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: March 31, 2005
|_| 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 60,756,757 issued
and outstanding shares of the registrant's common stock, par value $.001 per
share, as of May 12, 2005.
Transitional Small Business Disclosure Format (check one):
Yes |_| No |X|
TOUCHSTONE RESOURCES USA, INC.
QUARTERLY REPORT ON FORM 10-QSB
FOR FISCAL QUARTER ENDED MARCH 31, 2005
TABLE OF CONTENTS
Page
PART I
Item 1 Financial Statements...................................................1
Condensed Consolidated Balance Sheets (Unaudited)....................2
Condensed Consolidated Statements of Operations (Unaudited)..........3
Condensed Consolidated Statements of Cash Flows (Unaudited)..........4
Notes to Condensed Consolidated Financial Statements.................5
Item 2 Management's Discussion and Analysis..................................17
Item 3 Controls and Procedures...............................................26
PART II
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds...........27
Item 6 Exhibits .............................................................27
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Condensed Consolidated Balance Sheets
ASSETS
March 31, December 31,
2005 2004
------------ ------------
(Unaudited) (Audited)
Current assets
Cash and cash equivalents $ 3,813,843 $ 594,182
Restricted cash - joint interest 1,567,788 1,139,753
Accounts receivable - joint interest 3,097,741 2,945,421
Accounts receivable - joint interest related party 3,920,394 3,354,468
Notes and interest receivable 70,041 66,559
Due from related party 188,588 188,588
Prepaid expenses and advances to operators 361,757 1,593,079
------------ ------------
Total current assets 13,020,152 9,882,050
Undeveloped oil and gas interests, using successful efforts 4,838,348 4,763,311
Investment in limited partnerships and liability companies 7,467,927 6,117,046
Fixed assets, net 48,290 50,958
Deposits 30,149 30,149
------------ ------------
$ 25,404,866 $ 20,843,514
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses $ 1,146,983 $ 854,798
Accounts payable - joint interest 9,365,671 8,224,332
Notes payable 684,750 618,223
Notes payable - related party 216,541 216,541
Limited partnership subscriptions payable 200,000 200,000
Convertible debentures, net 3,596,559 1,080,287
------------ ------------
Total current liabilities 15,210,504 11,194,181
------------ ------------
Note payable - noncurrent 1,691,373 1,819,000
Convertible debenture - noncurrent -- 2,050,000
------------ ------------
1,691,373 3,869,000
------------ ------------
Total liabilities 16,901,877 15,063,181
------------ ------------
Commitment and contingencies
Minority interest 2,937,157 3,078,820
Stockholders' equity
Preferred stock; $.001 par value; authorized - 5,000,000 shares;
shares issued and outstanding - 490,994 at March 31, 2005 and 0 at
December 31, 2004; Liquidation preference: $5,402,118 491 --
Common stock; $.001 par value; authorized - 150,000,000 shares;
shares issued and outstanding - 60,756,757 and 285,000 issuable
at March 31, 2005 and 59,919,053 issued and outstanding
and 649,476 issuable at December 31, 2004 61,042 60,569
Additional paid-in capital 25,141,393 18,338,476
Deferred compensation -- (16,600)
Deficit accumulated during the development stage (19,637,094) (15,680,932)
------------ ------------
Total stockholders' equity 5,565,832 2,701,513
------------ ------------
$ 25,404,866 $ 20,843,514
============ ============
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)
Three Months March 5, 2001
Ended March 31, (Inception) to
----------------------------- March 31,
2005 2004 2005
------------- ------------- -------------
Operator revenues $ 115,296 $ 6,622 $ 316,105
------------- ------------- -------------
Expenses:
Exploration expenses 8,820 72,375 1,510,218
Impairment of oil and gas properties 790,177 -- 965,997
Impairment of goodwill -- -- 657,914
Bad debt expense -- 15,454 15,454
General and administrative 858,669 458,573 3,251,792
------------- ------------- -------------
Total expenses 1,657,666 546,402 6,401,375
------------- ------------- -------------
Loss from operations (1,542,370) (539,780) (6,085,270)
------------- ------------- -------------
Other (income) expense
Loss from limited partnerships and limited liability
companies 555,019 4,735 4,061,263
Impairment of equity investment -- -- 139,502
Interest income (493) (5,570) (9,298)
Interest expense 596,220 21,079 8,564,418
------------- ------------- -------------
Total other expense 1,150,746 20,244 12,755,885
------------- ------------- -------------
Loss before minority interest and pre-acquisition losses (2,693,116) (560,024) (18,841,155)
Addback:
Minority interest 258,352 959 514,146
Pre-acquisition losses -- 461,270 211,315
------------- ------------- -------------
Total minority interest and pre-acquisition losses 258,352 462,229 725,461
------------- ------------- -------------
Net Loss (2,434,764) (97,795) (18,115,694)
Preferred dividend on Series A Preferred Stock (1,521,400) -- (1,521,400)
------------- ------------- -------------
Net loss to common stockholders $ (3,956,164) $ (97,795) $ (19,637,094)
============= ============= =============
Net loss per common share - basic and diluted $ (0.07) $ (0.00) $ (0.15)
============= ============= =============
Weighted average number of common shares
outstanding - basic and diluted 60,772,785 125,711,264 129,991,306
============= ============= =============
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)
Three Months Ended March 5, 2001
March 31, (Inception) to
-------------------------- March 31,
2005 2004 2005
----------- ----------- ------------
Cash flows from operating activities
Net cash used in operating activities $ (654,644) $ (5,357) $ (2,646,168)
----------- ----------- ------------
Cash flows from investing activities
Cash acquired from acquisition of wholly-owned subsidiaries
and limited partnership interest -- 4,715 4,715
Repayment of note receivable 2,000 -- 2,000
Repayment of note receivable - related party -- -- 21,639
Notes receivable (4,989) -- (186,358)
Notes receivable - related party -- -- (54,975)
Purchase of oil and gas interests and drilling costs (61,066) -- (2,389,519)
Refund of payments for oil and gas interests and drilling costs 500,000 -- 500,000
Deposit on future investments -- (350,000) --
Investment in limited partnership interests (1,915,900) (1,133,000) (10,002,775)
Distributions from limited partnerships 10,000 -- 36,385
Purchase of fixed assets (2,320) -- (29,261)
----------- ----------- ------------
Net cash used in investing activities (1,472,275) (1,478,285) (12,098,149)
----------- ----------- ------------
Cash flows from financing activities
Advances from stockholder -- -- 10,000
Repayments to stockholder -- -- (10,000)
Proceeds from notes payable -- 3,000 807,100
Proceeds from notes payable - related party -- -- 279,000
Repayment of notes payable (61,100) -- (5,256,100)
Repayment of notes payable - related party -- -- (91,500)
Proceeds from issuance of convertible debt -- 2,100,000 11,090,000
Repayment of convertible debt -- (100,000) (150,000)
Loan costs -- (104,000) (104,000)
Capital contributed by officer -- 15,000 15,000
Minority contributions, net of issuance costs 116,690 -- 3,442,190
Proceeds from issuance of preferred stock, net of issuance costs 4,843,789 -- 4,843,789
Proceeds from issuance of common stock, net of issuance costs 447,201 -- 3,682,681
----------- ----------- ------------
Net cash provided by financing activities 5,346,580 1,914,000 18,558,160
Net increase in cash and cash equivalents 3,219,661 430,358 3,813,843
Cash and cash equivalents at beginning of year 594,182 91,578 --
----------- ----------- ------------
Cash and cash equivalents, end of period $ 3,813,843 $ 521,936 $ 3,813,843
=========== =========== ============
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 impairment on certain oil and gas
properties. 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 2004 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, 2005.
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 oil and gas 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. One of the Company's
wholly-owned subsidiaries is an operator of approximately five different oil
projects.
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
Consolidated Financial Statements
The accompanying consolidated financial statements include all of the accounts
of Touchstone Resources USA, Inc. and its eight subsidiaries consisting of:
o Touchstone Resources USA, Inc. ("Touchstone Texas"), a wholly-owned
Texas corporation incorporated in May 2000
o 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 - (Continued)
o Touchstone Louisiana, Inc. ("Touchstone Louisiana"), a wholly-owned
Delaware corporation incorporated in March 2004
o Touchstone Vicksburg, Inc. ("Touchstone Vicksburg"), a wholly-owned
Delaware corporation incorporated in March 2004
o Knox Gas, LLC ("Knox Gas"), a 68.18% owned Delaware limited
liability company formed in February 2004
o PHT West Pleito Gas, LLC ("PHT West"), a 86% owned Delaware limited
liability company formed in April 2004
o Touchstone Pierce Exploration, LLC ("Touchstone Pierce"), a
wholly-owned Delaware limited liability company formed in June 2004
o 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.
Development Stage Enterprise
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.
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 three months ended March 31, 2005 and 2004 by
geographical area were as follows:
March 31,
----------------------------
2005 2004
----------- -----------
United States $ 115,296 $ 6,622
New Zealand -- --
----------- -----------
$ 115,296 $ 6,622
=========== ===========
Long-lived assets as of March 31, 2005 and December 31, 2004 by geographical
area were as follows:
March 31, December 31,
2005 2004
----------- -----------
United States $11,851,866 $10,669,066
New Zealand 502,699 262,249
----------- -----------
$12,354,565 $10,931,315
=========== ===========
6
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)
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 include the number of
additional common shares that would have been outstanding if potentially
dilutive common shares had been issued and if the additional common shares were
dilutive. Shares associated with stock options, warrants and convertible debt
are not included because their inclusion would be antidilutive (i.e., reduce the
net loss per share).
The number of shares of common stock and the loss per share for the three months
ended March 31, 2005 and 2004 have been updated to reflect the 25 for 1 stock
split effected in March 2004.
The common shares potentially issuable arising from these instruments, which
were outstanding during the periods presented in the financial statements,
consisted of:
Three Months Ended
March 31,
---------------------------
2005 2004
----------- -----------
Warrants 9,212,833 250,000
Convertible debt 3,959,091 2,100,000
Series A convertible preferred stock 4,909,940 --
----------- -----------
18,081,864 2,350,000
=========== ===========
7
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
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 and it will
need additional cash to fund operations. 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.
The Company believes that the proceeds that it plans to raise from private
offerings of securities and its current and projected revenues from oil and gas
operations will be sufficient to fund its operations through March 2006. The
Company will 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 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 - DUE FROM RELATED PARTY
As of March 31, 2005, the Company had advanced $50,975 to PHT Vicksburg
Partners, LP ("PHT Vicksburg"), a limited partnership in which the Company has
an equity interest, and $35,000 to Touchstone Resources, Ltd. ("Touchstone
Canada"), respectively. The president of Touchstone Canada served as the
president of Touchstone Texas until his resignation on June 2, 2004. In
addition, the Company was owed $101,607 from Touchstone Canada for payment of
accounts payable, which Touchstone Canada had agreed to assume prior to the
Company's acquisition of Touchstone Texas.
8
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 6 - EQUITY INTERESTS IN OIL AND GAS PROPERTIES
The following table summarizes the Company's interests in oil and gas non-public
limited partnerships accounted for under the equity method of accounting:
March 31, 2005 December 31, 2004
---------------------------- ---------------------------
Temporary Temporary
Excess of Excess of
Carrying Carrying
Value Value
Carrying Over Net Carrying Over Net
Value Assets Value Assets
------------ ------------ ------------ ------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
PHT Vicksburg Partners, LP $ 338,214 $ 31,514 $ 404,552 $ 47,631
Awakino South Exploration, LLC 484,441 171,090 252,154 --
PHT Stent Partners, LP 18,258 10,612 10,094 47,616
Louisiana Shelf Partners, LP 2,521,542 1,274,532 2,484,428 1,219,497
PHT Wharton Partners, LP 1,220,679 -- 234,665 --
PHT Vela Partners, LP 445,266 11,387 449,919 68,987
PHT Good Friday Partners, LP 812,425 31,832 812,737 190,347
PHT Martinez Partners, LP 835,922 236,152 833,981 36,151
PHT La Paloma Partners, LP 782,039 147,034 625,375 73,166
Maverick Basin Exploration, LLC -- -- -- 345,850
LS Gas, LLC 1,000 1,000 1,000 1,000
2001 Hackberry Drilling Fund Partners, LP 8,141 -- 8,141 --
------------ ------------ ------------ ------------
$ 7,467,927 $ 1,915,153 $ 6,117,046 $ 2,030,245
============ ============ ============ ============
The Company expects the temporary excess carrying value to decrease as the
various entities receive payment of subscription receivables due them and
generate cash flows from the sale of oil and gas produced from the proved oil
and gas reserves.
The following table summarizes financial information for the limited
partnerships and limited liability companies accounted for under the equity
method of accounting at March 31, 2005 and December 31, 2004 and has been
compiled from the financial statements of the respective entities:
March 31, 2005 December 31, 2004
----------- -----------
(Unaudited) (Unaudited)
Total Assets $41,839,464 $30,760,273
=========== ===========
Total Liabilities $ 7,001,603 $ 7,352,041
=========== ===========
Three Months Ended March 31,
----------------------------
2005 2004
----------- -----------
(Unaudited) (Unaudited)
Results of Operations:
Revenue $ 392,577 $ --
Loss from operations $(4,019,967) $ (459,304)
Net Loss $(4,008,148) $ (459,304)
9
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 7 - NOTES PAYABLE
The following schedule summarizes the current and non-current portion of
Company's debts as of March 31, 2005:
Payable to Current Non-current Total
------------ ---------- ----------
SPH Investment, Inc. $ 75,000 $ -- $ 75,000
Louisiana Shelf Partners, LP 82,047 -- 82,047
2001 Hackberry Drilling Fund, LP 59,494 -- 59,494
------------ ---------- ----------
Subtotal - related parties 216,541 -- 216,541
IL Resources 150,000 -- 150,000
South Oil 87,500 -- 87,500
John Paul Dejoria 128,857 -- 128,857
Other 9,766 -- 9,766
Endeavour 308,627 1,691,373 2,000,000
------------ ---------- ----------
Subtotal 684,750 1,691,373 2,376,123
------------ ---------- ----------
$ 901,291 $1,691,373 $2,592,664
============ ========== ==========
The following schedule summarizes the current and non-current portion of
Company's debts as of December 31, 2004:
Payable to Current Non-current Total
------------ ---------- ----------
SPH Investment, Inc. $ 75,000 $ -- $ 75,000
Louisiana Shelf Partners, LP 82,047 -- 82,047
2001 Hackberry Drilling Fund, LP 59,494 -- 59,494
------------ ---------- ----------
Subtotal - related parties 216,541 -- 216,541
IL Resources 210,000 -- 210,000
South Oil 87,500 -- 87,500
John Paul Dejoria 128,857 -- 128,857
Other 10,866 -- 10,866
Endeavour 181,000 1,819,000 2,000,000
------------ ---------- ----------
Subtotal 618,223 1,819,000 2,437,223
------------ ---------- ----------
$ 834,764 $1,819,000 $2,653,764
============ ========== ==========
10
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 8 - CONVERTIBLE DEBENTURES
Convertible debentures consisted of the following at:
March 31, December 31,
2005 2004
---------- ----------
12% Secured convertible note $2,050,000 $2,050,000
12% Convertible promissory note 1,000,000 1,000,000
10% Convertible promissory note 1,000,000 1,000,000
---------- ----------
4,050,000 4,050,000
Less unamortized discount 453,441 919,713
---------- ----------
3,596,559 3,130,287
Less long-term portion -- 2,050,000
---------- ----------
Current portion of convertible debentures $3,596,559 $1,080,287
========== ==========
On March 23, 2005, the Company issued a warrant to Trident Growth Fund to
purchase 100,000 shares of common stock at an initial exercise price of $1.20
per share in consideration of Trident extending the due date of its $2,050,000
convertible promissory note to March 24, 2006 and waivering all financial
covenants on the convertible note. The warrants are exercisable immediately and
expire on March 31, 2014.
NOTE 9 - STOCKHOLDERS' EQUITY
Preferred Stock
On March 29, 2005, the Company filed a Certificate of Designation with the
Delaware Secretary of State to designate 2,000,000 of its authorized but
unissued shares of preferred stock as Series A Convertible Preferred Stock. Each
share of the Series A convertible preferred stock ("Series A Shares") is
initially convertible into ten (10) shares of the Company's common stock at an
initial conversion price of $1.10 per share. The conversion price is subject to
proportional adjustment for stock splits, combinations, recapitalizations and
stock dividends. In addition, if, prior to June 30, 2005, the Company issues
additional shares of common stock or securities convertible or exercisable into
shares of common stock in a capital raising transaction in which the Company
realizes net proceeds equal to at least fifty percent (50%) of the net proceeds
realized in the Regulation D Offering (as defined below), the conversion price
in effect immediately prior to such issuance will automatically be adjusted to a
price equal to the aggregate consideration per share received by the Company in
such transaction.
The Series A Shares are convertible at any time at the option of the holder, and
are subject to mandatory conversion in the event that: (i) there is an effective
registration statement covering the public sale of the shares of the Company's
common stock underlying the Series A Shares; and (ii) the volume weighted
average closing price per share of the Company's common stock for 20 consecutive
trading days is equal to or greater than 150% of the conversion price. In the
event of a merger or other transaction in which the Company is not the surviving
corporation, the Series A Shares and all accrued and unpaid dividends due
thereon, will automatically convert into common stock and participate in such
merger or other transaction.
11
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 9 - STOCKHOLDERS' EQUITY - (Continued)
Holders of the Series A Shares are entitled to receive dividends at the rate of
eight percent (8%) per annum of the $11.00 stated value of such shares payable
on an annual basis on December 31 of each year after issuance, or upon earlier
conversion, out of funds legally available therefore; provided, however, that at
the option of the holder, such dividends shall be payable in kind at the rate of
12% per annum of the $11.00 stated value of such shares by issuance of shares of
the Company's common stock having a fair market value equal to the amount of the
dividend. For this purpose, fair market value is defined as the average of the
high and low bid prices for the Company's shares of common stock as reported on
the OTC Bulletin Board for the five (5) trading days immediately preceding the
date the dividend is paid.
In the event of liquidation, dissolution or winding up of the Company, the
holders of the Series A Shares shall be entitled to a liquidation preference of
$11.00 per share plus all accrued and unpaid dividends prior to any payment or
distribution to holders of shares of the common stock.
Except as otherwise provided in the Delaware General Corporation Law, the shares
of Series A convertible preferred stock have no voting rights.
In the first quarter of 2005, the Company commenced concurrent private offerings
(the "Offerings") of units comprised of shares of its series A convertible
preferred stock and warrants to purchase shares of its common stock at a
purchase price of $11.00 per unit. Each unit consisted of one share of series A
convertible preferred stock and one common stock purchase warrant. Each share of
series A convertible preferred stock is immediately convertible at the option of
the holder into ten (10) shares of common stock at an initial conversion price
of $1.10 per share. Each warrant is immediately exercisable into five (5) shares
of common stock at an exercise price of $1.50 per share for a term of three
years.
The warrants have a call provision if the volume weighted average closing price
per share of the Company's common stock for twenty consecutive trading days
following the effectiveness of the registration of the shares underlying the
warrants is equal to or greater than 150% of the exercise price, the Company
will have unlimited discretion to call the warrants for surrender fifteen (15)
business days after it provides written notice to the holders of the warrants.
If the warrants are not exercised during such fifteen (15) business day period,
they will terminate.
The exercise price of the warrants will be adjusted for stock splits,
combinations, recapitalization and stock dividends. In addition, if the Company
issues additional warrants or options which have an exercise price less than the
exercise price of the warrants in effect immediately prior to such issuance, in
a capital raising transaction that closes prior to June 30, 2005 in which the
Company realizes net proceeds equal to at least fifty percent (50%) of the net
proceeds realized in the Regulation D Offering, the exercise price of the
warrants will automatically be adjusted to a price equal to the exercise price
per share of such other warrants or options.
The Company has agreed to use its best efforts to prepare and file with the
Securities and Exchange Commission within 60 days after the termination of the
offering, but in no case later than 90 days after the termination of the
offering, a registration statement under the Securities Act of 1933, as amended,
permitting the public resale of the shares of Common Stock issuable upon
conversion or exercise, as applicable, of the Series A Convertible Preferred
Stock and Warrants issued in the offering. The Company has agreed to pay certain
penalties to the subscribers in this offering if the registration statement is
not filed within 90 days after the termination of the offering or if the
registration statement is not declared effective within 180 days after the
termination of the offering.
The first offering was conducted out on a "best efforts" basis solely to a
limited number of accredited investors in the United States (the "Regulation D
Offering"). The second offering was conducted out on a "best efforts" basis
solely to a limited number of accredited investors who are not "U.S. persons"
(the "Regulation S Offering").
12
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 9 - STOCKHOLDERS' EQUITY - (Continued)
On March 30, 2005, the Company conducted an initial closing of the Regulation D
Offering in which it sold 204,100 units for aggregate gross proceeds of
$2,245,100. The Company paid commissions and expenses of $291,858 to Legend
Merchant Group, Inc. ("Legend"), a broker-dealer registered under the Securities
Exchange Act of 1934, as amended, and member of the NASD and the SIPC.
As of March 31, 2005, the Company was in the midst of closing its second round
of the Regulation D Offering in which it sold 61,894 units for aggregate gross
proceeds of $680,836. The Company accrued broker fees in the amount of $88,509
to Legend.
As of March 31, 2005, the Company sold 225,000 units in the Regulation S
Offering for aggregate gross proceeds of $2,475,000. The Company paid investment
banking fees in the amount of $220,000 to an independent third party consultant
in connection with this transaction.
In compensation for the services provided by Legend in connection with the
Regulation D Offerings, the Company issued warrants to Legend to purchase
398,991 shares of common stock during March 2005.
As a result of the Regulation D and Regulation S Offerings, as of March 31,
2005, the Company has issued a total of 490,994 shares of Series A preferred
stock and warrants to purchase 2,454,970 shares of common stock to the
investors. Under Emerging Issues Task Force ("EITF") 00-27, "Application of
Issue No. 98-5 to Certain Convertible Instruments," the Company has allocated
the proceeds from issuance of the Series A convertible preferred stock and
warrants based on a fair value basis of each item. Consequently, the convertible
Series A preferred stock was recorded with a discount of $760,700 based on the
ascribed value of the warrants as determined by using the Black-Scholes Model.
Under EITF 00-27, the discount for the warrant was recorded as a preferred
dividend. An additional beneficial conversion discount of $760,700 was recorded
since the Series A preferred stock is convertible into shares of common stock at
an effective conversion price of $0.95 per share while the prevailing common
stock share prices was $1.10. This discount was also recorded as a preferred
dividend.
Common Stock
On November 1, 2004, the Company's Board of Directors approved and commenced an
offering of up to 1,500,000 Units of its securities, each unit consisting of two
shares of the Company's common stock and one three-year $2.00 common stock
purchase warrant for a unit offering price of $2.10. During February 2005, the
Company sold 236,614 units in which 473,228 shares of common stock and 236,614
warrants were issued for an aggregate purchase price of $496,890. Offering costs
of $49,689 were paid. In March 2005, the Company issued warrants to the
placement agent to purchase 83,770 shares of common stock in compensation for
services provided by the placement agent.
13
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 9 - STOCKHOLDERS' EQUITY - (Continued)
Stock Warrants
The Company had the following outstanding common stock warrants to purchase its
securities at March 31:
2005 2004
----------------------------- -----------------------------
Number of Exercise Price Number of Exercise Price
Expiration Date Warrants issued Per Share Warrants issued Per Share
- --------------- ----------- ----------- ----------- -----------
April 2007 3,445,000 $ 2.00 -- $ --
July 2007 1,561,250 $ 2.00 -- $ --
November 2007 500,000 $ 2.00 -- $ --
November and
December 2007 418,852 $ 2.00 -- $ --
January 2008 83,770 $ 2.00 -- $ --
March 2008 2,853,961 $ 1.50 -- $ --
March 2014 350,000 $ 1.00 250,000 $ 1.00
----------- -----------
Common Stock 9,212,833 250,000
=========== ===========
NOTE 10 - 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 11 - 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.
14
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 11 - COMMITMENTS AND CONTINGENCIES - (Continued)
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.
NOTE 12 - SUBSEQUENT EVENTS
During April, 2005, the Company closed additional rounds of its Regulation D
Offering in which it sold 136,342 units for aggregate gross proceeds of
$1,499,760. The Company paid commissions and expenses of $194,967 to Legend. The
Company also issued warrants to the placement agent to purchase 204,513 shares
of common stock in compensation for services provided by the placement agent.
During April, 2005, the Company closed an additional round of its Regulation S
Offering in which it sold 82,727 units for aggregate gross proceeds of $910,000.
On April 4, 2005, the Company was subject to a capital call of $750,000 from
Touchstone Awakino.
On April 12, 2005, the Company was subject to a capital call of $500,000 from
PHT Wharton.
On April 12, 2005, the Company was subject to a capital call of $100,000 from
Maverick Basin.
On April 12, 2005, the Company was subject to a capital call of $50,000 from
Touchstone Vicksburg.
On April 12, 2005, the Company was subject to a capital call of $100,000 from
Touchstone Louisiana.
NOTE 13 - RECLASSIFICATION
For comparability, the 2004 figures have been reclassified where appropriate to
conform with the financial statement presentation used in 2005. These
reclassifications had no effect on reported net loss.
15
DISCLOSURE REGARDING 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.
The following factors, among others, could cause actual results and future
events to differ materially from those set forth or contemplated in the
forward-looking statements:
o our ability to obtain sufficient financing to satisfy capital calls,
debt obligations and operating expenses with respect to our oil and
gas properties;
o the accuracy of our reserve estimates and judgments when regarding
oil and gas resources and formations and reservoir performance;
o risks associated with the geographic concentration of substantially
all of our properties in Texas, Louisiana, Mississippi and New
Zealand;
o our ability to identify and acquire properties with commercially
productive reservoirs;
o our failure to identify liabilities associated with the properties
we acquire or obtain protection from sellers against such
liabilities;
o operational and drilling risks inherent in the exploration,
development and production of oil and gas;
o market fluctuations in the prices of oil and gas;
o our dependence upon various third-party operators and others that we
do not control;
o the unavailability or high cost of drilling rigs, equipment,
supplies, personnel and oil field services;
o title deficiencies in the properties underlying our leases;
o failure by us and our operators to maintain adequate insurance on
our properties;
o the impact of environmental and other laws and regulations; and
o international and domestic political and economic factors.
A more in-depth discussion of the factors that may cause our actual results to
differ materially from those indicated in the forward-looking statements is set
forth under the caption "Risk Factors" in our Annual Report on Form 10-KSB.
All subsequent written and oral forward-looking statements attributable to
us, or persons acting on our behalf, are expressly qualified in their entirety
by these cautionary statements. We assume no duty to update or revise our
forward-looking statements based on changes in internal estimates or
expectations or otherwise.
16
Item 2. Management's Discussion and Analysis.
We are an independent energy company engaged in the acquisition,
exploration, development and production of oil and natural gas reserves. We
entered the oil and gas business in March 2004 upon the completion of a change
in our management. Following the change in management, we changed our name from
"The Coffee Exchange, Inc." to "Touchstone Resources USA, Inc." and affected a
25-for-1 reverse stock split of our shares of common stock.
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. Our business model has been specifically designed to
exploit the unique opportunities currently available to small companies in the
oil and gas industry. Major integrated oil companies and other large independent
oil and gas exploration and production companies are divesting themselves of
small, less capital-intensive properties to focus on larger, more
capital-intensive projects that better match their long-term strategic goals. We
believe that these asset divestitures as well as the resource constraints of
major integrated oil companies and other large upstream companies may allow us
to acquire attractive prospects at favorable prices with a significant portion
of the up-front development expenses, such as infrastructure and seismic
analysis, already invested.
We currently own interests in 15 oil and gas projects in Texas, Louisiana,
Mississippi and New Zealand. 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, one well in our Maverick Basin Project located in Maverick County in
South Texas is in production and one is shut in, one well in our Vela Project
located in Zapata County, Texas is in production, and one well in our Wharton
Project located in Wharton County, Texas has been drilled and is now in
production, with one well shut in. Our remaining projects are in various stages
of exploration, development or testing.
We expect to continue to acquire additional projects and may 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. We intend to place primary emphasis on issuances of public
and private debt and equity to finance the growth of our business.
17
Our ability to generate future revenues, operating cash flow and earnings
is dependent on the successful development of our inventory of capital projects,
the volume and timing of our production, our ability to identify, acquire and
successfully exploit properties containing oil and gas reserves in commercial
quantities, and the commodity prices for oil and gas. Such pricing factors are
largely beyond our control, and may result in fluctuations in our financial
condition and results of operations.
Our ability to generate future revenues, operating cash flow and earnings
will also be influenced by exploration and development expenses we incur. Our
exploration efforts are balanced between discovering new reserves associated
with acquisitions and discovering reserves on acreage already under lease. The
investment associated with drilling a well and future development of a project
depends principally upon the complexity of the geological formations involved,
the depth of the well or wells, whether the well or project can be connected to
existing infrastructure or will require additional investment in infrastructure,
and, if applicable, the water depth of the well or project. If we underestimate
the amount of exploration and development costs necessary to exploit the oil or
gas reserves of our prospects, we may incur substantially more exploration and
development costs than planned, which may have a material adverse effect on our
financial condition and results of operations.
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.
We believe that the following significant accounting policies will be most
critical to an evaluation of our future financial condition and results of
operations.
Revenue Recognition
Oil and gas revenues are recognized when production is sold to a purchaser
at a fixed or determinable price, when delivery has occurred and title has
transferred, and if the collection of the revenue is probable. When we have an
interest in a property with other producers, we use the sales method of
accounting for our oil and gas revenues. Under this method of accounting,
revenue is recorded based upon our physical delivery of oil and gas to our
customers, which can be different from our net working interest in field
production. These differences create imbalances that are recognized as a
liability only when the estimated remaining reserves will not be sufficient to
enable the under-produced party to recoup its entitled share through production.
As of March 31, 2005, deliveries of oil and gas in excess of or less than our
working interest were not significant.
18
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, entered into
by the Company.
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 increased 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.
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.
19
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 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.
Comparison of Three Months Ended March 31, 2005 and March 31, 2004
We were organized in March 2001 for the purpose of developing Internet
cafes in Orange County, California, and surrounding areas. We were unable to
successfully implement this business plan and thus did not generate any revenues
or incur any significant operating expenses from those activities. We entered
the oil and gas business in March 2004 upon the completion of a change in our
management and have since engaged in significant oil and gas activities. As a
result of the foregoing, we believe that our consolidated revenues and operating
expenses for the three months ended March 31, 2005 are not comparable to our
consolidated revenues and operating expenses for the three months ended March
31, 2004 and, therefore, any differences between our consolidated revenues and
operating expenses for such three month periods should not be relied upon as an
indication of our future results of operations or performance.
Revenues
Revenues consist of fees generated from the operation of various oil and
gas wells for which we or our wholly-owned subsidiaries served as the operator.
We generated $115,296 of revenue during the three months ended March 31, 2005.
We generated $6,622 of revenue during the three months ended March 31, 2004. The
$108,674 increase in revenues was due to an increase in the number of projects
for which we serve as the operator. We expect revenues to increase in the future
as we continue to serve as the operator for existing and new wells, or if we
produce oil and gas from projects in which we have a majority interest.
Exploration Expenses
Exploration expenses consist of geological and geophysical costs,
exploratory dry hole expenses, leasehold abandonment expenses, and other
exploration expenses. Exploration expenses were $8,820 during the three months
ended March 31, 2005. We incurred $72,375 in exploration expenses during the
three months ended March 31, 2004. The decrease in exploration expenses resulted
primarily from our decreased exploration activities in our Mississippi
properties.
20
Impairment of Oil and Gas Properties and Equity Investments
We review our long-lived assets, including our oil and gas properties and
equity investments, whenever events or circumstances indicate that the carrying
value of those assets may not be recoverable. We incurred $790,177 in non-cash
charges associated with the impairment of the carrying value of certain of our
oil and gas properties and equity investments during the three months ended
March 31, 2005. We did not have any impaired property expenses during the three
months ended March 31, 2004. The $790,177 in non-cash charges related to
impairment of the carrying value of unproved properties acquisition and drilling
costs incurred in our Mississippi properties as a result of dry holes. We may
incur additional charges associated with the impairment of our oil and gas
properties in the event we abandon or withdrawal from additional oil and gas
projects in the future.
General and Administrative Expenses
General and administrative expenses consist of consulting and engineering
fees, professional fees, employee compensation, office rents, travel and
utilities, and other miscellaneous general and administrative costs. General and
administrative expenses increased $400,096 to $858,669 for the three months
ended March 31, 2005 from $458,573 for the three months ended March 31, 2004.
The increase of $400,096 resulted primarily from our commencement of operations
in the oil and gas exploration and development business, and consisted primarily
of $453,066 of professional fees incurred in connection with our acquisitions of
interests in oil and gas prospects, financing transactions and compliance with
our reporting obligations under federal securities laws, $56,100 of consulting
and engineering fees incurred in connection with our oil and gas operations,
$71,140 of employee compensation, and $58,189 of travel expenses. We expect
general and administrative expenses to increase in future periods as a result of
increased compensation expense for executive management personnel that we intend
to hire, increased consulting and engineering fees related to our oil and gas
operations, and continued expenditures for professional fees associated with
acquisitions of additional oil and gas properties and compliance with SEC public
reporting and corporate governance requirements.
Loss (Profit) From Limited Partnerships and Limited Liability Companies
Loss from limited partnerships and limited liability companies includes
the income or losses that we recognize from the financial performance of the oil
and gas limited partnerships and limited liability companies in which we own an
equity interest of greater than 5% but less than 50% of the applicable entity.
Loss from limited partnerships and limited liability companies increased
$550,284 to $555,019 for the three month period ended March 31, 2005 from $4,735
for the three months ended March 31, 2004. The loss from limited partnerships
and limited liability companies consisted primarily of the $400,000 loss that we
recognized from the Maverick Basin Project, the $62,885 loss that we recognized
from the Louisiana Shelf Project and the $86,338 loss that we recognized from
the Vicksburg Project. Since most of our equity interests in oil and gas
entities are currently greater than 5% but less than 50% of the applicable
entity's equity interests, and since we intend to make similar equity
investments in additional limited partnerships and limited liability companies
in the future, we expect loss (profit) from limited partnerships and limited
liability companies to continue to constitute a material component of our
overall financial performance for the foreseeable future.
21
Interest Expense
Interest expense consists of certain non-cash charges and interest accrued
on our various debt obligations. Interest expense increased $575,141 to $596,220
for the three month period ended March 31, 2005 from $21,079 for the three month
period ended March 31, 2004. The increase of $575,141 resulted primarily from
non-cash charges of $110,849 associated with the beneficial conversion feature
of the convertible promissory note due to Westwood AR, Inc. (the "Westwood
Note"), non-cash charges of $335,423 associated with the beneficial conversion
features of the convertible promissory note due to DDH Resources II, Ltd. ("DDH
Note") and the ascribed value of the warrants issued with the DDH Note, and
$114,078 of interest expense under our various term debt obligations issued for
the purpose of funding our oil and gas exploration and development business.
Specifically, we incurred interest expense of $60,312 under the convertible
promissory note due to Trident Growth Fund, LP, $24,658 under the Westwood Note
and $29,589 under the DDH Note. We may incur similar non-cash charges in the
future and expect interest expense under our various debt obligations to remain
constant for the foreseeable future.
Minority Interest and Pre-Acquisition (Profits) Losses
Minority interest consists of the aggregate profits and losses from the
operations of each of our consolidated subsidiaries (entities in which we own
greater than 50% of the outstanding equity interest) allocated to our minority
interest holders. Minority interest increased $257,393 to $258,352 for the three
month period ended March 31, 2005 from $959 for the three month period ended
March 31, 2004. The increase of $257,393 resulted primarily from the increased
net losses incurred by our consolidated subsidiaries.
Pre-acquisition (profits) losses consist of the aggregate profits and
losses from operations of each of our consolidated subsidiaries (entities in
which we own greater than 50% of the outstanding equity interests) allocated to
prior ownership of certain of our consolidated subsidiaries. Pre-acquisition
losses decreased $461,270 to zero for the three month period ended March 31,
2005 from $461,270 for the three month period ended March 31, 2004 since our
acquisitions of our consolidated subsidiaries all occurred in 2004. Since our
consolidated subsidiaries currently own the majority of our interests in oil and
gas projects, and since we intend to acquire interests in additional entities
that may be considered consolidated entities in the future, we expect minority
interest and pre-acquisition (profits) losses to continue to constitute a
material component of our overall financial performance for the foreseeable
future.
Liquidity and Capital Resources
Since our inception, we have funded our operations primarily through
private sales of equity securities and the use of short-term and long-term debt.
As of March 31, 2005, we had a cash balance of $5,381,631.
Net cash used in operating activities was $654,644 for the three month
period ended March 31, 2005 compared to $5,357 for the three month period ended
March 31, 2004. The $649,287 increase in cash used in operating activities was
primarily due to increases in loss before preferred dividends of $2,336,969 and
accounts receivable of $718,246. These amounts were partially offset by an
increase in accounts payable of $1,433,524, an increase in loss from our various
equity investments in limited partnerships and limited liability companies of
$550,284 and $790,177 of non-cash charges related to impairment of oil and gas
properties.
Net cash used in investing activities was $1,472,275 for the three month
period ended March 31, 2005 compared to $1,478,285 for the three month period
ended March 31, 2004. Although the amount of cash used in investing activities
remained virtually constant, we invested 1,915,900 in limited partnership
interests during the three month period ended March 31, 2005 as compared to
$1,483,000 (inclusive of a $350,000 deposit) during the three month period ended
March 31, 2004. This increase was offset by a $500,000 refund of payments for
oil and gas interests related to Knox Miss Partners.
22
Net cash provided by financing activities was $5,346,580 for the three
month period ended March 31, 2005 compared to $1,914,000 for the three month
period ended March 31, 2004. The $3,432,580 increase in net cash provided by
financing activities was due primarily to an increase in net proceeds from sales
of our equity securities.
At March 31, 2005, we had a working capital deficit of $2,190,352,
compared to a working capital deficit of $1,312,131 at December 31, 2004. The
$878,221 decrease in working capital was due primarily to an increase in
accounts payable and accrued expenses of $1,433,524, an increase in the current
portion of the convertible debentures payable of $2,516,270 and a decrease in
prepaid expenses of $1,231,322. These amounts were partially offset by a
$3,647,696 increase in cash and a $718,246 increase in accounts receivable.
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 was originally 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 that 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 extended the maturity date of the Trident Note to March 24, 2006,
waived compliance with certain negative covenants to permit us to issue up to
$12 million in promissory notes and waived compliance with all financial
covenants contained in the Trident Note until March 24, 2006. The current
outstanding balance of the Trident Note is $2,050,000.
In connection with the issuance of the Trident Note and the extension of
the maturity date of the Trident Note, we issued to Trident warrants to purchase
250,000 shares of our common stock at an exercise price of $1.00 per share and
warrants to purchase 100,000 shares of our common stock at an exercise price of
$1.20 per share, respectively. The warrants are immediately exercisable and
terminate 10 years from the date of grant.
On February 21, 2005, we completed a private offering of common stock and
warrants for which we received aggregate gross proceeds of $879,590. The shares
of common stock and warrants were issued in units at a purchase price of $2.10
per unit. Each unit consisted of two shares of common stock and one warrant. The
warrants are immediately exercisable at an exercise price of $2.00 per share and
terminate three years from the date of grant.
23
On April 19, 2005 we completed two concurrent offerings of units comprised
of shares of our Series A Convertible Preferred Stock and warrants. Each unit
was comprised of one share of our Series A Convertible Preferred Stock and one
warrant and were sold for a purchase price of $11.00 per unit. As of April 19,
we sold 710,063 units for aggregate gross proceeds of $7,810,693.
Each share of our Series A Convertible Preferred Stock is initially
convertible into ten shares of our common stock at an initial conversion price
of $1.10 per share. Holders of our Series A Convertible Preferred Stock are
entitled to receive dividends at the rate of eight percent (8%) per annum,
provided, however, that at the option of the holder, such dividends shall be
payable in kind at the rate of 12% per annum by issuance of shares of our common
stock having a fair market value equal to the amount of the dividend. Our Series
A Convertible Preferred Stock is convertible at any time at the discretion of
the holder, and is subject to mandatory conversion in the event that: (i) there
is an effective registration statement covering the public sale of the shares of
our common stock underlying the Series A Convertible Preferred Stock; and (ii)
the volume weighted average closing price per share of our common stock for 20
consecutive trading days is equal to or greater than 150% of the conversion
price. If, prior to June 30, 2005, we issue additional shares of our common
stock or securities convertible or exercisable into shares of our common stock
in certain capital-raising transactions for consideration that is less than the
conversion price of the Series A Convertible Preferred Stock, the conversion
price of our shares of Series A Convertible Preferred Stock will automatically
be adjusted to a price equal to the aggregate consideration per share received
by us for the issuance of such securities.
Each warrant is exercisable at an initial exercise price of $1.50 per
share and terminates three years after the date of issuance. If, prior to June
30, 2005, we issue additional warrants or options in certain capital-raising
transactions that have an exercise price that is less than the exercise price of
the warrants, the exercise price of the warrants will automatically be adjusted
to a price equal to the exercise price per share of such other warrants or
options. The warrants are subject to a call provision that provides that if the
volume weighted average closing price per share of our common stock for 20
consecutive trading days following the effectiveness of the registration of the
shares underlying the warrants is equal to or greater than 150% of the then
applicable exercise price, we may call the warrants for surrender 15 business
days after we provide written notice to the holders. If the warrants are not
exercised during the 15 business day period, they will terminate.
The foregoing constitutes our principal sources of financing during the
past three months. We do not currently maintain a line of credit or term loan
with any commercial bank or other financial institution.
We will need significant funds to meet capital calls, drilling and
production costs in our various oil and gas projects to explore, produce,
develop, and eventually sell the underlying oil and gas reserves. Specifically,
we expect to incur capital calls and production costs of approximately $8.5
million with respect to our various limited partnership and limited liability
company interests during the next 12 months as follows (each amount an
approximation):
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o $750,000 for exploration costs in the Awakino South Project;
o $1,600,000 for exploration and operating costs in the Knox Miss
Project;
o $1,100,000 for exploration and operating costs in the Louisiana
Shelf Project;
o $800,000 for exploration and operating costs in the Good Friday
Project;
o $600,000 for exploration and operating costs in the La Paloma
Project;
o $600,000 for exploration and operating costs in the Martinez Ranch
Project;
o $500,000 for exploration and operating costs in the Maverick Basin
Project;
o $300,000 for exploration and operating costs in the Vicksburg
Project;
o $1,300,000 for exploration and operating costs in the Vela Project;
and
o $1,000,000 for exploration and operating costs in the Wharton
Project.
We do not expect to incur any capital calls or production costs with respect to
our limited partnership interest and limited liability company interest in the
Stent Project and the Pierce Ranch Project, respectively, 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 also need significant funds to meet our obligations under our
outstanding term indebtedness during the next 12 months. Specifically, we will
need to repay approximately $4.1 million of term indebtedness during the next 12
months if the underlying notes are not converted into shares of our common stock
as follows:
o $1,000,000 outstanding under a convertible promissory note to DDH
Resources II, Ltd. due May 18, 2005;
o $1,000,000 outstanding under a convertible promissory note to
Westwood AR, Inc. due August 31, 2005; and
o $2,050,000 outstanding under a secured convertible promissory note
to Trident due March 24, 2006.
In addition, Touchstone Louisiana, Inc., our wholly-owned subsidiary,
issued a $2,000,000 promissory note (the "Endeavour Note") to Endeavour
International Corporation as partial consideration for the purchase of our
interest in the Louisiana Shelf Project. The Endeavour Note accrues interest at
the rate of three percent (3%) per annum. The repayment of principal and payment
of accrued interest under the Endeavour Note is contingent upon the completion
of the first producing oil or gas well in the project and, thereafter, is based
on the production level of all oil and gas wells in the project. In addition,
the Endeavour Note contains accelerated payment provisions in the event certain
production levels for any of the oil and gas wells are met or exceeded. We
expect payments to commence during our third fiscal quarter of 2005.
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As of the date of this report, we have cash resources of approximately
$4.3 million. We will need a total of approximately $14.1 million to execute our
business plan, satisfy capital calls, and pay drilling and production costs on
our various interests in oil and gas prospects during the next 12 months. Of
this amount, we will need approximately $8.5 million for capital calls and
production costs with respect to our various limited partnership and limited
liability company interests, approximately $4.1 million to repay our outstanding
term indebtedness, and approximately $1.5 million for general corporate
expenses. In the event 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 foregoing amounts during the next
12 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, make such term debt payments and operate at current levels for the next
12 months. Accordingly, we will be required to raise additional funds through
sales of our securities or otherwise. 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 projects.
Off-Balance Sheet Arrangements
As of March 31, 2005, we did not have any relationships with
unconsolidated entities or financial partners, such as entities often referred
to as structured finance or special purpose entities, which had been established
for the purpose of facilitating off-balance sheet arrangements or other
contractually narrow or limited purposes. As such, we are not materially exposed
to any financing, liquidity, market or credit risk that could arise if we had
engaged in such relationships.
Recent Accounting Pronouncements
In December 2004, FASB issued Statement of Financial Accounting Standards
No. 123R, "Share-Based Payment" ("SFAS No. 123R"), which revised Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation." SFAS No. 123R establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. This Statement focuses primarily on accounting for transactions in
which an entity obtains employee services in share-based payment transactions.
SFAS No. 123R requires that the fair value of such equity instruments be
recognized as expense in the historical financial statements as services are
performed. Prior to SFAS No. 123R, only certain pro forma disclosures of fair
value were required. SFAS No. 123R will be effective for small business issuers
as of the beginning of the first interim or annual reporting period that begins
after December 15, 2005. The Company cannot estimate the impact of adopting SFAS
No. 123R because it will depend on levels of share-based payments granted in the
future, but based solely upon the pro-forma disclosure for prior periods it
believes that the impact will not be material to its results of operations.
For a more complete discussion of our accounting policies and procedures,
see our Notes to Condensed Consolidated Financial Statements beginning on page
5.
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.
26
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On March 23, 2005, we issued warrants to Trident Growth Fund, L.P.
("Trident") to purchase 100,000 shares of our common stock at an exercise price
of $1.20 per share. The warrants are immediately exercisable and terminate 10
years from the date of grant. We issued the warrants in connection with
Trident's agreement to extend the maturity date of that certain $2,100,000
principal amount secured convertible promissory note to March 24, 2006 and to
waive compliance with all financial covenants contained in the promissory note
until March 24, 2006. 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 6. Exhibits.
Exhibit No. Exhibit
----------- -------
31.1 Certification of Chief Executive Officer of the Company required
by Rule 13a-14(a) under the Securities Exchange Act of 1934, as
amended
31.2 Certification of Treasurer of the Company required by Rule
13a-14(a) under the Securities Exchange Act of 1934, as amended
32.1 Certification of Chief Executive Officer and Treasurer of the
Company required by Rule 13a-14(b) under the Securities Exchange
Act of 1934, as amended
27
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: May 16, 2005 /s/ Stephen P. Harrington
--------------------------------------
Stephen P. Harrington
Chief Executive Officer, President and
Treasurer
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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
28