the Class A and managing member, available
cash will be distributed 99% to Class B members to the extent of its unreturned
capital balance and 1% to PHT Gas, LLC until all unreturned capital balances
have been returned and then 80% to the Class B members in proportion to their
respective percentage interests and 20% to the Class A member. Distributions in
liquidation of the limited liability company will be made in accordance with the
capital accounts subject to the above distributions. Profit and loss is
allocated to the members based on their respective distribution percentages.
PHT Stent Partners, L.P.
On March 26, 2004, the Company became a limited partner in PHT Stent Partners,
L.P. ("PHT Stent"), a Delaware limited partnership for which PHT Gas, LLC is the
general partner. As of September 30, 2004, the Company contributed $687,500 for
a 19.80% interest in PHT Stent. Pursuant to the partnership agreement, the
Company and the other limited partners in PHT Stent may be called upon from time
to time for additional contributions so as to meet the reasonable capital
requirements of PHT Stent.
In August 2004, the limited partnership agreement of PHT Stent was amended to
allow the addition of another limited partner, who became the sole Class B
limited partner. The Company, together with other limited partners, became the
Class A limited partners.
At the discretion of the general partner, available cash will be distributed as
follows:
(i) If on the date of such distribution there are any Class B limited
partners, 25% of the cash available for distribution will be distributed
to the Class B limited partners and the general partner in the order of
priority indicated on the amended limited partnership agreement.
(ii) The remainder of the cash available for distribution to limited partners
will be distributed among the Class A limited partners and the general
partner in the following order of priority:
15
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 8 - EQUITY INTERESTS IN OIL AND GAS PROPERTIES - (Continued)
(a) First, 99% to the Class A limited partners in proportion to and to
the extent of their unreturned capital balances and 1% to the
general partner until all unreturned capital balances have been
reduced to zero.
(b) Then, 75% to the limited partners in proportion to their percentage
interests and 25% to the general partner.
In general, profits will be allocated, after giving effect to certain regulatory
allocations and cumulative prior allocations, 56.25% to the Class A limited
partners, 25% to the Class B limited partners and 18.75% to the general partner.
Losses in general will be allocated, after giving effect to regulatory
allocations and certain proportionate allocations, to all partners with a
positive capital account in proportion to the extent of their balances and then
entirely to PHT Gas, LLC.
LS Gas, LLC
On March 23, 2004, the Company entered into an Interest Purchase Agreement by
and among the Company, Touchstone Louisiana and Touchstone Canada whereby
Touchstone Louisiana purchased a 10% membership interest in LS Gas, LLC, a
Delaware limited liability company, from Touchstone Canada, a related party, in
consideration for which the Company issued 100,000 shares of its common stock to
Touchstone Canada. The shares were valued at $1,000.
At the discretion of the managing member of LS Gas, LLC, available cash will be
distributed to the members pro rata in accordance with their respective
percentage interests. Profits and losses of the company will be allocated to the
members pro rata in accordance with their respective percentage interests.
Louisiana Shelf Partners, L.P.
In April 2004, Touchstone Louisiana purchased a 24.9975% Class A limited
partnership interest in Louisiana Shelf Partners, LP ("LSP") from Endeavour, in
consideration for which Touchstone Louisiana agreed to pay Endeavour $250,000
and issue a 3% promissory note payable to Endeavour in the amount of $2,000,000.
The note was contingent on LSP completing its first well which was completed as
of September 30, 2004. Payments are to be made against the note once the well
starts generating positive cash flow. There are also conditional accelerated
payments that are contingent upon certain production levels. This has been
disclosed in more detail in Note 9. Subsequent to the purchase, Touchstone
Louisiana invested an additional $1,000,000 in LSP. LSP is the holder of two
leases in the State Waters adjoining Cameron Parish, Louisiana. State Lease
17742 will expire in March 2006, providing that the annual rentals are promptly
paid in March 2005. State Lease 17666 will expire in December 2005, providing
that the annual rentals are promptly paid in December 2004.
In August 2004, LSP amended its limited partnership agreement to allow the
addition of another limited partner, who became the sole Class C limited
partner. The Company, together with other limited partners, became the Class A
limited partners. The company's ownership interest in LSP was reduced to 24.98%.
At the discretion of LS Gas, LLC, the general partner, available cash will be
distributed as follows:
(i) If on the date of such distribution there are any Class C limited
partners, 13% of the cash available for distribution will be distributed
to the Class C limited partners and the general partner in the order of
priority per the amended limited partnership agreement.
(ii) The remainder of the cash available for distribution to limited partners
will be distributed among the Class A limited partners, Class B limited
partners and the general partner in the following order of priority:
(a) First, to the Class A limited partners, an amount equal to the
accrued but unpaid Class A preferred return as of the date of the
distribution, distributed to each Class A limited partner pro rata
in proportion to the amount of each Class A limited partner's unpaid
Class A preferred return as of that date;
16
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 8 - EQUITY INTERESTS IN OIL AND GAS PROPERTIES - (Continued)
(b) Second, to the general partner and the Class A limited partners in
proportion to their respective unreturned capital as of the date of
the distribution, until the general partner's unreturned capital and
each Class A limited partner's unreturned capital has been reduced
to zero;
(c) Third, to the Class B limited partners in proportion to their
respective unreturned capital, until each Class B limited partner's
unreturned capital has been reduced to zero; and
(d) Thereafter, 40% to the general partner, and 60% to the Class A
limited partners, pro rata in proportion to each Class A limited
partner's percentage interest.
In general, profits and losses will be allocated, after giving effect to the
regulatory allocations per the amended limited partnership agreement, 13% to the
capital accounts of the Class C limited partners and the general partner, in the
order of priority. The remainder that is available for allocation to limited
partners will be allocated to the capital accounts for the Class A limited
partners, Class B limited partners and general partner per the amended limited
partnership agreement.
PHT Wharton Partners, L.P.
In April 2004, the Company became a limited partner in PHT Wharton Partners,
L.P. ("PHT Wharton"), a limited partnership formed in January 2004, for which
PHT Gas, LLC is the general partner. As of September 30, 2004, the Company has
contributed $900,000 to the partnership for a 17.82% limited partnership
interest. Pursuant to the partnership agreement, the Company and the other
limited partners in PHT Wharton may be called upon from time to time for
additional contributions so as to meet the reasonable capital requirements of
PHT Wharton. During 2004, PHT Wharton acquired various leases in the Colorado
Bend Prospect located in Wharton County, Texas.
In August 2004, PHT Wharton amended its limited partnership agreement to allow
the addition of another limited partner, who became the sole Class B limited
partner. The Company, together with other limited partners, became the Class A
limited partners.
At the discretion of the general partner, available cash will be distributed as
follows:
(i) If on the date of such distribution there are any Class B limited
partners, 20% of the cash available for distribution will be distributed
to the Class B limited partners and the general partner per the amended
limited partnership agreement.
(ii) The remainder of the cash available for distribution to limited partners
will be distributed among the Class A limited partners and the general
partner in the following order of priority:
(a) First, 99% to the Class A limited partners in proportion to and to
the extent of their unreturned capital balances and 1% to the
general partner until all unreturned capital balances have been
reduced to zero.
(b) Then, 75% to the limited partners in proportion to their percentage
interests and 25% to the general partner.
In general, profits will be allocated, after giving effect to certain regulatory
allocations and cumulative prior allocations, 60% to the Class A limited
partners, 20% to the Class B limited partners and 20% to the general partner.
Losses in general will be allocated, after giving effect to regulatory
allocations and certain proportionate allocations, to all partners with a
positive capital account in proportion to the extent of their balances and then
entirely to the general partner.
17
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 8 - EQUITY INTERESTS IN OIL AND GAS PROPERTIES - (Continued)
PHT Vela Partners, L.P.
In April 2004, the Company subscribed for $1,350,000 to PHT Vela Partners, L.P.
("PHT Vela") of which $1,200,000 was contributed as of September 30, 2004. PHT
Vela is a limited partnership formed in January 2004, of which the Company is a
limited partner with 35.64% interest and PHT Gas, LLC is the general partner.
Pursuant to the partnership agreement, the Company and the other limited
partners in PHT Vela may be called upon from time to time for additional
contributions so as to meet the reasonable capital requirements of PHT Vela.
During 2004, PHT Vela has acquired a 55% working interest in the Vela leases
located in Zapata County, Texas.
In August 2004, PHT Vela amended its limited partnership agreement to allow the
addition of another limited partner, who became the sole Class B limited
partner. The Company, together with other limited partners, became the Class A
limited partners. The Company's ownership interest in PHT Vela was reduced to
28.8%.
At the discretion of the general partner, available cash will be distributed as
follows:
(i) If on the date of such distribution there are any Class B limited
partners, 18.18% of the cash available for distribution will be
distributed to the Class B limited partners and the general partner per
the amended limited partnership agreement.
(ii) The remainder of the cash available for distribution to limited partners
will be distributed among the Class A limited partners and the general
partner in the following order of priority:
(a) First, 99% to the Class A limited partners in proportion to and to
the extent of their unreturned capital balances and 1% to the
general partner until all unreturned capital balances have been
reduced to zero.
(b) Then, 80% to the limited partners in proportion to their percentage
interests and 20% to the general partner.
In general, profits will be allocated, after giving effect to certain regulatory
allocations and cumulative prior allocations, 65.456% to the Class A limited
partners, 18.18% to the Class B limited partners and 16.364% to the general
partner. Losses in general will be allocated, after giving effect to regulatory
allocations and certain proportionate allocations, to all partners with a
positive capital account in proportion to the extent of their balances and then
entirely to the general partner.
PHT Good Friday Partners, L.P.
In June 2004, the Company subscribed for $900,000 to PHT Good Friday Partners,
L.P. ("PHT Good Friday") of which $700,000 was contributed as of September 30,
2004. PHT Good Friday is a limited partnership formed in June 2004, of which the
Company is a limited partner with 15.36% interest and PHT Gas, LLC is the
general partner. Pursuant to the partnership agreement, the Company and the
other limited partners in PHT Good Friday may be called upon from time to time
for additional contributions so as to meet the reasonable capital requirements
of PHT Good Friday.
In August 2004, PHT Good Friday amended its limited partnership agreement to
allow the addition of another limited partner, who became the sole Class B
limited partner. The Company, together with other limited partners, became the
Class A limited partners.
At the discretion of the general partner, available cash will be distributed as
follows:
(i) If on the date of such distribution there are any Class B limited partners,
33.33% of the cash available for distribution will be distributed to the
Class B limited partners and the general partner in the order of priority
per the amended limited partnership agreement.
18
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 8 - EQUITY INTERESTS IN OIL AND GAS PROPERTIES - (Continued)
(ii) The remainder of the cash available for distribution to limited partners
will be distributed among the Class A limited partners and the general
partners in the following order of priority:
(a) First, 99% to the Class A limited partners in proportion to and to
the extent of their unreturned capital balances and 1% to the
general partner until all unreturned capital balances have been
reduced to zero.
(b) Then, 75% to the limited partners in proportion to their percentage
interests and 25% to the general partner.
In general, profits will be allocated, after giving effect to certain regulatory
allocations and cumulative prior allocations, 50% to the Class A limited
partners, 33.33% to the Class B limited partners and 16.67% to the general
partner. Losses in general will be allocated, after giving effect to regulatory
allocations and certain proportionate allocations, to all partners with a
positive capital account in proportion to the extent of their balances and then
entirely to the general partner.
PHT Martinez Partners, L.P.
In June 2004, the Company subscribed for $900,000 to PHT Martinez Partners, L.P.
("PHT Martinez") of which $700,000 was contributed as of September 30, 2004. PHT
Martinez is a limited partnership formed in June 2004, of which the Company is a
limited partner with 19.8% interest and PHT Gas, LLC is the general partner.
Pursuant to the partnership agreement, the Company and the other limited
partners in PHT Martinez may be called upon from time to time for additional
contributions so as to meet the reasonable capital requirements of PHT Martinez.
In August 2004, PHT Martinez amended its limited partnership agreement to allow
the addition of another limited partner, who became the sole Class B limited
partner. The Company, together with other limited partners, became the Class A
limited partners.
At the discretion of the general partner, available cash will be distributed as
follows:
(i) If on the date of such distribution there are any Class B limited
partners, 33.33% of the cash available for distribution will be
distributed to the Class B limited partners and the general partner in the
order of priority per the amended limited partnership agreement;
(ii) The remainder of the cash available for distribution to limited partners
will be distributed among the Class A limited partners and the general
partner in the following order of priority:
(a) First, 99% to the Class A limited partners in proportion to and to
the extent of their unreturned capital balances and 1% to the
general partner until all unreturned capital balances have been
reduced to zero.
(b) Then, 75% to the limited partners in proportion to their percentage
interests and 25% to the general partner.
In general, profits will be allocated, after giving effect to certain regulatory
allocations and cumulative prior allocations, 50% to the Class A limited
partners, 33.33% to the Class B limited partners and 16.67% to the general
partner. Losses in general will be allocated, after giving effect to regulatory
allocations and certain proportionate allocations, to all partners with a
positive capital account in proportion to the extent of their balances and then
entirely to the general partner.
19
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 8 - EQUITY INTERESTS IN OIL AND GAS PROPERTIES - (Continued)
Maverick Basin Exploration, LLC
On June 23, 2004, the Company formed Maverick Basin Exploration, LLC as the
initial Class A member with a 74.25% membership interest and initial Class B
member with a 24.75% membership interest. PHT Gas, LLC was the initial Class C
member with a 1% membership interest. Pursuant to the operating agreement of
Maverick, the Company may be called upon from time to time for capital
contributions to meet the reasonable capital requirements of Maverick.
On July 14, 2004, the Company, prior to making any membership contributions to
Maverick, withdrew as the Class A member. Simultaneously, South Oil agreed to
become the Class A member of Maverick and assumed the capital contribution
requirements of the Class A member.
PHT La Paloma Partners, L.P.
On August 12, 2004, the Company acquired a limited partnership interest of
approximately 11% in PHT La Paloma Partners, L.P., a Delaware limited
partnership ("PHT La Paloma"), for consideration of $500,000. La Paloma owns a
leasehold interest in approximately 1,425 acres in Zapata County in South Texas,
and the underlying prospects are operated by Reichmann Petroleum.
Cash available for distribution will be distributed in the following order of
priority:
(a) First, to the limited partners in proportion to their respective
unreturned capital as of the date of distribution, until the limited
partners' unreturned capital has been reduced to zero.
(b) Second, and thereafter, 15% to the general partner and 85% to the
limited partners pro rata in proportion to each limited partner's
percentage interest.
In general, profits will be allocated after giving effect to certain regulatory
allocations and cumulative prior allocations, 85% to the limited partners and
15% to the general partner. Losses in general will be allocated, after giving
effect to regulatory allocations and certain proportionate allocations, to all
partners with a positive capital account in proportion to the extent of their
balances and then entirely to the general partner.
Summary
The following table summarizes the Company's interests in oil and gas non-public
limited partnerships accounted for under the equity method of accounting and the
excess of carrying value over net assets in those entities:
20
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 8 - EQUITY INTERESTS IN OIL AND GAS PROPERTIES - (Continued)
September 30, 2004
--------------------------------------
(Unaudited)
Excess of
Carrying Value
Carrying Value Over Net Assets
-------------- ---------------
PHT Vicksburg $ 388,125 $ 22,751
Awakino South 282,330 --
PHT Stent 358,722 206,312
LSP 3,373,809 1,309,126
PHT Wharton 546,733 329,102
PHT Vela 1,195,499 68,987
PHT Good Friday 698,340 59,467
PHT Martinez 697,444 --
PHT La Paloma 500,000 104,956
Maverick 58,585 --
LS Gas, LLC 1,000 1,000
2001 Hackberry Drilling Fund 14,741 --
---------- ----------
$8,115,328 $2,101,701
========== ==========
The Company expects the excess carrying value to decrease as the various
entities receive payment of subscription receivables due them. LSP's excess
carrying value is directly related to the recording of the $2,000,000 promissory
note payable during this quarter. (See Note 9) The Company believes that LSP's
oil and gas reserves are in place to adequately support the carrying value of
its investment in LSP at September 30, 2004.
The following table summarizes outstanding subscription receivables excluded
from the calculation of excess carrying value over net assets as of September
30, 2004.
Limited Partnership's
Total
Subscription Company's
Receivables Portion
---------- ----------
PHT Vicksburg $ 4,500 $ --
Awakino South 52,000 --
PHT Stent 329,500 --
LSP 387,700 --
PHT Wharton 127,900 --
PHT Vela 350,000 150,000
PHT Good Friday 1,632,000 200,000
PHT Martinez 950,000 200,000
PHT La Paloma 900,000 --
Maverick 3,082,100 --
---------- ----------
$7,815,700 $ 550,000
========== ==========
21
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 8 - EQUITY INTERESTS IN OIL AND GAS PROPERTIES - (Continued)
The following table summarizes financial information for the limited
partnerships accounted for under the equity method of accounting at September
30, 2004 and has been compiled from the financial statements of the respective
entities:
September 30, 2004
------------------
(Unaudited)
Total Assets $ 34,873,264
============
Total Liabilities $ 3,419,180
============
Nine Months Ended
September 30, 2004
-------------------
(Unaudited)
Results of Operations:
Revenue $ 482,014
Loss from operations $ (4,700,409)
Net Loss $ (4,700,409)
NOTE 9 - NOTES PAYABLE
In February 2004, Knox Gas issued a $4,500,000 promissory note to Endeavour as
part of the consideration for its purchase of Knox Miss, LP (See Note 5). The
note bears interest at 4% per annum. The Company was required to fund Knox Gas'
obligations under the promissory note to Endeavor as follows: $500,000 plus
accrued interest on or before March 27, 2004; $1,000,000 plus accrued interest
on or before April 27, 2004; $1,000,000 plus accrued interest on or before June
27, 2004; and $2,000,000 plus accrued interest on or before August 27, 2004. The
note is secured by Knox Gas' 99% limited partnership interest in Knox Miss LP
and 1% membership interest in Knox Miss LLC. As of September 30, 2004, Knox Gas
has paid off the entire principal balance of the note. However, accrued interest
of $63,864 on the note remained outstanding.
In April 2004, Touchstone Louisiana purchased a 24.9975% Class A limited
partnership interest in LSP from Endeavour, in consideration for which
Touchstone Louisiana, among other things, issued a promissory note payable to
Endeavour in the amount of $2,000,000. The $2,000,000 promissory note was
contingent on LSP completing its first well. The first well was completed as of
September 30, 2004, yet the well has been shut-in awaiting facilities for
production. The Company interpreted this event to be the triggering factor in
recording the note payable during the third quarter of 2004. The note bears
interest at 3% per annum and monthly installments are due as follows:
(i) Regular monthly installments are calculated monthly. The amount is
to be 24.9975% of the monthly cash flow for the immediately
preceding calendar month. Monthly cash flow is defined as any
positive dollar amount received by LSP during a calendar month from
any producing wells in which LSP has interests ("LSP Wells"), net of
royalties paid and lease operating expenses. If LSP sells,
transfers, assigns or farms out any of its right, title and interest
in the leases, monthly cash flow will include the net proceeds LSP
received from such transaction.
(ii) The note is also subject to two conditional accelerated payments
which are explained as follows:
a. First, in addition to the monthly payments described above, if
the initial production rate for any LSP wells meets or exceeds
an average of 5 million cubic feet per day of natural gas
during the first five 24-hour days of production, Touchstone
Louisiana must make a supplemental payment equal to the lesser
of the remaining unpaid principal or $800,000 plus accrued
interest.
22
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 9 - NOTES PAYABLE (Continued)
b. Second, in addition to the monthly payments and accelerated
payment described above, if the initial production rate for
any LSP wells meets or exceeds an average of 5 million cubic
feet per day of natural gas, and the six-month production
rate, which is defined as the average daily rate of production
from the LSP wells during the fifth months following the
calendar month when the date of first production occurs, meets
or exceeds an average of 3 million cubic feet per day of
natural gas, Touchstone Louisiana must make a supplemental
payment equal to the lesser of the remaining unpaid principal
or $1,200,000 plus accrued interest.
As of September 30, 2004, PF Louisiana and PHT West Pleito had outstanding note
payable balances of $150,000 and $87,500, which were due on demand bearing
interest of 3%, respectively. The Company had additional notes payable of
$133,857.
NOTE 10 - NOTES PAYABLE - RELATED PARTIES
As of September 30, 2004, Touchstone Texas owed LSP and 2001 Hackberry Drilling
Fund $82,048 and $59,493, respectively.
As of September 30, 2004, the Company owed SPH Investments Profit Sharing, Inc.,
a company controlled by Stephen P. Harrington, who is an officer and director of
the Company, $75,000 for a demand loan.
NOTE 11 - CONVERTIBLE DEBENTURES
In March 2003, the Company issued to Laguna Capital Group LLC, a California
limited liability company, a $100,000, 8% convertible debenture due March 27,
2004. The convertible debenture were convertible at any time into shares of the
Company's $.001 par value common stock. The conversion or purchase price of the
common stock was the market price of the Company's common stock at the time of
conversion. The convertible debenture was repaid on March 11, 2004. The interest
was forgiven by the debt holder and the Company recorded the forgiveness of debt
as income.
On March 23, 2004 the Company entered into a loan agreement to borrow $2,100,000
from Trident Growth Fund, LP ("Trident"), a Delaware limited partnership
pursuant to a 12% secured convertible promissory note (the "Trident Note"). The
Trident Note is secured by substantially all of the assets of the Company. The
Trident Note matures on March 23, 2005, however the Company has the option to
redeem the note at 100% of par at any time prior to the maturity date. Trident
has the option to convert at any time all or a portion of the principal amount
of the Trident Note into common stock of the Company. Trident was issued a
warrant to purchase 250,000 shares of the Company's common stock as an
additional incentive to make the loan. The warrants provide for a cashless
exercise at the option of Trident provided that the per share market price of
one share of common stock is greater than the warrant exercise price. The
warrants expire on March 31, 2014. The initial conversion price of the Trident
Note, and initial exercise price of the warrant is $1.00 per share of common
stock, subject to anti-dilution provisions. The notes contain certain reset
provisions which, if triggered, would require the Company to record a beneficial
conversion expense for the difference between the market price and new adjusted
price. The Company paid loan commitment and origination fees of 1% and 4%,
respectively, which were recorded as loan costs and will be amortized over the
life of the loan. Interest is due monthly and payable in cash unless Trident
elects to have the interest paid in common stock of the Company. Repayment of
the principal amount of the note has been guaranteed by subsidiaries of the
Company. As defined in the loan agreement, the Company is required to comply
with various financial covenants. Any failure to comply with such covenants may
be deemed a default on the loan by Trident. Trident waived compliance with
certain negative covenants contained in the Trident Note to permit the Company
to issue convertible notes in the Company's private placement of up to $12
million of convertible notes and warrants, and waived compliance with all
financial covenants contained in the Trident Note until the maturity date of the
convertible notes issued in the private placement.
23
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 11 - CONVERTIBLE DEBENTURES (Continued)
The Company has allocated the proceeds from issuance of the Trident Note and
warrants based on a fair value basis for each item. Consequently, the
convertible Trident promissory note was recorded with discounts of $1,175 based
on the ascribed value of the warrants as determined by using the Black-Scholes
Method. The discount was fully amortized and recorded as interest expense as of
September 30, 2004.
Under the terms of the loan agreement, if the Company files a registration
statement relating to any of its securities, it is required to notify Trident in
writing and, upon Trident's request, will include in the registration statement
the offer and sale of the shares of the common stock issuable upon Trident's
conversion of the note.
In September 2004, the Company paid $50,000 of principal outstanding on the
note.
In April and July 2004, the Company commenced a private placement of convertible
promissory notes bearing interest at 1.58% per annum together with warrants to
purchase shares of common stock in the Company at an exercise price of $2.00 per
share. The notes are payable in April and July 2005 and subordinated to the
Trident Note. The notes are mandatorily convertible into shares of the Company's
common stock upon the earlier of: (i) the Company's filing of an amendment to
the Company's Certificate of Incorporation increasing the number of shares of
common stock the Company is authorized to issue such that a sufficient number of
shares is authorized so that all convertible notes issued in the private
placement can be converted into shares of common stock, or (ii) the first
business day after the effective date of a reverse stock split of the
outstanding shares of common stock such that a sufficient number of shares is
authorized so that all convertible notes issued in the private placement can be
converted into shares of common stock. The initial conversion price of the note
is $1.00 per share of common stock subject to certain adjustments. As of
September 30, 2004 the Company issued $6,890,000 in principal of notes which
were converted into 6,899,053 shares of the Company's common stock as a result
of the Company's filing of an amendment to its Certificate of Incorporation
increasing its authorized shares of common stock. The Company also issued
3,445,000 warrants to purchase shares of common stock in the Company. The
Company has allocated the proceeds from issuance of the convertible notes and
warrants based on a fair value basis for each item.
Consequently, the convertible promissory notes were recorded with discounts of
$3,211,400 based on the ascribed value of the warrants as determined by using
the Black-Scholes Method. Beneficial conversion discounts of $3,678,600 were
recorded since the promissory notes were convertible into common shares of stock
at a rate of $1.00 per share while the prevailing common stock share price was
$1.59 and $1.51 when the notes were made. As of September 30, 2004, the
discounts related to the ascribed value of the warrants and beneficial
conversion feature were fully amortized as the notes were converted into common
stock of the Company. The Company paid offering costs of $358,250 and issued
warrant to purchase 61,250 shares of common stock to a placement agent in
connection with the financing.
On May 27, 2004 the Company entered into a loan agreement to borrow $1,000,000
from Westwood AR, Inc. ("Westwood"), pursuant to a 10% convertible promissory
note (the "Westwood Note"). The Westwood Note matures on August 31, 2005. The
initial conversion price of the Westwood Note is $1.00 per share of common
stock, subject to anti-dilution provisions. Westwood AR has the option to
convert at any time all or a portion of the principal amount of the Westwood
Note into any of the following at the initial conversion price of $1.00:
a) 1,000,000 shares of the Company's common stock;
b) 5 membership interests in Knox Gas;
c) 800,000 shares of the Company's common stock and 1 membership
interest in Knox Gas;
d) 600,000 shares of the Company's common stock and 2 membership
interests in Knox Gas;
e) 400,000 shares of the Company's common stock and 3 membership
interests in Knox Gas; or
f) 200,000 shares of the Company's common stock and 4 membership
interests in Knox Gas.
24
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 11 - CONVERTIBLE DEBENTURES (Continued)
A beneficial conversion discount of $540,000 was recorded since the Westwood
Note was convertible into common shares of stock at a rate of $1.00 per share
while the prevailing common stock share price was $1.54 when the note was made.
This discount is being amortized over the term of the loan. As of September 30,
2004, the Company amortized $115,136 of the discount.
Interest is due on the earlier of the maturity date or the note conversion date
and payable in cash unless Westwood elects to have the interest paid in common
stock of the Company.
If the Company completes an equity offering after January 1, 2005, Westwood AR
has the option to require the Company to repay Westwood AR up to 30% of the net
proceeds the Company received from the equity offering on the Westwood Note.
NOTE 12 - STOCKHOLDERS' EQUITY
Preferred Stock
The Company has not issued any of its authorized shares of preferred stock.
Common Stock
On March 15, 2004, the Company entered into stock purchase agreements with Scott
Yancey and George Sines, the Company's founding stockholders, pursuant to which
the Company purchased 116,775,000 shares of common stock for $2,000. The Company
subsequently cancelled those shares. The founding stockholders concurrently
entered into secondary stock purchase agreements with Stephen P. Harrington,
pursuant to which they sold their remaining 16,350,000 shares of common stock of
the Company. The founding stockholders subsequently resigned from their
positions as officers and directors of the Company. As a result of Stephen P.
Harrington's acquisition of 32.7% of the then issued and outstanding shares of
common stock of the Company and his appointment as the successor officer and
director of the Company, a change of control may be deemed to have occurred.
On March 19, 2004, the Company effected a twenty-five for one common stock
split. All shares and per share amounts in the financial statements and the
notes thereto have been restated to reflect the stock split.
On March 23, 2004, Stephen P. Harrington surrendered for cancellation 7,380,000
of his shares of the Company's common stock in order to facilitate the
transaction described below.
On March 23, 2004, the following transactions were consummated:
(a) Pursuant to a stock purchase agreement by and between the Company
and Touchstone Canada, the Company purchased 100% of the issued and
outstanding shares of capital stock, no par value per share, of
Touchstone Texas, a development stage corporation and wholly-owned
subsidiary of Touchstone Canada. As consideration for the
acquisition, the Company issued 7,000,000 shares of its common stock
to Touchstone Canada valued at $70,000 by an independent valuation
consultant. Upon the consummation of the acquisition, the Company
paid an advisory fee to HMA Advisors, Inc. consisting of 280,000
shares of its common stock, which was valued at $2,800.
(b) Pursuant to an interest purchase agreement by and among the Company,
Touchstone Louisiana and Touchstone Canada, Touchstone Louisiana
purchased a 10% membership interest in LS Gas, LLC from Touchstone
Canada, in consideration for which the Company issued 100,000 shares
of its common stock to Touchstone Canada valued at $1,000.
25
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 12 - STOCKHOLDERS' EQUITY (Continued)
During March 2004, Stephen P. Harrington contributed $15,000 as additional
paid-in capital to fund the operating expenses of the Company.
In June 2004, the Company amended its Certificate of Incorporation to increase
its authorized shares of common stock to 150,000,000.
In April through July 2004, as an incentive for the lenders to loan a total of
$6,890,000 to the Company, the Company issued to the lenders warrants to
purchase a total of 3,445,000 shares of the Company's common stock at an
exercise price of $2.00 exercisable immediately. The warrants expire in three
years. (See Note 11)
In June and July 2004, the Company issued 6,899,053 shares of common stock upon
the conversion of the promissory notes in the principal amount of $6,890,000
plus accrued interest due thereon.
On July 15, 2004, the Company issued warrants to a placement agent to purchase
61,250 shares of common stock in compensation for services the placement agent
provided in connection with the private placement offering. (See Note 11) The
warrants have an exercise price of $2.00, exercisable immediately and expire in
three years.
On July 19, 2004, the Company obtained $3,000,000 from AltaFin, B.V., a
Netherlands Antilles Company, in consideration for which units were issued that
were comprised of 3,000,000 shares of common stock and warrants to acquire
1,500,000 shares of common stock. Each warrant is immediately exercisable into
one share of common stock at an exercise price of $1.00 per share and terminates
three years from the date of grant. In connection with the financing, the
Company incurred offering costs of $150,000 plus it issued 285,000 shares of
common stock to a placement agent.
On September 7, 2004, the Company issued 20,000 shares of common stock to
Sanders Morris Harris, Inc. ("SMH") as compensation for the financial advisory
service SMH will provide for twelve months. The 20,000 shares were valued at
$24,800 and recorded as deferred compensation. As of September 30, 2004, $4,100
has been charged to expense.
NOTE 13 - LOSS PER SHARE
Loss per common share is calculated in accordance with SFAS No. 128, "Earnings
Per Share." Basic loss per common share is computed by dividing net loss
attributable to common stockholders by the weighted average number of common
shares outstanding. Diluted loss per share is computed similarly to basic loss
per share except that the denominator is increased to reflect the number of
additional shares of common stock issuable upon the exercise of convertible
securities issued by the Company if the additional shares are dilutive to
earnings. Since the issuance of these additional shares of common stock would
have been anti-dilutive (i.e. reduce the loss per share), they were not included
in the denominator. As of September 30, 2004, the Company excluded 8,356,250
potentially dilutive shares.
The number of shares of common stock and the loss per share reflected in the
financial statements and notes thereto for the periods ended September 30, 2004
and 2003 have been updated to reflect the 25 for 1 stock split effected in March
2004 (see Note 12).
26
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 14 - SETTLEMENT OF LAWSUIT WITH CLAYTON WILLIAMS
On or about May 3, 2003, Knox Miss LP filed a complaint in the District Court Of
Harris County, Texas, 234th Judicial District against Clayton Williams as a
result of Clayton Williams' breach of the Exploration and Development Agreement
(See Note 7). Under the Agreement, Knox Miss LP had the right to participate in
a 50% share of certain leases acquired by Clayton Williams during the term of
the Agreement. Knox Miss LP elected to participate in the acquisition of certain
additional leases and paid in excess of $1.7 million to Clayton Williams between
July and February 2003 in payment of its share of the acquisition costs. In
April 2003, Clayton Williams notified Knox Miss LP that it would not permit Knox
Miss LP to participate, alleging that the foregoing payments were not received
within the time frame set forth in the Agreement. Knox Miss LP sought a
declaratory judgment establishing its right under the Agreement to participate
in the acquisition of the leases at issue. Clayton Williams denied all
allegations.
On October 31, 2003, Clayton Williams filed a counterclaim against Knox Miss LP
and a third party petition against PHT Gas, LLC alleging that Knox Miss LP
breached the Agreement by assigning an overriding royalty interest to PHT Gas,
LLC in the area of mutual interest ("AMI") subject to the Agreement to PHT Gas,
LLC. Clayton Williams sought a declaratory judgment establishing its rights
under the Agreement and an order of specific performance compelling Knox Miss LP
to convey the royalty interest to Clayton Williams together with attorney's
fees.
On May 26, 2004, Knox Miss LP and Clayton Williams entered into a Settlement
Agreement and Mutual Release ("Settlement"), pursuant to which:
A. Clayton Williams paid $75,000 to Knox Miss LP;
B. Knox Miss LP assigned all of its leasehold interests it acquired
from May 23, 2002 through April 30, 2004 in the AMI to Clayton
Williams except for the School Board Lease on the Mathiston
prospect, in which Knox Miss LP retained its 50% interest (see Note
7);
C. Knox Miss LP assigned all of its leasehold interests it acquired
pursuant to an exploration agreement with SKH Exploration (see Note
7) in the Savannah Lake prospect to Clayton Williams;
D. Knox Miss LP assigned half of the leasehold interests it acquired
for $90,249 in the Noxubee County, Mississippi to Clayton Williams;
E. Knox Miss LP received a release of certain deed of trust between
Knox Miss LP as the grantor and Trident Growth Fund as the
beneficiary as to the interests assigned by Knox Miss LP to Clayton
Williams;
F. Knox Miss LP was deemed to have paid all amounts owed to Clayton
Williams as of April 30, 2004 and received a credit from Clayton
Williams in the amount of $1,000,000. The credit was applied to Knox
Miss LP's share of the drilling costs of the Gammill well, which is
estimated to be $1,649,999, as well as the final monthly payment of
Knox Miss LP's AMI management fee owed to Clayton Williams in the
amount of $20,833 (See Note 7). As of September 30, 2004, the
prepaid advance to the operator was $1,642,895.
G. Knox Miss LP withdrew its leasehold interests and participation
rights on the Natchez Trace prospect. As a result, the advance
payment Knox Miss LP made to Clayton Williams in the amount of
$549,600 in April 2004 was also applied as a credit towards Knox
Miss LP's share of the drilling of the Gammill well; and
H. Knox Miss LP paid the remaining balance of $257,875 for its share of
the drilling costs of the Gammill well to Clayton Williams.
27
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 15 - CONCENTRATIONS
A majority of the Company's equity investments in oil and gas entities have a
common general partner/managing member of PHT Gas, LLC.
NOTE 16 - COMMITMENTS AND CONTINGENCIES
General
Federal, state and local authorities regulate the oil and gas industry. In
particular, gas and oil production operations and economics are affected by
environmental protection statutes, tax statutes and other laws and regulations
relating to the petroleum industry, as well as changes in such laws, changing
administrative regulations and the interpretations and application of such laws,
rules and regulations. The Company believes it is in compliance with all
federal, state and local laws, regulations, and orders applicable to the Company
and its properties and operations, the violation of which would have a material
adverse effect on the Company or its financial condition.
Operating Hazards and Insurance
The gas and oil business involves a variety of operating risks, including the
risk of fire, explosions, blow-outs, pipe failure, abnormally pressured
formation, and environmental hazards such as oil spills, gas leaks, ruptures or
discharges of toxic gases, the occurrence of any of which could result in
substantial losses to the Company due to injury or loss of life, severe damage
to or destruction of property, natural resources and equipment, pollution or
other environmental damage, cleanup responsibilities, regulatory investigation
and penalties and suspension of operations.
In those projects for which the Company is an operator, the Company maintains
certain insurance of various types to cover its operations with policy limits
and retention liability customary in the industry. In those projects in which
the Company is not the operator, but in which it owns a non-operating interest
directly or owns an equity interest in a limited partnership or limited
liability company that owns a non-operating interest, the operator for the
prospect maintains insurance to cover its operations.
There can be no assurance that insurance, if any, will be adequate to cover any
losses or exposure to liability. Although the Company believes that the policies
obtained by operators provide coverage in scope and in amounts customary in the
industry, they do not provide complete coverage against all operating risks. An
uninsured or partially insured claim, if successful and of significant
magnitude, could have a material adverse effect on the Company and its financial
condition via its contractual liability to the prospect.
Potential Loss of Oil and Gas Interests/ Cash Calls
The Company is subject to cash calls related to its various investments in oil
and gas prospects. If the Company does not pay its share of future Authorization
For Expenditures ("AFE") invoices, it may have to forfeit all of its rights in
certain of its interests in the applicable prospects and any related profits. If
one or more of the other members of the prospects fail to pay their share of the
prospect costs, the Company may need to pay additional funds to protect its
investments.
28
TOUCHSTONE RESOURCES USA, INC.
(A DEVELOPMENT STAGE ENTITY)
Notes to Condensed Consolidated Financial Statements
NOTE 17 - SUBSEQUENT EVENTS - NOT DISCLOSED ELSEWHERE
In October 2004, Knox Gas invested an additional $37,000 in Knox Miss.
In October 2004, Touchstone Vicksburg invested an additional $48,055 in PHT
Vicksburg.
During October 2004, the Company subscribed for $500,000 to PHT Resendez, L.P.
("PHT Resendez") for a 9.9% Class A limited partnership interest. PHT Resendez
owns leases covering 1,248.2 acres of land in Zapata County, Texas.
29
CAUTIONARY STATEMENT FOR FORWARD-LOOKING STATEMENTS
This report includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. All statements other than
statements of historical facts included or incorporated by reference in this
report, including, without limitation, statements regarding the Company's future
financial position, business strategy, budgets, projected revenues, projected
costs and plans and objective of management for future operations, are
forward-looking statements. In addition, forward-looking statements generally
can be identified by the use of forward-looking terminology such as "may,"
"will," "expect," "intend," "project," "estimate," "anticipate," or "believe" or
the negative thereof or any variation thereon or similar terminology. Although
we believe that the expectations reflected in such forward-looking statements
are reasonable, we can give no assurance that such expectations will prove to
have been correct.
Important factors that could cause actual results to differ materially
from our expectations include, but are not limited to, our assumptions about
energy markets, production levels, reserve levels, operating results,
competitive conditions, technology, the availability of capital resources,
capital expenditure obligations, the supply and demand for oil, natural gas, and
other products or services, the price of oil, natural gas, and other products or
services, currency exchange rates, the weather, inflation, the availability of
goods and services, successful exploration and drilling, drilling risks, future
processing volumes and pipeline throughput, general economic conditions, either
nationally or internationally or in the jurisdictions in which we or any of our
subsidiaries are doing business, legislative or regulatory changes, including
changes in environmental regulation, environmental risks and liability under
federal, state and foreign environmental laws and regulations, the securities or
capital markets and other factors disclosed under "Risk Factors" in our annual
report on Form 10-KSB and other filings with the Securities and Exchange
Commission. All subsequent written and oral forward-looking statements
attributable to the Company, or persons acting on our behalf, are expressly
qualified in their entirety by these cautionary statements. Except as required
by law, we assume no duty to update or revise our forward-looking statements
based on changes in internal estimates or expectations
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS.
Touchstone Resources USA, Inc. (f/k/a The Coffee Exchange, Inc.) is a
Delaware corporation formed on March 5, 2001. Our offices are located at 111
Presidential Boulevard, Suite 165, Bala Cynwyd, Pennsylvania 19004. Unless the
context otherwise requires, references to the "Company," "Touchstone," "we,"
"us" or "our," mean Touchstone Resources USA, Inc., our consolidated
subsidiaries and/or partnerships or companies in which we have an interest. The
following discussion should be read in conjunction with our condensed
consolidated financial statements and related notes thereto included elsewhere
in this report.
We were formerly engaged in the business of developing internet cafes in
Orange County, California. On March 15, 2004, all of our officers and directors
resigned and Stephen P. Harrington was appointed as our Chief Executive Officer,
Treasurer, Secretary and sole Director. Immediately following the change in
management, we entered into the oil and gas exploration business, changed our
name from The Coffee Exchange, Inc. to Touchstone Resources USA, Inc. and
effected a 25-for-1 stock split of our shares of common stock.
30
OVERVIEW
We are an independent energy company engaged primarily in oil and gas
exploration, development and production and the acquisition of producing
properties. We target high-potential oil and gas assets located primarily in
Texas, Louisiana, Mississippi and other traditional oil producing states in the
southern United States, as well as in New Zealand.
Our operations are focused on the identification and evaluation of
prospective oil and gas properties, and the contribution of capital to projects
that we believe have the potential to produce oil or gas in commercial
quantities. We participate in projects directly and indirectly as equity
participants in limited partnerships and limited liability companies. We also
act as the operator of certain of the properties in which we acquire interests,
drilling the wells thereon and producing any oil and gas located therein. We
assist and advise companies and partnerships in identifying and leasing
properties on favorable terms. We also provide such entities with additional
reserve assessment analysis and engineering services in connection with the
exploration and development of prospects.
Our primary objectives are to build reserves, production, cash flow and
earnings per share by acquiring oil and gas properties, exploring for new oil
and gas reserves, and optimizing production and value from existing oil and gas
properties. We seek to achieve these objectives by acquiring and developing high
profit margin properties, disposing of producing, marginal and non-strategic
properties, balancing reserves between oil and gas, and maintaining a high
degree of financial flexibility.
We seek to create shareholder value by building oil and gas reserves,
production revenues and operating cash flow. We believe that building oil and
gas reserves and production, on a cost-effective basis, are the most important
indicators of performance success for an independent oil and gas company. We
seek to build oil and gas reserves, production and cash flow through a balanced
program of capital expenditures involving acquisition, exploitation and
exploration activities. We intend to place primary emphasis on issuances of
public and private debt and equity to finance our business.
Our ability to generate future revenues and operating cash flow will be
dependent on the successful development of our inventory of capital projects,
the volume and timing of our production, as well as commodity prices for oil and
gas. Such pricing factors are largely beyond our control, and may result in
fluctuations in our earnings.
We are in the development stage, have significant debt obligations to
repay, have current liabilities that exceed our current assets and have incurred
losses since inception. We will need to expend a significant amount of funds
during the next twelve months to meet capital calls and pay drilling and
production costs on our various interests in oil and gas prospects and to
acquire additional properties. Due to these and other factors, our independent
auditors have included an explanatory paragraph in their opinion for the year
ended December 31, 2003 as to the substantial doubt about our ability to
continue as a going concern. Our long-term viability and growth will ultimately
depend upon the success of the projects in which we acquire interests, as to
which we can provide no assurances.
31
BUSINESS STRATEGY
Our business strategy is to provide long-term growth in net asset value
through the acquisition of oil and gas reserves and production. We plan on
building reserve value through the careful evaluation and aggressive pursuit of
oil and gas drilling and acquisition opportunities.
Some of the key elements of our business strategy are as follows:
o Exploit and Develop Existing Property Base. We seek to maximize the value
of the properties we acquire by developing and exploiting properties with
the highest production and reserve growth potential. We intend to perform
continuous field studies of such properties using advanced technologies,
and seek to minimize costs by controlling operations to the extent
possible.
o Selectively Grow Through Exploration. We are in the process of
implementing an active exploration program that is designed to complement
our exploitation and development efforts with exploration projects
offering superior reserve potential. We utilize 2-D and 3-D seismic data
and other technical applications, as appropriate, to manage our
exploration risks.
o Pursue Strategic Acquisitions. We continue to develop a network of
contacts in the oil and gas exploration business who provide access to
strategic investment and acquisition opportunities. We seek to leverage
these industry contacts and our extensive regional knowledge base by
acquiring leasehold acreage and producing or non-producing properties in
areas such as Louisiana, Mississippi and Texas that are in mature fields
with complex geology that have multiple reservoirs and existing
infrastructure.
o Joint Venture Formation. We may seek to form joint ventures and seek joint
venture partners in order to reduce our investment in a particular project
and share the costs of operating the prospect.
o Rationalize Property Portfolio. We intend to rationalize the portfolio of
properties we acquire by selling marginal properties in an effort to
redeploy capital to exploitation, development and exploration projects
that offer a potentially higher overall return.
During 2004, we began to execute our business strategy by acquiring
interests in approximately fifteen oil and gas projects in Texas, Mississippi,
Australia and Louisiana. Of these projects, several wells in our Vicksburg
Project located in Starr and Hidalgo Counties in South Texas are currently in
production, one well in our Louisiana Shelf Project located offshore in Southern
Louisiana has been drilled and is now shut in awaiting hook-up to production
facilities, and our remaining projects are in various stages of exploration,
development or testing. We have abandoned our West Plieto project in Kern
County, California.
32
We expect to continue to acquire additional projects and sell all or part
of our interest in existing projects to further diversify our holdings, spread
risk and reduce our obligations to make additional capital contributions. As our
business continues to grow, we expect to retain additional executive management
with substantial experience in the oil and gas exploration and development
business.
RESULTS OF OPERATIONS
COMPARISON OF THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003
Revenues
We generated $60,316 and $144,253 of revenue during the three and nine
months ended September 30, 2004, respectively. We had no revenue during the
corresponding periods in 2003. The revenue consisted of fees generated from the
operation of various oil and gas wells for which our wholly owned subsidiary
serves as the operator. We expect revenues to increase in the future as we
continue to serve as the operator for existing and new wells. We also expect to
generate oil and gas sales from our consolidated subsidiaries in future periods.
Exploration Expenses
Exploration expenses were $0 and $112,748 during the three and nine months
ended September 30, 2004, respectively. We had no exploration expenses during
the corresponding periods in 2003. The exploration expenses resulted primarily
from exploration activities conducted on our Mississippi prospects. We expect
exploration expenses to continue to increase during the remainder of 2004 as we
continue to acquire interests in various properties.
Impairment of Oil and Gas Properties
We incurred $20,221 and $1,333,466 in impairment of oil and gas properties
expenses during the three and nine months ended September 30, 2004,
respectively. We did not have any impaired property expenses during the
corresponding periods in 2003. The expense related primarily to an impairment of
the carrying value of the unproved properties acquisition costs and the drilling
costs incurred in PHT West Pleito Gas, LLC ("PHT West Pleito") that we acquired
as a result of our withdrawal as the operator of the ORCA fee 32x-23 well and
surrender of our working interest in the West Pleito project and associated
leasehold.
General and Administrative
General and administrative expenses were $835,838 and $1,804,336 during
the three and nine months ended September 30, 2004, respectively, as compared to
$5,860 and $11,109 during the corresponding periods in 2003. The increase in
general and administrative expenses was primarily due to the substantial
increase in operations we experienced when we entered into the oil and gas
exploration business, completed a number of acquisitions and acquired equity
interests in a number of oil and gas limited partnerships and limited liability
companies.
The expenses during the three and nine months ended September 30, 2004
consisted of $297,358 and $654,128, respectively, of professional fees incurred
in connection with our recent acquisitions, financing transactions and
compliance with our reporting obligations under the federal securities laws,
$57,767 and $169,276, respectively, in consulting and engineering fees, and
$482,382 and $982,601, respectively, of other general and administrative
expenses consisting primarily of expenses for compensation, rent, travel and
utilities. We expect general and administrative expenses to remain at current
levels during the remainder of 2004.
33
Total Other (Income)Expenses
Other expenses totaled $892,099 and $7,961,766 during the three and nine
months ended September 30, 2004, respectively. We had no other expenses during
the corresponding periods in 2003. The other expenses consisted of $288,510 and
$7,252,307 of interest expense during the three and nine month periods ended
September 30, 2004, respectively, related to interest incurred on outstanding
convertible notes of which approximately $7,000,000 were non cash charges
associated with the beneficial conversion feature of the notes and the ascribed
value of the warrants issued together with the notes. The balance consisted
primarily of equity losses from our investment in limited partnerships and
limited liability companies of $604,276 and $717,760 during the three and nine
month periods ended September 30, 2004.
Other (income) expense includes any income or losses recognized from the
financial performance of the oil and gas projects in which we have an equity
interest. As the majority of our interests in oil and gas projects consist of
equity investments in such projects, we expect other (income) expense to be a
material component of our overall financial performance.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities during the nine months ended
September 30, 2004 was $595,811 and consisted primarily of payments for
professional fees and compensation expenses, partially offset by operating
revenue and collections from accounts receivable.
Net cash used in investing activities during the nine months ended
September 30, 2004 was $9,555,265 and consisted primarily of: $7,319,654 of
investments in limited partnership interests accounted for under the equity and
cost method of accounting, $2,548,420 for the purchase of oil and gas interests
and drilling costs for projects which are consolidated on our financial
statements, and $214,549 of loans. The forgoing amounts were partially offset by
$510,273 of cash acquired in connection with our acquisition of Touchstone
Resources USA, Inc., a Texas corporation and our wholly-owned subsidiary.
Net cash provided by financing activities for the nine months ended
September 30, 2004 was $11,460,218 and consisted primarily of $1,071,568 of
proceeds from notes, $3,425,500 from minority contributions which consisted
primarily of capital contributions from members of Knox Gas, LLC, $9,990,000 of
proceeds from the issuance of convertible debt ($6,890,000 of which has been
converted into common stock), and $2,559,250 of proceeds from the issuance of
common stock, net of offering costs. The forgoing amounts were offset by
repayment of promissory notes in the amount of $5,329,600, repayment of
convertible debt in the amount of $150,000 and loan costs of $121,500.
At September 30, 2004 we had a working capital deficit of $3,371,209,
compared to a deficit of $38,928 at December 31, 2003. The $3,332,281 decrease
in working capital was due primarily to increases in convertible debentures
payable of $2,525,136, in limited partnership subscriptions payable of $550,000,
in accounts payable and accrued expenses of $3,960,409 and in notes payable of
$1,198,628. These amounts were offset by increases in cash and cash equivalents
of $1,309,142, in accounts receivable of $2,092,625, and in prepaid expenses of
$1,721,105.
34
We are a development stage company with no significant operating history.
Our principal requirements for cash are for working capital needs for existing
operations, costs of development of oil and gas properties, and the acquisition
of oil and gas properties. We do not currently maintain a line of credit with
any commercial bank or other financial institution. We expect to raise all
necessary capital through public and private placements of debt or equity
securities, property divestitures and joint ventures with industry participants.
On or about March 23, 2004, we obtained gross proceeds of $2,100,000
through the issuance of a $2,100,000 principal amount secured convertible
promissory note (the "Trident Note") and warrants to Trident Growth Fund, LP
("Trident"). The Trident Note is due March 23, 2005, accrues interest at 12% per
annum payable monthly in arrears, is secured by substantially all of our assets,
is convertible at the option of Trident into shares of our common stock at an
initial conversion price of $1.00 per share (subject to adjustment pursuant to
anti dilution and reset provisions), and is redeemable at our option at 100% of
par prior to maturity. Interest is payable in cash unless Trident elects to have
it paid in shares of common stock. The Trident Note contains various financial
covenants with which we are required to comply and various negative covenants
which prohibit us from taking certain action without obtaining the prior written
consent of Trident. These include incurring additional liens on our property,
incurring indebtedness in excess of $100,000, selling any of our assets other
than in the ordinary course of business, and making capital expenditures in
excess of $50,000. Trident subsequently waived compliance with certain negative
covenants to permit us to engage in a private offering of convertible notes and
warrants (described below), and waived compliance with all financial covenants
contained in the Trident Note until the maturity date of the convertible notes
issued in the private placement. The current outstanding balance of the Trident
Note is $2,050,000.
In connection with the issuance of the Trident Note, we issued warrants to
Trident to purchase 250,000 shares of common stock. The warrants are immediately
exercisable at an exercise price of $1.00 per share (subject to adjustment
pursuant to anti dilution provisions of the warrant) and terminate 10 years from
the date of grant.
In July 2004, we completed a private offering of convertible notes and
warrants through which we received aggregate gross cash proceeds of
approximately $6,890,000. The notes contained a mandatory conversion feature
that provided that all of the notes would convert automatically into shares of
our common stock at a conversion price of $1.00 per share upon the effective
date of an amendment to our certificate of incorporation to increase the number
of shares we are authorized to issue sufficient to enable all of the notes to be
converted or exercised, as applicable, into shares of our common stock. On June
4, 2004, an amendment to our certificate of incorporation became effective that
increased the number of shares of common stock we are authorized to issue from
50 million to 150 million, and all of the notes were automatically converted
into shares of our common stock. The warrants became exercisable immediately
upon the effective date of the amendment to our certificate of incorporation at
an exercise price of $2.00 per share and terminate three (3) years from the date
of grant.
On May 27, 2004, we obtained gross proceeds of $1,000,000 through the
issuance of a $1,000,000 principal amount convertible promissory note (the
"Westwood Note") to Westwood AR, Inc., a Nevada corporation ("Westwood"). The
Westwood Note is due August 31, 2005 and accrues interest at 10% per annum
payable at maturity. The principal amount of the Westwood Note and any accrued
interest thereon is convertible, in whole or in part, at the option of Westwood
into: (i) shares of our common stock at an initial conversion price of $1.00 per
share, (ii) five (5) membership interests in Knox Gas, LLC, a Delaware limited
liability company ("Knox Gas"); or (iii) any of certain specified combinations
of the foregoing. Under the terms of the Westwood Note, we are subject to a
prepayment option such that, in the event we complete any equity offerings after
January 1, 2005, Westwood has the right to require that we distribute to
Westwood up to thirty percent (30%) of the amount of the net proceeds received
by us in any or all of such offerings towards repayment of the Westwood Note.
35
On July 19, 2004, we obtained $3,000,000 from AltaFin, B.V., a Netherlands
Antilles company, in consideration for which we issued units comprised of
3,000,000 shares of common stock and warrants to acquire 1,500,000 shares of
common stock. Each warrant is immediately exercisable into one (1) share of
common stock at an exercise price of $2.00 per share and terminates three (3)
years from the date of grant.
The forgoing constitutes our principal sources of financing during the
past twelve months.
During 2004 we purchased interests in various oil and gas limited
partnerships and limited liability companies for consideration consisting of a
combination of cash, shares of our common stock and promissory notes. In that
connection, we issued a $2,000,000 note for the purchase of our interest in
Louisiana Shelf Partners, L.P., payment of which is contingent upon the
completion of the first producing well in the project and the production level
of the wells in the project. We expect payments to commence during the first
quarter of 2005. All other such notes have been repaid in full.
We will need to expend significant funds to meet capital calls and pay
drilling and production costs on our various interests in oil and gas prospects
to explore, produce, develop, and eventually sell the underlying natural gas and
oil products. Specifically, we expect to incur capital calls and production
costs of approximately $8,000,000 with respect to our various limited
partnership and limited liability company interests during the next 12 months.
If any of the other owners of leasehold interests in any of the projects
in which we participate, or any of the limited partners or membership interest
holders in the limited partnerships or limited liability companies in which we
have invested, respectively, fails to pay their equitable portion of development
costs or capital calls, we may need to pay additional funds to protect our
ownership interests.
We will need approximately $10,000,000 to execute our business plan,
satisfy capital calls, and pay drilling and production costs during the next
twelve months. In addition, we will need approximately $3,100,000 to repay our
outstanding term indebtedness during the next twelve months. In the event that
we locate additional prospects for acquisition, experience cost overruns at our
current prospects or fail to generate projected revenues, we will need funds in
excess of the forgoing amounts during the next twelve months. Based on our
available cash resources, cash flows that we are currently generating from our
various oil and gas properties, and projected cash flows that we expect to
generate from our various oil and gas projects in the future, we will not have
sufficient funds to continue to meet such capital calls and operate at current
levels for the next twelve months. Accordingly, we will be required to raise
additional funds through sales of our securities or otherwise. In that regard,
we recently retained Sanders Morris Harris, a Houston Texas based investment
banking firm, to assist us in raising additional capital to execute our business
plan. If we are unable to obtain additional funds on terms favorable to us, if
at all, we may be required to delay, scale back or eliminate some or all of our
exploration and well development programs, and may be required to relinquish our
interests in one or more of our prospects.
36
CRITICAL ACCOUNTING POLICIES
Our financial statements are prepared in accordance with accounting
principles generally accepted in the United States. The preparation of our
financial statements requires us to make estimates and judgments that affect the
reported amount of assets, liabilities, revenues and expenses. These estimates
are based on information that is currently available to us and on various other
assumptions that we believe to be reasonable under the circumstances. Actual
results could vary significantly from those estimates under different
assumptions and conditions.
Critical accounting policies are defined as those significant accounting
policies that are most critical to an understanding of a company's financial
condition and results of operation. We consider an accounting estimate or
judgment to be critical if: (i) it requires assumptions to be made that were
uncertain at the time the estimate was made, and (ii) changes in the estimate or
different estimates that could have been selected could have a material impact
on our results of operations or financial condition.
Our recent entrance into the oil and gas business subjects us to new
accounting policies that we were not previously subject to. We believe that the
following significant accounting policies are most critical to an evaluation of
our financial condition and results of operations.
Proved Oil and Natural Gas Reserves
Proved reserves are defined by the SEC as the estimated quantities of
crude oil, condensate, natural gas and natural gas liquids that geological and
engineering data demonstrate with reasonable certainty are recoverable in future
years from known reservoirs under existing economic and operating conditions.
Prices include consideration of changes in existing prices provided only by
contractual arrangements, but not on escalations based upon future conditions.
Prices do not include the effect of derivative instruments, if any, that we may
enter into.
Proved developed reserves are those reserves expected to be recovered
through existing equipment and operating methods. Additional oil and gas
expected to be obtained through the application of fluid injection or other
improved recovery techniques for supplementing the natural forces and mechanisms
of primary recovery are included as proved developed reserves only after testing
of a pilot project or after the operation of an installed program has confirmed
through production response that increase recovery will be achieved.
Proved undeveloped oil and gas reserves are reserves that are expected to
be recovered from new wells on non-drilled acreage, or from existing wells where
a relatively major expenditure is required for re-completion. Reserves on
non-drilled acreage are limited to those drilling units offsetting productive
units that are reasonably certain of production when drilled. Proved reserves
for other non-drilled units are claimed only where it can be demonstrated with
certainty that there is continuity of production from the existing productive
formation.
37
Volumes of reserves are estimates that, by their nature, are subject to
revision. The estimates are made using all available geological and reservoir
data as well as production performance data. There are numerous uncertainties in
estimating crude oil and natural gas reserve quantities, projecting future
production rates and projecting the timing of future development expenditures.
Oil and gas reserve engineering must be recognized as a subjective process of
estimating underground accumulations of oil and gas that cannot be measured in
an exact way and estimates of engineers that we use may differ from those of
other engineers. The accuracy of any reserve estimate is a function of the
quantity of available data and of engineering and geological interpretation and
judgment. Accordingly, future estimates are subject to change as additional
information becomes available.
Successful Efforts Accounting
We utilize the successful efforts method to account for our crude oil and
natural gas operations. Under this method of accounting, all costs associated
with oil and gas lease acquisition costs, successful exploratory wells and all
development wells are capitalized and amortized on a unit-of-production basis
over the remaining life of proved developed reserves and proved reserves on a
field basis. Unproved leasehold costs are capitalized pending the results of
exploration efforts. Exploration costs, including geological and geophysical
expenses, exploratory dry holes and delay rentals, are charged to expense when
incurred.
Impairment of Properties
We review our proved properties at the field level when management
determines that events or circumstances indicate that the recorded carrying
value of the properties may not be recoverable. Such events include a projection
of future oil and natural gas reserves that will be produced from a field, the
timing of this future production, future costs to produce the oil and natural
gas, and future inflation levels. If the carrying amount of an asset exceeds the
sum of the undiscounted estimated future net cash flows, we recognize impairment
expense equal to the difference between the carrying value and the fair value of
the asset which is estimated to be the expected present value of future net cash
flows from proved reserves, utilizing a risk-free rate of return. We cannot
predict the amount of impairment charges that may be recorded in the future.
Unproved leasehold costs are reviewed periodically and a loss is recognized to
the extent, if any, that the cost of the property has been impaired.
Property Retirement Obligations
We are required to make estimates of the future costs of the retirement
obligations of our producing oil and gas properties. This requirement
necessitates that we make estimates of our property abandonment costs that, in
some cases, will not be incurred until a substantial number of years in the
future. Such cost estimates could be subject to significant revisions in
subsequent years due to changes in regulatory requirements, technological
advances and other factors that may be difficult to predict.
38
ITEM 3. CONTROLS AND PROCEDURES.
An evaluation of the effectiveness of our "disclosure controls and
procedures" (as such term is defined in Rules 13a-15(e) or 15d-15(e) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act")) was carried
out by us under the supervision and with the participation of our Chief
Executive Officer ("CEO") and Treasurer ("Treasurer"). Based upon that
evaluation, our CEO and Treasurer concluded that, as of the end of the period
covered by this quarterly report, our disclosure controls and procedures were
effective to provide reasonable assurance that information we are required to
disclose in reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission rules and forms. There has been no change in
our internal control over financial reporting identified in connection with that
evaluation that occurred during the period covered by this report that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
PART II. OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
Sales of Unregistered Securities
1. On September 13, 2004, we issued 20,000 shares of common stock to
Sanders Morris Harris, Inc., a Houston Texas based investment banking firm, in
partial consideration of financial advisory services to be provided to the
Company. The shares were issued to one accredited investor in a private
placement transaction exempt from the registration requirements of the
Securities Act of 1933, as amended, pursuant to Section 4(2) thereof without
payment of underwriting discounts or commissions to any person.
2. On July 15, 2004, we issued a warrant to Fort House, Inc., a Toronto,
Canada based consulting firm, to purchase 61,250 shares of common stock at an
exercise price of $2.00 per share. The warrant is immediately exercisable in
full and expires on July 15, 2007. We issued the warrant as partial
consideration for consulting services provided by Fort House, Inc. to the
Company. The warrants were issued to one accredited investor in a private
placement transaction exempt from the registration requirement of the Securities
Act of 1933, as amended, pursuant to section 4(2) thereof without payment of
underwriting discounts or commissions to any person.
ITEM 5. OTHER INFORMATION
Increase in Size of Board of Directors; Appointment of New Director
On July 7, 2004, we increased the size of our board of directors from one
to two members and appointed Wesley E. Franklin to fill the vacancy on our board
of directors created by such increase. We also appointed Mr. Franklin to serve
as the Executive Vice President of the Company. Mr. Franklin has over 30 years
of successful oil and gas exploration and production experience and has worked
in every aspect of exploration and production. Since January 2001, Mr. Franklin
has served as Executive Vice President of Touchtone Resources USA, Inc., a
Houston, Texas based oil and gas exploration and development company which we
recently acquired. In 1999, he founded Quantum Oil & Gas LLC, a Texas based oil
and gas exploration company. Between 1982 and 1997, Mr. Franklin held senior
management positions at Tenneco Oil Company and Fina Oil & Chemical. At Fina, he
was involved in discoveries of 200 million barrels of oil and 200 billion cubic
feet of natural gas and directed exploration for Fina in the United States,
including Alaska, and parts of Alberta, Canada.
39
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
10.1 Amendment to the Operating Agreement of Maverick Basin Exploration,
LLC, dated July 14, 2004, by and among the Company, PHT Gas, LLC and
South Oil, Inc. (Incorporated by reference to Exhibit 10.21 to the
Company's Quarterly Report on Form 10-QSB for the period ended June
30, 2004)
31.1 Certificate of CEO of Registrant required by Rule 13a-14(a) under
the Securities Exchange Act of 1934, as amended
31.2 Certificate of Treasurer of Registrant required by Rule 13a-14(a)
under the Securities Exchange Act of 1934, as amended
32.1 Certificate of CEO and Treasurer of Registrant required by Rule
13a-14(b) under the Securities Exchange Act of 1934, as amended
(b) Current Reports on Form 8-K filed during the three month period ended
September 30, 2004:
1. On July 21, 2004, we filed a Current Report on Form 8-K/A with the SEC under
Items 2 and 7 disclosing our purchase of an interest in PHT Vela Partners, L.P.,
a Delaware limited partnership, and agreement to make an initial capital
contribution to PHT Vela and filing the financial statements and pro forma
financial information required in connection with our purchase of Touchstone
Resources USA, Inc., a Texas corporation, and our purchase of interests in Knox
Miss Partners, LP, a Delaware limited partnership, and Louisiana Shelf Partners,
L.P., a Delaware limited partnership, each of which was previously disclosed in
reports on Form 8-K filed with the SEC.
2. On September 7, 2004 and September 13, 2004, we filed Amendment Numbers 2, 3,
and 4 (the "Amendments") to our Current Report on Form 8-K/A ("Initial Report")
with the SEC under Item 9.01 for the purpose of re-filing the financial
statements and pro forma financial information previously filed in our Current
Report on Form 8-K/A filed with the SEC on July 21, 2004. The financial
statements and pro forma financial information included in the Initial Report
were accessible and readable in text format on the SEC's website, however, for
reasons unknown to us, the financial statements and pro forma financial
information were accessible but unreadable in html format on the SEC's website.
In order to ensure that such statements and information were both accessible and
readable in html format, we filed the Amendments.
40
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, as amended, the registrant caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
TOUCHSTONE RESOURCES USA, INC.
Date: November 18, 2004 /s/ Stephen P. Harrington
--------------------------
Stephen P. Harrington
Chief Executive Officer, President and Treasurer
41
EXHIBIT INDEX
Exhibit
Number Description
31.1 Certificate of CEO of Registrant required by Rule 13a-14(a) under
the Securities Exchange Act of 1934, as amended
31.2 Certificate of Treasurer of Registrant required by Rule 13a-14(a)
under the Securities Exchange Act of 1934, as amended
32.1 Certificate of CEO and Treasurer of Registrant required by Rule
13a-14(b) under the Securities Exchange Act of 1934, as amended
42