UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB/A-1
(Amendment No. 1)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended: September 30, 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.)
1600 Smith Street
Suite 5100
Houston, TX 77002
-------------------------------------
(Address of Principal Executive Offices)
(713) 784-1113
---------------------------------------
(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 [_]
Indicate by check mark whether the registrant is a shell company (as
defined in rule 12b-2 of the Exchange Act).
Yes [_] No [X]
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 68,811,773 issued
and outstanding shares of the registrant's common stock, par value $.001 per
share, as of November 10, 2005.
Transitional Small Business Disclosure Format (check one):
Yes [_] No [X]
EXPLANATORY NOTE
Touchstone Resources, Inc. ("the Company") is filing this Amendment No. 1
("the Amendment") to our Quarterly Report on Form 10-QSB for the three-month
period ended September 30, 2005 filed with the Securities and Exchange
Commission ("SEC") on November 14, 2005 ("the Original Report") to restate our
financial statements for the quarter then ended. During the course of its audit
of our financial statements, our independent auditors notified us about recent
guidance issued by the Securities and Exchange Commission Staff related to the
evaluation of registration rights agreements, convertible preferred stock,
convertible debt and warrant instruments for possible application of derivative
accounting under Statement of Financial Accounting Standard No 133: Accounting
for Derivative Instruments and Hedging Activities, Emerging Issues Task Force
("EITF") 00-19: Accounting for Derivative Financial Instrument Indexed to, and
Potentially Settled in, a Company's Own Stock, EITF 01-6: The Meaning of
"Indexed to a Company's Own Stock", EITF 05-2: The Meaning of "Conventional
Convertible Debt Instrument" in Issue No. 00-19 and various related EITF's.
After analyzing these issues, we concluded that the registration rights
agreements related to our Series A Preferred Stock and related warrants, were
subject to derivative accounting and determined that the fair value of the
forgoing registration rights at September 30, 2005 was $798,817. As a result, we
have restated our statement of operations for the three and nine month periods
ending September 30, 2005 from the amounts previously reported. The restatement
includes an adjustment to (i) record an additional amount of registration rights
penalty expense in the amount of $621,791 and (ii) record a corresponding
increase to liabilities.
Corresponding revisions have been made to Management's Discussion and
Analysis appearing in Item 2 of Part I of this Amendment.
With the exception of the events set forth in Note 15 appearing in Item 2
of Part I of this Amendment, this Amendment does not reflect events that have
occurred after November 14, 2005, the date the Original Report was filed with
the SEC, nor does it modify or update the disclosures set forth in the Original
Report, except to reflect the effects of the restatement of the condensed
consolidated financial statements for the period ended September 30, 2005 and
corresponding changes to Item 2 of Part I, or as deemed necessary in connection
with the completion of such financial statements. Information with respect to
any such events has been or will be set forth, as appropriate, in our filings
with the SEC subsequent to November 14, 2005. We have supplemented Item 6 of
Part II of this Amendment to include current certifications of our chief
executive officer and chief financial officer pursuant to Sections 302 and 906
of the Sarbanes-Oxley Act of 2002, filed as Exhibits 31.1, 31.2 and 32 to this
Amendment. The remaining information contained in this Amendment, which consists
of all other information originally contained in the Original Report, is not
amended hereby, but is included for the convenience of the reader.
TOUCHSTONE RESOURCES USA, INC.
QUARTERLY REPORT ON FORM 10-QSB
FOR FISCAL QUARTER ENDED SEPTEMBER 30, 2005
(Amendment No. 1)
TABLE OF CONTENTS
Page
----
PART I
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - (Unaudited).............. 2
Condensed Consolidated Statements of Operations - (Unaudited).... 3
Condensed Consolidated Statements of Cash Flows - (Unaudited).... 4
Notes to Condensed Consolidated Financial Statements............. 5
Item 2. Management's Discussion and Analysis............................... 21
Item 3. Controls and Procedures............................................ 34
PART II
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........ 36
Item 5. Other Information.................................................. 37
Item 6. Exhibits........................................................... 37
Signature.................................................................. 38
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Condensed Consolidated Balance Sheets
ASSETS
September 30, December 31,
2005 2004
-------------- -------------
(Unaudited) (Audited)
Current assets
Cash and cash equivalents $ 4,756,056 $ 594,182
Restricted cash - joint interest 596,524 1,139,753
Accounts receivable - joint interest 1,978,847 2,945,421
Accounts receivable - joint interest related party 984,592 3,354,468
Notes and interest receivable 89,105 66,559
Due from related party 959,898 188,588
Prepaid expenses and advances to operators 250,836 1,593,079
-------------- --------------
Total current assets 9,615,858 9,882,050
Undeveloped oil and gas interests, using successful efforts 4,775,721 4,763,311
Investment in limited partnerships and liability companies 5,149,370 6,117,046
Fixed assets, net 51,733 50,958
Deposits 26,720 30,149
-------------- --------------
$ 19,619,402 $ 20,843,514
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses $ 2,522,798 $ 854,798
Accounts payable - joint interest 4,021,612 8,224,332
Notes payable 517,123 618,223
Notes payable - related party 59,493 216,541
Limited partnership subscriptions payable 122,226 200,000
Convertible debentures, net 3,050,000 1,080,287
-------------- --------------
Total current liabilities 10,293,352 11,194,181
-------------- --------------
Note payable - noncurrent 1,819,000 1,819,000
Convertible debenture - noncurrent - 2,050,000
-------------- --------------
1,819,000 3,869,000
-------------- --------------
Total liabilities 12,112,252 15,063,181
-------------- --------------
Commitment and contingencies
Minority interest 2,954,774 3,078,820
Stockholders' equity
Preferred stock; $.001 par value; authorized - 5,000,000 shares; shares
issued and outstanding - 710,063 at September 30, 2005 and 0 at
December 31, 2004; Liquidation preference: $8,119,021 710 -
Common stock; $.001 par value; authorized - 150,000,000 shares;
shares issued and outstanding - 62,204,551 and 3,918,332 issuable
at September 30, 2005 and 59,919,053 issued and outstanding
and 649,476 issuable at December 31, 2004 66,123 60,569
Additional paid-in capital 32,608,815 18,338,476
Deferred compensation - (16,600)
Deficit accumulated during the development stage (28,123,272) (15,680,932)
-------------- --------------
Total stockholders' equity 4,552,376 2,701,513
-------------- --------------
$ 19,619,402 $ 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)
For the Three Months For the Nine Months March 5, 2001
Ended September 30, Ended September 30, (Inception) to
------------------------------------------------------------------ September 30,
2005 2004 2005 2004 2005
--------------- ------------- -------------- -------------- ---------------
Operator revenues $ 46,361 $ 60,316 $ 240,211 $ 144,253 $ 441,020
--------------- ------------- -------------- -------------- ---------------
Expenses:
Exploration expenses 2,527 - 54,702 112,748 1,556,100
Impairment of oil and gas properties 446,233 20,221 1,185,684 1,333,466 1,361,504
Impairment of goodwill - - - - 657,914
Bad debt expense - - - 15,454 15,454
General and administrative 623,422 837,507 2,426,744 1,806,005 4,819,867
--------------- ------------- -------------- -------------- ---------------
Total expenses 1,072,182 857,728 3,661,130 3,267,673 8,410,839
--------------- ------------- -------------- -------------- ---------------
Loss from operations (1,025,821) (797,412) (3,426,919) (3,123,420) (7,969,819)
--------------- ------------- -------------- -------------- ---------------
Other (income) expense
Loss from limited partnerships
and limited liability companies 1,063,286 604,276 4,377,222 717,760 7,883,466
Impairment of equity investment - - - - 139,502
Interest income (13,490) (687) (24,114) (8,301) (32,919)
Interest expense 496,464 288,510 1,600,697 7,252,307 9,568,895
Registration rights penalty 798,817 - 798,817 - 798,817
Total other expense 2,345,077 892,099 6,752,622 7,961,766 18,357,761
--------------- ------------- -------------- -------------- ---------------
Loss before minority interest and
pre-acquisition losses (3,370,898) (1,689,511) (10,179,541) (11,085,186) (26,327,580)
--------------- ------------- -------------- -------------- ---------------
Addback:
Minority interest 6,062 106,013 301,548 480,737 557,342
Pre-acquisition losses - - - 211,315 211,315
--------------- ------------- -------------- -------------- ---------------
Total minority interest and
pre-acquisition losses 6,062 106,013 301,548 692,052 768,657
--------------- ------------- -------------- -------------- ---------------
Net loss (3,364,836) (1,583,498) (9,877,993) (10,393,134) (25,558,923)
Preferred dividend on Series A (320,988) - (2,564,349) - (2,564,349)
--------------- ------------- -------------- -------------- ---------------
Net loss to common shareholders $ (3,685,824) $(1,583,498) $(12,442,342) $(10,393,134) $ (28,123,272)
=============== ============= ============== ============== ===============
Net loss per common share -
basic and diluted $ (0.06) $ (0.03) $ (0.20) $ (0.12) $ (0.23)
=============== ============= ============== ============== ================
Weighted average number of common shares
outstanding - basic and diluted 62,466,843 59,531,635 61,454,487 85,799,555 122,517,724
=============== ============== ============== ============== ================
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended
September 30, March 5, 2001
--------------------------------- (Inception) to
2005 2004 September 30, 2005
--------------------------------- ------------------
Cash flows from operating activities
Net cash used in operating activities $ (2,082,459) $ (595,811) $ (4,073,983)
--------------- --------------- ----------------
Cash flows from investing activities
Cash acquired from acquisition of wholly-owned subsidiaries
and limited partnership interest - 510,273 4,715
Repayment of note receivable - related party 2,000 6,250 23,639
Notes receivable (23,050) (30,000) (204,419)
Notes receivable - related party (752,000) (184,549) (806,975)
Purchase of oil and gas interests and drilling costs (460,120) (2,548,420) (2,788,573)
Refund of oil and gas prepayment 500,000 - 500,000
Investment in limited partnership interests (3,559,820) (7,319,654) (11,646,695)
Distributions from limited partnerships 72,500 - 98,885
Purchase of fixed assets (12,731) 10,835 (39,672)
--------------- --------------- ------------------
Net cash used in investing activities (4,233,221) (9,555,265) (14,859,095)
--------------- --------------- ------------------
Cash flows from financing activities
Advances from stockholder - - 10,000
Repayments to stockholder - - (10,000)
Proceeds from notes payable - 925,100 807,100
Proceeds from notes payable - related party - 146,468 279,000
Repayment of notes payable (101,100) (5,253,600) (5,446,100)
Repayment of notes payable - related party (157,048) (76,000) (248,548)
Proceeds from issuance of convertible debt - 9,990,000 11,090,000
Repayment of convertible debt - (150,000) -
Loan costs - (121,500) (104,000)
Capital contributed by officer - 15,000 15,000
Minority contributions, net of issuance costs 116,690 3,425,500 3,442,190
Proceeds from issuance of preferred stock, net of issuance costs 6,940,081 2,559,250 6,940,081
Proceeds from issuance of common stock, net of issuance costs 3,678,931 - 6,914,411
--------------- --------------- ------------------
Net cash provided by financing activities 10,477,554 11,460,218 23,689,134
Net increase in cash and cash equivalents 4,161,874 1,309,142 4,756,056
Cash and cash equivalents at beginning of year 594,182 91,578 -
--------------- --------------- ------------------
Cash and cash equivalents, end of period $ 4,756,056 $ 1,400,720 $ 4,756,056
=============== =============== ==================
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.
Touchstone follows the provisions of SFAS No. 123. As permitted under SFAS No.
123, Touchstone continues to utilize Accounting Principles Board ("APB") No. 25
in accounting for its stock-based compensation to employees. Had compensation
expense for the three months and nine months ended September 30, 2005 and 2004
been determined under the fair value provisions of SFAS No. 123, as amended by
SFAS 148, Touchstone's net loss to common shareholders and net loss per share
would have been as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------- ------------------------------------
2005 2004 2005 2004
-------------- --------------- ---------------- ----------------
Net loss, to common stockholders
as reported $ (3,685,824) $ (1,583,498) $ (12,442,342) $ (10,393,134)
Add: Stock-based employee
compensation expense included
in reported net income determined
under APB No. 25, net of related
tax effects - - - -
Deduct: Total stock-based employee
compensation expense determined
under fair-value-based method for
all awards, net of related tax (346,088) - (346,088) -
effects
-------------- --------------- ---------------- ---------------
Pro forma net income to common
stockholders $ (4,031,912) $ (1,583,498) $ (12,788,430) $ (10,393,134)
-------------- --------------- ---------------- ----------------
Net loss per common share:
Basic and diluted - as reported $ (0.06) $ (0.03) $ (0.20) $ (0.12)
Basic and diluted - pro forma $ (0.06) $ (0.03) $ (0.21) $ (0.12)
5
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
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 New Zealand, Inc. ("Touchstone New Zealand"), formerly known
as Touchstone Awakino, Inc. ("Touchstone Awakino"), a wholly-owned
Delaware corporation incorporated in March 2004
o Touchstone Louisiana, Inc. ("Touchstone Louisiana"), a wholly-owned
Delaware corporation incorporated in March 2004
o Touchstone Texas Properties, Inc. ("Touchstone Properties"), formerly
known as 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 Oklahoma, LLC ("Touchstone Oklahoma"), formerly known as
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
o CE Operating, LLC ("CE Operating"), a wholly-owned Oklahoma limited
liability company formed in May 2005
All significant intercompany accounts and transactions have been eliminated in
consolidation.
6
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
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 nine months ended September 30, 2005 and 2004 by
geographical area were as follows:
September 30,
------------------------------
2005 2004
------------- ------------
United States $ 240,211 $ 144,253
New Zealand - -
------------- ------------
$ 240,211 $ 144,253
============= ============
Operating revenues for the three months ended September 30, 2005 and 2004 by
geographical area were as follows:
September 30,
------------------------------
2005 2004
------------- ------------
United States $ 46,361 60,316
New Zealand - -
------------- ------------
$ 46,361 $ 60,316
============= ============
Long-lived assets as of September 30, 2005 and December 31, 2004 by geographical
area were as follows:
September 30, December 31,
2005 2004
------------- ------------
United States $ 9,861,173 $ 10,669,066
New Zealand 115,651 262,249
------------- ------------
$ 9,976,824 $ 10,931,315
============= ============
7
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
Loss per share
Loss per common share is calculated in accordance with SFAS No. 128, "Earnings
Per Share." Basic loss per common share is computed by dividing net loss
attributable to common stockholders by the weighted average number of common
shares outstanding. Diluted loss per share is computed similarly to basic loss
per share except that the denominator is increased to 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 related to the three
months ended March 31, 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:
Nine Months Ended
September 30,
----------------------------------
2005 2004
---------------- -----------------
Warrants 13,413,671 5,256,250
Options 4,967,540 -
Convertible debt 3,050,000 3,100,000
Series A convertible preferred stock 7,100,630 -
---------------- -----------------
28,531,841 8,356,250
================ =================
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 from private offerings of securities and
its current and projected revenues from oil and gas operations will be
sufficient to fund its operations through September 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.
8
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 5 - DUE FROM RELATED PARTY
As of September 30, 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 $750,000 to Awakino South Exploration, LLC ("Awakino"),
a limited liability company in which the Company has an equity interest, and
$35,000 to Touchstone Resources, Ltd. ("Touchstone Canada"). 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
(approximately $752,000 less a reserve for collection of $650,393) from
Touchstone Canada for payment of accounts payable, which Touchstone Canada had
agreed to assume prior to the Company's acquisition of Touchstone Texas.
NOTE 6 - OIL AND GAS PROSPECTS
PF Louisiana, LLC
On August 11, 2005, PF Louisiana elected not to make the delay rental payment on
State Lease #18219 located in Ibera Parish, Louisiana. This resulted in PF
Louisiana impairing its total investment in the lease in the amount of $447,921.
Touchstone Oklahoma, LLC
On August 31, 2005, Touchstone Oklahoma, entered into a farmout agreement with
Checotah Exploration, LP. Touchstone Oklahoma acquired approximately 10,600 net
mineral acres in McIntosh County, Oklahoma for $350,000. The agreement calls for
the drilling of two test wells in which Touchstone Oklahoma will be responsible
for the first $1,000,000 in costs; after which the costs of drilling will be
split equally between Touchstone Oklahoma and Checotah Exploration, LP. Upon
successful completion of the two test wells ("additional wells"), Touchstone
Oklahoma will earn a 25% working interest in and to the farmout acreage. After
completion of the two test wells, Touchstone Oklahoma has the right to drill two
or more test wells in which Touchstone Oklahoma will be responsible for the
first $1,000,000 in costs; after which the costs of drilling will be split
equally between Touchstone Oklahoma and Checotah Exploration, LP. Upon
successful completion of the additional wells, Touchstone Oklahoma will earn an
additional 25% working interest in and to the farmout acreage (cumulative
working interest of 50%).
CE Operating, LLC
In September 2005, the Company acquired one hundred percent (100%) of the
membership interest of CE Operating, LLC, a qualified Oklahoma oil and gas
operator, from Austex Production Company, LLC for $8,000. The Company
subsequently contributed $150,000 to CE Operating. CE Operating purchased two
certificates of deposit in the amount of twenty-five thousand dollars ($25,000)
to back letters of credit required by governmental authorities of the State of
Oklahoma. The Company serves as the sole and managing member.
NOTE 7 - EQUITY INTERESTS IN OIL AND GAS PROPERTIES
Checotah Pipeline, LLC
In September 2005, the Company formed Checotah Pipeline, LLC. The Company owns
50% of the membership interest of the limited liability company, with Checotah
Exploration, LP owning the other 50%. The Company contributed $45,000 in initial
capital to the limited liability company, which was used to fund acquisition of
a gathering system in McIntosh County, Oklahoma. The Company and the other
member of the limited liability company may be subject to capital calls as
necessary to fund the operation, maintenance, and expansion of the pipeline. The
company will serve as managing member.
9
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
The following table summarizes the Company's interests in oil and gas non-public
limited partnerships accounted for under the equity method of accounting:
September 30, 2005 December 31, 2004
-------------------------------------- --------------------------------------
Temporary Temporary
Excess of Excess of
Carrying Value Carrying Value
Carrying Value Over Net Assets Carrying Value Over Net Assets
-------------- ---------------- ---------------- ----------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
PHT Vicksburg Partners, LP $ 604,275 $ 80,592 $ 404,552 $ 47,631
Awakino South Exploration, LLC 115,651 - 252,154 -
PHT Stent Partners, LP - - 10,094 47,616
Louisiana Shelf Partners, LP 2,558,866 1,224,874 2,484,428 1,219,497
PHT Wharton Partners, LP 112,818 - 234,665 -
PHT Vela Partners, LP 340,703 11,387 449,919 68,987
PHT Good Friday Partners, LP 351,750 31,832 812,737 190,347
PHT Martinez Partners, LP 835,645 28,252 833,981 36,151
PHT La Paloma Partners, LP 175,521 135,724 625,375 73,166
Maverick Basin Exploration, LLC - - - 345,850
Checotah Pipeline, LLC 45,000 - - -
LS Gas, LLC 1,000 1,000 1,000 1,000
2001 Hackberry Drilling Fund Partners, LP 8,141 - 8,141 -
-------------- ---------------- ---------------- ----------------
$ 5,149,370 $ 1,513,661 $ 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 September 30, 2005 and December 31, 2004 and has been
compiled from the financial statements of the respective entities:
September 30, 2005 December 31, 2004
------------------ -----------------
(Unaudited) (Unaudited)
Total Assets $ 25,121,794 $ 30,760,273
================= =================
Total Liabilities $ 8,043,079 $ 7,352,041
================= =================
Nine Months Ended September 30, Three Months Ended September 30,
----------------------------------------- -------------------------------------
2005 2004 2005 2004
-------------------- ----------------- ---------------- ----------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Results of Operations:
Revenue $ 1,433,388 $ 482,014 $ 528,205 $ 431,097
Loss from Operations $ (29,994,664) $ (4,700,409) $(5,816,595) $(3,169,824)
Net Loss $ (29,994,664) $ (4,700,409) $(5,816,595) $(3,169,824)
10
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 8 - NOTES PAYABLE
The following schedule summarizes the current and non-current portion of
Company's debts as of September 30, 2005:
Payable to Current Non-current Total
- ---------------------------------- ----------------- ------------------ -----------------
2001 Hackberry Drilling Fund, LP 59,493 - 59,493
----------------- ------------------ -----------------
Subtotal - related parties 59,493 - 59,493
-----------------
IL Resources 110,000 - 110,000
South Oil 87,500 - 87,500
John Paul Dejoria 128,857 - 128,857
Other 9,766 - 9,766
Endeavour 181,000 1,819,000 2,000,000
----------------- ------------------ -----------------
Subtotal 517,123 1,819,000 2,336,123
----------------- ------------------ -----------------
$ 576,616 $ 1,819,000 $ 2,395,616
================= ================== =================
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 International Corporation 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
=============== =============== ================
11
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 9 - CONVERTIBLE DEBENTURES
Convertible debentures consisted of the following at:
September 30, 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
-------------- ---------------
3,050,000 4,050,000
Less unamortized discount - 919,713
-------------- ---------------
3,050,000 3,130,287
Less long-term portion - 2,050,000
-------------- ---------------
Current portion of convertible debentures $ 3,050,000 $ 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 waiving all financial
covenants on the convertible note. The warrants are exercisable immediately and
expire on March 31, 2014.
On May 16, 2005, the Company entered into an agreement with DDH Resources II,
Limited, to extend the maturity date of its outstanding convertible note from
May 18, 2005 to May 18, 2006, in consideration for which the Company reduced the
conversion price of the note from $1.10 to $1.00 and issued an additional
100,000 warrants which had an ascribed value of $14,000, to purchase common
stock at $2.00 per share. The warrants are exercisable immediately and expire
November 2007.
On August 18, 2005, the Company entered into an agreement with Westwood AR, Inc.
("Westwood AR"), to amend the conversion rights of the convertible note dated
May 27, 2004. The note was amended so that Westwood AR could convert, all or any
part, of the original principal amount of the note, plus accrued interest into
units consisting of two (2) shares of common stock and one (1) three-year common
stock purchase warrant for $1.50 per common share; and 2 membership interests in
Knox Gas, LLC. The conversion price per unit was stated to be $1.80. On August
19, 2005, Westwood AR converted the entire principal, plus accrued interest into
623,897 units and two membership interests in Knox Gas, LLC. The Company issued
1,247,794 shares of its common stock and 623,897 three-year warrants with an
exercise price of $1.50 per share.
Under Financial Accounting Standard ("FAS") No. 84, "Induced Conversions of
Convertible Debt an amendment of APB Opinion No. 26," the Company's amendment of
the convertible note was deemed as an inducement for Westwood AR to convert the
note. Accordingly, the value of the inducement to convert the promissory note
was recorded as interest expense in the amount of $280,324.
During August 2005, as defined in the 12% Secured convertible note agreement
with Trident Growth Fund ("Trident"), the options granted to Roger Abel
triggered a reset provision. The note has been reset to a conversion price of
$0.86, the exercise price of Mr. Abel's options. Since the reset price was
greater than of fair market value of the stock on the date when the original
note was issued to Trident, no additional beneficial conversion expense was
recorded.
12
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 10 - 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.
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.
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. As of September 30, 2005, the Company has recorded an
accrued preferred stock dividend of $308,328.
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.
During March and April of 2005, the Company completed 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.
13
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
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. As of September 30, 2005, the Company has not yet
filed the registration statement. The Company therefore accrued $798,817 of
penalties for the period through September 30, 2005.
The first offering was conducted 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 on a "best efforts" basis solely
to a limited number of accredited investors who are not "U.S. persons" (the
"Regulation S Offering").
During March and April 2005, the Company sold 402,336 units in the Regulation D
Offering for aggregate gross proceeds of $4,425,696. The Company paid
commissions and expenses of $575,333 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. In addition, as compensation for
the services provided by Legend in connection with the Regulation D Offering,
the Company issued warrants to Legend to purchase 602,004 shares of common stock
at $1.50 that expire in three years.
During March and April 2005, the Company sold 307,727 units in the Regulation S
Offering for aggregate gross proceeds of $3,384,997. The Company paid investment
banking fees in the amount of $338,500 to independent third party consultants in
connection with this transaction. In addition, as compensation for services
provided by such consultants in connection with the Regulation S Offering, the
Company issued warrants to purchase 107,727 shares of common stock at $1.25 that
expire in three years.
As a result of the Regulation D and Regulation S Offerings during March and
April 2005, the Company has issued a total of 710,063 shares of Series A
preferred stock and warrants to purchase 3,550,315 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 $1,109,335 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 $1,146,686 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, $1.11 and $1.16 at each closing date. 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.
14
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
On May 26, 2005, the Company issued 200,000 shares of common stock to a
consultant in exchange for consulting services for one year. The shares were
valued at the Company's fair market value at the time of issuance in the amount
of $166,000 and fully expensed as of September 30, 2005.
On July 11, 2005, The Company's Board of Directors approved and commenced an
offering of up to 14,000,000 Units of its securities, each unit consisting of
two shares of the Company's common stock and one three-year $1.50 common stock
purchase warrant for a unit offering price of $1.80. The exercise price of the
warrants will be adjusted for stock splits, combinations, recapitalization and
stock dividends. In the event of a consolidation or merger in which we the
Company is not the surviving corporation (other than a merger with a wholly
owned subsidiary for the purpose of incorporating the Company in a different
jurisdiction), all holders of the warrants shall be given at least fifteen (15)
days notice of such transaction and shall be permitted to exercise the warrants
during such fifteen (15) day period. Upon expiration of such fifteen (15) day
period, the warrants shall terminate. The securities were issued in a private
placement transaction to a limited number of accredited investors pursuant to
the exemption from registration provided by Section 4(2) of the Securities Act
of 1933, as amended (the "Securities Act"), and Rule 506 of Regulation D. The
Company agreed to include the shares of common stock and shares of common stock
issuable upon exercise of the warrants in any registration statement (excluding
registration statements on SEC Forms S-4, S-8 or any similar or successor form)
they file with the Securities and Exchange Commission under the Securities Act
for the purpose of registering the public sale of any of our securities.
During August and September 2005, the Company sold 1,816,667 units in which
3,633,332 shares of common stock and 1,816,667 warrants were issued for an
purchase price of $3,270,000. The Company accrued broker fees of $181,600
related to this transaction.
Stock options
On September 30, 2005, the Company's Board of Directors adopted the Touchstone
Resources USA, Inc. 2005 Stock Incentive Plan (the "Plan"). The Plan reserves
10,000,000 shares of common stock for issuance pursuant to stock options, stock
appreciation rights, restricted stock awards, restricted stock units,
unrestricted stock awards, and other equity based or equity related awards to
employees, officers, directors, or advisors to the Company or any of the
Company's subsidiaries as well as individuals who have entered into an agreement
with the Company under which they will be employed by the Company or any of its
subsidiaries in the future. The Plan is administered by the Board of Directors
(the "Board") of the Company which has full and final authority to interpret the
Plan, select the persons to whom awards may be granted, and determine the amount
and terms of any award. In order to comply with certain rules and regulations of
the Securities and Exchange Commission or the Internal Revenue Code, the Board
can delegate authority to appropriate committees of the Board. Although the Plan
provides for the issuance of options that qualify as incentive stock options
("ISOs") under the Internal Revenue Code of 1986, as amended, since the Plan was
not approved by the Company's stockholders, the Company cannot issue ISOs unless
and until it obtains the requisite shareholder approval.
Stock options issued under the Plan have a term of no more than 10 years, an
exercise price equal to at least 85% of the fair market value of the Company's
common stock on the date of grant (100% in the case of ISOs), are subject to
vesting as determined by the Board, and unless otherwise determined by the
Board, may not be transferred except by will, the laws of descent and
distribution, or pursuant to a domestic relations order. Unless otherwise
determined by the Board, awards terminate three (3) months after termination of
employment or other association with the Company or one (1) year after
termination due to disability, or death or retirement. In the event that
termination of employment or association is for a cause, as that term is defined
in the Plan, awards terminate immediately upon such termination.
In connection with his employment, the Company issued an option to Mr. Abel to
purchase 4,876,540 shares of common stock at an exercise price of $.86 per
share, the last sales price of the Company's common stock as reported on the OTC
Bulletin Board on the date of grant. The option has a term of 7 years and vests
in two equal installments on August 15, 2006 and 2007 provided that Mr. Abel
remains continuously employed by the Company through the applicable vesting date
or is receiving severance payment from the Company in accordance with his
employment agreement. In the event that Mr. Abel is terminated for a cause
during this period, the option shall forthwith terminate. Unless Mr. Abel is
terminated for a cause, once vested, the option can be exercised at any time
prior to expiration.
15
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
On September 30, 2005, the Company issued a nonstatutory stock option under the
Plan to Jerry Walrath, it's Vice President of Land and Project Development, to
purchase 100,000 shares of common stock at an exercise price of $.96 per share,
the last sales price of it's common stock reported on the OTCBB on the date of
grant. The options vest in equal annual installments over a four-year period
commencing September 1, 2005 and are otherwise subject to the terms of the Plan.
Stock Warrants
On June 10, 2005, the Company issued warrants to purchase 250,000 shares of
common stock to Legend with ascribed value of $30,000, in consideration for the
consulting service Legend agreed to provide over a year. The warrants have an
exercise of $1.10 per share and expire in two years.
The Company had the following outstanding common stock warrants to purchase its
securities at September 30:
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 3,445,000 $ 2.00
June 2007 250,000 $ 1.10 - $ -
July 2007 1,561,250 $ 2.00 1,561,250 $ 2.00
November 2007 600,000 $ 2.00 - $ -
November and
December 2007 418,852 $ 2.00 - $ -
January 2008 87,959 $ 2.00 - $ -
March 2008 4,152,319 $ 1.50 - $ -
June 2008 107,727 $ 1.25 - $ -
August and
September 2008 2,440,564 $ 1.50 - $ -
March 2014 100,000 $ 0.86 - $ -
March 2014 250,000 $ 0.86 250,000 $ 1.00
---------------- ---------------
Common Stock 13,413,671 5,256,250
================ ===============
NOTE 11 - 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.
16
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 12 - COMMITMENTS AND CONTINGENCIES
General
Federal, state and local authorities regulate the oil and gas industry. In
particular, gas and oil production operations and economics are affected by
environmental protection statutes, tax statutes and other laws and regulations
relating to the petroleum industry, as well as changes in such laws, changing
administrative regulations and the interpretations and application of such laws,
rules and regulations. The Company believes it is in compliance with all
federal, state and local laws, regulations, and orders applicable to the Company
and its properties and operations, the violation of which would have a material
adverse effect on the Company or its financial condition.
Operating Hazards and Insurance
The gas and oil business involves a variety of operating risks, including the
risk of fire, explosions, blow-outs, pipe failure, abnormally pressured
formation, and environmental hazards such as oil spills, gas leaks, ruptures or
discharges of toxic gases, the occurrence of any of which could result in
substantial losses to the Company due to injury or loss of life, severe damage
to or destruction of property, natural resources and equipment, pollution or
other environmental damage, cleanup responsibilities, regulatory investigation
and penalties and suspension of operations.
In those projects for which the Company is an operator, the Company maintains
certain insurance of various types to cover its operations with policy limits
and retention liability customary in the industry. In those projects in which
the Company is not the operator, but in which it owns a non-operating interest
directly or owns an equity interest in a limited partnership or limited
liability company that owns a non-operating interest, the operator for the
prospect maintains insurance to cover its operations.
There can be no assurance that insurance, if any, will be adequate to cover any
losses or exposure to liability. Although the Company believes that the policies
obtained by operators provide coverage in scope and in amounts customary in the
industry, they do not provide complete coverage against all operating risks. An
uninsured or partially insured claim, if successful and of significant
magnitude, could have a material adverse effect on the Company and its financial
condition via its contractual liability to the prospect.
Potential Loss of Oil and Gas Interests/ Cash Calls
The Company is subject to cash calls related to its various investments in oil
and gas prospects. If the Company does not pay its share of future Authorization
For Expenditures ("AFE") invoices, it may have to forfeit all of its rights in
certain of its interests in the applicable prospects and any related profits. If
one or more of the other members of the prospects fail to pay their share of the
prospect costs, the Company may need to pay additional funds to protect its
investments.
17
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 13 - SUBSEQUENT EVENTS
In October 2005, the Company entered into an Exploration and Development
Agreement with two industry partners to acquire acreage for development in
Northern Arkansas. Under the agreement, the Company will own forty-five percent
(45%) of the leasehold acquired and bear forty-five percent (45%) of the costs
attributable thereto. Pursuant to this Agreement, the Company has expended six
hundred fifty thousand dollars ($650,000) to date.
During November 2005, the Company received payment of $250,000 against the
outstanding promissory note due from Awakino South Exploration.
In the fourth quarter of 2005 the Company is making demands for payment from
related parties.
In the fourth quarter of 2005 the Company is reviewing its existing insurance
coverage and will make adjustments to coverage as it deems necessary.
In continuation of the July offering, between October 1, 2005 and November 10,
2005, the Company sold 2,688,890 shares of common stock and warrants to purchase
an additional 1,344,445 shares of common stock for aggregate gross cash proceeds
of $2,420,000. The securities were sold in units consisting of two shares of the
Company's common stock and one common stock purchase warrant at a purchase price
of $1.80 per unit. Each warrant is immediately exercisable into one (1) share of
common stock at an exercise price of $1.50 per share for a term of three years.
Since commencing operation in the oil and gas exploration and development
business in March 2004, the Company has acquired a number of interests in oil
and gas projects. Most of these interests were acquired by limited liability
companies or limited partnerships in which the Company owns an equity interest.
Under this structure, the Company's equity investee, rather than the Company,
owns the direct working interest in the prospect.
This structure has the following effects:
- As an equity interest holder in most of the limited liability
companies and partnerships, the Company does not have sole
management control over the working interest owned by the
limited liability company or partnership.
- When a partnership or limited liability company in which the
Company owns an equity interest receives a request for
expenditure, although the Company is only required to pay its
proportionate share of such expense, if any of the other
partners or members fails to make payment of its proportionate
share, the partnership or limited liability company is at risk
of losing its entire working interest as a result of the
delinquency of a single member or partner. As a result, the
Company is exposed to unnecessary risks associated with the
financial stability of its partners.
- The transactions related to the limited liability companies
and partnerships are accounted for under the equity method of
accounting. This results in all of the expenses and revenues
applicable to each entity being combined into a single line
item on the Company's statement of operations captioned "Loss
(Profit) from Limited Partnerships and Limited Liability
Companies" and all assets being accounted for on its balance
sheet as "Investments in Limited Partnerships and Liability
Companies."
During September 2005, the Company began the process of reorganizing its
corporate structure so that it directly owns its oil and gas assets. The process
involves its withdrawal as a member or partner in these limited liability
companies and limited partnerships and the assignment to the Company of a record
title interest of its beneficial interest in the working interest held by such
entities. Upon completion of these transactions, the Company will become direct
owners of its oil and gas assets, receive joint interest billing statements
directly from the operator of the various properties for all activities
conducted on its leaseholds, and be directly responsive to elections and cash
calls from such operators. These transactions have been designed to: (i) reduce
the risks in these projects associated with the credit worthiness of its
partners; (ii) increase the Company's control over its assets; and (iii)
streamline the Company's accounting process. The Company expects the foregoing
to be completed during the fourth quarter of 2005.
18
TOUCHSTONE RESOURCES USA, INC.
(A Development Stage Entity)
Notes to Condensed Consolidated Financial Statements
NOTE 14 - 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.
NOTE 15 - REVISION AND RESTATEMENT OF FINANCIAL STATEMENTS
The Company was notified by its independent auditors of recent guidance issued
by the Securities and Exchange Commission Staff. This guidance related to
evaluating registration rights agreements, convertible preferred stock,
convertible debt and warrant instruments for possible application of derivative
accounting under Statement of Financial Accounting Standard ("SFAS") No 133:
Accounting for Derivative Instruments and Hedging Activities, Emerging Issues
Task Force ("EITF") 00-19: Accounting for Derivative Financial Instrument
Indexed to, and Potentially Settled in, a Company's Own Stock, EITF 01-6: The
Meaning of "Indexed to a Company's Own Stock", EITF 05-2: The Meaning of
"Conventional Convertible Debt Instrument" in Issue No. 00-19 and various
related EITF's
The Company re-evaluated its various financial instruments in light of the
abovementioned accounting literature and determined that select items,
consisting of registration rights agreements related to the Series A Preferred
Stock and related warrants, were subject to derivative accounting.
In evaluating these registration rights and their related financial instruments
the Company applied the methodology of View C in EITF 05-4 Issue Summary No. 1
and accounted for them each as a freestanding instrument. The related Series A
Preferred and warrants were not subject to derivative accounting but were
subject to beneficial conversion accounting as described elsewhere in these
financial statements.
The Company determined the fair value of the registration rights in accordance
with paragraph 17 of SFAS No. 133. The fair value of these registration rights
agreements was immaterial when they were initially granted in 2005 and at June
30, 2005. However, the fair value at September 30, 2005 was determined to be
$798,817. Under paragraph 18 of SFAS No. 133 this amount was recorded in the
statement of operations. Since the Company had already accrued $177,026 relating
to the registration rights penalty at September 30, 2005 it recorded an
additional expense and related liability of $621,791 in these restated financial
statements.
The Company determined its convertible debt was not subject to derivative
accounting as it was deemed a "conventional convertible debt" based on practice
in existence at the time the debt was issued. The Company continues to evaluate
its convertible debt in accordance with the EITF 05-2 which was issued in June
2005 and applies prospectively to any convertible debt which is subsequently
modified.
The Company has restated its statement of operations for the three and nine
month periods ending September 30, 2005 from the amounts previously reported.
The restatement include an adjustment to (a) record an additional amount of
registration rights penalty expense in the amount of $621,791 and (b) record a
corresponding increase to liabilities. Following is a summary of the restatement
adjustment:
19
For the three months ended September 30, 2005:
As As
Reported Adjustments Restated
Total revenues $ 46,361 $ -- $ 46,361
Total operating expenses 1,249,208 (177,026) 1,072,182
------------ ------------ ------------
Loss from operations (1,202,847) (177,026) (1,025,821
Other expense 1,546,260 798,817 2,345,077
------------ ------------ ------------
Loss (2,749,107) 621,791 (3,370,898)
Add minority interest and pre-
acquisition losses 6,062 -- 6,062
Preferred Series A Stock dividend (320,988) -- 320,988
------------ ------------ ------------
Net loss to common shareholders $ (3,064,033) $ 621,791 $ (3,685,824)
============ ============ ============
Basic and diluted loss per
common share $ (0.05) $ (0.06)
For the nine months ended September 30, 2005:
As As
Reported Adjustments Restated
Total revenues $ 240,211 $ -- $ 240,211
Total operating expenses 3,844,156 (177,026) 3,667,130
------------ ------------ ------------
Loss from operations (3,603,945) (177,026) (3,426,919)
Other expense 5,953,805 798,817 6,752,622
------------ ------------ ------------
Loss (9,557,750) 621,791 (10,179,541)
Add minority interest and pre-
acquisition losses 301,548 -- 301,548
Preferred Series A Stock dividend (2,564,349) -- (2,564,349)
------------ ------------ ------------
Net loss to common shareholders $(11,820,551) $ -- $(12,442,342)
============ ============ ============
Basic and diluted loss per
common share $ (0.19) $ (0.20)
20
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 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 filed
with the Securities and Exchange Commission.
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.
21
Item 2. Management's Discussion and Analysis.
Unless otherwise indicated or the context otherwise requires, all
references to "Touchstone," the "Company," "we," "us" or "our" and similar terms
refer to Touchstone Resources USA, Inc. and its subsidiaries.
The following Management's Discussion and Analysis is intended to help the
reader understand our results of operations and financial condition.
Management's Discussion and Analysis is provided as a supplement to, and should
be read in conjunction with, our financial statements and the accompanying notes
thereto. The revenue and operating income (loss) amounts in this Management's
Discussion and Analysis are presented in accordance with United States generally
accepted accounting principles.
Overview
We are an independent energy company engaged in the acquisition,
development and production of oil and natural gas reserves.
We currently own working interests in approximately 16 oil and gas projects in
Texas, Louisiana, Mississippi, Oklahoma, and New Zealand. These include several
producing properties in Starr, Hidalgo, Wharton, Maverick, and Zavala Counties
in Texas and working interests in currently completed wells and wells awaiting
completion in Zapata County, Texas. We also own a working interest in an
offshore well in Southern Louisiana which is capable of production but currently
awaiting facilities and additional interests in non-proved acreage in
Mississippi, Oklahoma and Arkansas. We are currently awaiting assignment of a
record title interest in our Awakino and Stent projects in New Zealand.
Our vision is to build a high growth, high efficiency, cost-effective
developer of energy resources and infrastructure. We seek to create shareholder
value through building oil and gas reserves, production revenues, and operating
cash flow by:
o Engaging in a program of high potential exploration projects within proven
petroleum basins while mitigating risk through the use of advanced
geophysical modeling
o Participating in the development of non-conventional, resource based gas
projects
o Participating in low risk energy gathering and transportation systems
where competition is limited and which generate stable cash flow and
provide sufficient upside opportunity through expansion
o Utilizing the most cost effective development and completion techniques
for development
22
o Constantly evaluating our portfolio of assets to assess potential reward
versus further development risk, and selling or trading assets when deemed
appropriate
o Acquiring undercapitalized firms with attractive development
opportunities.
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. By initially building a base of
long-term reserves in resource based plays to generate and sustain operating
cash flow, such as our recently announced acquisition in the Caney Shale Play in
the Arkoma Basin of Oklahoma and our Fayetville Shale Play in Northern Arkansas,
we will be in a better position to participate in the higher risk and higher
growth rate exploration opportunities that still exist.
Outlook
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 our exploration and
development efforts. Our exploration and development expenditures will initially
be weighted towards shale gas resource plays. We intend to remain active in
searching for high potential exploration opportunities, but may find ourselves
leveraging them until such time, if ever, that funding is more readily available
from the asset development by shale gas, through project based financing or
otherwise. We will also seek to create alliances with significant holders of
exploration data resources to increase our exposure to discovery.
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.
To execute our plan, we need to retain additional executive officers and
directors with substantial experience in the oil and gas exploration and
development business. In that regard, during the third quarter, we retained a
Chief Executive Officer, a Vice President of Land and Business Development and
we expect to retain additional executive management with substantial industry
experience. Our future success will continue to be dependent upon our ability to
identify projects which are capable of producing oil and gas in commercial
quantities which in turn, is dependent upon access to the capital necessary to
exploit such opportunities. As of the date of this report, we have generated
minimal revenues, sustained substantial losses, our expected capital
expenditures exceed our available cash resources, and we need to raise
substantial additional capital to execute our business plan. Due to these
factors, our independent auditors have included an explanatory paragraph in
their opinion for the fiscal year ended December 31, 2004 as to the substantial
doubt about our ability to continue as a going concern. Our prospects must be
considered in light of the forgoing and the risks, expenses and difficulties
encountered by companies at an early stage of development.
23
Direct Ownership of Oil and Gas Assets
Since commencing operations in the oil and gas exploration and development
business in March 2004, we have acquired a number of interests in oil and gas
projects. Most of these interests were acquired by limited liability companies
or limited partnerships in which we own an equity interest. Under this
structure, the limited liability company or limited partnership, rather than the
Company, owns the direct working interest in the prospect.
This structure has the following effects:
o As an equity interest owner in most of the limited liability companies
and partnerships, we do not have sole management control over the working
interest owned by the limited liability company or partnership.
o When a partnership or limited liability company in which we own an
equity interest receives a request for expenditure, although we are only
required to pay our proportionate share of such expense, if any of the
other partners or members fails to make payment of its proportionate
share, the partnership or limited liability company is at risk of losing
its entire working interest as a result of the delinquency of a single
member or partner. As a result, we are exposed to unnecessary risks
associated with the financial stability of our partners.
o The transactions related to the limited liability companies and
partnerships are accounted for under the equity method of accounting. This
results in all of the expenses and revenues applicable to each entity
being combined into a single line item on our statement of operations
captioned "Loss (Profit) from Limited Partnerships and Limited Liability
Companies)" and all assets being accounted for on our balance sheet as
"Investments in Limited Partnerships and Liability Companies." In order to
accurately record the forgoing, we are dependent on the underlying
partnerships and limited liability companies generating timely and
accurate financial reports to us.
During September 2005, we began the process of reorganizing our corporate
structure so that we directly own our oil and gas assets. The process involves
our withdrawal as a member or partner in these limited liability companies and
limited partnerships and the assignment to us of a record title interest of our
beneficial interest in the working interest held by such entities. Upon
completion of these transactions, we will become direct owners of our oil and
gas assets, receive joint interest billing statements directly from the operator
of the various properties for all activities conducted on our leaseholds, and be
directly responsive to elections and cash calls from such operators. These
transactions have been designed to: (i) reduce the risks in these projects
associated with the credit worthiness of our partners; (ii) increase our control
over our assets; and (iii) streamline our accounting process. We expect the
foregoing to be completed during the current quarter.
24
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 important to the portrayal of the Company's financial
condition and results and require management's most difficult, subjective, or
complex judgment - often because of the need to make estimates about the effects
of inherently uncertain matters. We consider an accounting estimate or judgment
to be critical if: (i) the nature of the estimates and assumptions is material
because of the subjectivity and judgment necessary to account for highly
uncertain matters or the susceptibility of such matters to change, and (ii) the
impact of the estimates and assumptions on financial condition or operating
performance is material.
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.
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.
25
Volumes of reserves are estimates that, by their nature, are subject to
revision. The estimates are made using all available geological and reservoir
data as well as production performance data. There are numerous uncertainties in
estimating crude oil and natural gas reserve quantities, projecting future
production rates and projecting the timing of future development expenditures.
Oil and gas reserve engineering must be recognized as a subjective process of
estimating underground accumulations of oil and gas that cannot be measured in
an exact way and estimates of engineers that we use may differ from those of
other engineers. The accuracy of any reserve estimate is a function of the
quantity of available data and of engineering and geological interpretation and
judgment. Accordingly, future estimates are subject to change as additional
information becomes available.
Successful Efforts Accounting
We utilize the successful efforts method to account for our crude oil and
natural gas operations. Under this method of accounting, all costs associated
with oil and gas lease acquisition costs, successful exploratory wells and all
development wells are capitalized and amortized on a unit-of-production basis
over the remaining life of proved developed reserves and proved reserves on a
field basis. Unproved leasehold costs are capitalized pending the results of
exploration efforts. Exploration costs, including geological and geophysical
expenses, exploratory dry holes and delay rentals, are charged to expense when
incurred.
Impairment of Properties
We review our proved properties at the field level when management
determines that events or circumstances indicate that the recorded carrying
value of the properties may not be recoverable. Such events include a projection
of future oil and natural gas reserves that will be produced from a field, the
timing of this future production, future costs to produce the oil and natural
gas, and future inflation levels. If the carrying amount of an asset exceeds the
sum of the undiscounted estimated future net cash flows, we recognize impairment
expense equal to the difference between the carrying value and the fair value of
the asset, which is estimated to be the expected present value of discounted
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.
26
Recent Accounting Pronouncements
On April 4, 2005 the FASB adopted FASB Staff Position (FSP) FSB 19-1
"Accounting for Suspended Well Costs" that amends SFAS 19, "Financial Accounting
and Reporting by Oil and Gas Producing Companies," to permit the continued
capitalization of exploratory well costs beyond one year if the well found a
sufficient quantity of reserves to justify its completion as a producing well
and the entity is making sufficient progress assessing the reserves and the
economic and operating viability of the project. In accordance with the guidance
in the FSP, we applied the requirements prospectively in the third quarter of
2005. The adoption of FSP 19-1 by us during the third quarter of 2005 did not
have an immediate affect on the consolidated financial statements. However, it
could impact the timing of the recognition of expenses for exploratory well
costs in future periods.
In March 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations," which clarifies that an entity is
required to recognize a liability for the fair value of a conditional asset
retirement obligation if the fair value can be reasonably estimated even though
uncertainty exists about the timing and (or) method of settlement. We are
required to adopt Interpretation No. 47 prior to the end of 2006. We are
currently assessing the impact of Interpretation No. 47 on our results of
operations and financial condition.
In November 2004, the FASB issued SFAS No. 151 "Accounting for
Inventory Costs" that amends Accounting Research Bulletin (ARB) No. 43, Chapter
4, "Inventory Pricing" to clarify the accounting for abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage). SFAS
151 requires that those items be recognized as current-period charges regardless
of whether they meet the criterion of "so abnormal" and requires that allocation
of fixed production overheads to the costs of conversion be based on the normal
capacity of the production facilities. We are required to adopt SFAS No. 151 in
the beginning of 2006 and its adoption is not expected to have a significant
effect on our results of operations or financial condition.
In December 2004, the FASB issued SFAS No. 153 "Exchanges of Nonmonetary
Assets" that amends Accounting Principles Board (APB) Opinion No. 29,
"Accounting for Nonmonetary Transactions" and Amends FAS 19 "Financial
Accounting and Reporting by Oil and Gas Producing Companies", paragraphs 44 and
47(e). ARB No. 29 is based on the principle that exchanges of nonmonetary assets
should be measured based on the fair value of the assets exchanged and SFAS 153
amended ABP 29 to eliminate the exception for nonmonetary exchanges of similar
productive assets and replaced it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. We are required to
adopt SFAS No. 153 for nonmonetary asset exchanges occurring in the first
quarter of 2006 and its adoption is not expected to have a significant effect on
our results of operations or financial condition.
In May 2005, the FASB issued SFAS No. 154 "Accounting Changes and Error
Corrections" to replace ABP No. 20 "Accounting Changes" and SFAS No. 3
"Reporting Accounting Changes in Interim Financial Statements." Opinion 20
previously required that most voluntary changes in accounting principle be
recognized by including in net income of the period of the change the cumulative
effect of changing to the new accounting principle. SFAS 154 requires
retrospective application to prior periods' financial statements of changes in
accounting principle, unless it is impracticable to determine either the
period-specific effects or the cumulative effect of the change. When it is
impracticable to determine the period-specific effects of an accounting change
on one or more individual prior periods presented, SFAS 154 requires that the
new accounting principle be applied to the balances of assets and liabilities as
of the beginning of the earliest period for which retrospective application is
practicable and that a corresponding adjustment be made to the opening balance
of retained earnings (or other appropriate components of equity or net assets in
the statement of financial position) for that period rather than being reported
in an income statement. When it is impracticable to determine the cumulative
effect of applying a change in accounting principle to all prior periods, SFAS
154 requires that the new accounting principle be applied as if it were adopted
prospectively from the earliest date practicable. SFAS 154 is effective for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. The implementation of FAS 154 is not expected to have a
significant effect on our results of operations or financial condition.
27
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. We cannot estimate the impact of adopting SFAS No. 123R
because it will depend on levels of share-based payments granted in the future.
Comparison of Three and Nine Months Ended September 30, 2005 and September 30,
2004
We entered the oil and gas exploration and development business in March
2004. Prior to that time, we were unsuccessful in the execution of our business
plan and thus, did not generate any revenues or incur any significant operating
expenses. As a result of the foregoing, we believe that our consolidated
revenues and operating expenses for the nine months ended September 30, 2005 are
not comparable to our consolidated revenues and operating expenses for the nine
months ended September 30, 2004 and, therefore, any differences between our
consolidated revenues and operating expenses for such nine month period 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
or from sales of oil and gas projects in which we have a majority interest.
We generated $46,361 of revenue during the three-month period ended
September 30, 2005 as compared to $60,316 during the three-month period ended
September 30, 2004. We generated $240,211 of revenue the nine-month period ended
September 30, 2005 as compared to $144,253 during the nine-month period ended
September 30, 2004. The $95,958 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 and produce oil and gas from our various working interests. As we
complete the transfer of our working interests from beneficial interests in
partnerships to direct ownership, sales of oil and gas allocated to us from
these interest will be accounted for as revenue.
28
Exploration Expenses
Exploration expenses consist of geological and geophysical costs,
exploratory dry hole expenses, and other exploration expenses. Exploration
expenses were $2,527 during the three-month period ended September 30, 2005. We
did not incur any exploration expenses during the three-month period ended
September 30, 2004.
Exploration expenses were $54,702 during the nine-month period ended
September 30, 2005 as compared to $112,748 in exploration expenses during the
nine-month period ended September 30, 2004. The decrease in exploration expenses
resulted primarily from our focus on development and production in the various
properties and less exploration activity. We expect exploration expenses to
increase in future periods due to the need to drill several obligation wells
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 for impairment or circumstances indicate
that the carrying value of those assets may not be recoverable. We incurred
$446,233 of 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-month period ended September 30, 2005 as compared to $20,221 of non-cash
charges during the three-month period ended September 30, 2004. The charge
resulted from our subsidiary PF Louisiana electing not to make the delay rental
payment on State Lease #18219 located in Ibera Parish, Louisiana.
We incurred $1,185,684 in impairment of the carrying value of certain of
our oil and gas properties and equity investments during the nine-month period
ended September 30, 2005 as compared to $1,333,466 of such charges during the
nine-month period ended September 30, 2004. The impairment of the carrying value
of unproved properties acquisition and drilling costs related to our Mississippi
properties as a result of dry holes and PF Louisiana electing not to make the
delay rental payment on State Lease #18219 located in Ibera Parish, Louisiana,
which were partially offset by credits received for over-billed drilling costs
on our PHT West Pleito Project. We may incur additional charges associated with
the impairment of our oil and gas properties in the event we abandon or withdraw
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 were $623,422 for the three-month period ended September 30, 2005
as compared to $837,507 for the three-month period ended September 30, 2004.
29
General and administrative expenses increased $620,739 to $2,426,744 for
the nine-month period ended September 30, 2005 from $1,806,005 for the
nine-month period ended September 30, 2004. The increase resulted primarily from
our commencement of operations in the oil and gas exploration and development
business in March 2004, and consisted primarily of $363,987 of professional fees
incurred in connection with our increased interests in oil and gas prospects,
financing transactions and compliance with our reporting obligations under
federal securities laws, $127,288 of consulting and engineering fees incurred in
connection with our oil and gas operations. We expect general and administrative
expenses to increase in future periods as a result of increased compensation
expense for executive management personnel, including our chief executive
officer and additional executive officers we expect to retain, 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
$459,010 to $1,063,286 for the three-month period ended September 30, 2005 from
$604,276 for the three-month period ended September 30, 2004. The loss from
limited partnerships and limited liability companies consisted primarily of the
$88,248 loss that we recognized from our leasehold interest in Zapata County,
Texas (the "Good Friday Project"), the $812,536 loss that we recognized from our
leasehold interest in Wharton County, Texas (the "Wharton Project"), the $97,118
loss that we recognized from our leasehold interest in the Maverick Basin in
South Texas (the "Maverick Basin Project"), the $39,862 loss that we recognized
from our leasehold interest in the Taranaki Basin in New Zealand (the "Awakino
South Project"), and the $102,057 loss that we recognized from our leasehold
interest in Zapata County, Texas (the "Vela Project").
Loss from limited partnerships and limited liability companies increased
$3,659,462 to $4,377,222 for the nine-month period ended September 30, 2005 from
$717,760 for the nine-month period ended September 30, 2004. The loss from
limited partnerships and limited liability companies consisted primarily of the
460,987 loss that we recognized from the Good Friday Project, the $1,651,847
loss that we recognized from the Wharton Project, the $607,854 loss that we
recognized from the loss that we recognized from our leasehold interest in
Zapata County, Texas, the $1,080,125 loss that we recognized from the Maverick
Basin Project, and the $374,403 loss that we recognized from the Awakino South
Project.
During the periods covered by this report, most of our oil and gas
interests were owned by limited liability companies in which we owned greater
than 5% but less than 50% of the applicable entity's equity interests. As a
result, loss (profit) from limited partnerships and limited liability companies
constituted a material component of our overall financial performance for the
foreseeable future. As we expect to own most of our working interests directly
in future periods, cash generated by these interests will be recorded as
revenue, and related expenditures will be recorded in the appropriate expense
account.
30
Interest Expense
Interest expense consists of certain cash and non-cash charges and
interest accrued on our various debt obligations. We incurred $496,464 of
interest expense during the three-month period ended September 30, 2005 as
compared to $288,510 during the three-month period ended September 30, 2004. The
interest expense consisted of interest accrued 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 $62,351
under the convertible promissory note due to Trident Growth Fund, LP, $14,582
under the convertible promissory note due to Westwood AR, Inc. (the "Westwood
Note") and $30,247 under the convertible promissory note due to DDH Resources
II, Ltd. ("DDH Note"). The $207,954 increase in interest expense was primarily
the result of non-cash charges of $372,072 incurred from the amortization of the
Westwood note discount and inducement fee in connection with the conversion of
the Westwood Note.
We incurred $1,600,697 of interest expense during the nine-month period
ended September 30, 2005 as compared to $7,252,307 for the nine-month period
ended September 30, 2004. The interest expense consisted primarily of $337,771
of interest accrued 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 $183,847 under the convertible
promissory note due to Trident Growth Fund, LP, $64,171 under the Westwood Note
and $89,753 under the DDH Note. The balance of the interest expense consisted of
$1,262,926 of non cash charges. The $5,651,610 decrease in interest expense
resulted primarily from a decrease in non-cash charges associated with the
beneficial conversion feature and the ascribed value of the warrants issued
together with convertible promissory notes that were issued during the nine-
month period ended September 2004 as compared to those nine- month period ended
September 2005. 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.
Registration Rights Penalty
Our Series A Preferred Stock holders have registration rights which
require us to register the underlying common shares by a certain time or we are
subject to a penalty. For the quarter ended September 30, 2005 the Company
recorded an accrual of $798,817 and a corresponding expense titled registration
rights penalty.
Minority Interest and (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 decreased $99,951 to $6,062 during the three
month period ended September 30, 2005 from $106,013 for the three month period
ended September 30, 2004. The $99,951 decrease resulted primarily from the
decrease in net losses incurred by our consolidated subsidiaries. We recorded
minority interest of $301,548 for the nine-month period ended September 30, 2005
as compared to $480,737 for the nine-month period ended September 30, 2004. The
decrease of $179,189 resulted primarily from the decrease in net losses incurred
by our consolidated subsidiaries.
31
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 September 30, 2005, we had a cash balance of $4,756,056.
Net cash used in operating activities was $2,082,459 for the nine-month
period ended September 30, 2005 as compared to net cash used in operating
activities of $595,811 for nine-month period ended September 30, 2004. The
$1,486,648 increase in cash used in operating activities was primarily due to an
increase in losses to fund operations 960,081, net of non cash charges and an
increase in the changes in accounts payable of $4,794,034. These amounts were
partially offset by a decrease in accounts receivable and restricted cash of
$3,061,154 and $625,423, respectively
Net cash used in investing activities was $4,233,221 for the nine-month
period ended September 30, 2005 compared to $9,555,265 for the nine-month period
ended September 30, 2004. The $5,322,044 decrease was primarily due to a
$3,759,834 decrease in investments in limited partnership interests and a
$2,088,300 decrease in purchase of oil and gas interests and drilling costs.
These amounts were partially offset by a $567,451 increase in notes
receivable-related party, a $500,000 refund of oil and gas prepayment, and
$72,500 of distributions from limited partnerships.
Net cash provided by financing activities was $10,477,554 for the
nine-month period ended September 30, 2005 compared to $11,460,218 for the
nine-month period ended September 30, 2004. The amounts in both periods
represent net proceeds from sales of our equity securities.
At September 30, 2005, we had a working capital deficit of $55,603,
compared to a working capital deficit of $1,312,131 at December 31, 2004. The
$1,256,528 increase in working capital was due primarily to a decrease in
accounts payable-joint interest of $4,202,720 which was partially offset by a
$1,046,209 increase in accounts payable and accrued expenses and a $1,969,713
increase in convertible debentures payable.
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 and pursuant to
anti-dilution adjustment, the conversion price is currently $.86.
32
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 on March 31, 2014 and pursuant to anti-dilution adjustment, the
exercise price is currently $.86.
On November 18, 2004, we obtained gross proceeds of $1,000,000 through the
issuance of the DDH Note to DDH Resources. The note is due May 18, 2006, accrues
interest at the rate of 12% per annum, and is convertible into shares of our
common stock at a conversion price of $1.00 per share.
On February 21, 2005, we completed a private offering of common stock and
warrants in 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.
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 was sold for a purchase price of $11.00 per unit. We sold 710,063
units for aggregate gross proceeds of $7,810,693 in the offerings.
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.
Each warrant is exercisable at an initial exercise price of $1.50 per
share and terminates three years after the date of issuance. 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.
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Between August and October, 2005, we have generated gross proceeds of
$5,690,001 through the issuance of shares of common stock and warrants. The
securities were sold in units consisting of two shares of our common stock and
one common stock purchase warrant at a purchase price of $1.80 per unit. Each
warrant is immediately exercisable into one (1) share of common stock at an
exercise price of $1.50 per share for a term of three years.
The foregoing constitutes our principal sources of financing during the
past twelve 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 costs and drilling and
production costs in our various oil and gas projects to explore, develop,
produce and eventually sell the underlying oil and gas reserves. Specifically,
we expect to incur capital calls and production costs of approximately $19
million with respect to our jointly owned properties during the next 12 months
as follows (each amount an approximation):
o $250,000 for exploration costs in the Awakino South Project;
o $150,000 for exploration in the Knox Miss Project;
o $1,100,000 for facilities 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 $200,000 for exploration and operating costs in the Martinez Ranch
Project;
o $200,000 for exploration and operating costs in the Maverick Basin
Project;
o $775,000 for exploration and operating costs in the Vicksburg Project;
o $1,300,000 for exploration and operating costs in the Vela Project;
o Up to $2,500,000 for exploration and operating costs in the McIntosh
Project;; and
o Up to $11,700,000 for exploration and operating costs in the Arkansas
Project
We do not expect to incur any capital calls or production costs with
respect to the Stent Project, during the next 12 months.
If any of the other owners of leasehold interests in any of the projects
in which we participate 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 $3.1 million of term indebtedness during the next 12
months if the underlying notes are not converted into shares of our common stock
as follows:
34
o $1,000,000 outstanding under the DDH Note due May 18, 2006; and
o $2,050,000 outstanding under the Trident Note 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 3% per annum. The repayment of principal and payment of accrued
interest under the Endeavour Note is based on 25% of the monthly cash flows (as
defined in the note) of the project. 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 2006.
As of the date of this report, we had cash resources of approximately
$5,300,000. We will need a total of approximately $25 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 $19 million for capital calls and
production costs with respect to our various jointly owned properties,
approximately $3.1 million to repay our outstanding term indebtedness, and
approximately $2.0 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 September 30, 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.
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, who serves as our principal financial
officer ("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 not 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.
35
As part of this evaluation, our CEO and Treasurer reviewed a letter dated
July 11, 2005 from L J Soldinger Associates LLC, our independent registered
accountants, addressed to our Board of Directors which identified a number of
reportable conditions that it considers to be material weaknesses in our
internal control over financial reporting that were discovered during its audit
of our financial statements for the year ended December 31, 2004. The
significant deficiencies noted were: (a) inability to timely and accurately
close books and records at the end of each reporting period; (b) insufficient
number of accounting and financial personnel; (c) deficiencies in the recording
and classification of unproved and proved oil and gas properties and in the
calculation of the working percentage interests in or impairments of certain of
wells; (d) insufficient procedures to detect errors in the books of the limited
liability companies and limited partnerships in which the Company has an equity
interest; (e) improper or lack of accounting for and/or failure to identify
transactions; (f) inadequate controls relating to the receipt and disbursement
of cash received in accordance with joint interest agreements; and (g) weakness
in the process and tools used to consolidate the financial statements of the
Company and our subsidiaries.
We believe that all adjustments required as a result of the foregoing
deficiencies were detected in the audit process and were appropriately recorded
and disclosed in our annual report on Form 10-KSB. Likewise, we believe that all
adjustments required in subsequent periods were detected in connection with the
preparation of our quarterly reports and appropriately recorded and disclosed in
such quarterly reports.
Since entering the oil and gas exploration and development industry, we
have had a very limited management team that was primarily focused on acquiring
interests in oil and gas prospects. Many of the deficiencies in our internal
controls identified above are likely the result of a combination of our limited
management team and staff, the large number of interests in oil and gas
prospects we acquired during 2004 and early 2005, and the structural complexity
of the ownership of the interests.
During the third quarter of 2005, we retained a chief executive officer
with over 35 years of industry experience and an additional executive officer
with more than 7 years of experience in the legal and business aspects of oil
and gas exploration transactions. Since his appointment, our new CEO has devoted
substantial time addressing each of the material weaknesses in our internal
controls over financial reporting identified above, and is committed to
effectively remediating them as soon as possible. Under his direction, we are in
the process of establishing a plan to address our deficiencies and improve our
control environment. The principal components of the plan include: (i)
establishing and implementing additional controls and procedures related to
improving the supervision and training of our accounting staff, particularly
with respect to SEC guidelines relating to oil and gas operations; (ii)
retaining additional persons to serve on our accounting staff; (iii) retaining a
chief financial officer, chief accounting officer, and additional executive
management with extensive experience in preparing natural gas and oil reserve
estimates and in petroleum accounting matters; (iv) modifying systems and/or
procedures to ensure appropriate segregation of responsibilities for accounting
personnel; (v) establishing and implementing procedures to require our
engineering staff to communicate all information regarding all wells and
properties in which we have an interest to our accounting staff on a "real time"
basis; (vi) establishing and implementing procedures to require our accounting
staff to engage in constant communication with the operators of our prospects to
ensure timely reporting to us; (vii) engaging an independent, industry
recognized reservoir engineering firm to perform an audit of our oil and gas
reserves; and (viii) obtaining direct ownership of our working interests in
order to eliminate any reliance on the management and accounting functions of
the limited partnerships and limited liability companies in which we have an
interest. We expect the forgoing actions and controls to be fully in place by no
later than the end of the first quarter 2006.
36
Concurrent with the establishment of the forgoing, we will be initiating a
project to ensure compliance with Section 404 of the Sarbanes-Oxley Act of 2002
(SOX), which will apply to us as of December 31, 2007. This project will entail
a detailed review and documentation of the processes that impact the preparation
of our financial statements, an assessment of the risks that could adversely
affect the accurate and timely preparation of those financial statements, and
the identification of the controls in place to mitigate the risks of untimely or
inaccurate preparation of those financial statements.
As we continue the forgoing compliance efforts, including the testing of
the effectiveness of our internal controls, we may identify additional
deficiencies in our system of internal controls over financial reporting that
either individually or in the aggregate may represent a material weakness
requiring additional remediation efforts. We are committed to effectively
remediating known deficiencies as expeditiously as possible and continuing our
efforts to comply with Section 404 of SOX by December 31, 2007.
There has been no change in our internal control over financial reporting
identified in connection with that evaluation that occurred during the period
covered by this report that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
1. On June 10, 2005, we issued warrants to purchase 250,000 shares of
common stock to Legend Merchant Group, Inc. and its affiliates in consideration
of financial advisory services. The warrants are immediately exercisable as
$1.10 per share and terminate two years from the date of grant. The warrants
were issued to two accredited investors in a private placement transaction
exempt from the registration requirements of the Securities Act of 1933, as
amended, pursuant to section 4(2) thereof without payment of underwriting
discounts or commissions to any person.
2. On August 19, 2005, we issued 1,247,794 shares of common stock and
warrants to purchase 623,897 shares of common stock to Westwood AR, Inc. in
consideration of the conversion of $1,000,000 principal amount and $123,014 of
accrued interest due under a promissory note. Each warrant is immediately
exercisable into one share of common stock at an exercise price of $1.50 per
share for a term of three years. The securities 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.
37
3. Between October 13 and October 28, 2005 we sold 2,688,890 shares of
common stock and warrants to purchase an additional 1,344,445 shares of common
stock for aggregate gross cash proceeds of $2,420,001. The securities were sold
in units consisting of two shares of our common stock and one common stock
purchase warrant at a purchase price of $1.80 per unit. Each warrant is
immediately exercisable into one (1) share of common stock at an exercise price
of $1.50 per share for a term of three years. The securities were issued in a
private placement transaction to a limited number of accredited investors
pursuant to the exemption from registration provided by Section 4(2) of the
Securities Act of 1933, as amended, and Rule 506 of Regulation D thereunder. We
paid cash commissions of $132,400 to Legend Merchant Group, Inc., a
broker-dealer registered under the Securities Exchange Act of 1934, as amended,
and member of the NASD and the SIPC, and $43,200 to Mid-South Capital, Inc., a
broker-dealer registered under the Securities Exchange Act of 1934, as amended,
and member of the NASD and the SIPC. We agreed to issue warrants to Legend
Merchant Group
Item 5. Other Information
On November 5, 2005, Wesley Franklin tendered his resignation as a
Director of the Company. We are currently in the process of identifying
additional individuals with a substantial financial and industry experience to
serve on our Board of Directors.
We have received a subpoena from the Securities and Exchange Commission.
We understand that the subpoena relates to an SEC investigation concerning
trading in the stocks of a number of publicly-traded companies, including the
Company. We have cooperated, and will continue to cooperate, in producing
documents and providing information to the SEC.
Item 6. Exhibits.
Exhibit Number Description
- -------------- -----------
31.1 Certificate of Chief Executive Officer of Registrant required
by Rule 13a-14(a) under the Securities Exchange Act of 1934,
as amended
31.2 Certificate of Chief Financial Officer of Registrant required
by Rule 13a-14(a) under the Securities Exchange Act of 1934,
as amended
32.1 Certificate of Chief Executive Officer and Chief Financial
Officer of Registrant required by Rule 13a-14(b) under the
Securities Exchange Act of 1934, as amended
38
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: March 31, 2006 /s/ Roger L. Abel
--------------------------------------
Roger L. Abel
Chief Executive Officer
39
EXHIBIT INDEX
Exhibit Number Description
- -------------- -----------
31.1 Certificate of Chief Executive Officer of Registrant required
by Rule 13a-14(a) under the Securities Exchange Act of 1934,
as amended
31.2 Certificate of Chief Financial Officer of Registrant required
by Rule 13a-14(a) under the Securities Exchange Act of 1934,
as amended
32.1 Certificate of Chief Executive Officer and Chief Financial
Officer of Registrant required by Rule 13a-14(b) under the
Securities Exchange Act of 1934, as amended
40