UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
(MARK ONE)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2005
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ________________
Commission File Number 0-17325
ERHC ENERGY INC.
(Exact name of registrant as specified in its charter)
Colorado 88-0218499
(State of Incorporation) (I.R.S. Employer Identification No.)
5444 Westheimer Road
Suite 1570
Houston, Texas 77056
(Address of principal executive offices, including zip code.)
(713) 626-4700
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 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 |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
Yes |X| No |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
The number of common shares outstanding as of February 7, 2006 was 710,912,226.
TABLE OF CONTENTS
ERHC ENERGY INC.
Part I. Financial Information Page
------
Item 1. Financial Statements
Consolidated Balance Sheets at December 31, 2005
and September 30, 2005 3
Consolidated Statements of Operations for the Three Months Ended
December 31, 2005 and 2004 4
Consolidated Statements of Cash Flows for the Three Months Ended
December 31, 2005 and 2004 5
Notes to the Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 13
Item 4. Controls and Procedures 13
Part II. Other Information
Item 1. Legal Proceedings 16
Item 2. Unregistered Sale of Securities and Use of Proceeds 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 16
Signatures 17
2
ERHC ENERGY INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
December 31, 2005 and September 30, 2005
- --------------------------------------------------------------------------------
December 31, September 30,
2005 2005
--------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents $ 352,700 $ 988,490
Prepaid expenses and other current assets 10,000 32,093
--------------- ---------------
Total current assets 362,700 1,020,583
DRSTP concession fee 5,679,000 5,679,000
Furniture and equipment, net 18,352 20,627
--------------- ---------------
Total assets $ 6,060,052 $ 6,720,210
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued liabilities $ 184,539 $ 192,634
Accounts payable and accrued liabilities, related party 2,138,417 2,064,675
Accrued interest 3,650 3,189
Asset retirement obligation 485,000 485,000
Current portion of convertible debt 33,513 33,513
--------------- ---------------
Total current liabilities 2,845,119 2,779,011
--------------- ---------------
Commitments and contingencies:
Shareholders' equity:
Preferred stock, par value $0.0001; authorized
10,000,000; none issued and outstanding -- --
Common stock, par value $0.0001; authorized 950,000,000
shares; issued and outstanding 710,912,226 shares 71,091 71,091
Additional paid-in capital 83,780,537 83,584,956
Accumulated deficit (80,636,695) (79,407,711)
Deferred compensation -- (307,137)
--------------- ---------------
Total shareholders' equity 3,214,933 3,941,199
--------------- ---------------
Total liabilities and shareholders' equity $ 6,060,052 $ 6,720,210
=============== ===============
The accompanying notes are an integral part of these financial statements
3
ERHC ENERGY INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Three Months Ended December 31, 2005 and 2004
- --------------------------------------------------------------------------------
2005 2004
-------------- --------------
General and administrative expenses $ 1,232,792 $ 643,235
-------------- --------------
Other income and (expenses):
Interest income 4,269 --
Interest expense (461) (698,258)
Loss on extinguishment of debt -- (5,749,575)
-------------- --------------
Total other income and expenses, net 3,808 (6,447,833)
-------------- --------------
Net loss $ (1,228,984) $ (7,091,068)
============== ==============
Net loss per common share - basic
and diluted $ (0.00) $ (0.01)
============== ==============
Weighted average number of common
shares outstanding - basic and diluted 710,912,226 603,273,708
============== ==============
The accompanying notes are an integral part of these financial statements
4
ERHC ENERGY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Three Months Ended December 31, 2005 and 2004
- --------------------------------------------------------------------------------
2005 2004
--------------- ---------------
Cash Flows From Operating Activities
Net loss $ (1,228,984) $ (7,091,068)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation expense 2,275 --
Compensatory stock options 502,718 63,750
Amortization of beneficial conversion feature
associated with convertible debt 413,503
Loss on extinguishment of debt 5,749,575
Changes in operating assets and liabilities:
Prepaid expenses and other current assets 22,093 --
Accounts payable and other accrued liabilities (8,095) 83,240
Accounts payable, and accrued liabilities
related party 73,742 59,603
Accrued interest 461 284,756
--------------- ---------------
Net cash used by operating activities (635,790) (436,641)
--------------- ---------------
Cash Flows From Financing Activities:
Proceeds from line of credit, related party -- 1,000,000
Proceeds from convertible debt, related party -- 402,099
Repayment of convertible debt, related party -- (70,400)
--------------- ---------------
Net cash provided by financing activities -- 1,331,699
--------------- ---------------
Net increase (decrease) in cash and cash equivalents (635,790) 895,058
Cash and cash equivalents, beginning of period 988,490 20,272
--------------- ---------------
Cash and cash equivalents, end of period $ 352,700 $ 915,330
=============== ===============
The accompanying notes are an integral part of these financial statements
5
ERHC Energy Inc.
Notes to Consolidated Financial Statements
(Unaudited)
- --------------------------------------------------------------------------------
Note 1 - Business Organization
The consolidated financial statements included herein, which have not been
audited pursuant to the rules and regulations of the Securities and Exchange
Commission, reflect all adjustments which, in the opinion of management, are
necessary to present a fair statement of the results for the interim periods on
a basis consistent with the annual audited financial statements. All such
adjustments are of a normal recurring nature. The results of operations for the
interim periods are not necessarily indicative of the results to be expected for
an entire year. Certain information, accounting policies and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been omitted pursuant to such rules and regulations, although the Company
believes that the disclosures are adequate to make the information presented not
misleading. These financial statements should be read in conjunction with the
Company's audited financial statements included in the Company's Annual Report
on Form 10-K for the year ended September 30, 2005.
General Business and Nature of Operations and Significant Accounting Policies
ERHC Energy Inc. ("ERHC" or the "Company") is an independent oil and gas
company. The Company was formed in 1986, as a Colorado corporation, and was
engaged in a variety of businesses until 1996, when it began its current
operations as an independent oil and gas company. The Company's goal is to
maximize its value through exploration and exploitation of oil and gas reserves
in the Gulf of Guinea offshore of central West Africa. The Company's current
focus is to exploit its only assets, which are rights to working interest in
exploration acreage in the Joint Development Zone ("JDZ") between the Democratic
Republic of Sao Tome & Principe ("DRSTP") and the Federal Republic of Nigeria
("FRN") and in the exclusive territorial waters of Sao Tome (the "Exclusive
Economic Zone" or "EEZ"). The Company has formed relationships with upstream oil
and gas companies to assist the Company in exploiting its assets in the JDZ. The
Company currently has no other operations.
Consolidated Financial Statements
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiary after elimination of all significant inter-company
accounts and transactions.
Use of Estimates
The consolidated financial statements have been prepared in conformity with U.S.
generally accepted accounting principles. In preparing the consolidated
financial statements, management is required 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
revenues and expenses during the reporting period for the quarters then ended.
Actual results could differ significantly from those estimates.
Stock-Based Compensation
As more fully discussed below in Note 6, the Company adopted Statement of
Financial Accounting Standards ("SFAS") No. 123R, Share-Based Payment effective
October 1, 2005. The Company adopted the modified prospective transition method
provided under SFAS No. 123R and consequently has not retroactively adjusted
results for prior periods.
Reclassifications
During the year ended September 30, 2005, the Company corrected a 1,222,153
understatement in the number of shares of common stock outstanding that has
consistently existed for many years. The shares were issued at a time when the
stock had no significant value, accordingly, the correction of outstanding
shares resulted in a $122 increase in common stock and a corresponding decrease
in additional paid-in capital. All periods presented have been corrected to
include these additional shares.
Note 2 - Going Concern
The Company's current liabilities exceed its current assets by $2,482,419 at
December 31, 2005. The Company has incurred net losses since inception. These
conditions raise substantial doubt as to the ability of the Company to continue
as a going concern. The Company is in ongoing negotiations to raise general
operating funds and funds for specific projects. Management will be required to,
and expects to, raise additional capital through the issuance of debt securities
and offerings of equity securities to fund the Company's operations, and will
attempt to continue raising capital resources until such time as the Company
generates revenues sufficient to maintain itself as a viable entity. However,
there is no assurance that such financing will be obtained.
6
ERHC Energy Inc.
Notes to Consolidated Financial Statements
(Unaudited)
- --------------------------------------------------------------------------------
The Company's current focus is to exploit its only assets, which are agreements
with the DRSTP concerning oil and natural gas exploration in Sao Tome, an island
nation located in the Gulf of Guinea off the coast of central West Africa, and
in a JDZ between Sao Tome and the FRN. The Company has formed relationships with
other oil and gas companies having technical and financial capabilities to
assist the Company in leveraging its interests in the JDZ. Should circumstances
impede the Company's progress in negotiating production-sharing contracts to
develop its interests in the 2001 Agreement and the 2003 Option Agreement with
DRSTP, the Company's business would be adversely affected. Should the Company
complete successful negotiations of production sharing contracts, there is no
certainty that the Company and its joint venture partner(s) will be able to
successfully develop the Company's interests. The Company currently has no other
operations.
The Company expects to continue borrowing funds from Chrome in the future but
there is no assurance that funds will be made available or under similar terms.
If the Company is successful in its efforts to negotiate production-sharing
contracts, it expects that those contracts will provide cash to the Company for
continued operations. In prior years, the Company was able to raise funds in a
timely manner, but there is no assurance that it will continue to do so in the
future. The accompanying financial statements have been prepared on the
assumption that the Company will continue as a going concern. If the Company is
unable to continue as a going concern, the values realized from the Company's
assets may be less than the carrying amounts reported in its financial
statements. The accompanying financial statements do not include any adjustments
relating to the recoverability and classification of asset carrying amounts or
the amount and classification of liabilities that might result should the
Company be unable to continue as a going concern.
Note 3 - Sao Tome Concession
Concession Fee Payment
The 1997 Agreement required the Company to pay a $5,000,000 concession fee to
the DRSTP.
In October 1999, the DRSTP claimed that the Company had breached certain terms
of the 1997 Agreement and announced a termination of the Agreement. The Company
immediately exercised its rights to have the matter settled via international
arbitration in accordance with the terms of the 1997 Agreement.
Concession Fee Agreement
In May 1997, the Company entered into an exclusive joint venture with the DRSTP
(the "1997 Agreement"). On May 21, 2001, the 1997 Agreement was replaced by a
Memorandum of Agreement (the "2001 Agreement"), which was embodied in a Consent
Award issued by the arbitrator as a result of the satisfaction of several
conditions, including the ratification of a treaty between the FRN and the
DRSTP. The 2001 Agreement gives the Company rights to participate in exploration
and production activities in both the exclusive territorial waters of Sao Tome
referred to as the EEZ and an area between Sao Tome and the FRN that the two
nations have designated as the JDZ.
After the acquisition by Chrome in February 2001, the Company initiated
negotiations with the DRSTP concurrent with the arbitration process. On May 21,
2001, the Company and the DRSTP reached the 2001 Agreement, witnessed by the
FRN, which replaced the 1997 Agreement and suspended the arbitration process. In
July 2002, the 2001 Agreement was embodied in a Consent Award issued by the
arbitrator as a result of the satisfaction of several conditions, including the
ratification of a treaty between the FRN and the DRSTP relative to the JDZ
between the countries, and will remain in effect through September 30, 2024.
In April 2003, the Company and DRSTP entered into an Option Agreement (the "2003
Option Agreement") in which the Company relinquished certain financial interests
in the JDZ in exchange for exploration rights in the JDZ. In April 2003, the
Company additionally entered into an administration agreement with the
Nigeria-Sao Tome and Principe Joint Development Authority ("JDA"). The
administration agreement is the formal agreement by the JDA that it will fully
implement ERHC's preferential rights to working interests in the JDZ acreage as
set forth in the 2003 Option Agreement and describes certain procedures
regarding the exercising of these rights. However, ERHC retained under the 2001
Agreement the following rights to participate in exploration and production
activities in the EEZ subject to certain restrictions: (a) right to receive up
to two blocks of ERHC's choice, and (b) the option to acquire up to a 15% paid
working interest in up to two blocks of ERHC's choice in the EEZ. The Company
will be required to pay its proportionate share of the signature bonus and all
other costs related to the exploration and exploitation of the blocks in the
EEZ.
Under the 2003 Option Agreement, ERHC may exercise options to acquire fractional
working interests in six (6) of the nine (9) blocks that have been announced by
the JDA and will be available for bidding in the JDZ. A block is an area
designated as an individual unit for exploration or production of crude oil and
natural gas. Additionally, the amount of signature bonus that is payable by ERHC
to acquire these working interests is zero in four (4) blocks. ERHC must pay its
proportionate share of any signature bonuses in two (2) blocks.
7
ERHC Energy Inc.
Notes to Consolidated Financial Statements
(Unaudited)
- --------------------------------------------------------------------------------
On April 13, 2004, the Company submitted a letter to the JDA exercising its
option rights in the JDZ. The options exercised by the Company were:
Option Pick-ERHC Working Interest
Choice Percentage JDZ Block # Signature Bonus Payable
- ----------------------- -------------------- --------------- ------------------------------------------
1 15% 6 Signature Bonus Free
2 15% 5 100% of 15% of the total Signature Bonus
3 20% 3 Signature Bonus Free
4 30% 2 Signature Bonus Free
5 25% 4 Signature Bonus Free
6 20% 9 100% of 20% of the total Signature Bonus
This exercise of the Company's rights was subject to the condition that if no
license is awarded or a license is awarded and subsequently withdrawn by the JDA
prior to the commencement of operations, ERHC will be entitled to receive its
working interest in that block in a future license awarded for the block.
On April 26, 2004, the Company announced that, at meetings on April 23rd and
24th, 2004, the Joint Ministerial Council ("JMC") of the JDZ acknowledged the
Company's option selections for award of interests pursuant to the exercise of
rights under the April 7, 2003 Administration Agreement.
In August 2004, the Company entered into a Participation Agreement with Pioneer
whereby the companies will jointly apply for rights in the production-sharing
contract for Block 2 of the JDZ.
In September 2004, the Company entered into a Participation Agreement with Noble
whereby the companies will jointly apply for rights in the production sharing
contract for Block 4 of the JDZ.
In December 2004, the Company entered into a Participation Agreement with
Pioneer under which the companies jointly applied for rights in the
production-sharing contract for Block 3 of the JDZ.
In May 2005, the JDA announced the awards for the blocks in the 2004 JDZ
Licensing Round as follows:
o In Block 2, the Pioneer and ERHC group was awarded 35% interest as a
result of the joint bid submitted by the companies. In addition the
JDA confirmed the award to ERHC of its 30% Option Interest, free of
any signature bonus.
o In Block 3, the Pioneer and ERHC group was awarded 5% interest as a
result of the joint bid submitted by the companies. In addition the
JDA confirmed the award to ERHC of its 20% Option Interest, free of
any signature bonus.
o In Block 4 the Noble and ERHC group was awarded 35% interest as a
result of the joint bid submitted by the companies. In addition the
JDA confirmed the award to ERHC of its 25% Option Interest, free of
any signature bonus. The Company originally formed a relationship
with Noble Energy Resources ("Noble") to negotiate a production
sharing agreement for Block 4. However, Noble subsequently withdrew
from negotiations and the company has entered into an agreement with
Addax Petroleum ("Addax") under which Addax will replace Noble in
the ERHC/Noble group. Approval for Addax to participate in Block 4
has been requested from the JDA.
o In Block 5, the JDA confirmed the award to ERHC of its 15% Option
Interest, with signature bonus payable.
o In Block 6, the JDA confirmed the award to ERHC of its 15% Option
Interest, free of any signature bonus payable.
In June 2005, ERHC accepted the awards by the JDA for Blocks 2, 3, 4, 5 and 6,
subject to the execution of a mutually acceptable production-sharing contract
and joint operating agreement for each block.
The above is only a brief summary of the terms of the 2001 Agreement and the
2003 Option Agreement and such summaries do not purport to be complete and are
qualified in their entirety by reference to the 2001 Agreement and 2003 Option
Agreement, respectively (any and all related documents).
8
ERHC Energy Inc.
Notes to Consolidated Financial Statements
(Unaudited)
- --------------------------------------------------------------------------------
Note 4 - Notes Payable
As of December 31, 2005, the Company had $33,513 of nonaffiliated convertible
debt and $3,650 accrued but unpaid interest outstanding. As of December 31,
2005, if the outstanding convertible debt and accrued interest were converted
using the conversion price of $0.20 per share, the Company would be required to
issue 185,815 shares of common stock.
Note 5 - Shareholders' Equity
Under three consulting agreements with the Company, 1,750,000 options were
granted to consultants on December 31, 2005. These options have an exercise
price of $0.20 per share with no expiration date. The Company recognized
consulting expense of $401,100 during the quarter ended December 31, 2005
related to the fair value of these options. Upon adoption of Statement of
Financial Accounting Standards No. 123R (as discussed in Note 6) the Company
also recognized $101,618 in expense related to the fair value computation of an
employee's options.
Note 6 - Stock-Based Compensation
During the year ended September 30, 2004, the Company issued options to purchase
3,000,000 shares of common stock to an employee as part of his initial
compensation package. These options have an adjusted exercise price of $0.20 per
share, with 1,000,000 options vesting on September 1, 2004, August 1, 2005 and
August 1, 2006.
Effective October 1, 2005, the Company began recording compensation expense
associated with stock options and other forms of equity compensation in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 123R,
Share-Based Payment, as interpreted by SEC Staff Accounting Bulletin No. 107.
Prior to October 1, 2005, the Company had accounted for stock options according
to the provisions of Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations, and
therefore no related compensation expense was recorded for awards granted with
no intrinsic value. The Company adopted the modified prospective transition
method provided for under SFAS No. 123R, and, consequently, has not
retroactively adjusted results from prior periods. Under this transition method,
compensation cost associated with stock options recognized in the first quarter
of Fiscal 2006 includes: 1) quarterly amortization related to the remaining
unvested portion of all stock option awards granted prior to October 1, 2005,
based on the grant date fair value estimated in accordance with the original
provisions of SFAS No. 123; and 2) quarterly amortization related to all stock
option awards granted subsequent to July 1, 2005, based on the grant-date fair
value estimated in accordance with the provisions of SFAS No. 123R.
Stock awards outstanding under the Company's current plans have generally been
granted at prices which are equal to the market value of the Company's stock on
the date of grant, generally vest over one year and bear no expiration date.
Effective October 1, 2005, the Company began recognizing compensation expense
ratably over the vesting period, net of estimated forfeitures. At December 31,
2005, there was $304,854 of unrecognized compensation cost related to nonvested
options, which is expected to be recognized over a remaining weighted-average
vesting period of eight months. No options were granted or exercised during the
three months ended December 31, 2005.
During the quarter ended December 31, 2004, the Company recognized $63,750 in
share-based compensation expense. Had compensation cost for our share-based
compensation plan been determined consistent with SFAS No. 123R, the Company's
net income and earnings per share would have been reduced to the following pro
forma amounts (in thousands, except per share data):
Description 2004
- ------------------------------------------------------------------------------------ ---------------
Net loss - as reported $ (7,091,068)
Plus: stock-based compensation expense determined
using the intrinsic value of the option at the
measurement date 63,750
Less: stock-based employee compensation determined
under fair value method for all awards granted to
Employees (107,479)
-----------------
Net loss - pro forma $ (7,134,797)
=================
Basic and diluted net loss per share - as reported $ (0.01)
=================
Basic and diluted net loss per share - pro forma $ (0.01)
=================
9
ERHC Energy Inc.
Notes to Consolidated Financial Statements
(Unaudited)
- --------------------------------------------------------------------------------
The fair values of the options granted under the Company's fixed stock option
plans were estimated on the date of grant using the Black-Scholes option-pricing
model with the following assumptions:
Assumptions 2005 2004
- ------------------------------------------------------------------ --------------- ---------------
Expected life (years) 5.00 years 3.58 years
Interest rate 3.47% 4.00%
Dividend yield 0.00% 0.00%
Volatility (Based on historical experience) 88.4% 107.00%
The Black-Scholes option-pricing model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in subjective input
assumptions can materially affect the fair value estimate, the actual value
realized at the time the options are exercised may differ from the estimated
values computed above.
Note 7 - Commitments and Contingencies
Contingencies
From time to time, certain potential obligations are presented to the Company
that may have originated during periods not under existing management's control.
These alleged obligations are generally for goods and services for which the
Company has no record. The Company actively investigates these claims as they
arise. All known material obligations of the Company have been recorded and
reflected in the financial statements, but there is no certainty that all
material claims have been presented to the Company nor have the benefits of
available statutes of limitations been considered, should they apply.
Employment and Consulting Agreements
From August 1, 2004 until January 20, 2006, Mr. Ali Memon was the Company's
President and Chief Executive Officer. Mr. Memon had a three-year employment
agreement that originally included a base salary of $150,000 per year. On
January 25, 2005, the Board of Directors approved an increase in Mr. Memon's
salary from $150,000 to $200,000 per year for the remaining term of the
contract, beginning January 1, 2005, and expiring July 31, 2007. See subsequent
event at Note 9.
Effective January 1, 2005, the Company entered into consulting agreements with
two individuals, which require payment of cash and issuance of options for a
total of 1,250,000 shares of common stock upon completion of a full year of
service which was met on December 31, 2005. These options have an exercise price
of $0.20 per share and will vest immediately upon issuance and will have no
expiration date. Either party may terminate these consulting agreements with 30
days notice. The options issued under these consulting agreements include
provisions for cashless exercise.
Effective January 1, 2005, the Company entered into a consulting agreement with
an individual which requires payment of cash and the issuance of options for a
total of 500,000 shares of common stock upon a full year of service which was
met on December 31, 2005 (This agreement was signed September 1, 2005, but was
effective at January 1, 2005). These options have an exercise price of $0.20 per
share and will vest immediately upon issuance and will have no expiration date.
Either party may terminate these consulting agreements with 30 days notice. The
options issued under these consulting agreements include provisions for cashless
exercise.
In August 2005, the Company entered into an agreement with a consulting group to
identify and introduce to the Company oil and gas acquisition opportunities in
Nigeria. The Company is required to pay a base fee of $1,000 per month. In
addition the Company shall pay a success fee of $75,000 per successful
acquisition, as defined. The agreement has a term of one year but expires
immediately upon the 30 day written notice of termination by either party,
without penalty to either party.
In August 2005, the Company entered into an agreement with a consulting group to
identify and introduce to the Company oil and gas acquisition interests in
oil/mining leases granted by the government of the Federal Republic of Nigeria.
The Company is required to pay a base fee of $1,000 per month. In addition the
Company shall pay a success fee of $80,000 per successful acquisition, as
defined. The agreement also provides for the payment of legal fees per
successful transaction, as defined. The agreement has a term of one year but
expires immediately upon the 30 day written notice of termination by either
party, without penalty to either party.
10
ERHC Energy Inc.
Notes to Consolidated Financial Statements
(Unaudited)
- --------------------------------------------------------------------------------
Operating Lease
The Company leases office space at 5444 Westheimer Road, Houston, Texas. The
lease for office space expires February 2006. The monthly base rent payment is
$3,567 based on approximately 1,900 square feet of office space. Upon expiration
of its current lease, the Company expects to lease the same space or comparable
space in the normal course of business.
Note 8 - Supplemental Disclosure of Cash Flow Information
Following is an analysis of non-cash operating and financing activities and
non-cash investing and financing activities for the three months ended December
31, 2005 and 2004.
2005 2004
--------------- ---------------
Non-cash operating and financing activities: Stock issued in exchange for:
Accounts payable and accrued liabilities $ -- $ 175,645
Accrued interest -- 84,852
Accrued interest, related party -- 2,620,295
Non-cash investing and financing activities:
Stock issued for conversion of non-related
party debt to equity -- 1,592,521
Beneficial conversion feature associated with
convertible debt -- 347,517
Exchange of convertible and non convertible
debt, related party -- 10,134,084
Note 9 - Subsequent Event
On January 20, 2006, by mutual agreement with the Board of Directors, Ali Memon
resigned as Director and Chief Executive Officer of the Company. On January 21,
2006, the Board of Directors appointed Walter Brandhuber as Director and Chief
Executive Officer. Mr. Brandhuber's employment agreement is for a period of 36
months and provides for a base salary of $200,000 per year, payable monthly.
Further, the employment agreement provides incentive compensation based on Board
approval and on attainment of performance targets as mutually agreed between the
Board and Mr. Brandhuber. The Company will recognize approximately $623,000 of
expense in the second quarter of 2006 related to Mr. Memon's agreement.
On January 30, 2006, the JDA notified the Company of its approval of the
ERHC/Addax Petroleum ("Addax") Consortium as operator of JDZ Block 4. On
February 6 2006, Pioneer informed the JDA, the Minister of Petroleum of Nigeria
and ERHC of its decision to withdraw from the consortium participating in Blocks
2 and 3.
On February 7, 2006, ERHC entered into a memorandum of understanding with
Sinopec and Addax Petroleum regarding the entry into a participation agreement
whereby Sinopec and Addax will replace Pioneer in the consortium's 35% interest
in Block 2. Further, on February 7, 2006 ERHC entered into a memorandum of
understanding with Addax regarding the entry into a participation agreement
whereby Addax will replace Pioneer in the consortium's 5% interest in Block 3.
Both memorandums of understanding have been submitted for approval by the JDA.
11
Forward Looking Statements
This report contains forward-looking statements. These statements relate to
future events or ERHC Energy Inc.'s ("Company" or "ERHC") future financial
performance and involve known and unknown risks, uncertainties and other factors
that may cause ERHC or its industry's actual results, levels of activity,
performance or achievements to be materially different from any future results,
levels of activity, performance or achievements expressed or implied by the
forward-looking statements.
In some cases, you can identify forward-looking statements by terminology such
as "may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential," or the negative of these terms or other
comparable terminology. These statements are only predictions. Actual events or
results may differ materially.
Although the Company believes that the expectations reflected in the
forward-looking statements are reasonable, there can be no guarantee of future
results, levels of activity, performance, or achievements. Moreover, neither the
Company nor any other person assumes responsibility for the accuracy and
completeness of these forward-looking statements. The Company is under no duty
to update any of the forward-looking statements after the date of this report to
conform prior statements to actual results.
Item 2. Management's Discussion and Analysis of Financial Condition and Plan of
Operations
You must read the following discussion of the results of the operations and
financial condition of the Company in conjunction with its financial statements,
including the notes included in its Form 10-K filing. The Company's historical
results are not necessarily an indication of trends in operating results for any
future period.
Overview
The Company's current focus is to exploit its only assets, which are rights to
working interests in exploration acreage in the JDZ and the EEZ. The Company has
entered into agreements with upstream oil and gas companies to jointly negotiate
production sharing contracts in these JDZ Blocks. The technical and operational
expertise in conducting exploration operations will be provided by the Company's
co-ventures.
Results of Operations
Three Months Ended December 31, 2005 Compared with Three Months Ended December
31, 2004
During the three months ended December 31, 2005, the Company incurred a net loss
of $1,228,984, compared to a net loss of $7,091,068 for the three months ended
December 31, 2004. A significant portion of the decrease in net loss for the
three months ended December 31, 2005 was attributable to a $5,749,575 non-cash
loss on extinguishment of debt during the three months ended December 31, 2004
as the result of the issuance of shares in conjunction with the Chrome debt
restructuring. Interest expense decreased by $697,797 due to conversion of the
outstanding convertible debt during the three months ended December 31, 2004.
General and administrative expenses increased by $589,557 for the three months
ended December 31, 2005 as compared to the three months ended December 31, 2004
primarily due to $401,100 in consulting charges in the period for the fair value
calculation of options issued to consultants.
Through December 31, 2004, the Company was a party to a management services
agreement with COS. Pursuant to that agreement, COS provided the Company with
management and business development services. COS provided these services to the
Company for a management fee of $68,000 per month. The Chief Financial Officer
and Secretary were consultants to COS that provided services to the Company and
these persons received salaries and overhead expense reimbursement from COS, not
from the Company. Expenses not covered under the management services agreement
were paid by the Company, which includes primarily general office supplies.
During each of the three months ended December 31, 2004 total expenses incurred
under this management services agreement were $208,000. On December 23, 2004,
the Company and COS cancelled, effective December 31, 2004, the management
services agreement.
The Company's executive officers incurred significant travel expenses of
approximately $75,000 and $96,000 for the quarters ended December 31, 2005 and
2004, respectively, as they continued negotiations with officials of the FRN and
DRSTP as well as numerous trips to the United States from Nigeria by several
Chrome executives while managing the ongoing affairs of the Company. The Company
anticipates travel related expenses to continue to be significant as the Company
further develops its business interests.
During the quarters ended December 31, 2005 and 2004, the Company had no
revenues from which cash flows could be generated to support operations and thus
relied on borrowings funded from its line of credit provided by Chrome as well
as the sale of common stock.
12
Liquidity and Capital Resources
As of December 31, 2005, the Company had $352,700 in cash and cash equivalents
and negative working capital of $2,482,419. Historically, the Company has
financed its operations from the sale on a best-efforts basis of debt and equity
securities (including the issuance of its securities in exchange for goods and
services). There have been no cash flows generated from operations in the past
two years.
Management will be required to raise additional capital through the sale on a
best-efforts basis of common stock and debt securities, and will attempt to
continue raising capital resources until such time as the Company generates
revenues sufficient to maintain itself as a viable entity. It is expected that a
minimum of $2,500,000 will need to be raised to fund working capital
requirements in fiscal 2006. However, there is no assurance that such financing
will be obtained.
The Company presently intends to utilize any available sources of funds to
provide for general corporate overhead and to continue to pursue its interests
in Sao Tome and the JDZ/EEZ. If the Company is successful in negotiating
production sharing contracts in Blocks 2, 3 and 4, the Company expects to
receive funding from its partners that will support its operations.
Debt Financing Arrangements
At December 31, 2005, the Company had $33,513 of convertible debt and $3,650
accrued but unpaid interest outstanding. At December 31, 2005, if the
outstanding convertible debt plus accrued interest were converted using the
conversion price of $0.20 per share, the Company would be required to issue
185,815 shares of common stock.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company's current focus is to exploit its only assets, which are rights to
working interests in the JDZ and EEZ under agreements with the JDA and DRSTP.
The Company has formed relationships with other oil and gas companies with
technical and financial capabilities to assist the Company in leveraging its
interests in the JDZ. The Company also intends to form relationships with other
oil and gas companies with technical and financial capabilities to assist the
Company in leveraging its interests in the EEZ. Should circumstances impede the
Company from perfecting its interests in the 2001 Agreement with DRSTP or the
2003 Option Agreement, the Company's business would be materially affected.
Should the Company perfect its interests in the 2001 Agreement and the 2003
Option Agreement, there is no certainty that the Company will be able to obtain
sufficient financial and other resources to develop its interests. The Company
currently has no other operations.
At December 31, 2005, all of the Company's operations were located outside the
United States. The Company's only assets are agreements with DRSTP and the JDA,
which provide ERHC with rights to participate in exploration and production
activities in the Gulf of Guinea off the coast of central West Africa. Foreign
governments that have historically experienced volatility, which is out of
management's control, control this geographic area of interest. The Company's
ability to exploit its interests in the agreements it this area may be impacted
by this circumstance. The future success of the Company's international
operations may also be adversely affected by risks associated with international
activities, including economic and labor conditions, political instability, risk
of war, expropriation, renegotiation or modification of existing contracts, tax
laws (including host-country import-export, excise and income taxes and United
States taxes on foreign subsidiaries) etc. Also changes in exchange rates may
adversely affect the Company's future results of operations and financial
condition.
Market risks relating to the Company's operations result primarily from changes
in interest rates as well as credit risk concentrations. The Company's interest
expense is generally not sensitive to changes in the general level of interest
rates in the United States, particularly because a substantial majority of its
indebtedness is at fixed rates.
The Company holds no derivative financial or commodity instruments, nor does it
engage in any foreign currency denominated transactions.
Item 4. Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's reports under
the Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms, and that such information is
accumulated and communicated to management, including the Company's Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure. The Company's management, with
participation of the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Company's disclosure controls
and procedures as of the end of the quarter covered by this Quarterly Report on
Form 10-Q. As described below under Management's Report on Internal Control Over
Financial Reporting, the Company has identified material weaknesses in the
Company's internal control over financial reporting (as defined in Exchange Act
Rules 13a-15(f) and 15d-15(f)). The Company's Chief Executive Officer and Chief
Financial Officer have concluded that as a result of the material weaknesses, as
of the end of the period covered by this Quarterly Report on Form 10-Q, the
Company's disclosure controls and procedures were not effective.
13
Management's Report on Internal Control over Financial Reporting
The management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting as defined in Rules 13a-15(f)
and 15d-15(f) under the Securities Exchange Act of 1934. The Company's internal
control over financial reporting is designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles in the United States of America. The Company's internal
control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of the
Company; (ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of
the Company are being made only in accordance with authorizations of management
and directors of the Company; and (iii) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use or disposition
of the Company's assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate. Management assessed the
effectiveness of the Company's internal control over financial reporting as of
September 30, 2005. In making this assessment, management used the criteria set
forth by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) in Internal Control-Integrated Framework.
Based on our assessment and those criteria, management has concluded that the
Company did not maintain effective internal control over financial reporting as
of December 31, 2005 as a result of material weaknesses in (a) internal controls
surrounding corporate governance, and (b) internal controls surrounding the
accounting for common stock issuances.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected.
Internal Controls Surrounding Corporate Governance: The principal factors
contributing to the material weakness in corporate governance are as follows:
|X| Inadequate number of independent directors.
|X| Lack of independent audit committee.
|X| Lack of audit committee financial expert.
If these weaknesses are not addressed, they could result in material
misstatements of annual or interim financial statements that might not be
detected, corrected or disclosed in a timely manner, or at all.
Internal Controls Surrounding the Accounting for Transactions Involving Common
Stock: The principal factor contributing to the material weakness in the
accounting for issuances of shares of common stock is based on:
|X| The existence of differences in the number of shares of common stock
outstanding as reflected in the Company's accounting records and
prior financial reports and the number reported by the Company's
stock transfer agent that resulted in a change in previously issued
financial statements at September 30, 2005.
|X| An error in accounting for conversion of debt to equity that
occurred in fiscal 2005 and resulted in a $347,517 audit adjustment
at September 30, 2005.
The Company's independent registered public accounting firm has audited
management's assessment of the effectiveness of the Company's internal control
over financial reporting as of September 30, 2005, as stated in their report
which appears on page F-2 of the Company's September 30, 2005 Form 10-K under
the heading, Report of Independent Registered Public Accounting Firm.
Remediation Plans for Material Weaknesses in Internal Control over Financial
Reporting
14
Corporate Governance
The Company has retained an executive recruiting firm to aid them in a search of
an independent financial expert to chair the audit committee. The Company is
also is the process of amending their Audit Committee Charter to include the
responsibilities of the financial expert and to ensure independent directors
fill all positions on the committee.
Accounting for Stock Issuances
The Company is implementing enhancements to its internal control over financial
reporting to provide reasonable assurance those errors and control deficiencies
in its accounting for stock issuances will not recur. These steps include the
engagement of independent financial reporting consultants for review of critical
accounting areas and disclosures and material non-standard transactions.
Until these changes are completed, weaknesses will continue to exist. Management
presently anticipates that the changes necessary to remediate these weaknesses
will be in place by the conclusion of the 2006 fiscal year.
Changes in Internal Control over Financial Reporting
Except as otherwise discussed herein, there have been no changes in our internal
control over financial reporting during the most recently completed fiscal
quarter that have materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
15
Part II. Other Information
Item 1. Legal Proceedings
The Company is not aware of any material legal proceedings pending to which it
is a party or its property is subject. From time to time, the Company may be
subject to proceedings, lawsuits and other claims in the ordinary course of
business, the resolution of which, in the opinion of management should not have
a materially adverse effect on the Company's financial position. The Company is
opposing vigorously each of the claims discussed below and intends to continue
to do so unless an agreeable resolution may otherwise be secured with regard to
each such claim.
Item 2. Unregistered Sale of Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
In August 2004, the Company entered into a participation agreement with Pioneer
Natural Resources ("Pioneer") whereby the companies jointly applied for rights
in the production sharing contract for Block 2 of the Joint Development Zone. In
December 2004, the Company entered into a participation agreement with Pioneer
whereby the companies jointly applied for rights in the production sharing
contract for Block 3 of the Joint Development Zone.
In May 2005, the Nigeria-Sao Tome and Principe Joint Development Authority
("JDA") awarded the ERHC / Pioneer consortium a 35% interest in Block 2, and a
5% interest in Block 3. On February 6 2006, Pioneer informed the JDA, the
Minister of Petroleum of Nigeria and ERHC of its decision to withdraw from the
consortium participating in Blocks 2 and 3.
On February 7, 2006, ERHC entered into a memorandum of understanding with
Sinopec and Addax Petroleum ("Addax") regarding the entry into a participation
agreement whereby Sinopec and Addax will replace Pioneer in the consortium's 35%
interest in Block 2. Further, on February 7, 2006 ERHC entered into a memorandum
of understanding with Addax regarding the entry into a participation agreement
whereby Addax will replace Pioneer in the consortium's 5% interest in Block 3.
Both memorandums of understanding have been submitted for approval by the JDA.
Item 6. Exhibits and Reports on Form 8-K
EXHIBIT NO. IDENTIFICATION OF EXHIBIT
- ---------- -------------------------
10.9* Employment Agreement with Walter Brandhuber
31.1* Certification Pursuant to 18 U.S.C Section 7241, as adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
31.2* Certification Pursuant to 18 U.S.C Section 7241, as adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
32.1* Certification Pursuant to 18 U.S.C Section 1350, as adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
32.2* Certification Pursuant to 18 U.S.C Section 1350, as adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
- ----------
*Filed herein
16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
following persons, in the capacities and on the dates indicated below, have
signed this report.
ERHC Energy, Inc.
Name Title Date
---- ----- ----
/s/ Walter Brandhuber President & Chief Executive Officer February 8, 2006
- ---------------------
Walter Brandhuber
/s/ Cosmas (Ike) Okpala Chief Financial Officer February 8, 2006
- -----------------------
Cosmas (Ike) Okpala
17