PROSPECTUS
TENGASCO, INC.
12,100,000
SUBSCRIPTION RIGHTS
TO PURCHASE
36,300,000
SHARES OF COMMON STOCK
We are distributing to holders of our outstanding common stock, at no
charge, nontransferable subscription rights to purchase up to an aggregate of
36,300,000 shares of our common stock at a cash subscription price of $0.25 per
share. You will receive for each share of our common stock you own a right to
purchase three shares of our common stock at an exercise price of $0.25 for each
share purchased. If you exercise your rights in full, you may over-subscribe for
the purchase of additional shares that remain unsubscribed at the expiration of
the rights offering, subject to availability and allocation of shares among
persons exercising this over-subscription privilege. In no event, however, may
any subscriber purchase shares of our common stock in the offering that, when
aggregated with all of the shares of our common stock otherwise owned by the
subscriber and his, her or its affiliates, would immediately following the
closing represent more than 50% of our issued and outstanding shares. You will
not be entitled to receive any rights unless you hold of record shares of our
common stock as of the close of business on February 27, 2004.
This rights offering is being made in order to obtain funds to pay non-bank
indebtedness, including to Dolphin Offshore Partners, L.P., which we refer to as
Dolphin, in the aggregate amount of up to approximately six million dollars
(including up to $3,850,000 in principal amount plus accrued interest to
Dolphin), with the balance of the net proceeds, if any, to be used to pay bank
indebtedness and/or for working capital purposes. See "Certain Relationships and
Related Transaction." Dolphin, of which Peter E. Salas, a member of our Board of
Directors, is the general partner and the controlling person, is deemed to
beneficially own approximately 19.8% of our outstanding common stock. Our Board
of Directors has determined that this rights offering is advisable under our
present financial, operational and other circumstances. Our Board of Directors
formed a four-person special committee of its members charged with, among other
things, recommending to the full Board of Directors the financial and other
terms of this rights offering. No special committee member is an employee of
ours nor has any personal interest in the rights offering. We have no agreements
or understandings with any persons or entities, including Dolphin, members of
our Board of Directors, our management and any broker dealers, with respect to
their exercise of any rights offered hereby or their participation as an
underwriter, broker or dealer in this offering. See "The Rights Offering -
Background of the Rights Offering."
The rights will expire if they are not exercised by 5:00 p.m., New York
City time, on March 18, 2004, the expected expiration date of the rights
offering. We may extend the period for exercising the rights for up to an
additional 30 days. Subscription amounts received will be held by the
subscription agent until completion of the rights offering, during which period
the right holders will not earn interest on those subscription amounts. Rights
that are not exercised by the expiration date of the rights offering will expire
and will have no value. Rights may not be sold or transferred except under the
very limited circumstances described later in this prospectus. You should
carefully consider whether to exercise your rights before the expiration date.
See "The Rights Offering." Our Board of Directors makes no recommendation
regarding your exercise of rights.
Shares of our common stock are traded on the American Stock Exchange under
the symbol "TGC." On February 9, 2004, the last reported sales price for our
common stock was $1.20 per share. Although application has been made to list
the shares of common stock offered hereby on the American Stock Exchange, the
Company cannot be sure that such listing will be granted. See "Risk Factors.
Delisting of our common stock from AMEX, which is possible, would adversely
affect us and holders of those shares.
AN INVESTMENT IN OUR COMMON STOCK IS VERY RISKY. YOU SHOULD CAREFULLY
CONSIDER THE RISK FACTORS BEGINNING ON PAGE 8 OF THIS PROSPECTUS BEFORE
EXERCISING YOUR RIGHTS.
PROCEEDS OF OFFERING
PER SHARE TOTAL
--------- -----
Subscription Price.................................... $0.25 $9,075,000
Estimated Expenses.................................... $0.004 $150,000
Net Proceeds to Tengasco.............................. $0.246 $8,925,000
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
THE DATE OF THIS PROSPECTUS IS FEBRUARY 13, 2004.
TABLE OF CONTENTS
Summary.................................1 Management..........................45
Risk Factors............................8 Certain Relationships And Related
Forward Looking Statements.............14 Transactions........................50
Use Of Proceeds........................15 Principal Stockholders..............53
Price Range Of Common Stock............16 The Rights Offering.................55
Capitalization.........................17 Description Of Capital Stock........66
Selected Consolidated Financial United States Federal Income Tax
Data...................................18 Consequences........................69
Management's Discussion And Analysis Plan of Distribution................70
Of Financial Condition And Results Of Tennessee Anti-Takeover Law.........70
Operations.............................19 Limitation Of Liability Of
Quantitative And Qualitative Directors...........................70
Disclosure About Market Risks..........27 Legal Matters.......................72
Business...............................28 Experts.............................72
Production.............................41 Where You Can Find More Information.72
Legal Proceedings......................43 Index to Financial Statements......F-1
SUMMARY
THIS SUMMARY HIGHLIGHTS INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS.
THIS SUMMARY MAY NOT CONTAIN ALL OF THE INFORMATION THAT IS IMPORTANT TO YOU.
THIS PROSPECTUS INCLUDES INFORMATION ABOUT OUR BUSINESS AND OUR FINANCIAL AND
OPERATING DATA. BEFORE MAKING AN INVESTMENT DECISION, WE ENCOURAGE YOU TO READ
THE ENTIRE PROSPECTUS CAREFULLY, INCLUDING THE RISKS DISCUSSED IN THE "RISK
FACTORS" SECTION. WE ALSO ENCOURAGE YOU TO REVIEW OUR FINANCIAL STATEMENTS AND
THE OTHER INFORMATION US PROVIDE IN THE REPORTS AND OTHER DOCUMENTS THAT WE FILE
WITH THE SEC, AS DESCRIBED UNDER "WHERE YOU CAN FIND MORE INFORMATION."
OUR COMPANY
We are in the business of exploring for, producing and transporting oil and
natural gas in Tennessee and Kansas. We lease producing and non-producing
properties with a view toward exploration and development. Emphasis is also
placed on pipeline and other infrastructure facilities to provide transportation
services. We utilize seismic technology to improve the discovery and recovery of
reserves.
To date, we have drilled primarily on a portion of our Tennessee leases
known as the Swan Creek Field in Hancock County focused within what is known as
the Knox formation, one of the geologic formations in that field. During the
first nine months of 2003, we produced an average of approximately 1.2 million
cubic feet of natural gas per day and approximately 2,171 barrels of oil per
month from 23 producing gas wells and six producing oil wells in the Swan Creek
Field. We also operate wells in the State of Kansas. During the first nine
months of 2003, we produced an average of approximately .73 million cubic feet
of natural gas per day and 10,531 barrels of oil per month from 59 producing gas
wells and 149 producing oil wells in Kansas.
We were initially organized under the laws of the State of Utah on April
18, 1916, under the name "Gold Deposit Mining & Milling Company." We
subsequently changed our name to Onasco Companies, Inc. We were formed
originally for the purpose of mining, reducing and smelting mineral ores. On
November 10, 1972, we conveyed to an unaffiliated entity substantially all of
our assets and we ceased all business operations. From approximately 1983 to
1991, our operations were limited to seeking out the acquisition of assets,
property or businesses. In 1995 we began acquiring oil and gas assets and have
since focused our efforts on the operation of these assets as well as the
acquisition of additional oil and gas assets.
We are a Tennessee corporation, the address of our principal executive
office is 603 Main Avenue, Suite 500, Knoxville, TN 37902, and our telephone
number at that address is (865)523-1124.
THE RIGHTS OFFERING
You should read "Risk Factors" before you exercise your rights.
WHAT IS THE RIGHTS OFFERING? The rights offering is a distribution to
holders of our common stock, at no
charge, of nontransferable subscription
rights at the rate of one right (to
purchase three shares of our common
stock) for each share of common stock
owned as of February 27, 2004, the
record date. Each right will be
evidenced by a nontransferable rights
certificate.
WHAT IS A SUBSCRIPTION RIGHT? Each subscription right is a right to
purchase three shares of our common
stock and carries with it a basic
subscription privilege and an
over-subscription privilege.
WHAT IS THE BASIC SUBSCRIPTION The basic subscription privilege of each
PRIVILEGE? right entitles you to purchase three
shares of our common stock at the
subscription price of $0.75 in the
aggregate, or $0.25 per each share
purchased. You must purchase all three
shares relating to each outstanding
share if you wish to exercise the
subscription privilege relating thereto.
Fractional rights will be eliminated by
rounding up to the next higher whole
right.
WHAT IS THE OVER-SUBSCRIPTION We do not expect that all of our
PRIVILEGE? stockholders will exercise all of their
basic subscription rights. By extending
over-subscription privileges to our
stockholders, we are providing
stockholders that exercise all of their
basic subscription privileges with the
opportunity to purchase those shares
that are not purchased by other
stockholders through the exercise of
their basic subscription privileges. The
over-subscription privilege of each
right entitles you, if you fully
exercise your basic subscription
privilege, to subscribe for additional
shares of our common stock unclaimed by
other holders of rights in the rights
offering, at the same subscription price
per share. If an insufficient number of
shares is available to fully satisfy all
over-subscription privilege requests,
the available shares will be distributed
proportionately among rights holders who
exercised their over-subscription
privilege based on the number of shares
each rights holder subscribed for under
the basic subscription privilege. The
subscription agent will return any
excess payments by mail without interest
or deduction promptly after the
expiration of the rights offering.
HOW LONG WILL THE RIGHTS OFFERING You will be able to exercise your
LAST? subscription rights only during a
limited period. If you do not exercise
your subscription rights before 5:00
p.m., New York City time, on March 18,
2004, your subscription rights will
expire. We may, in our discretion,
extend the rights offering for up to an
additional 30 days.
IS THERE ANY LIMITATION ON THE Yes. In no event may any subscriber
NUMBER OF MY RIGHTS THAT I MAY purchase shares of our common stock in
EXERCISE? the offering that, when aggregated with
all of the shares of our common stock
otherwise owned by the subscriber and
his, her or its affiliates, would
immediately following the closing
represent more than 50% of our issued
and outstanding shares.
WHY IS TENGASCO ENGAGING IN A The net proceeds of the rights offering
RIGHTS OFFERING? will be used initially to pay non-bank
indebtedness in the aggregate amount of
up to six million dollars (including up
to $3,850,000 in principal amount plus
accrued interest to Dolphin), with the
balance of the net proceeds, if any, to
be used to repay bank indebtedness
and/or for working capital purposes,
including the drilling of additional
wells. See "Certain Relationships and
Related Transactions." The rights
offering gives you the opportunity to
participate in this fund-raising effort
and to purchase additional shares of our
common stock.
WHAT HAPPENS IF I CHOOSE NOT TO You will retain your current number of
EXERCISE MY SUBSCRIPTION RIGHTS? shares of common stock even if you do
not exercise your subscription rights.
If you choose not to exercise your
subscription rights, then the percentage
of our common stock that you own will
decrease. Rights not exercised prior to
the expiration of the rights offering
will expire.
HOW DO I EXERCISE MY SUBSCRIPTION You may exercise your rights by properly
RIGHTS? completing and signing your rights
certificate. You must deliver your
rights certificate with full payment of
the subscription price (including any
amounts in respect of the
over-subscription privilege) to the
subscription agent on or prior to the
expiration date. If you use the mail, we
recommend that you use insured,
registered mail, return receipt
requested. If you cannot deliver your
rights certificate to the subscription
agent on time, you may follow the
guaranteed delivery procedures described
under "The Rights Offering--Guaranteed
Delivery Procedures" beginning on page
55.
WHAT SHOULD I DO IF I WANT TO If you hold shares of our common stock
PARTICIPATE IN THE RIGHTS OFFERING through a broker, custodian bank or
BUT MY SHARES ARE HELD IN THE NAME other nominee, we will ask your broker,
OF MY BROKER, CUSTODIAN BANK OR custodian bank or other nominee to
OTHER NOMINEE? notify you of the rights offering. If
you wish to exercise your rights, you
will need to have your broker, custodian
bank or other nominee act for you.
To indicate your decision, you should
complete and return to your broker,
custodian bank or other nominee the form
entitled "Beneficial Owner Election
Form." You should receive this form from
your broker, custodian bank or other
nominee with the other rights offering
materials. You should contact your
broker, custodian bank or other nominee
if you believe you are entitled to
participate in the rights offering but
you have not received this form.
WHAT SHOULD I DO IF I WANT The subscription agent will mail rights
TO PARTICIPATE IN THE RIGHTS OFFERING certificates to you if you are a rights
AND I AM A STOCKHOLDER IN A FOREIGN holder whose address is outside the
COUNTRY OR IN THE ARMED SERVICES? United States or if you have an Army
Post Office or a Fleet Post Office
address. To exercise your rights, you
must notify the subscription agent on or
prior to 5:00 p.m., New York City time,
on March 18, 2004, and take all other
steps which are necessary to exercise
your rights, on or prior to that time.
If you do not follow these procedures
prior to the expiration of the rights
offering, your rights will expire.
WHAT IF THE MARKET PRICE PER SHARE Consult your broker. Depending on the
OF OUR COMMON STOCK IS LESS THAN market price of our common stock, it
THE SUBSCRIPTION PRICE PER SHARE most likely will be more cost effective
WHEN I AM DECIDING TO EXERCISE MY for you to purchase shares of our common
SUBSCRIPTION RIGHTS? stock on the American Stock Exchange
rather than exercise your subscription
rights.
WILL I BE CHARGED A SALES COMMISSION No. We will not charge a brokerage
OR A FEE BY TENGASCO IF I EXERCISE commission or a fee to rights holders
MY SUBSCRIPTION RIGHTS? for exercising their rights. However, if
you exercise your rights through a
broker or nominee, you will be
responsible for any fees charged by your
broker or nominee.
WHAT IS THE BOARD OF DIRECTORS' Our board of directors is not making any
RECOMMENDATION REGARDING THE RIGHTS recommendation as to whether you should
OFFERING? exercise your subscription rights. You
are urged to make your decision based on
your own assessment of the rights
offering and Tengasco.
HOW MANY SHARES MAY I PURCHASE? You will receive one nontransferable
subscription right for each share of
common stock that you owned on
February 27, 2004, the record date.
Each subscription right contains the
basic subscription privilege and the
over-subscription privilege. Each basic
subscription privilege entitles you to
purchase three shares of common stock
for $0.25 per each share purchased.
Fractional rights will be eliminated by
rounding up to the next higher whole
right. See "The Rights Offering -
Subscription Privileges - Basic
Subscription Privilege."
The over-subscription privilege entitles
you to subscribe for additional shares
of our common stock at the same
subscription price per share on a
pro-rata basis to the number of shares
you purchased under your basic
subscription privilege, provided you
fully exercise your basic subscription
privilege. "Pro-rata" means in
proportion to the number of shares of
our common stock that you and the other
rights holders electing to exercise
their over-subscription privileges have
purchased by exercising the basic
subscription privileges on their
holdings of common stock. See "The
Rights Offering - Subscription Privilege
-Over-Subscription Privilege."
HOW WAS THE SUBSCRIPTION PRICE The subscription price per share has
ESTABLISHED? been recommended to our Board of
Directors by a special committee of our
Board charged with, among other things,
recommending to our Board the financial
and other terms of this offering. The
special committee considered a number of
factors, including the historic and then
current market price of the common
stock, our business prospects, our
recent and anticipated operating
results, general conditions in the
securities markets and the energy
markets, our need for capital,
alternatives available to us for raising
capital, the amount of proceeds desired,
the pricing of similar transactions, the
liquidity of our common stock and the
level of risk to our investors. The
matters considered by the special
committee in its determination also
included negotiations with a
representative of Dolphin, of which Mr.
Salas is the controlling person, as to a
subscription price at which Dolphin
might participate in the offering,
although Dolphin has not entered into
any agreement with the Company with
respect to such participation. The
special committee's recommendations
regarding subscription price per share
and other terms of the offering were
finally presented to our Board of
Directors (with Mr. Salas not
participating with respect to these
matters) on December 23, 2003. In its
deliberations, the special committee was
advised by a financial adviser and by
counsel. See "The Rights Offering -
Background of the Rights Offering."
IS EXERCISING MY SUBSCRIPTION Yes. The exercise of your rights
RIGHTS RISKY? involves risks. Exercising your rights
means buying additional shares of our
common stock and should be considered as
carefully as you would consider any
other equity investment. Among other
things, you should carefully consider
the risks described under the heading
"Risk Factors," beginning on page 8.
MAY I TRANSFER MY RIGHTS IF I DO No. Should you choose not to exercise
NOT WANT TO PURCHASE ANY SHARES? your rights, you may not sell, give away
or otherwise transfer your rights.
However, rights will be transferable to
certain affiliates of the recipient and
by operation of law - for example, upon
death of the recipient.
AM I REQUIRED TO SUBSCRIBE IN THE No.
RIGHTS OFFERING?
HOW MANY SHARES WILL BE OUTSTANDING Assuming the rights offering is fully
AFTER THE RIGHTS OFFERING? subscribed, the number of shares of
common stock that will be outstanding
immediately after the rights offering
will be approximately 48,400,000 shares,
subject to any increase(s) that may
occur after the date of this prospectus
as a result of the exercise, conversion
or exchange of outstanding stock
options, convertible securities or
exchangeable securities.
WHAT HAPPENS IF THE RIGHTS OFFERING Any rights not exercised after giving
IS NOT FULLY SUBSCRIBED AFTER effect to the over-subscription
GIVING EFFECT TO THE privilege will expire.
OVER-SUBSCRIPTION PRIVILEGE?
HOW WILL THE RIGHTS OFFERING AFFECT The members of our board of directors
OUR BOARD'S OWNERSHIP OF OUR COMMON and their affiliates are deemed to
STOCK? beneficially own 4,363,661 shares of our
common stock, representing approximately
34.5% of our outstanding common stock.
Dolphin is deemed to beneficially own
2,441,019 shares of our common stock,
representing approximately 19.8% of our
outstanding common stock. See "Principal
Stockholders."
If no rights holders other than Dolphin
exercise their rights in the rights
offering, Dolphin will, as a result of
its subscription for and purchase of the
maximum number of unsubscribed shares,
be limited by the terms of this offering
to ownership of not more than 50% of our
issued and outstanding shares, when such
ownership is aggregated with the
ownership of its affiliates. If no
rights holders other than all of the
members of our board of directors
exercise their respective rights in the
rights offering, our board of directors
collectively will, as a result of its
subscription for and purchase of all
unsubscribed shares, own 81.9% of our
issued and outstanding shares and be
deemed to beneficially own approximately
84.1% of our common stock. See
"Principal Stockholders."
AFTER I EXERCISE MY RIGHTS, CAN I No. Once you send in your subscription
CHANGE MY MIND AND CANCEL MY certificate and payment you cannot
PURCHASE? revoke the exercise of your rights, even
if you later learn information about us
that you consider to be unfavorable and
even if the market price of our common
stock is below the $0.25 per share
subscription price. You should not
exercise your subscription rights unless
you are certain that you wish to
purchase additional shares of our common
stock at a price of $0.25 per share. See
"The Rights Offering - No Revocation."
WHAT ARE THE FEDERAL INCOME TAX A holder of common stock will not
CONSEQUENCES OF EXERCISING MY recognize income or loss for federal
SUBSCRIPTION RIGHTS AS A HOLDER OF income tax purposes in connection with
COMMON STOCK? the receipt or exercise of subscription
rights in the rights offering. See
"United States Federal Income Tax
Consequences" on page 62.
WHEN WILL I RECEIVE MY NEW SHARES? If you purchase shares of common stock
through this rights offering, you will
receive certificates representing those
shares as soon as practicable after the
expiration of the rights offering.
Subject to state securities laws and
regulations, we have the discretion to
delay allocation and distribution of any
shares you may elect to purchase by
exercise of your basic or
over-subscription privilege in order to
comply with state securities laws.
WILL THE NEW SHARES BE INITIALLY Yes. Our common stock is traded on the
LISTED ON THE AMERICAN STOCK American Stock Exchange under the symbol
EXCHANGE AND TREATED LIKE OTHER "TGC." On February 9, 2004, the last
SHARES? reported sales price of our common stock
on the AMEX was $1.20 per share.
IF THE RIGHTS OFFERING IS NOT Yes. The subscription agent will hold
COMPLETED, WILL MY SUBSCRIPTION all funds it receives in escrow until
PAYMENT BE REFUNDED TO ME? completion of the rights offering. If
the right offering is not completed, the
subscription agent will return promptly,
without interest, all subscription
payments.
WHAT SHOULD I DO IF I HAVE OTHER If you have questions or need
QUESTIONS? assistance, please contact Mellon
Investor Services LLC, the subscription
agent, at: (800) 932-6798.
For a more complete description of the
rights offering, see "The Rights
Offering" beginning on page 50.
AMERICAN STOCK EXCHANGE TRADING TGC
SYMBOL:
TO WHOM SHOULD I SEND FORMS AND
PAYMENTS:
MELLON BANK, N.A.
BY MAIL: BY HAND:
Mellon Bank, N.A. Mellon Bank, N.A.
c/o Mellon Investor Services LLC c/o Mellon Investor Services LLC
P.O. Box 3301 120 Broadway, 13th Floor
South Hackensack, NJ 07606 New York, New York 10271
Attention: Reorganization Dept. Attention: Reorganization Dept
BY OVERNIGHT COURIER:
Mellon Bank, N.A.
c/o Mellon Investor Services LLC
85 Challenger Road
Overpeck Centre
Ridgefield Park, NJ 07660
Attention: Reorganization Dept.
For instructions on how your subscription payment should be sent to the
subscription agent, see "The Rights Offering - Required Forms of
Payment of Subscription Price" on page 55.
If you have questions, need additional copies of offering documents or
otherwise need assistance, please contact the information agent for
this offering:
Mellon Investor Services LLC
85 Challenger Road
Overpeck Centre
Ridgefield Park, NJ 07660
800-932-6798
To ask other questions or to receive copies of our recent SEC filings,
you also can contact us by mail or telephone, or refer to the other
sources described under "Where You Can Find More Information" on the
inside back cover of this prospectus.
SUMMARY CONSOLIDATED FINANCIAL DATA
The following summary financial data should be read together with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the consolidated financial statements and notes thereto, and other
financial information included elsewhere in this prospectus. Our consolidated
statement of loss data set forth below for the years ended December 31, 2002 and
2001 and 2000 and the consolidated balance sheet data as of December 31, 2002
and 2001 have been derived from our audited consolidated financial statements
which are included elsewhere in this prospectus. The consolidated statement of
loss data set forth below for the years ended December 31, 1999 and 1998 and the
consolidated balance sheet data as of December 31, 2000, 1999 and 1998 have been
derived from our audited consolidated financial statements that are not included
in this prospectus. The balance sheet data and the statement of loss data as of
and for the nine months ended September 30, 2003 and 2002 have been derived from
our unaudited financial statements, included elsewhere in this prospectus, which
we believe have been prepared on the same basis as the audited financial
statements and include all adjustments, consisting of normal recurring
adjustments, which we consider necessary for a fair presentation of the summary
financial data shown.
Nine Months Ended
Year Ended December 31, (1) September 30,
--------------------------------------------------------------------- -------------------------
2002 2001 2000 1999 1998 2003 2002
(unaudited)
LOSS STATEMENT DATA.
Oil and Gas Revenues $5,437,723 $6,656,758 $5,241,076 $3,017,252 $2,078,101 $4,907,216 $3,859,050
Production Costs and Taxes $3,094,731 $2,951,746 $2,614,414 $2,564,932 $1,943,944 $2,571,898 $2,084,597
Depreciation, Depletion
and Amortization $2,413,597 $1,849,963 $371,249 $283,907 $290,030 $1,887,333 $1,731,182
General and Administrative $1,868,141 $2,957,871 $2,602,311 $1,961,348 $1,372,132 $1,112,289
Interest Expense $578,039 $850,965 $415,376 $417,497 $574,906 $462,518 $448,046
Net Loss Before
Cumulative Effect of a
Change in Accounting
Principle $(3,154,555) $(2,262,787) $(1,541,884) $(2,671,923) $(3,083,638) $(1,897,568) $(2,820,539)
Cumulative Effect of a
Change in Accounting
Principle - - - - - $(351,204) -
Net Loss Attributable to
Common Stockholders $(3,661,334) $(2,653,970) $(1,799,441) $(2,791,270) $(3,083,638) $(2,248,772) $(2,820,539)
Earnings Per Share Data:
Net Loss Before
Cumulative Effect of a
Change in Accounting
Principle Per Share $(0.33) $(0.26) $(0.19) $(0.33) $(0.42) $(0.16) $(0.26)
Cumulative Effect of a
Change in Accounting
Principle Per Share - - - - - $(0.03) -
Net Loss Attributable to
Common Stockholders Per
Share $(0.33) $(0.26) $(0.19) $(0.33) $(0.42) $(0.19) $(0.26)
Nine Months
As of December 31,(2)(3) Ended
------------------------------------------------------------------------- September 30,
2002 2001 2000 1999 1998 2003
(unaudited)
BALANCE SHEET DATA.
Working Capital Deficit $(7,998,835) $(6,326,204) $(708,317) $(1,406,263) $(1,929,215) $(9,296,959)
Oil and Gas Properties, $13,864,321 $13,269,930 $9,790,047 $8,444,036 $7,747,655 $13,096,898
Net
Pipeline Facilities, Net $15,372,843 $15,039,762 $11,047,038 $4,212,842 $4,019,209 $15,312,212
Total Assets $32,584,391 $32,128,245 $25,224,724 $15,182,712 $13,525,777 $31,662,903
Debt $9,867,454 $10,302,588 $9,217,085 $4,894,378 $4,693,865 $9,549,053
Asset Retirement Obligations -- -- -- -- -- $666,421
Mandatorily Redeemable $6,762,218 $5,459,050 $3,938,900 $1,988,900 $800,000 $6,884,257
Preferred Stock
Stockholders Equity $14,210,623 $14,991,847 $10,864,202 $7,453,930 $7,245,090 $12,458,833
(1) All references in this table to common stock and per share data have been
retroactively adjusted to reflect the 5% stock dividend declared by the
Company effective as of September 4, 2001.
(2) With respect to the pipeline facilities, during the years ended December
31, 2000, 1999, and 1998, this information included portions which were
under construction.
(3) No cash dividends have been declared or paid by the Company for the periods
presented.
RISK FACTORS
THIS OFFERING AND AN INVESTMENT IN THE SHARES OF OUR COMMON STOCK INVOLVE A
HIGH DEGREE OF RISK. YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS AND
OTHER INFORMATION PRESENTED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS
BEFORE DECIDING TO INVEST IN OUR COMMON STOCK. IF WE DO NOT SUCCESSFULLY ADDRESS
ANY ONE OR MORE OF THE RISKS DESCRIBED BELOW, THERE COULD BE A MATERIAL ADVERSE
EFFECT ON OUR FINANCIAL CONDITION, OPERATING RESULTS AND BUSINESS.
RISKS RELATED TO OUR BUSINESS
OUR AUDITORS HAVE GIVEN US A GOING CONCERN QUALIFICATION, INDICATING
SUBSTANTIAL DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN.
Our independent certified public accountants have indicated in their report
on our Consolidated Financial Statements for the year ended December 31, 2002,
that these circumstances raise substantial doubt about our ability to continue
as a going concern, which depends upon our ability to obtain long-term debt or
raise capital to satisfy our cash flow requirements. We must make substantial
capital expenditures for the acquisition, exploration and development of oil and
gas reserves. Historically, we have paid for these expenditures with cash from
operating activities, proceeds from debt and equity financings and asset sales.
Our ability to re-work existing wells and resume our drilling program in the
Swan Creek Field is dependent upon our ability to fund these expenditures.
Although we anticipated that by this time we would be able to fund the
completion of our drilling program in the Swan Creek Field from revenues from
the sales of gas, we are unable to do so. Further, the availability of
additional borrowings under our credit facility with Bank One has been revoked
by Bank One. As a result of Bank One's revocation of the credit facility and the
corresponding demand for repayment, combined with the fact that we are still in
the early stages of our oil and gas operating history, during which time we have
a history of losses from operations and have an accumulated deficit of
$(30,147,538) and a working capital deficit of $(9,296,959) as of September 30,
2003 our independent certified public accountants have indicated their going
concern qualification as described above.
WE HAVE SIGNIFICANT CAPITAL REQUIREMENTS AND A NEED FOR ADDITIONAL
FINANCING.
At the present time and if and until we are able to increase our production
and sales of gas, we must obtain the necessary funds to proceed with our
drilling program from other sources, such as this offering as well as other
equity investments, bank loans or joint ventures with other companies. In
addition, our revenues or cash flows could decline in the future because of a
variety of reasons, including lower oil and gas prices or the inoperability of
some or all of our existing wells. If our revenues or cash flows decrease and/or
we are unable to procure additional financing, we would be required to reduce
production over time or would otherwise be adversely affected, which would
adversely impact our ability to continue in business. Where we are not the
majority owner or operator of an oil and gas project, we may have no control
over the timing or amount of capital expenditures required with the particular
project. If we cannot fund our capital expenditures in such projects, our
interests in such projects may be reduced or forfeited. In addition to our
operational cash requirements, we have a significant amount of loans and other
obligations either due or maturing January 4, 2004 and April 4, 2004. These
loans, excluding our obligations to Bank One (in outstanding principal amount in
excess of $4.7 million), include interest-bearing loans in the aggregate
principal amount of approximately $5.6 million (of which approximately $3.9
million is owed to Dolphin) plus accrued interest and past due accounts payable
in the aggregate amount of approximately $600,000 (including preferred dividends
in arrears in an aggregate amount in excess of $600,000). See "Certain
Relationships and Related Transactions." We cannot assure you that the proceeds
of this offering will be sufficient to pay all of our loans and obligations
currently due or maturing as described above or that we will be able to obtain
any additional funding required as described above, in either or which events we
may not be able to continue as a going concern.
DECLINES IN OIL AND GAS PRICES WILL MATERIALLY ADVERSELY AFFECT US.
Our future financial condition and results of operations will depend in
part upon the prices obtainable for our oil and natural gas production and the
costs of finding, acquiring, developing and producing reserves. Prices for oil
and natural gas are subject to fluctuations in response to relatively minor
changes in supply, market uncertainty and a variety of additional factors that
are beyond our control. These factors include worldwide political instability
(especially in the Middle East and other oil-producing regions), the foreign
supply of oil and gas, the price of foreign imports, the level of drilling
activity, the level of consumer product demand, government regulations and
taxes, the price and availability of alternative fuels and the overall economic
environment. A substantial or extended decline in oil and gas prices would have
a material adverse effect on our financial position, results of operations,
quantities of oil and gas that may be economically produced, and access to
capital. Oil and natural gas prices have historically been and are likely to
continue to be volatile. This volatility makes it difficult to estimate with
precision the value of producing properties in acquisitions and to budget and
project the return on exploration and development projects involving our oil and
gas properties. In addition, unusually volatile prices often disrupt the market
for oil and gas properties, as buyers and sellers have more difficulty agreeing
on the purchase price of properties.
THERE ARE RISKS IN RATES OF OIL AND GAS PRODUCTION; DEVELOPMENT
EXPENDITURES; AND CASH FLOWS.
Projecting the effects of commodity prices on production, and timing of
development expenditures include many factors beyond our control. The future
estimates of net cash flows from our proved reserves and their present value are
based upon various assumptions about future production levels, prices, and costs
that may prove to be incorrect over time. Any significant variance from
assumptions could result in the actual future net cash flows being materially
different from the estimates.
OIL AND GAS OPERATIONS INVOLVE SUBSTANTIAL COSTS AND ARE SUBJECT TO
VARIOUS ECONOMIC RISKS.
Our oil and gas operations are subject to the economic risks typically
associated with exploration, development and production activities, including
the necessity of significant expenditures to locate and acquire producing
properties and to drill exploratory wells. In conducting exploration and
development activities, the presence of unanticipated pressure or irregularities
in formations, miscalculations or accidents may cause our exploration,
development and production activities to be unsuccessful. This could result in a
total loss of our investment. In addition, the cost and timing of drilling,
completing and operating wells is often uncertain.
WE HAVE SIGNIFICANT COSTS TO CONFORM TO GOVERNMENT REGULATION OF THE OIL
AND GAS INDUSTRY.
Our exploration, production and marketing operations are regulated
extensively at the federal, state and local levels. We have made and will
continue to make large expenditures in our efforts to comply with the
requirements of environmental and other regulations. Further, the oil and gas
regulatory environment could change in ways that might substantially increase
these costs. Hydrocarbon-producing states regulate conservation practices and
the protection of correlative rights. These regulations affect our operations
and limit the quantity of hydrocarbons we may produce and sell. In addition, at
the federal level, the Federal Energy Regulatory Commission regulates interstate
transportation of natural gas under the Natural Gas Act. Other regulated matters
include marketing, pricing, transportation and valuation of royalty payments.
WE HAVE SIGNIFICANT COSTS RELATED TO ENVIRONMENTAL MATTERS.
Our operations are subject to numerous and frequently changing laws and
regulations governing the discharge of materials into the environment or
otherwise relating to environmental protection. We own or lease, and have in the
past owned or leased, properties that have been used for the exploration and
production of oil and gas and these properties and the wastes disposed on these
properties may be subject to the Comprehensive Environmental Response,
Compensation and Liability Act, the Oil Pollution Act of 1990, the Resource
Conservation and Recovery Act, the Federal Water Pollution Control Act and
analogous state laws. Under such laws, we could be required to remove or
remediate previously released wastes or property contamination.
Laws and regulations protecting the environment have generally become more
stringent and, may in some cases, impose "strict liability" for environmental
damage. Strict liability means that we may be held liable for damage without
regard to whether we were negligent or otherwise at fault. Environmental laws
and regulations may expose us to liability for the conduct of or conditions
caused by others or for acts that were in compliance with all applicable laws at
the time they were performed. Failure to comply with these laws and regulations
may result in the imposition of administrative, civil and criminal penalties.
Our ability to conduct continued operations is subject to satisfying
applicable regulatory and permitting controls. Our current permits and
authorizations and ability to get future permits and authorizations may be
susceptible, on a going forward basis, to increased scrutiny, greater complexity
resulting in increased costs or delays in receiving appropriate authorizations.
INSURANCE DOES NOT COVER ALL RISKS.
Exploration for and production of oil and natural gas can be hazardous,
involving unforeseen occurrences such as blowouts, cratering, fires and loss of
well control, which can result in damage to or destruction of wells or
production facilities, injury to persons, loss of life, or damage to property or
the environment. Insurance is not available to us against all operational risks.
WE ARE NOT COMPETITIVE WITH RESPECT TO ACQUISITIONS OR PERSONNEL.
The oil and gas business is highly competitive. In addition, we have a weak
financial condition. In seeking any suitable oil and gas properties for
acquisition, or drilling rig operators and related personnel and equipment, we
are not able to compete with most other companies, including large oil and gas
companies and other independent operators with greater financial and technical
resources and longer history and experience in property acquisition and
operation.
WE DEPEND ON KEY PERSONNEL, WHOM WE MAY NOT BE ABLE TO RETAIN OR RECRUIT.
Members of present management and certain company employees have
substantial expertise in the areas of endeavor presently conducted and to be
engaged in by us. To the extent that their services become unavailable, we will
be required to retain other qualified personnel. We do not know whether we would
be able to recruit and hire qualified persons upon acceptable terms. We do not
maintain "Key Person" insurance for any of our key employees.
RISKS RELATING TO THIS RIGHTS OFFERING
THE SUBSCRIPTION PRICE DETERMINED FOR THIS OFFERING IS NOT AN INDICATION OF
OUR VALUE OR THE VALUE OF OUR COMMON STOCK.
The subscription price for this rights offering has been determined to be
$0.25 for each share purchased. The subscription price was determined by a
special committee of our Board of Directors formed for that purpose, among
others, and recommended to our full Board of Directors and does not necessarily
bear any relationship to the book value of our assets, past operations, cash
flows, losses, financial condition or any other established criteria for value.
The matters considered by the special committee in its determination included
negotiations with a representative of Dolphin as to a subscription price at
which Dolphin might participate, although Dolphin has not entered into any
agreement with us with respect to such participation. You should not consider
the subscription price as an indication of our value. After the date of this
prospectus, our common stock may trade at prices below the subscription price.
DELISTING OF OUR COMMON STOCK FROM AMEX, WHICH IS POSSIBLE, WOULD ADVERSELY
AFFECT US AND HOLDERS OF THOSE SHARES.
Our common stock is listed on the American Stock Exchange, which we refer
to as AMEX. To maintain listing of securities, AMEX requires satisfaction of
certain maintenance criteria that we are not sure that we will continue to be
able to satisfy. For example, AMEX may require prior shareholder approval of
this offering, which has not been obtained. If we are unable to satisfy such
maintenance criteria in the future, or if AMEX requires prior shareholder
approval and we fail to comply, our common stock may be delisted from trading on
AMEX. If our common stock is delisted from trading on AMEX, then trading, if
any, would thereafter be conducted in the over-the-counter market in the
so-called "pink sheets" or on the "Electronic Bulletin Board" of the National
Association of Securities Dealers, Inc. (the "NASD") and consequently an
investor could find it more difficult to dispose of, or to obtain accurate
quotations as to the price of, our common stock.
OUR COMMON STOCK MAY NOT BE EXCEPTED FROM "PENNY STOCK" RULES, WHICH MAY
ADVERSELY EFFECT THE MARKET LIQUIDITY FOR OUR COMMON STOCK.
The Securities Enforcement and Penny Stock Reform Act of 1990 requires
additional disclosure relating to the market for penny stocks in connection with
trades in any stock defined as a penny stock. Commission regulations generally
define a penny stock to be an equity security that has a market price of less
than $5.00 per share, subject to certain exception. Such exceptions include any
equity security listed on a national securities exchange and any equity security
issued by an issuer that has (i) net tangible assets of at least $2,000,000, if
such issuer has been in continuous operation for three years, (ii) net tangible
assets of at least $5,000,000, if such issuer has been in continuous operation
for less than three years, or (iii) average annual revenue of at least
$6,000,000, if such issuer has been in continuous operation for less than three
years. Unless an exception is available, the regulations require the delivery,
prior to any transaction involving a penny stock, of a disclosure schedule
explaining the penny stock market and the risks associated therewith.
In addition, if our common stock is not listed on AMEX, or if we do not
meet the other exceptions to the penny stock regulations cited above, trading in
our common stock, including exercising the rights offered hereby, would be
covered by the Commission's Rule 15g-9 under the Exchange Act for non-national
securities exchange listed securities. Under this rule, broker/dealers who
recommend such securities to persons other than established customers and
accredited investors must make a special written suitability determination for
the purchaser and receive the purchaser's written agreement to a transaction
prior to sale. Securities also are exempt from this rule if the market price is
at least $5.00 per share.
If the our common stock becomes subject to the regulations applicable to
penny stocks, the market liquidity for our common stock could be adversely
affected. In such event, the regulations on penny stocks could limit the ability
of broker/dealers to sell our common stock and thus the ability of purchasers of
our common stock to sell their shares in the secondary market.
AS A RESULT OF THIS OFFERING, CERTAIN PERSONS MAY OBTAIN EFFECTIVE VOTING
CONTROL OF US AND BE ABLE TO DIRECT OUR ACTIONS.
As a result of this offering, Dolphin would, in the event that it were to
subscribe for and purchase the maximum number of unsubscribed shares, be able to
acquire the ownership of up to 50% of our issued and outstanding shares.
Similarly, if no rights holders other than all of the members of our board of
directors exercise their respective rights in this offering, our board of
directors collectively would, as a result of its subscription for and purchase
of all unsubscribed shares, own up to 81.9% of our issued and outstanding shares
and be deemed to beneficially own approximately 84.1% of our common stock.
Consequently, such control would allow such persons to be able to elect all of
our directors and otherwise control our operations, including being able to
direct our actions. Further, such control might discourage potential acquirers
from seeking to acquire control of us through the purchase of our common stock,
which could have a limiting effect on the price of our common stock.
IF YOU EXERCISE YOUR RIGHTS, YOU MAY LOSE MONEY IF THERE IS A DECLINE IN
THE TRADING PRICE OF OUR SHARES OF COMMON STOCK.
The trading price of our common stock in the future may decline below the
subscription price. We cannot assure you that the subscription price will remain
below any future trading price for the shares of our common stock. Future prices
of the shares of our common stock may adjust negatively depending on various
factors including our future revenues and earnings, changes in earnings
estimates by analysts, our ability to meet analysts' earnings estimates,
speculation in the trade or business press about our operations, and overall
conditions affecting our businesses, economic trends and the securities markets.
YOU MAY NOT REVOKE THE EXERCISE OF YOUR RIGHTS EVEN IF THERE IS A DECLINE
IN OUR COMMON STOCK PRICE PRIOR TO THE EXPIRATION DATE OF THE SUBSCRIPTION
PERIOD.
Even if our common stock price declines below the subscription price for
the common stock, resulting in a loss on your investment upon the exercise of
rights to acquire shares of our common stock, you may not revoke or change your
exercise of rights after you send in your subscription forms and payment.
YOU MAY NOT REVOKE THE EXERCISE OF YOUR RIGHTS EVEN IF WE DECIDE TO EXTEND
THE EXPIRATION DATE OF THE SUBSCRIPTION PERIOD.
We may, in our discretion, extend the expiration date of the subscription
period for up to an additional 30 days. During any potential extension of time,
our common stock price may decline below the subscription price and result in a
loss on your investment upon the exercise of rights to acquire shares of our
common stock. If the expiration date is extended after you send in your
subscription forms and payment, you still may not revoke or change your exercise
of rights.
YOU WILL NOT RECEIVE INTEREST ON SUBSCRIPTION FUNDS RETURNED TO YOU.
If we cancel the rights offering, neither we nor the subscription agent
will have any obligation with respect to the subscription rights except to
return, without interest, any subscription payments to you.
WE MAY NOT RECEIVE SUFFICIENT PARTICIPATION TO GENERATE SUFFICIENT PROCEEDS
FOR ALL INTENDED PURPOSES
We have no agreements or understandings with any persons or entities,
including Dolphin, members of our Board of Directors, our management and any
broker dealers, with respect to their exercise of any rights offered hereby or
their participation as an underwriter, broker or dealer in this offering. As
such, we do not know to what extent stockholders will participate in the
offering and therefore what amount of proceeds will be raised in the offering.
Assuming that stockholders exercise all of the rights we are offering, we will
receive gross proceeds of approximately $9,075,000. We intend to use the net
proceeds initially to pay non-bank indebtedness of up to $6 million, with the
balance, if any, to pay bank indebtedness to some extent and/or for working
capital purposes in our discretion. The net proceeds of this offering, even at a
maximum participation level, may provide insufficient working capital to us for
any minimum period of time. The net proceeds of this offering at less than a
maximum participation level will be used in the priorities described above and
will be available in the amounts at the levels described below:
Percentage
Participation Gross Proceeds Net Proceeds
------------- -------------- ------------
25% $2,268,750 $2,118,750
50% $4,537,500 $4,387,500
75% $6,806,250 $6,656,250
100% $9,075,000 $8,925,000
It should be noted from the table above that, unless the offering is
approximately 75% participated, there may not be sufficient proceeds remaining
for other purposes following payment of non-bank indebtedness. See "--
Significant Capital Requirements and a Need for Additional Financing" and "Use
of Proceeds."
BECAUSE WE MAY TERMINATE THE OFFERING, YOUR PARTICIPATION IN THE OFFERING
IS NOT ASSURED.
Once you exercise your subscription rights, you may not revoke the exercise
for any reason unless we amend the offering. If we decide to terminate the
offering, we will not have any obligation with respect to the subscription
rights except to return any subscription payments, without interest.
OUR ABILITY TO USE OUR NET OPERATING LOSS CARRYFORWARDS MAY BE
SUBSTANTIALLY REDUCED AS A RESULT OF THIS OFFERING.
Section 382 of the Internal Revenue Code of 1986 imposes a limitation on a
corporation's use of net operating loss ("NOL") carryforwards if the corporation
has undergone an "ownership change." Depending on a number of circumstances,
including the extent to which the rights offered hereby are exercised out of
proportion to existing common stock ownership, this offering may create an
ownership change in us for purposes of Section 382 and therefore substantially
reduce the amount of NOL carryforwards that we may use in future years to offset
our taxable income. At December 31, 2002, we had federal tax NOL carryforwards
of $7,139,000. Because we previously have taken a full valuation reserve for our
deferred tax assets on our financial statements, an ownership change would not
have an immediate impact on our reported earnings for financial accounting
purposes.
FORWARD LOOKING STATEMENTS
The statements contained in this prospectus that are not purely historical
are forward-looking statements within the meaning of applicable securities laws.
Forward-looking statements include statements regarding our "expectations,"
"anticipations," "intentions," "beliefs," or "strategies" regarding the future.
Forward-looking statements also include statements regarding revenue, margins,
expenses, and earnings analysis for 2003 and thereafter; our going concern
qualification; oil and gas prices; exploration activities; development
expenditures; costs of regulatory compliance; environmental matters;
technological developments; future products or product development; our products
and distribution development strategies; potential acquisitions or strategic
alliances; liquidity and anticipated cash needs and availability; prospects for
success of this offering; impact of this offering on our financial condition or
prospects or the market for or price of our common stock; and control of our
company. All forward-looking statements included in this prospectus are based on
information available to us as of the date of this prospectus, and we assume no
obligation to update any such forward-looking statements. Our actual results
could differ materially from the forward-looking statements. Among the factors
that could cause results to differ materially are the factors discussed in "Risk
Factors."
Projecting the effects of commodity prices on production, and timing of
development expenditures include many factors beyond our control. The future
estimates of net cash flows from our proved reserves and their present value are
based upon various assumptions about future production levels, prices, and costs
that may prove to be incorrect over time. Any significant variance from
assumptions could result in the actual future net cash flows being materially
different from the estimates.
This prospectus is part of a registration statement filed with the SEC. You
should rely only on the information contained in this prospectus. We have not
authorized anyone to provide you with different information. This prospectus may
only be used where it is legal for us to sell these securities.
USE OF PROCEEDS
Assuming that stockholders exercise subscription rights for all of the
common stock that we are offering, we will receive gross proceeds of
approximately $9,075,000. We will pay estimated expenses of approximately
$150,000 in connection with the rights offering. We intend to use the net
proceeds from this offering initially to pay non-bank indebtedness in the
aggregate amount of up to approximately $6,000,000 (including up to $3,850,000
in principal amount plus accrued interest to Dolphin), and to apply the balance
of such proceeds, if any, to repay bank indebtedness to some extent and/or for
working capital purposes, possibly including the drilling of additional wells.
In the event that less than all $9,075,000 of gross proceeds is received in the
offering, we intend to apply the received gross proceeds, unless the offering is
terminated by us by reason of the insufficiency of investor participation or any
other reason in our discretion, first for the repayment of non-bank
indebtedness, including to Dolphin, with secured non-bank indebtedness to be
repaid before unsecured non-bank indebtedness, and next to pay bank indebtedness
to some extent and/or for working capital purposes in our discretion. The
non-bank indebtedness to be discharged with the proceeds hereof includes secured
loans from Dolphin from time to time since December 2002 in the aggregate
principal amount of $3,350,000 bearing interest at 12% per annum and matured
January 4, 2004, unsecured convertible loans from Dolphin and others in the
aggregate principal amount of $1,150,000 bearing interest at 8% per annum and
matured January 4, 2004, all of which loans were made to us to provide working
capital and to cover certain due and payable liabilities and accounts payable.
See `Certain Relationships and Related Transactions." There can be no assurance
that the net proceeds of this offering will provide sufficient working capital
to us for any minimum period of time. See "Risk Factors - Going Concern
Qualification" and "- Significant Capital Requirements; Need for Additional
Financing."
We have no agreements or understandings with any persons or entities,
including Dolphin, members of our Board of Directors, our management and any
broker dealers, with respect to their exercise of any rights offered hereby or
their participation as an underwriter, broker or dealer in this offering. As
such, we do not know to what extent stockholders will participate in the
offering and therefore what amount of proceeds will be raised in the offering.
As noted above, assuming that stockholders exercise all of the rights we are
offering, we will receive gross proceeds of approximately $9,075,000, which we
intend to use initially to pay non-bank indebtedness of up to $6 million, with
the balance, if any, to pay bank indebtedness to some extent and/or for working
capital purposes in our discretion. Also as noted, the net proceeds of this
offering, even at a maximum participation level, may provide insufficient
working capital to us for any minimum period of time. The net proceeds of this
offering at less than a maximum participation level will be used in the
priorities described above and will be available in the amounts at the levels
described below:
Percentage
Participation Gross Proceeds Net Proceeds
------------- -------------- ------------
25% $2,268,750 $2,118,750
50% $4,537,500 $4,387,500
75% $6,806,250 $6,656,250
100% $9,075,000 $8,925,000
It should be noted from the table above that, unless the offering is
approximately 75% participated, there may not be sufficient proceeds remaining
for other purposes following payment of non-bank indebtedness.
PRICE RANGE OF COMMON STOCK
Our common stock is listed on the American Stock Exchange under the symbol
"TGC." The following table sets forth the high and low closing sales prices per
share of our common stock for the periods indicated. The prices for the first
three quarters of 2001 have been retroactively adjusted by a 5% reduction to
take into account the 5% stock dividend declared by us payable on October 1,
2001 to all stockholders of record as of September 4, 2001.
HIGH LOW
---- ---
Year Ending December 31, 2004
First Quarter (through February 9, 2004)...... $1.21 $0.71
Year Ending December 31, 2003
First Quarter................................. 2.00 1.00
Second Quarter................................ 1.23 0.36
Third Quarter................................. 1.28 0.65
Fourth Quarter ............................... 0.94 0.63
Year Ended December 31, 2002
First Quarter................................. 8.19 5.80
Second Quarter................................ 6.49 2.71
Third Quarter................................. 3.45 2.20
Fourth Quarter................................ 2.90 1.05
Year Ended December 31, 2001
First Quarter................................. 14.20 9.69
Second Quarter................................ 15.01 11.16
Third Quarter................................. 13.69 7.60
Fourth Quarter................................ 10.54 7.39
CAPITALIZATION
The following table sets forth our summary capitalization as of September
30, 2003, and our summary capitalization as of September 30, 2003 as adjusted to
reflect the assumed sale of 36,300,000 shares of our common stock (the maximum
number of shares offered) in this rights offering at an offering price of $0.25
per share and the application of the estimated net proceeds therefrom, after
deducting estimated offering expenses of $150,000.
September 30, 2003
--------------------------------
As
Actual Adjusted
------------ --------------
Total Debt:
Long-term debt, less current maturities............................. $ 590,055 $ 590,055
------------ --------------
Mandatorily Redeemable Preferred Stock:
Cumulative convertible redeemable preferred; redemption value
$7,072,000; 70,720 shares outstanding............................... 6,884,257 6,884,257
------------ --------------
Stockholders Equity:
Common Stock, $0.001 par value, 50,000,000 shares authorized........ 12,065 48,365
Additional paid-in capital.......................................... 42,855,693 51,744,393
Treasury stock, at cost............................................. (145,887) (145,887)
Accumulated other comprehensive loss................................ (115,500) (115,500)
Accumulated deficit................................................. (30,147,538) (30,147,538)
------------ --------------
Total stockholders' equity................................. 12,458,833 21,383,833
------------ --------------
Total capitalization..................................................... $19,933,145 $ 28,858,145
============ ==============
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read together
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations," the consolidated financial statements and notes thereto, and other
financial information included elsewhere in this prospectus. Our consolidated
statement of loss data set forth below for the years ended December 31, 2002,
2001 and 2000 and the consolidated balance sheet data as of December 31, 2002
and 2001 have been derived from our audited consolidated financial statements
which are included elsewhere in this prospectus. The consolidated statement of
loss data set forth below for the years ended December 31, 1999 and 1998 and the
consolidated balance sheet data as of December 31, 2000, 1999, and 1998 have
been derived from our audited consolidated financial statements that are not
included in this prospectus. The balance sheet data and the statement of loss
data as of and for the nine months ended September 30, 2003 and 2002 have been
derived from our unaudited financial statements included elsewhere in this
prospectus, which we believe have been prepared on the same basis as the audited
financial statements and include all adjustments, consisting of normal recurring
adjustments, which we consider necessary for a fair presentation of the selected
financial data shown.
Nine Months Ended
Year Ended December 31,(1) September 30,
-------------------------
2002 2001 2000 1999 1998 2003 2002
(unaudited)
LOSS STATEMENT DATA.
Oil and Gas Revenues $5,437,723 $6,656,758 $5,241,076 $3,017,252 $2,078,101 $4,907,216 $3,859,050
Production Costs and Taxes $3,094,731 $2,951,746 $2,614,414 $2,564,932 $1,943,944 $2,571,898 $2,084,597
Depreciation, Depletion
and Amortization $2,413,597 $1,849,963 $371,249 $283,907 $290,030 $1,887,333 $1,731,182
General and Administrative $1,868,141 $2,957,871 $2,602,311 $1,961,348 $1,372,132 $1,112,289
Interest Expense $578,039 $850,965 $415,376 $417,497 $574,906 $462,518 $448,046
Net Loss Before
Cumulative Effect of a
Change in Accounting
Principle $(3,154,555) $(2,262,787) $(1,541,884) $(2,671,923) $(3,083,638) $(1,897,568) $(2,820,539)
Cumulative Effect of a
Change in Accounting
Principle - - - - - $(351,204) -
Net Loss Attributable to
Common Stockholders $(3,661,334) $(2,653,970) $(1,799,441) $(2,791,270) $(3,083,638) $(2,248,772) $(2,820,539)
Earnings Per Share Data:
Net Loss Before
Cumulative Effect of a
Change in Accounting
Principle
Per Share $(0.33) $(0.26) $(0.19) $(0.33) $(0.42) $(0.16) $(0.26)
Cumulative Effect of a
Change in Accounting
Principle Per Share - - - - - $(0.03) -
Net Loss Attributable to
Common Stockholders Per
Share $(0.33) $(0.26) $(0.19) $(0.33) $(0.42) $(0.19) $(0.26)
Nine Months
As of December 31,(2)(3) Ended
------------------------------------------------------------------------ September 30,
2002 2001 2000 1999 1998 2003
(unaudited)
BALANCE SHEET DATA.
Working Capital Deficit $(7,998,835) $(6,326,204) $(708,317) $(1,406,263) $(1,929,215) $(9,296,959)
Oil and Gas Properties, $13,864,321 $13,269,930 $9,790,047 $8,444,036 $7,747,655 $13,096,898
Net
Pipeline Facilities, Net $15,372,843 $15,039,762 $11,047,038 $4,212,842 $4,019,209 $15,312,212
Total Assets $32,584,391 $32,128,245 $25,224,724 $15,182,712 $13,525,777 $31,662,903
Debt $9,867,454 $10,302,588 $9,217,085 $4,894,378 $4,693,865 $9,549,053
Asset Retirement Obligations -- -- -- -- -- $666,421
Mandatorily Redeemable
Preferred Stock $6,762,218 $5,459,050 $3,938,900 $1,988,900 $800,000 $6,884,257
Stockholders Equity $14,210,623 $14,991,847 $10,864,202 $7,453,930 $7,245,090 $12,458,833
(1) All references in this table to common stock and per share data have been
retroactively adjusted to reflect the 5% stock dividend declared by the
Company effective as of September 4, 2001.
(2) With respect to the pipeline facilities, during the years ended December
31, 2000, 1999, and 1998, this included portions which were under
construction.
(3) No cash dividends have been declared or paid by the Company for the periods
presented.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section should be read in conjunction with our consolidated financial
statements included elsewhere in this prospectus. Comments on the results of
operations and financial condition below refer to our continuing operations.
OVERVIEW
We are in the business of exploring for, producing and transporting oil and
natural gas in Tennessee and Kansas. We lease producing and non-producing
properties with a view toward exploration and development. Emphasis is also
placed on pipeline and other infrastructure facilities to provide transportation
services. We utilize seismic technology to maximize the recovery of reserves.
Our activities in the oil and gas business commenced in May 1995 with the
acquisition of oil and gas leases in Hancock, Claiborne, Knox, Jefferson and
Union counties in Tennessee. Our current lease position in these areas in
Tennessee is approximately 41,088 acres. In addition, in 1997, we acquired
approximately 32,000 acres of leases in the vicinity of Hays, Kansas.
To date, we have drilled primarily on a portion of our Tennessee leases
known as the Swan Creek Field in Hancock County focused within what is known as
the Knox formation, one of the geologic formations in that field. During the
first nine months of 2003, we produced an average of approximately 1.2 million
cubic feet of natural gas per day and approximately 2,171 barrels of oil per
month from 23 producing gas wells and six producing oil wells in the Swan Creek
Field. We also operate wells in the State of Kansas. During the first nine
months of 2003, we produced an average of approximately .73 million cubic feet
of natural gas per day and 10,531 barrels of oil per month from 59 producing gas
wells and 149 producing oil wells in Kansas.
The availability of additional borrowings under our credit facility with
Bank One has been revoked by Bank One. As a result of Bank One's revocation of
the credit facility and the corresponding demand for payment, combined with the
fact that we are still in the early stages of our oil and gas operating history,
during which time we have a history of losses from operations and have an
accumulated deficit of $(30,147,538) and a working capital deficit of
$(9,296,959) as of September 30, 2003, our independent certified public
accountants have indicated in their report on our Consolidated Financial
Statements for the year ended December 31, 2002, that these circumstances raise
substantial doubt about our ability to continue as a going concern, which
depends upon our ability to obtain long-term debt or raise capital to satisfy
our cash flow requirements. See "Risk Factors - Going Concern Qualification."
A reporting issue has arisen regarding the application of certain
provisions of SFAS No. 141 and SFAS No. 142 to companies in the extractive
industries, including oil and gas companies. The issue is whether SFAS No. 142
requires registrants to classify the costs of mineral rights held under lease or
other contractual arrangement associated with extracting oil and gas as
intangible assets in the balance sheet, apart from other capitalized oil and gas
property costs, and provide specific footnote disclosures. Historically, we have
included the costs of such mineral rights associated with extracting oil and gas
as a component of oil and gas properties. If it is ultimately determined that
SFAS No. 142 requires oil and gas companies to classify costs of mineral rights
held under lease or other contractual arrangement associated with extracting oil
and gas as a separate intangible assets line item on the balance sheet, we would
be required to reclassify approximately $453,000 at September 30, 2003 and
$346,000 at December 31, 2002, respectively, out of oil and gas properties and
into a separate intangible assets line item. Our cash flows and results of
operations would not be affected since such intangible assets would continue to
be depleted and assessed for impairment in accordance with full cost accounting
rules. Further, we do not believe the classification of the costs of mineral
rights associated with extracting oil and gas as intangible assets would have
any impact on compliance with covenants under our debt agreements.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
KANSAS During the first nine months of 2003, we produced and sold 94,782
barrels of oil and 196,373 Mcf of natural gas from our Kansas Properties, which
are comprised of 149 producing oil wells and 59 producing gas wells. The first
nine months production of 94,782 barrels of oil compares to 106,683 barrels
produced in the first nine months of 2002. The first nine months production of
196,373 Mcf of gas compares to 214,859 Mcf produced in the first nine months of
2002. In summary, the first nine months production reflected expected continued
relatively stable production levels from the Kansas Properties, which have been
in production for many years. The decrease in production reflects a normal
decline curve for the Kansas properties. The revenues from the Kansas properties
were $2,959,430 in the first nine months of 2003 as compared to $2,438,136 for
the first nine months of 2002. The increase in revenues is due to a significant
increase in the price of oil and gas during the period.
TENNESSEE During the first nine months of 2003, we produced gas from 23
wells in the Swan Creek Field, which gas was sold to our two industrial
customers in Kingsport, Tennessee, BAE SYSTEMS Ordnance Systems Inc. as operator
of the Holston Army Ammunition Plant, or BAE, and Eastman Chemical Company.
Natural gas production from the Swan Creek Field for the first nine months of
2003 was an average of 1.195 million cubic feet per day during that period as
compared to 2.114 million cubic feet per day during the first nine months of
2002. The first nine months production reflected expected natural decline in
production from the existing Swan Creek gas wells, which were first brought into
production in mid-2001 upon completion of our pipeline. Although this decline is
normal, the reduced production volume was not replaced as we had expected by
additional drilling. In order for overall field production to remain steady or
grow, new wells must be brought online. We expect that any of the new wells we
drill would also experience the same harmonic (i.e. a relatively steep initial
decline curve followed by longer periods of relatively flat or stable
production) decline like other natural wells in formations similar to the Knox
formation, so continuous drilling is vital to maintaining or increasing initial
levels of production. We have not drilled any new wells to date in 2003. The
decrease in our pipeline transportation revenues is directly related to the
decrease in our gas production volumes.
We recognized $5,053,454 in oil and gas revenues from our Kansas Properties
and the Swan Creek Field during the first nine months of 2003 compared to
$4,059,165 in the first nine months of 2002. The increase in revenues was due to
a significant increase in price from oil and gas sales. Oil prices averaged
$28.60 per barrel in 2003 as compared to $22.98 during the comparable period in
2002. Gas prices averaged $5.31 per Mcf in 2003 as compared to $2.89 during the
comparable period in 2002. The Swan Creek Field produced 322,739 Mcf and 570,883
Mcf in the first nine months of 2003 and 2002, respectively. This decrease was
due to the declines in production, which could not be offset due to the lack of
funds to continue drilling wells.
We realized a net loss attributable to common stockholders of $2,248,772
(($0.19) per share of common stock) during the first nine months of 2003
compared to a net loss in the first nine months of 2002 attributable to common
stockholders of $2,820,539 (($0.26) per share of common stock). A non-cash
charge of $351,204 was recognized as a cumulative effect of a change in
accounting principle during the first quarter of 2003 relating to the
implementation of SFAS 143. See "--Recent Accounting Pronouncements" and the
Notes to the Consolidated Financial Statements contained elsewhere in this
Prospectus.
Production costs and taxes in the first nine months of 2003 of $2,571,898
were consistent with production costs and taxes of $2,084,597 in the first nine
months of 2002. The difference of $487,301 was due to a reclassification of
insurance cost relating to field activities of $148,098 from general and
administrative to production costs. Part of the increase in production costs in
2003 was due to the fact that our field personnel cost was capitalized as we
were drilling new wells in 2002, as compared to 2003 when all employees were
working to maintain production. Field salaries in Swan Creek was $209,563 in the
first nine months of 2003. The remaining increase was due to increased property
taxes on the pipeline as a result of its higher assessed value after completion.
Depreciation, Depletion, and Amortization expense for the first nine months
of 2003 was $1,887,333 compared to $1,731,182 in the first nine months of 2002.
The December 31, 2002, Ryder Scott Company, L.P. reserve reports were used as a
basis for the 2003 estimate. We review our depletion analysis and industry oil
and gas prices on a quarterly basis to ensure that the depletion estimate is
reasonable. The depletion taken in the first nine months of 2003 was $1,072,926
as compared to $1,019,138 in the first nine months of 2002. We also amortized
$153,633 of loan fees relating to the Bank One loan and convertible notes in the
first nine months of 2003 as compared to $129,540 in the same period of 2002.
During the first nine months of 2003, we reduced our general and
administrative costs significantly by $415,699 from those of the first nine
months of 2002. Management has made an effort to control costs in every aspect
of its operations. Some of these cost reductions included the closing of our New
York office and a reduction in personnel from 2002 levels. Professional fees
have remained at a high level, primarily due to costs incurred for legal and
accounting services as a result of the Bank One lawsuit. Dividends on preferred
stock have increased from $372,595 during the first nine months of 2002 to
$402,583 during the first nine months of 2003 as a result of the increase in the
amount of preferred stock outstanding from new private placements occurring
during the second quarter of 2002. Our 2003 public relations costs were reduced
by $146,967 from those of 2002 as part of our efforts to cut costs.
FISCAL YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
We realized oil and gas revenues of $5,437,723 in 2002 as compared to
$6,656,758 in 2001 and $5,241,076 in 2000. The decrease in revenues in 2002 from
2001 was due to a decrease in volumes produced in 2002 from the volumes produced
in 2001. Gas produced from the Swan Creek Field was 717,701 MCF in 2002 as
compared to 966,967 MCF in 2001, resulting in approximately $800,000 in reduced
revenues. Oil production from the Swan Creek Field was 20,122 barrels in 2002,
down from 30,323 barrels in 2001, resulting in approximately $200,000 in reduced
revenues. Gas production from the Kansas Properties was 287,198 MCF in 2002
compared to 324,915 MCF in 2001, resulting in approximately $100,000 in reduced
revenues. Oil production from the Kansas Properties was 137,851 barrels in 2002
compared to 147,029 barrels in 2001, resulting in approximately $200,000 in
reduced revenues. The reason for the decrease in volumes produced in 2002 was
our disputed credit reduction by Bank One, which significantly limited our
ability to drill new wells to maintain or increase production volumes. The
increased revenues in 2001 of $6,656,758 compared to $5,241,076 in 2000 was
primarily due to gas sales from the Swan Creek field of $2,563,935 being made
for the first time during 2001. However, oil sales decreased by approximately
$951,000 in 2001 from 2000 levels due to price decreases, as the number of
barrels produced remained constant.
Our subsidiary, TPC, had pipeline transportation revenues of $259,677 in
2002, a decrease compared to $296,331 in 2001, the first year of transportation
revenues.
Our production costs and taxes have increased each year from 2000 to 2002
as additional costs have been incurred to maintain the Kansas Properties and to
begin production from the Swan Creek Field in 2001 and to maintain it in 2002.
The production costs and taxes increased from $2,951,746 in 2001 to $3,094,731
in 2002. An increase in 2001 of $337,332 in production costs and taxes as
compared to 2000 was due primarily to the commencement of production from the
Swan Creek Field.
Depletion, depreciation, and amortization increased significantly in 2002
to $2,413,597 over 2001 and 2000 levels of $1,849,963 and $371,249,
respectively. The primary reason for the increase from 2002 over 2001 was due to
depreciation being taken for the first time for a full year on our pipeline
facilities in 2002, whereas only a half year of depreciation was taken in 2001
after the pipeline was placed in service in mid-year. Also, approximately
$186,000 of loan fees were amortized in 2002. The primary increase in 2001 from
2000 was due to significant increases in depletion expense during 2001
($1,142,000) as a result of the following: decreases in reserve estimates on oil
and gas properties arising from declining commodity prices; certain of our gas
wells had decreased production levels at year-end due to problems encountered
with liquids in the wells. This decreased production level at year-end was
factored into the estimated future proved reserves calculation performed as of
December 31, 2001, resulting in a lower future proved reserves estimate.
Additionally, in 2001 we depreciated the pipeline for the first time ($220,371).
We significantly reduced our general administrative costs to $1,868,141 in
2002 from $2,957,871 in 2001. Management has made a significant effort to
control costs in every aspect of its operations. Some of these cost reductions
include the closing of the New York office and a reduction in personnel from
2001 levels. General and administrative expenses had increased to $2,957,871 in
2001 from $2,602,311 in 2000. The increases in 2001 from 2000 were attributable
to an increase in insurance of approximately $400,000 in 2001 to expand coverage
including blowout insurance and the addition of company provided medical
insurance for employees.
Interest expense for 2002 decreased significantly over 2001 levels due to
the reduced interest rate on the Bank One loan over the rate applicable under
previous financing arrangements. Interest expense in 2002 was $578,039 compared
to $850,965 in 2001. Interest expense for 2001 had in turn increased
significantly from $415,376 in 2000. This increase was due to additional
interest cost associated with financing for the completion of Phase II of our
65-mile pipeline. The increase in 2001 was reduced by interest cost of
approximately $148,000 which was capitalized in the first three months of 2001
during construction of the pipeline. Interest of $128,000 was capitalized in
2000.
Public relations costs were significantly reduced in 2002 to $193,229 from
$293,448 in 2001 as we applied cost saving methods in the preparation of our
annual report to stockholders and in publishing of press releases. Public
relations costs increased to $293,448 in 2001 as compared to 2000 costs of
$106,195 due to costs associated with producing the annual report, the proxy
statement and press releases.
Professional fees increased to $707,296 in 2002 from $355,480 in 2001 due
to legal and accounting services primarily related to the Bank One litigation
and new accounting regulations. Professional fees had decreased substantially in
2001 from 2000 fees of $719,320 which included a charge in 2000 of $242,000 for
stock options issued in 2000 to non-employees.
Dividends on preferred stock increased to $506,789 in 2002 from $391,183 in
2001 and from $257,557, in 2000 as a result in the increase in the amount of
preferred stock outstanding.
LIQUIDITY AND CAPITAL RESOURCES
In November 2001, Bank One extended to us a line of credit of up to $35
million. The initial borrowing base under such credit agreement was $10 million.
In April 2002, we received a notice from Bank One stating that it had
redetermined and reduced the borrowing base under the credit agreement to
approximately $3.1 million and requiring a $6 million reduction of the
outstanding loan. The schedule of reserve reports required by the Credit
Agreement upon which such redeterminations were to be based specifically
established a procedure involving an automatic monthly principal payment of
$200,000 commencing February 1, 2002. As of February 1, 2004, the outstanding
principal balance under the credit agreement was approximately $4.7 million.
As a result of Bank One's unexpected reduction of the borrowing base and
the corresponding demand for payment of $6 million, combined with the fact that
we are still in the early stages of our oil and gas operating history during
which time we have had a history of losses from operations and have an
accumulated deficit of $(29,491,533) and a working capital deficit of
$(9,194,357) as of June 30, 2003, our independent auditors indicated in their
report on the audit of our consolidated financial statements for the year ended
December 31, 2002 that our ability to continue as a going concern is uncertain.
Our ability to continue as a going concern depends upon our ability to obtain
long-term debt or raise capital and satisfy cash flow requirements.
In May 2002, we filed suit against Bank One in federal court in the Eastern
District of Tennessee, Northeastern Division at Greeneville, Tennessee to
restrain Bank One from taking any steps pursuant to the credit agreement to
enforce its demand that we reduce our loan obligation or else be deemed in
default and for actual and punitive damages resulting from the demand. See
"Legal Proceedings" for a discussion of this action. Although the parties
continue to discuss settlement of all outstanding issues, no settlement has been
reached. The Court has adjusted the procedural schedule to lead to trial on
December 7, 2004 in the event settlement is not concluded. Even if we conclude a
settlement with Bank One, we do not anticipate that we will be able to either
increase the borrowing base under the Bank One credit agreement or borrow any
additional sums from Bank One. To fund additional drilling and to provide
additional working capital, we are required to pursue other options. Although we
intend to apply the net proceeds from this offering initially to repay
outstanding non-bank indebtedness and to apply the balance of such proceeds, if
any, to repay bank indebtedness to some extent and/or to fund the drilling of
additional wells, there can be no assurances that such net proceeds will be
sufficient for such purposes or that we will be able to resolve the difficulties
currently preventing us from drilling additional wells and increasing production
volumes of natural gas from the Swan Creek Field. See "Use of Proceeds."
If funding for drilling becomes sufficiently available, as to which there
can be no assurance, we plan to drill wells in the Swan Creek Field and in new
locations in Ellis and Rush Counties, Kansas on existing leases in response to
drilling activity in the area establishing new areas of oil production. Although
we drilled a well in Kansas in 2001 and completed the well as an oil well, we
were not able to drill any new wells in Kansas in or since 2002 due to lack of
funds.
As of September 30, 2003, we had total stockholders' equity of $12,458,833
on total assets of $31,662,903. We had a net working capital deficiency at
September 30, 2003 of $(9,296,959) as compared to a net deficiency of
$(7,998,835) at December 31, 2002.
Net cash used in operating activities increased from $221,176 in 2001 to
$566,017 in 2002. Net cash used in operating activities was $(724,084) during
the first nine months of 2002 as compared to net cash provided by operating
activities during the first nine months of 2003 of $543,258. Our net loss in
2002 increased to $(3,154,555) from $(2,262,787) in 2001 and decreased from
$(2,447,944) during the first nine months of 2002 to $(1,494,985) during the
first nine months of 2003.
Net cash used in investing activities amounted to $2,889,937 for 2002
compared to net cash used in the amount of $9,408,684 for 2001 and $386,681 for
the first nine months of 2003 as compared to $2,549,984 for the first nine
months of 2002. The decrease in net cash used for investing activities during
2002 is primarily attributable to the construction of Phase II of the pipeline
of $4,213,095 in 2001 as compared to $841,750 in 2002 and additions to oil and
gas properties of $4,821,883 in 2001 as compared to $1,982,529 in 2002.
Net cash provided by financing activities decreased to $3,246,633 in 2002
from $8,419,336 in 2001. Net cash used in financing activities amounted to
$8,522 during the first nine months of 2003 as compared to net cash provided by
financing activities of $3,203,156 during the first nine months of 2002. The
decrease over the full years was due, in part, to our inability to enter into
new financing arrangements in 2002 as a result of our dispute with Bank One as
discussed above. The decrease over the nine-month periods was a result, in part,
of the private placements of common stock and preferred stock during the earlier
period in the aggregate amount of $3,980,168 as compared to only $250,000 during
the recent period. In 2001 the primary sources of financing included proceeds
from borrowings of $10,442,068 as compared to $2,063,139 in 2002 and net
proceeds of issuances of common stock of $3,900,000 in 2001 as compared to
$2,677,000 in 2002. In addition, proceeds from exercise of options were
$2,341,000 in 2001 as compared to zero in 2002 as the market price of our stock
fell below the exercise price of the earlier granted options. The primary use of
cash in financing activities in 2001 was the use of the funds received from Bank
One to repay our prior borrowings of $8,833,325 as compared to 2002 when
$2,378,273 was used primarily to make payments to Bank One.
We must make substantial capital expenditures for the acquisition,
exploration and development of oil and gas reserves. We are presently unable to
fund the resumption of our drilling program in the Swan Creek Field. At the
present time and until we are able to increase our production and sales of gas
and to resolve our dispute with Bank One, we must obtain the necessary funds to
proceed with our drilling program from other sources, such as this offering as
well as equity investment, bank loan or a joint venture with other companies, as
to which there can be no assurances. Although we intend to apply the net
proceeds from this offering initially to repay non-bank indebtedness and to
apply the balance of such proceeds, if any, to repay in part bank indebtedness
and/or other working capital purposes, including the drilling of additional
wells, there can be no assurances that such net proceeds will be sufficient for
such purposes or that we will be able to resolve the financial difficulties
currently preventing us from drilling wells and increasing production volumes of
natural gas from the Swan Creek Field. In addition, our revenues or cash flows
could be reduced because of a variety of reasons, including lower oil and gas
prices or the inoperability of some or all of our existing wells, as to which
there can be no assurances. We do not know that we will be able to obtain
additional funding. In addition to our operational cash requirements, we have a
significant amount of loans and other obligations either due or maturing January
4, 2004 and April 4, 2004, including $1,150,000 principal amount of unsecured
convertible notes and $3,850,000 principal amount of secured promissory notes,
plus interest to Dolphin. See "Risk Factors - Significant Capital Requirements;
Need for Additional Financing" and "Certain Relationships and Related
Transactions."
CRITICAL ACCOUNTING POLICIES
Our accounting policies are described in the Notes to Consolidated
Financial Statements contained in this prospectus. We prepare our Consolidated
Financial Statements in conformity with accounting principles generally accepted
in the United States of America, which requires us to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the year.
Actual results could differ fro those estimates. We consider the following
policies to be the most critical in understanding the judgments that are
involved in preparing our financial statements and the uncertainties that could
impact our results of operations, financial condition and cash flows.
FULL COST METHOD OF ACCOUNTING
We follow the full cost method of accounting for oil and gas property
acquisition, exploration and development activities. Under this method, all
productive and non-productive costs incurred in connection with the acquisition
of, exploration for and development of oil and gas reserves for each cost center
are capitalized. Capitalized costs include lease acquisitions, geological and
geophysical work, daily rentals and the costs of drilling, completing and
equipping oil and gas wells. We capitalized $45,312, $1,982,529, $4,821,883 and
$1,456,996 of these costs for the first nine months of 2003 and for the years
ended December 31, 2002, 2001 and 2000, respectively. Costs, however, associated
with production and general corporate activities are expensed in the period
incurred. Interest costs related to unproved properties and properties under
development are also capitalized to oil and gas properties. Gains or losses are
recognized only upon sales or dispositions of significant amounts of oil and gas
reserves representing an entire cost center. Proceeds from all other sales or
dispositions are treated as reductions to capitalized costs.
OIL AND GAS RESERVES/DEPLETION DEPRECIATION AND AMORTIZATION OF OIL AND GAS
PROPERTIES
The capitalized costs of oil and gas properties, plus estimated future
development costs relating to proved reserves and estimated costs of plugging
and abandonment, net of estimated salvage value, are amortized on the
unit-of-production method based on total proved reserves. The costs of unproved
properties are excluded from amortization until the properties are evaluated,
subject to an annual assessment of whether impairment has occurred.
Our proved oil and gas reserves as at December 31, 2002 were estimated by
Ryder Scott Company, L.P., oil and gas consultants. Projecting the effects of
commodity prices on production, and timing of development expenditures include
many factors beyond our control. The future estimates of net cash flows from our
proved reserves and their present value are based upon various assumptions about
future production levels, prices, and costs that may prove to be incorrect over
time. Any significant variance from assumptions could result in the actual
future net cash flows being materially different from the estimates.
CONTINGENCIES
We account for contingencies in accordance with Financial Accounting
Standards Board Statement of Financial Accounting Standards ("SFAS") No. 5,
"Accounting Contingencies." SFAS No. 5 requires that we record an estimated loss
from a loss contingency when information available prior to the issuance of our
financial statements indicate that it is probable an asset has been impaired or
a liability has been incurred at the date of the financial statements and the
amount of the loss can be reasonably estimated. Accounting for contingencies
such as environmental, legal and income tax matters requires our management to
use its judgment. While our management believes that our accrual for these
matters are adequate, if the actual loss from a loss contingency is
significantly different from the estimated loss, our results of operations may
be over or understated. The primary area in which we have to estimate contingent
liabilities is with respect to legal actions brought against us. See "Legal
Proceedings."
RECENT ACCOUNTING PRONOUNCEMENTS
A reporting issue has arisen regarding the application of certain
provisions of SAFS No. 141 and SFAS No. 142 to companies in the extracting
industries including oil and gas companies. The issue is whether SFAS No. 142
regulates registrants to classify the costs of mineral rights held under lease
or other contractual arrangement associated with extracting oil and gas as
intangible assets in the balance sheet, apart from other capitalized oil and gas
property owned and provide specific footnote disclosures. Historically, we had
included the costs of such mineral rights associated with extracting oil and gas
as a component of oil and gas properties. If it is ultimately determined that
SFAS No. 142 requires oil and gas companies to classify cost of mineral rights
held under lease or other contractual arrangement associated with extracting oil
and gas as a separate intangible asset line item on the balance sheet, we would
be required to reclassify approximately $453,000 at September 30, 2003 and
$346,000 at December 31, 2002, respectively, out of oil and gas properties and
into a separate intangible asset line item. Our cash flows and results of
operations would not be affected since such intangible assets would continue to
be depleted and amortized for impairment in accordance with full cost accounting
rules. Further, we do not believe the classification of the cost of mineral
rights associated with extracting oil and gas as intangible assets would have
any impact on compliance with covenants under our debt agreements.
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for
Asset Retirement Obligations "SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement cost. This statement requires
companies to record the present value of obligations associated with the
retirement of tangible long-lived assets in the periods in which it is incurred.
The liability is capitalized as part of the related long-lived assets carrying
amount. Over time, accretion of the liability is recognized as an operating
expense and the capitalized cost is depreciated over the expected useful life of
the related asset. Our asset retirement obligations relate primarily to the
plugging, dismantlement, removal site reclamation and similar activities of our
oil and gas properties. Prior to adoption of this statement, such obligations
were accrued ratably over the productive lives of the assets through our
depreciation, depletion and amortization for oil and gas properties without
recording a separate liability for such amounts. The impact of applying this
statement as of January 1, 2003 and September 30, 2003 is discussed in the Notes
to the Consolidated Financial Statements contained elsewhere in this Prospectus.
In April 2002, the Financial Accounting Standards Board issued SFAS No.
145, "Rescission of SFAS No. 4, 44, 64, Amendment of SFAS No. 13, and Technical
Corrections" ("SFAS 145"). SFAS 4, which was amended by SFAS 64, required all
gains and losses from the extinguishment of debt to be aggregated and, if
material, classified as an extraordinary item, net of related income tax effect.
As a result of SFAS 145, the criteria in Accounting Principles Board opinion 30
will now be used to classify those gains and losses. SFAS 13 was amended to
eliminate an inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that
have economic effects that are similar to sale-leaseback transactions. The
adoption of SFAS 145 will not have a current impact on our consolidated
financial statements.
In July 2002, FASB issued SFAS No. 146, Accounting for Cost Associated with
Exit or Disposal Activities. The standard requires companies to recognize cost
associated with exit or disposal activities when they are incurred rather than
at the date of commitment to an exit or disposal plan. Examples of cost covered
by the standard include lease termination costs and certain employee severance
costs that are associated with restructuring, discontinued operation, plant
closing, or other exit or disposal activity. Previous accounting guidance was
provided by EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." Statement 146 replaces Issue 94-3.
Statement 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. We do not currently have any plans for exit
or disposal activities, and therefore do not expect this standard to have a
material effect on our consolidated financial statements upon adoption.
In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45.
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others", which clarifies disclosure and
recognition/measurement requirements related to certain guarantees. The
disclosure requirements are effective for financial statements issued after
December 15, 2002 and here cognition/measurement requirements are effective on a
prospective basis for guarantees issued or modified after December 31, 2002. The
application of the requirements of FIN 45 did not have an impact on our
financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
compensation -- Transition and Disclosure -- an amendment of FASB Statement No.
123 ("Statement 148"). This amendment provides two additional methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. Additionally, more prominent disclosures
in both annual and interim financial statements are required for stock-based
employee compensation. The transition guidance and annual disclosure provisions
of Statement 148 are effective for fiscal years ending after December 15, 2002.
The interim disclosure provisions are effective for financial reports containing
financial statements for interim periods beginning after December 15, 2002. The
adoption of Statement 148 did not have a material impact on our consolidated
financial statements.
In January 2003, the FASB issued FASB Interpretation No. (FIN) 46,
"Consolidation of Variable Interest Entities." This interpretation of Accounting
Research Bulletin No. 51 "Consolidated Financial Statements" consolidation by
business enterprises of variable interest entities, which possess certain
characteristics. The Interpretation requires that if a business enterprise has a
controlling financial interest in a variable interest entity, the assets,
liabilities, and results of the activities of the variable interest entity must
be included in the consolidated financial statements with those of the business
enterprise. This Interpretation applies immediately to variable interest
entities created after January 31, 2003 and to variable interest entities in
which an enterprise obtains an interest after that date. We do not have any
ownership in any variable interest entities.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity". SFAS
No. 150 requires three types of freestanding financial instruments to be
classified as liabilities in statements of financial position. One type is
mandatory redeemable shares, which the issuing company is obligated to buy back
in exchange for cash or other assets. A second type, which includes put options
and forward purchase contracts, involves instruments that do or may require the
issuer to buy back some of its shares in exchange for cash or other assets. The
third type of instrument is obligations that can be settled with shares, the
monetary value of which is fixed, tied solely or predominately to a variable
such as a market index, or varies inversely with the value of the issuer's
shares. The majority of the guidance in SFAS No. 150 is effective for all
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. In accordance with SFAS No. 150, we adopted this standard on July 1,
2003. Adoption of SFAS No. 150 did not have a material impact on our
consolidated financial statements.
QUANTITATIVE AND QUALITATIVE
DISCLOSURE ABOUT MARKET RISKS
COMMODITY RISK
Our major market risk exposure is in the pricing applicable to our oil and
gas production. Realized pricing is primarily driven by the prevailing worldwide
price for crude oil and spot prices applicable to natural gas production.
Historically, prices received for oil and gas production have been volatile and
unpredictable and price volatility is expected to continue. Monthly oil price
realizations ranged from a low of $18.56 per barrel to a high of $27.49 per
barrel during 2002. Gas price realizations ranged from a monthly low of $1.91
per Mcf to a monthly high of $4.01 per Mcf during 2002.
As required by our credit agreement with Bank One, we entered into hedge
agreements on December 28, 2001 on notional volumes of oil and natural gas
production for the first six months of 2002 in order to manage some exposure to
oil and gas price fluctuations. Realized gains or losses from our price risk
management activities were recognized in oil and gas production revenues when
the associated production occurred. Notional volumes associated with our
derivative contracts were 27,000 barrels and 630,000 MMBTU's for oil and natural
gas, respectively. We do not generally hold or issue derivative instruments for
trading purposes. These hedge agreements expired in June 2002 and have not been
renewed. Hedging activities resulted in a loss to the Company of approximately
$118,000 for the year ended December 31, 2002 and had no impact on operations
for the first nine months of 2003. We currently have no hedging arrangements.
INTEREST RATE RISK
At December 31, 2002, we had debt outstanding of approximately $9.9
million. The interest rate on the revolving credit facility of $7.5 million at
December 31, 2002 is variable based on the financial institution's prime rate
plus 0.25%. The remaining debt of $2.4 million has fixed interest rates ranging
from 6% to 11.95%. As a result, our annual interest costs in 2002 fluctuated
based on short-term interest rates. The impact of interest expense and our cash
flows of a ten percent increase in the financial institution's prime rate
(approximately 0.5 basis points) would be approximately $32,000, assuming
borrowed amounts under the credit facility remain at $7.5 million. We did not
have any open derivative contracts relating to interest rates at September 30,
2003.
BUSINESS
OVERVIEW
We are in the business of exploring for, producing and transporting oil and
natural gas in Tennessee and Kansas. We lease producing and non-producing
properties with a view toward exploration and development. Emphasis is also
placed on pipeline and other infrastructure facilities to provide transportation
services. We utilize seismic technology to improve the recovery of reserves.
Our activities in the oil and gas business commenced in May 1995 with the
acquisition of oil and gas leases in Hancock, Claiborne, Knox, Jefferson and
Union counties in Tennessee. Our current lease position in these areas in
Tennessee is approximately 41,088 acres.
To date, we have drilled primarily on a portion of our Tennessee leases
known as the Swan Creek Field in Hancock County focused within what is known as
the Knox formation, one of the geologic formations in that field. During the
first nine months of 2003, we produced an average of approximately 1.2 million
cubic feet of natural gas per day and 2,171 barrels of oil per month from 23
producing gas wells and six producing oil wells in the Swan Creek Field.
In 2001, our wholly-owned subsidiary, Tengasco Pipeline Corporation, or
TPC, completed a 65-mile intrastate pipeline from the Swan Creek Field to
Kingsport, Tennessee. Until our pipeline was completed, the gas wells that had
been drilled in the Swan Creek Field could not be placed into actual production
and the gas transported and sold to our industrial customers in Kingsport. We
initially believed that the production of natural gas from the Swan Creek Field
would be significantly higher than the actually experienced production. The
reasons for the lower production volumes include initial production problems
caused by naturally occurring fluids entering the well bore, slower than
anticipated production of the wells due to underground reservoir characteristics
that became apparent only when the wells were placed into actual production, and
our inability to drill additional wells due to shortage of available capital. We
have taken steps to minimize fluid problems in existing wells by mechanical
means and to avoid them in future wells by drilling and completion techniques.
Management believes, however, that the only way to increase production volumes
of gas from this field is to drill additional wells to drain the underground
reservoirs of the full reserves of gas, and our ability to do so is dependent
upon raising additional capital for drilling. Although we intend to apply the
net proceeds from this offering initially to repay outstanding non-bank
indebtedness and to apply the balance of such proceeds, if any, to repay in part
bank indebtedness and/or to fund in part the drilling of additional wells, there
can be no assurances that such net proceeds will be sufficient for such purposes
or that we will be able to resolve the difficulties currently preventing us from
drilling additional wells and increasing production volumes of natural gas from
the Swan Creek Field.
In 1998, we acquired from AFG Energy, Inc., or AFG, a private company,
approximately 32,000 acres of leases in the vicinity of Hays, Kansas. Included
in that acquisition were 273 wells, including 208 working wells, of which 149
were producing oil wells and 59 were producing gas wells, a related 50-mile
pipeline and gathering system, three compressors and 11 vehicles. The total
purchase price of these assets was approximately $5.5 million. During the first
six months of 2003, our Kansas properties produced an average of approximately
..13 MMcf of natural gas per day and 10,800 barrels of oil per month. Net
revenues from our Kansas properties were an average of approximately $342,000
per month during the first six months of 2003.
HISTORY OF THE COMPANY
We were initially organized under the laws of the State of Utah in 1916,
under the name "Gold Deposit Mining & Milling Company." We were formed for the
purpose of mining, reducing and smelting mineral ores. In 1972, we conveyed to
an unaffiliated entity substantially all of our assets and we ceased all
business operations. From approximately 1983 to 1991, our operations were
limited to seeking out the acquisition of assets, property or businesses.
In 1995, we acquired certain oil and gas leases, equipment, securities and
vehicles owned by Industrial Resources Corporation, a Kentucky corporation,
changed our name from "Onasco Companies, Inc." to "Tengasco, Inc.", and changed
our domicile from the State of Utah to the State of Tennessee by merging into
Tengasco, Inc., a Tennessee corporation, formed by us solely for this purpose.
During 1996, we formed TPC to manage the construction and operation of our
pipeline, as well as other pipelines planned for the future.
GENERAL
THE SWAN CREEK FIELD
Amoco Production Company, during the late 1970's and early 1980's acquired
approximately 50,500 acres of oil and gas leases in the Eastern Overthrust in
the Appalachian Basin, including the area now referred to as the Swan Creek
Field. In 1982, Amoco successfully drilled two natural gas discovery wells in
the Swan Creek Field to the Knox Formation at approximately 5,000 feet of total
depth. These wells, once completed, had a high pressure and apparent volume of
deliverability of natural gas. In the mid-1980's, however, a substantial decline
in worldwide oil and gas prices occurred and further exacerbated the high cost
of constructing a necessary 23-mile pipeline across three rugged mountain ranges
and crossing the environmentally protected Clinch River from Sneedville to the
closest market in Rogersville, Tennessee. In 1987, Amoco farmed out our leases
to Eastern American Energy Company which held the leases until July 1995. In
July 1995 we commenced a legal action, under laws passed by the Tennessee
legislature, as to our right to lease Amoco's prior acreage. In July 1995
pursuant to such action, we acquired the Swan Creek leases. These leases provide
for a landowner royalty of 12.5%.
SWAN CREEK PIPELINE FACILITIES. In July 1998, we completed Phase I of our
pipeline from the Swan Creek Field, a 30-mile pipeline made of six- and
eight-inch steel pipe running from the Swan Creek Field into the main city gate
of Rogersville, Tennessee. With the assistance of the Tennessee Valley
Authority, or TVA, we were successful in utilizing TVA's right-of-way along its
main power line grid from the Swan Creek Field to the Hawkins County Gas Utility
District located in Rogersville. The cost of constructing Phase I of the
pipeline was approximately $4,200,000.
In April 2000, construction commenced on Phase II of our pipeline. This was
an additional 35 miles of eight- and 12-inch pipe laid at a cost of
approximately $11.1 million extending our pipeline from a point near the
terminus of Phase I and connecting to an existing pipeline and meter station at
Eastman Chemical Company's chemical plant. The pipeline system was completed in
March 2001 at an overall cost of approximately $15.3 million and extends 65
miles from our Swan Creek Field to Kingsport, Tennessee.
SWAN CREEK CONTRACTUAL ARRANGEMENTS. In November 1999, we entered into an
agreement with Eastman Chemical Company that provides that Eastman would
purchase daily from the Swan Creek Field at Eastman's plant in Kingsport a
minimum of the lesser of (i) 5,000 MMBtu's (MMBtu means one million British
thermal units, which is the equivalent of approximately one thousand cubic feet
of gas) or (ii) forty percent (40%) of the natural gas requirements of Eastman's
plant and a maximum of 15,000 MMBtu's per day. Under the terms of the agreement,
we had the option to install facilities to treat the delivered gas so that the
total non-hydrocarbon content of the delivered gas is not greater than two
percent (2%). This would have allowed the gas to be used in certain processes in
the Eastman plant requiring low levels of non-hydrocarbons. If we elected to
perform this option by installing additional facilities, the minimum daily
amount of gas to be purchased by Eastman from us would increase to the lesser of
(i)10,000 MMBtu's or (ii) eighty percent (80%) of the natural gas requirements
of Eastman's chemical plant.
In March 2000, we signed an amendment to the agreement with Eastman
permitting us a further option with respect to the allowable level of
non-hydrocarbons in the delivered gas from the Swan Creek Field. This amendment
gives us the further option to tender gas without treatment, at a minimum volume
of 10,000 MMBtu's per day, in consideration of which we agreed to accept a price
reduction of five cents per MMBtu for the volumes per day between 5,000 and
10,000 MMBtu's per day under the pricing structure in place under the original
agreement. To date, to our knowledge, none of the gas sold by us to Eastman
exceeds the allowable level of non-hydrocarbons permitted under the agreement
and no such gas requires treatment.
Under the agreement as amended in March 2000, Eastman agreed to pay us the
index price plus $0.10 for all natural gas quantities up to 5,000 MMBtu's
delivered per day, the index price plus $0.05 for all quantities in excess of
5,000 MMBtu's per day and the index price for all quantities in excess of 15,000
MMBtu's per day. The index price means the price per MMBtu published in
McGraw-Hill's INSIDE F.E.R.C Gas Market Report equal to the Henry Hub price
index as shown in the table labeled Market Center Spot Gas Prices. The agreement
with Eastman is for an initial term of twenty years and will be automatically
extended, if the parties agree, for successive terms of one year. The initial
term of the agreement commenced in March 2001.
In January 2000, TPC, signed a franchise agreement to install and operate
new natural gas utility services for residential, commercial and industrial
users in Hancock County, Tennessee for the Powell Valley Utility District, which
we refer to as the District. The District had no existing natural gas facilities
and the system to be installed by TPC was initially intended to extend to
schools and small customers and gradually be expanded over time to serve as many
of the 6,900 residents of the County as is economically feasible. TPC purchases
gas from us on behalf of the District, which gas is to be resold at an average
retail price of about $8.00 Mcf. Under the franchise agreement, which has an
initial term of ten years and may be renewed by us for an additional ten years,
TPC will receive 95% of the gross proceeds of the sale of gas for our services
under the agreement. In June 2000, TPC began installation of the necessary
facilities to begin to serve residential and industrial consumers in the City of
Sneedville, county seat of Hancock County. Our existing eight-inch main line
from our Swan Creek Field passes through the city limit of Sneedville. A
one-half mile of interconnecting pipeline from our existing pipeline was
installed, as well as an additional four miles of pipeline as the initial phase
of the distribution system. The construction was completed and delivery of
initial volumes of gas into the system from the Swan Creek field occurred in
December 2000. The cost of construction of these facilities was approximately
$300,000. Upon enactment of initial rate schedules by the District, initial
sales began in January 2001 to a small number of residential and small
commercial customers.
In March 2002, we began delivering gas to our first commercial customer,
Kiefer Built, Inc, an Iowa-based manufacturer of livestock and industrial
trailers, in a new industrial park in Sneedville. Although there can be no
assurance, we hope to be able to supply gas to other District customers who may
move into that industrial park. At this time, however, no gas sales agreements
for large volume or base load sales have been signed and there can be no
assurances that such agreements will be signed and if signed, we are not able to
predict when such sales may begin, if at all, or what the overall volumes of gas
sold may be. Due to the small number of existing customers and relatively high
operating costs, we experienced a loss of approximately $35,000 attributable to
the operation of this system in 2002. Although there can be no assurance, we
intend to either expand the operation of this system so as to increase revenues
or to sell these assets to neighboring utilities or the City of Sneedville. In
the event of such a sale, we could still sell gas to the District.
In March 2001, we signed a contract to supply natural gas to BAE Systems
Ordnance Systems Inc., or BAE, operator of the Holston Army Ammunition Plant in
Kingsport, Tennessee for a period of twenty years. Natural gas is used at the
Holston Army ammunition facility to fire boilers and furnaces for steam
production and process operations utilized in the manufacture of explosives by
BAE for the United States military. Under the agreement, BAE's daily purchases
of natural gas may be between 1.8 million and five million cubic feet, and
volume could, although there can be no assurance, increase over the life of the
agreement as BAE conducts additional operations at the Holston facility. The
contract calls for a price based on the monthly published index price for spot
sales of gas at the Henry Hub plus five cents per MMBtu in the same manner as
the price is calculated in the contract between us and Eastman.
We have the only gas pipeline located on the grounds of the 6,000-acre
Holston facility. A portion of the Holston facility is being developed by BAE as
the new Holston Business and Technology Park, which is expected to serve as a
location for additional commercial and industrial customers. Although there can
be no assurance, our presence at the Holston Business and Technology Park is
expected to position us to provide gas service to those customers and we
understand that our presence is considered by BAE to be a favorable factor in
the development of the Park.
SWAN CREEK PRODUCTION AND DEVELOPMENT. We began delivering gas through our
pipeline to BAE in April 2001 and to Eastman in May 2001. Daily production in
June 2001 averaged 4,936.2 Mcf and in July 2001 daily production averages
increased to 5,497 Mcf per day. Although our gas production in mid-2001 was at
anticipated levels, we were unable to maintain those production levels for the
remainder of 2001 and since then. This was due primarily to three problems:
o initial fluid problems in some wells;
o natural and expected production declines from the type of reservoir
that exists in the Swan Creek field; and
o our inability to offset expected natural declines in production by
drilling new wells because of inadequate capital.
As to the first of these problems, we experienced the in-flow of
substantially more fluids in the existing wells than had been expected when they
were first brought into continuous production in 2001. These fluids entered the
wells from the boreholes. The fluids obstructed and significantly reduced the
flow of gas from the existing wells in the Swan Creek Field and required
substantial additional work and repairs to increase the production from existing
wells. First, we installed a drip tank system to eliminate the fluids in the
pipeline. Next, we installed mechanical devices in many of the existing wells to
reduce the fluid problems. Many of the existing wells had to be shut down while
the repairs were made. Gas lifts have been installed in 15 of our existing wells
and act as mechanisms to remove the fluids and stabilize erratic behavior, such
as large swings in individual well production. These measures have had only
limited success in increasing production from existing wells. We expect that
techniques used in addressing these fluid problems will be applied in our future
wells in the Swan Creek Field and we anticipate, although there can be no
assurance, that this will minimize or prevent these problems.
As to the second problem, we experienced an expected and we believe normal
decline in initial production from existing wells in the newly-producing Swan
Creek Field. We believe that all types of gas wells experience some type of
decline as in the course of initial production. These declines were expected and
do not diminish either the shut-in pressure or our actual reserves in the Swan
Creek Field. The declines, however, suggest the production rates from some of
our smaller wells will continue to be slower, which may result in such wells
lasting longer than we originally expected.
As to the third problem, the declines in production have not been addressed
and replaced by additional drilling as we had planned. We believe that in order
for overall field production to remain steady or grow in a field such as the
Swan Creek Field, new wells must be brought online to offset the normal
production declines in wells as described above. We anticipate, although there
can be no assurances, that any new wells drilled by us would experience a
similar harmonic (i.e. a relatively steep initial decline curve followed by
longer periods of relatively flat or stable production) decline as a normal
function. Consequently, continuous drilling is important to maintaining or
increasing initial levels of production. Only two gas wells were added by us in
2002. We anticipate that the natural decline of production from existing wells
is now predictable in the Swan Creek Field, that the total volume of our
reserves remains largely intact, and that these reserves can be extracted
through both existing wells and by additional well drilled by us, subject to the
availability of requisite funding. Although we intend to apply the net proceeds
from this offering initially to repay outstanding non-bank indebtedness and to
apply the balance of such proceeds, if any, to repay in part bank indebtedness
and/or to fund such net proceeds will be sufficient for such purposes or that
the drilling of additional wells, there can be no assurance that such net
proceeds will be sufficient for such purposes or that we will have or be able to
further raise sufficient capital to fund our proposed drilling program to
successfully increase production from the Swan Creek Field.
Due to natural and expected declines that continue to occur in ongoing
production from any oil and gas well, some additional declines are expected to
occur in production from our existing wells in the Swan Creek Field. Although
there can be no assurance, we expect these natural declines to be less than the
decline experienced to date, and that ongoing production from existing wells
will tend to level off. This expectation is based on two factors:
o first, repairs have been performed on many of the existing wells,
and
o second, the natural production decline from any well is normally
greatest during the initial producing periods, which initial periods
have largely elapsed.
Natural gas production from the Swan Creek Field during 2002 averaged 2.567
million cubic feet per day in the first quarter; 2.553 million cubic feet per
day in the second quarter; 2.224 million cubic feet per day in the third
quarter; and, 1.467 million cubic feet per day in the fourth quarter. Natural
gas production from the Swan Creek Field for the first nine months of 2003
averaged 1.195 million cubic feet per day. This production history reflects a
combination of natural and expected decline from initial production from
existing wells, partially offset in the second and third quarters by the
addition of production from two new gas wells. During the fourth quarter of 2002
and the first nine months of 2003, no wells were added to offset the natural and
expected declines in production from existing wells.
We also experienced reductions or declines in our sales volumes during
certain times in 2002 for reasons unrelated to the production capability of our
wells or fields. These declines were caused by reductions in our customers'
usage requirements and/or by delivery restrictions. During a period in 2002,
Eastman temporarily ceased purchases from us because we were delivering most of
our then available volumes to supply BAE's newly-increased requirements. During
that period, we were unable to sell to Eastman all volumes of gas exceeding
BAE's increased requirements, although we were able to produce these volumes,
because Eastman requires a minimum volume for its meters that available volumes
did not meet and a uniform rate of delivery that taking short-term volumes would
interrupt. During the time Eastman was not purchasing gas from us, BAE purchased
additional volumes until BAE experienced a partial equipment outage in July 2002
and reduced our purchased volumes. As a result of these occurrences, which were
not within our control, our sales volume to BAE and Eastman in July 2002
declined to 42,382 Mcf or an average of 1,367 Mcf per day. In order to increase
the volumes of gas for delivery from the Swan Creek Field, we must drill
additional wells. However, even if additional wells are drilled, we anticipate
based on all information acquired to date, although there can be no assurance,
that deliverability from the Swan Creek Field, once stabilized, may not exceed
approximately three million cubic feet per day, and there can be no assurances
as to any minimum productivity.
During 2002, we had 30 producing gas wells and seven producing oil wells in
the Swan Creek Field. Miller Petroleum, Inc. and others had a participating
interest in twelve of these wells. In total, we have completed 45 wells in the
Swan Creek Field. The majority of these gas wells were drilled prior to the
completion of the pipeline system so only test data was available prior to full
production. Of the completed wells, twelve are shut-in or currently not
producing because these wells are either not presently producing commercial
quantities of hydrocarbons, or are awaiting workover or tie-in to our pipeline.
However, certain of these wells may not be tied in to our pipeline since the
expense of connection over rough terrain may not be justified in view of the
expected volumes to be produced. During the first nine months of 2003, we
produced gas from 23 gas wells in the Swan Creek Field.
We were not able to drill a substantial number of additional gas or oil
wells at Swan Creek in 2002 because we did not have sufficient funds to do so.
Although we had expected to commence and continue our drilling program in 2002,
we were forced to postpone any further drilling until additional funds are
available and our dispute with Bank One is resolved, as to which there can be no
assurance. Because the Knox formation has been defined by the accumulation of
data from previously drilled wells and seismic data, new locations and new wells
when drilled are expected, although there can be no assurances, to contribute to
achieving increases in production totals. We believe, although there can be no
assurance, that new wells can be strategically based on information we have
developed from our existing wells as to the shape and key producing horizons of
the Knox formation. We have obtained approval from the Tennessee regulatory
authorities with jurisdiction over spacing of wells to drill additional wells on
smaller spacing in the field, effectively allowing more wells to be drilled and
the reservoir to produce more quickly but with no decrease in the long term
efficiency of production of the maximum amount of reserves from the reservoir.
We are hopeful that production from these new wells will be in line with our
more productive existing wells in the Swan Creek Field and will have a
noticeable effect on increasing the total production from the Field. Although
there can be no assurance, our strategy is that once this work is completed and
the new wells are drilled production from the Swan Creek Field will increase.
We anticipate that even if new wells were drilled in the Swan Creek field,
the deliverability of natural gas from the Swan Creek field will not be
sufficient to satisfy the volumes deliverable under our contracts with Eastman
Chemical and BAE in Kingsport, Tennessee. The Eastman Contract provides that
Eastman Chemical will buy a minimum of the lesser of eighty percent of that
customer's daily usage or 10,000 MMBtu per day, and the BAE contract provides
that BAE will buy a minimum of all of that customer's usage or 5,000 MMbtu per
day after Eastman's volumes have been provided. Our current production from the
Swan Creek field is approximately 1,000 MMBtu per day. Our contracts with these
customers are only for gas produced from the Swan Creek field. So long as that
field is not capable of supplying these volumes, we are not in breach or
violation of these contracts. No penalty is associated with the inability of the
field to produce the volumes that we could deliver and buyers would be obligated
to buy under these industrial contracts if the volumes were physically available
from the field. However, in the event that we were found to be in breach of our
obligations for failure to deliver any volumes of gass that is produced from the
Swan Creek field to either of these customers, the agreements limit potential
exposure to damages. Damages are limited to no more than $.40 per MMBtu for any
replacement volumes that are proved in a court proceeding as having been
obtained to replace volumes required to be furnished but not furnished by us.
Our strategy also includes commencing drilling in other formations in our
Swan Creek Field. To date, drilling in the Swan Creek Field has focused on
production of gas primarily from the Knox formation. Immediately adjacent to
this formation, however, and shallower over these formations, are other
formations that we believe, although there can be no assurance, have a potential
for gas production. These other formations hold the possibility for yielding
both oil and gas and have produced some gas to date and have not been a primary
target for gas production. The shallower depths needed for drilling in these
other formations and the moderate gas production from them may make the
production of additional gas feasible. As noted above, we can not proceed with
such drilling until such time as funding is available, as to which there can be
no assurance.
THE KANSAS PROPERTIES
In 1997, we acquired the Kansas Properties, which presently include 134
producing oil wells and 51 producing gas wells in the vicinity of Hays, Kansas
and a gathering system including 50 miles of pipeline. We also acquired 37 other
wells, which now serve as saltwater disposal wells in the vicinity of Hays,
Kansas. Saltwater wells are used to store saltwater encountered in the drilling
process that would otherwise have to be transported out of the area. These
saltwater disposal wells reduce operating costs by eliminating the need for
transport. The aggregate production for the Kansas Properties at present is
approximately 800 Mcf and 336 barrels of oil per day. Revenue for the Kansas
Properties was approximately $275,000 per month in 2002.
We employ a full time geologist in Kansas to oversee operations of the
Kansas Properties. We have identified five new locations for drilling wells in
Ellis and Rush Counties, Kansas on our existing leases in response to drilling
activity in the area indicating new areas of production. In 2001 we successfully
drilled the Dick No. 7 well in Kansas and completed the well as an oil well. We
did not drill any new wells in Kansas in 2002 or the first nine months of 2003
due to lack of funds available for such drilling. We are also engaged in
gathering for a fee the gas produced from wells owned by others located in
Kansas adjacent to our wells and near our gathering lines. Our plans for our
Kansas properties include maintaining the current productive capacity of our
existing wells through normal workovers and maintenance of the wells, performing
gathering or sales services for adjacent producers, and expanding our own
production through drilling these additional wells. Such plans are subject to
the availability of funds, in addition to the funds raised by this offering, to
finance the work.
In addition, there are several capital development projects that we have
considered with respect to the Kansas Properties, including recompletion of
wells and major workovers to increase current production. Although there can be
no assurances, these projects when completed might increase production in
Kansas. Management, however, has made the decision not to undertake any of these
projects, as we do not presently have the necessary funds. We will, however,
reconsider our decision if such funds become available.
OTHER AREAS OF DEVELOPMENT
We are presently exploring other geological structures in the East
Tennessee area that are similar to the Swan Creek Field and which we believe,
although there can be no assurance, have a high probability of producing
hydrocarbons. We have either acquired seismic data on these structures from
third-party sources or are conducting our own seismic studies with our own
trucks and equipment. The seismic analysis is continuing and related leasing
activities have begun based on initial analysis of seismic results. We plan to
conduct exploration activities in these areas. The first of these locations was
in Cocke County, Tennessee which is approximately 40 miles southeast of the Swan
Creek Field. In 2002, we, in conjunction with Southeast Gas & Oil Corp. of
Newport, Tennessee, drilled an approximately 6,000-foot exploratory well to the
Knox formation. This well did not result in any commercial quantities of
hydrocarbons. Although these and other exploratory efforts have commenced or are
under consideration, there can be no assurances that any such efforts will be
completed or will be commercially successful.
GOVERNMENTAL REGULATIONS
We are subject to numerous state and federal regulations, environmental and
otherwise, that may have a substantial negative effect on our ability to operate
at a profit. For a discussion of the risks involved as a result of such
regulations, see, "Effect of Existing or Probable Governmental Regulations on
Business" below.
PRINCIPAL PRODUCTS OR SERVICES AND MARKETS
The principal markets for our crude oil are local refining companies, local
utilities and private industry end- users. The principal markets for our natural
gas are local utilities, private industry end-users and natural gas marketing
companies.
Gas production from the Swan Creek Field can presently be delivered through
our completed pipeline to the Powell Valley Utility District in Hancock County,
Eastman and BAE in Sullivan County, as well as other industrial customers in the
Kingsport area. We believe, although there can be no assurance, that we have
acquired all necessary regulatory approvals and necessary property rights for
the pipeline system. Our pipeline would not only provide transportation service
for gas produced from our wells, but would provide transportation of gas for
small independent producers in the local area as well. We also could, although
there can be no assurance, sell our products to certain local towns, industries
and utility districts.
Natural gas from the Kansas Properties is delivered to Kansas-Nebraska
Energy, Inc. in Bushton, Kansas. At present, crude oil is sold to the National
Cooperative Refining Association in McPherson, Kansas, 120 miles from Hays.
National Cooperative is solely responsible for transportation of the oil it
purchases whether by truck or pipeline.
DRILLING EQUIPMENT
On November 1, 2000, we purchased an Ingersoll Rand RD20 drilling rig and
related equipment from Ratliff Farms, Inc., an affiliate of Malcolm E. Ratliff,
who at that time was our Chief Executive Officer and Chairman of the Board of
Directors. We also receive contract drilling services from Miller Petroleum,
Inc. and Union Drilling in the Swan Creek Field. The purchase price for the
drilling rig and related equipment was $995,000, which was paid by delivery of a
convertible note to Ratliff Farms, Inc. The note was paid in full from the
proceeds of the loan to us from Bank One in November 2001. In 2001, the drilling
rig was used to drill and complete four wells in the Swan Creek field. In 2002,
the drilling rig was used to drill two of the four wells we drilled that year.
The drilling rig has not been used on a contract drilling basis for any other
operators since it was purchased and was not used in 2003 due to lack of funds
to cover drilling costs, including casing, logging, bits and cementing and due
to the insufficiency of the number of our remaining employees to conduct
drilling operations. We estimate that the drilling rig was used for
approximately one-third of our drilling activities since the rig was purchased.
DISTRIBUTION METHODS OF PRODUCTS OR SERVICES
Crude oil is normally delivered to refineries in Tennessee and Kansas by
tank truck and natural gas is distributed and transported via pipeline.
COMPETITIVE BUSINESS CONDITIONS, COMPETITIVE POSITION IN THE INDUSTRY AND
METHODS OF COMPETITION
Our contemplated oil and gas exploration activities in the States of
Tennessee and Kansas will be undertaken in a highly competitive and speculative
business atmosphere. In seeking any other suitable oil and gas properties for
acquisition, we will be competing with a number of other companies, including
large oil and gas companies and other independent operators with greater
financial resources. Management does not believe that our initial competitive
position in the oil and gas industry will be significant.
Our principal competitors in the State of Tennessee are Nami Resources,
LLC, Miller Petroleum, Inc., Knox Energy Development and Penn Virginia
Corporation. We believe that we are in a favorable position in the area in which
our pipeline is located. Within that area, we own leases on approximately 41,088
acres.
There are numerous producers in the area of the Kansas Properties. Some are
larger with greater technological and financial resources.
Although we do not now foresee any difficulties in procuring drilling rigs
or the manpower to run them in the area of our operation, several factors,
including increased competition in the area, may limit the availability of
drilling rigs, rig operators and related personnel and/or equipment in the
future. Such limitations would have a natural adverse effect on our operations.
The prices of our products are controlled by the world oil market and the
United States natural gas market. Thus, competitive pricing behaviors are
considered unlikely; however, competition in the oil and gas exploration
industry exists in the form of competition to acquire the most promising acreage
blocks and obtaining the most favorable prices for transporting the product. We
believe that we are well-positioned in these areas because of the transmission
lines that run through and adjacent to the properties leased by us and because
we hold relatively large acreage blocks in our areas of current operation.
SOURCES AND AVAILABILITY OF RAW MATERIALS
Excluding the development of oil and gas reserves and the production of oil
and gas, our operations are not dependent on the acquisition of any raw
materials .
DEPENDENCE ON ONE OR A FEW MAJOR CUSTOMERS
We presently are dependent upon a small number of customers for the sale of
gas from the Swan Creek Field, principally Eastman and BAE, and other industrial
customers in the Kingsport area with which we may enter into gas sales
contracts.
Natural gas from the Kansas Properties is delivered to Kansas-Nebraska
Energy, Inc. in Bushton, Kansas. At present, crude oil from the Kansas
Properties is being trucked and transported through pipelines to the National
Cooperative Refining Association in McPherson, Kansas, 120 miles from Hays,
Kansas. National Cooperative is solely responsible for transportation of
products whether by truck or pipeline.
PATENTS, TRADEMARKS, LICENSES, FRANCHISES, CONCESSIONS, ROYALTY AGREEMENTS OR
LABOR CONTRACTS, INCLUDING DURATION
Royalty agreements relating to oil and gas production are standard in the
industry. The amounts of our royalty payments vary from lease to lease.
NEED FOR GOVERNMENTAL APPROVAL OF PRINCIPAL PRODUCTS OR SERVICES
Although none of the principal products offered by us require governmental
approval, permits are required for drilling oil or gas wells.
The transportation service offered by TPC is subject to regulation by the
Tennessee Regulatory Authority to the extent of certain construction, safety,
tariff rates and charges, and nondiscrimination requirements under state law.
These requirements are typical of those imposed on regulated utilities. TPC has
been granted a certificate of public convenience and necessity to operate as a
pipeline utility in Hancock, Hawkins, and Claiborne counties, Tennessee. In
addition, TPC was authorized to construct and operate the portion of Phase II of
the pipeline to Eastman by resolution of the City of Kingsport in May, 2000.
This resolution was approved by the Tennessee Regulatory Authority as required
by state law. All approvals for our pipeline have been granted.
The City of Kingsport, Tennessee has also enacted an ordinance granting to
TPC a franchise for twenty years to construct, maintain and operate a gas system
to import, transport, and sell natural gas to the City of Kingsport and
inhabitants, institutions and businesses for domestic, commercial, industrial
and institutional uses. This ordinance and the franchise agreement it authorizes
also require approval of the Tennessee Regulatory Authority under state law. We
will not initiate the required approval process for the ordinance and franchise
agreement until such time that we can supply gas to the City of Kingsport.
Although we anticipate that regulatory approval will be granted, there can be no
assurance that it will be granted, or that such approval may be granted in a
timely manner, or that such approval may not be limited in some manner by the
Tennessee Regulatory Authority.
EFFECT OF EXISTING OR PROBABLE GOVERNMENTAL REGULATIONS ON BUSINESS
Exploration and production activities relating to oil and gas leases are
subject to numerous environmental laws, rules and regulations. The Federal Clean
Water Act requires us to construct a fresh water containment barrier between the
surface of each drilling site and the underlying water table. This involves the
insertion of a seven-inch diameter steel casing into each well, with cement on
the outside of the casing. We have complied with this environmental regulation,
the cost of which is approximately $10,000 per well.
The State of Tennessee also requires the posting of a bond to ensure that
our wells are properly plugged when abandoned. A separate $2,000 bond is
required for each well drilled. We currently have the requisite amount of bonds
on deposit with the State of Tennessee.
As part of our purchase of the Kansas Properties we acquired a statewide
permit to drill in Kansas. Applications under such permit are applied for and
issued within one to two weeks prior to drilling. At the present time, the State
of Kansas does not require the posting of a bond either for permitting or to
insure that our wells are properly plugged when abandoned. All of the wells in
the Kansas Properties have all permits required and we believe that we are in
substantial compliance with the laws of the State of Kansas.
Our exploration, production and marketing operations are regulated
extensively at the federal, state and local levels. We have made and will
continue to make expenditures in our efforts to comply with the requirements of
environmental and other regulations. Further, the oil and gas regulatory
environment could change in ways that might substantially increase these costs.
Hydrocarbon-producing states regulate conservation practices and the protection
of correlative rights. These regulations affect our operations and limit the
quantity of hydrocarbons we may produce and sell. In addition, at the federal
level, the Federal Energy Regulatory Commission regulates interstate
transportation of natural gas under the Natural Gas Act. Other regulated matters
include marketing, pricing, transportation and valuation of royalty payments.
Our operations are subject to numerous and frequently changing laws and
regulations governing the discharge of materials into the environment or
otherwise relating to environmental protection. We own or lease, and have in the
past owned or leased, properties that have been used for the exploration and
production of oil and gas and these properties and the wastes disposed on these
properties may be subject to the Comprehensive Environmental Response,
Compensation and Liability Act, the Oil Pollution Act of 1990, the Resource
Conservation and Recovery Act, the Federal Water Pollution Control Act and
analogous state laws. Under such laws, we could be required to remove or
remediate previously released wastes or property contamination.
Laws and regulations protecting the environment have generally become more
stringent and, may in some cases, impose "strict liability" for environmental
damage. Strict liability means that we may be held liable for damage without
regard to whether we were negligent or otherwise at fault. Environmental laws
and regulations may expose us to liability for the conduct of or conditions
caused by others or for acts that were in compliance with all applicable laws at
the time they were performed. Failure to comply with these laws and regulations
may result in the imposition of administrative, civil and criminal penalties.
While we believe that our operations are in substantial compliance with
existing requirements of governmental bodies, our ability to conduct continued
operations is subject to satisfying applicable regulatory and permitting
controls. Our current permits and authorizations and ability to get future
permits and authorizations may be susceptible, on a going forward basis, to
increased scrutiny, greater complexity resulting in increased costs or delays in
receiving appropriate authorizations.
The foregoing is only a brief summary of some of the existing environmental
laws, rules and regulations to which our business operations are subject, and
there are many others, the effects of which could have an adverse impact on us.
Future legislation in this area will no doubt be enacted and revisions will be
made in current laws. No assurance can be given as to what effect these present
and future laws, rules and regulations will have on our current and future
operations.
RESEARCH AND DEVELOPMENT
We have not expended any material amount in research and development
activities during the last two fiscal years. Research done in conjunction with
our exploration activities would consist primarily of conducting seismic surveys
on the lease blocks. This work would be performed by our geology and engineering
personnel and other employees and would not be expected to have a material cost
of above their standard salaries.
NUMBER OF TOTAL EMPLOYEES AND NUMBER OF FULL-TIME EMPLOYEES
We presently have 25 full time employees and no part-time employees.
PROPERTY LOCATION, FACILITIES, SIZE AND NATURE OF OWNERSHIP
SWAN CREEK FIELD. Our Swan Creek leases are on approximately 41,088 acres
in Hancock, Claiborne, Knox, Jefferson, Morgan and Union Counties in Tennessee.
The initial terms of these leases vary from one to five years. Some of them will
terminate unless we have commenced drilling. In 2002, we reduced the acreage
comprising the Swan Creek Field from approximately 50,500 acres to the present
41,088 acres. This reduction in acreage was a result of our improved
understanding of the geological and geophysical makeup of the Swan Creek Field.
We believe that the acreage eliminated from the field does not have the
potential to produce commercial quantities of oil or gas and that the reduction
of this acreage does not affect the reserves of the Swan Creek Field. Further,
the elimination of the leases for this acreage is expected to result in cost
savings to us.
Morita Properties, Inc., an affiliate of Shigemi Morita, a former Director,
currently has a 25% overriding royalty in nine of our existing wells, and a 50%
overriding royalty and 6% overriding royalty, respectively, in two of our other
existing wells. All of these wells are located in the Swan Creek Field and all
but two are presently producing wells. In addition, to those interests, Morita
Properties, Inc. previously owned a 25% working interest in three of our other
existing wells and 12.5% working interest in another of our wells all of which
subsequently have been sold.
An individual who is not an affiliate of us purchased 25% working interests
in two other wells located in the Swan Creek Field that are presently producing
wells.
Another individual has a 29% revenue interest in a producing well located
in the Swan Creek Field by virtue of having contributed her unleased acreage to
the drilling unit and paying her proportionate share of the drilling costs of
the well. We were obligated to allow that individual to participate on that
basis in accordance with both customary industry practice and the requirements
of the procedures of the Tennessee Oil and Gas Board in a forced pooling action
brought by us to require the acreage to be included in the unit so that the well
could be drilled. The forced pooling procedure was concluded by her contribution
of acreage and agreement to pay proportionate share of drilling costs.
We also entered into a farmout agreement with Miller Petroleum, Inc. for
ten wells to be drilled in the Swan Creek Field and we have an option to award
up to an additional ten future wells. All locations were to be mutually agreed
upon. Net revenues, as defined, are to be 81.25% to Miller. Our subsidiary TPC
will transport Miller's gas. We reserved all offset locations to wells drilled
under the farmout agreement. All ten wells have been drilled under the farmout
agreement. We acquired back from Miller a 50% working interest in nine of those
ten wells in addition to our rights under the farmout agreement. In addition, we
along with Miller have drilled two additional wells on a 50-50 basis, although
we declined to exercise our option for a ten-well extension of the farmout
agreement. Of the wells in which Miller owns an interest, six are presently
producing.
Other than the working interests described or referred to above, we retain
all other working interests in wells drilled or to be drilled in the Swan Creek
Field.
Other working interest owners in oil and gas wells in which we have working
interests are entitled to market their respective shares of production to
purchasers other than purchasers with whom we have contracted. Absent such
contractual arrangements being made by the working interest owners, we are
authorized but are not required to provide a market for oil or gas attributable
to working interest owners' production. At this time, we have not agreed to
market gas for any working interest owner to customers other than our customers.
If we agree to market gas for working interest owners to our customers, we will
have to agree, at that time, to the terms of such marketing arrangements and it
is possible that as a result of such arrangements, our revenues from such
customers may be correspondingly reduced. If the working interest owners make
their own arrangements to market their natural gas to other end users along the
pipeline which have been served by East Tennessee Natural Gas, an interstate
pipeline, such gas would be transported by TPC at published tariff rates. The
current published tariff rate is for firm transportation at a demand charge of
five cents per MMBtu per day plus a commodity charge of $0.80 per MMBtu. If the
working interest owners do not market their production, either independently or
through us, then their interest will be treated as not yet produced and will be
balanced either when marketing arrangements are made by such working interest
owners or when the well ceases to produce in accordance with customary industry
practice.
KANSAS PROPERTIES. The Kansas Properties contain 138 leases totaling 32,158
acres in the vicinity of Hays, Kansas. The original terms on these leases were
from one to ten years and in most cases have expired. Most of these leases,
however, are still in effect because they are being held by production. We
maintain a 100% working interest in most wells. The leases provide for a
landowner royalty of 12.5%. Some wells are subject to an overriding royalty
interest from 0.5% to 9%.
Although we do not pay any taxes on our Swan Creek Leases, we pay ad
valorem taxes on our Kansas Properties. We have general liability insurance for
the Kansas Properties and the Swan Creek Field.
We lease our principal executive offices, consisting of approximately 5,647
square feet located at 603 Main Avenue, Suite 500, Knoxville, Tennessee at a
rental of $4,705.83 per month and an office in Hays, Kansas at a rental of $500
per month. During 2002 and the first nine months of 2003, we closed a field
office in Sneedville, Tennessee and an office in New York City we had previously
leased at an aggregate rental of $3,100 per month.
RESERVE ANALYSES
Ryder Scott Company, L.P. of Houston, Texas has performed reserve analyses
of all our productive leases. Ryder Scott Company, L.P. and its employees and
its registered petroleum engineers have no interest in the Company and performed
these services at their standard rates. The net reserve values used hereafter
were obtained from a reserve report dated February 10, 2004, which we refer to
as the Report, prepared by Ryder Scott Company, L.P. as of December 31, 2003.
The Report indicates our "TOTAL PROVEN ALL CATEGORIES" reserves for
Tengasco Inc. to be as follows: net production volumes of 1,371,512 bbls of oil
and 14,363.21 MMCF of Gas. The present value discounted at 10% (PV10) is stated
to be $26,330,111.00. The Report indicates the "proven developed producing"
reserves for Tengasco Inc. to be as follows: net production volumes of 1,059,038
bbls of oil and 5,205.709 MMCF of Gas. The present value discounted at 10%
(PV10) is stated to be $12,224,620.
In substance, the Report used estimates of oil and gas reserves based upon
standard petroleum engineering methods which include production data, decline
curve analysis, volumetric calculations, pressure history, analogy, various
correlations and technical factors. Information for this purpose was obtained
from owners of interests in the areas involved, state regulatory agencies,
commercial services, outside operators and files of Ryder Scott Company, L.P.
The net reserve values in the Report were adjusted to take into account the
working interests that have been sold by us in various wells in the Swan Creek
Field.
We believe that the reserve analysis reports prepared by Ryder Scott
Company, L.P. for us for the Swan Creek Field and Kansas Properties provide an
essential basis for review and consideration of our producing properties by all
potential industry partners and all financial institutions across the country.
We believe that it standard in the industry for reserve analyses of only proved
developed producing reserves to be used as a basis for financing of drilling
costs.
We have not filed the reserve analysis reports prepared by Ryder Scott
Company, L.P. or any other reserve reports with any Federal authority or agency
other than the earlier reports with the Securities and Exchange Commission. We,
however, have filed the information in the Report of our reserves with the
Energy Information Service of the Department of Energy in compliance with that
agency's statutory function of surveying oil and gas reserves nationwide.
The term "Proved Oil and Gas Reserves" is defined in Rule 4-10(a)(2) of
Regulation S-X as follows:
2. Proved oil and gas reserves. Proved oil and gas reserves are the
estimated quantities of crude oil, natural gas, and natural gas liquids which
geological and engineering data demonstrate with reasonable certainty to be
recoverable in future years from known reservoirs under existing economic and
operating conditions, i.e., prices and costs as of the date the estimate is
made. Prices include consideration of changes in existing prices provided only
by contractual arrangements, but not on escalations based upon future
conditions.
i. Reservoirs are considered proved if economic producibility is supported
by either actual production or conclusive formation test. The area of a
reservoir considered proved includes (A) that portion delineated by
drilling and defined by gas-oil and/or oil-water contacts, if any, and (B)
the immediately adjoining portions not yet drilled, but which can be
reasonably judged as economically productive on the basis of available
geological and engineering data. In the absence of information on fluid
contacts, the lowest known structural occurrence of hydrocarbons controls
the lower proved limit of the reservoir.
ii. Reserves which can be produced economically through application of
improved recovery techniques (such as fluid injection) are included in the
proved classification when successful testing by a pilot project, or the
operation of an installed program in the reservoir, provides support for
the engineering analysis on which the project or program was based.
iii. Estimates of proved reserves do not include the following: (A) Oil
that may become available from known reservoirs but is classified
separately as indicated additional reserves; (B) crude oil, natural gas,
and natural gas liquids, the recovery of which is subject to reasonable
doubt because of uncertainty as to geology, reservoir characteristics, or
economic factors; (C) crude oil, natural gas, and natural gas liquids,
that may occur in undrilled prospects; and (D) crude oil, natural gas, and
natural gas liquids, that may be recovered from oil shales, coal,
gilsonite and other such sources.
PRODUCTION
The following tables summarize for the past three fiscal years the volumes
of oil and gas produced to our interests, our operating costs and our average
sales prices for our oil and gas. The information does not include volumes
produced to royalty interests or other working interests.
Tennessee
COST OF
YEAR ENDED PRODUCTION AVERAGE
DECEMBER 31 PRODUCTION (PER BOE)(2) SALES PRICE
----------- ---------- ------------ -----------
OIL GAS OIL GAS
(BBL) (MCF) (BBL) (PER MCF)
---------------------------- -----------------------
2002............ 15,111.54 521,834.35 $ 4.10(2) $21.85 $3.22
2001............ 22,776.21 703,073.56 $ 0.31 $16.05 $2.55
2000............ 37,210.67 2,411.00 $ 0.69 $20.32 $2.86
Gas volumes and prices for 2000 reflect only the nominal purchases made by
Hawkins County Gas Utility District upon completion of Phase I of Tengasco
Pipeline Company's pipeline system.
---------------------------
(1) A "BOE" is a barrel of oil equivalent. A barrel of oil contains
approximately 6 Mcf of natural gas by heating content. The volumes of gas
produced have been converted into "barrels of oil equivalent" for the purposes
of calculating costs of production.
(2) The increase in cost of production in 2002 was a result of this being the
first full year of production in the Swan Creek Field.
Kansas
COST OF
YEAR ENDED PRODUCTION AVERAGE
DECEMBER 31 PRODUCTION (PER BOE)(2) SALES PRICE
----------- ---------- ------------ -----------
OIL GAS OIL GAS
(BBL) (MCF) (BBL) (PER MCF)
---------------------------- -----------------------
2002............. 105,473.54 246,510.98 $ 8.71 $23.89 $2.96
2001............. 112,495.88 278,884.66 $10.72 $23.50 $4.12
2000............. 111,734.81 291,096.22 $ 9.68 $28.06 $3.75
OIL AND GAS DRILLING ACTIVITIES
Our oil and gas developmental drilling for the past three fiscal years are
as set forth in the following tables. During the fiscal years ending December
31, 2000 and 2001 we did not drill any exploratory wells. In 2002, we drilled
one exploratory well in Cocke County, Tennessee which did not result in finding
commercial quantities of hydrocarbons. The information should not be considered
indicative of future performance, nor should it be assumed that there is
necessarily any correlation between the number of wells drilled, quantities of
reserves found or economic value.
GROSS AND NET WELLS
The following tables set forth for the fiscal years ending December 31,
2000, 2001, and 2002 the number of gross and net development wells drilled by
us. The dry hole set forth in the table below is the Cocke County well referred
to above. The term gross wells means the total number of wells in which we own
an interest, while the term net wells means the sum of the fractional working
interests we own in gross wells.
Year ended December 31,
----------------------------------------------------------------------
2002 2001 2000
-------------------- --------------------- ---------------------
Gross Net Gross Net Gross Net
------- ------- ------- -------- ------- -------
TENNESSEE
Productive Wells....... 3 2.625 19 11.42 9 4.0515
Dry Holes.............. 1 .50 0 0 0 0
KANSAS
Productive Wells....... 0 0 3 2.594 0 0
Dry Holes.............. 0 0 0 0 0 0
PRODUCTIVE WELLS
The following table sets information regarding the number of productive
wells in which we held a working interest as of December 31, 2002. Productive
wells are either producing wells or wells capable of commercial production
although currently shut-in. One or more completions in the same bore hole are
counted as one well.
Gas Oil
------------------------ ------------------------
Gross Net Gross Net
---------- --------- ---------- ---------
Tennessee............. 31 18.9 12 6.18
Kansas................ 52 43.45 128 110.5
DEVELOPED AND UNDEVELOPED OIL AND GAS ACREAGE
As of December 31, 2002, we owned working interests in the following
developed and undeveloped oil and gas acreage. Net acres refer to our interest
less the interest of royalty and other working interest owners.
Developed Undeveloped
-------------------------- --------------------------
Gross Acres Net Acres Gross Acres Net Acres
----------- ---------- ----------- ----------
Tennessee........... 1,840.00 1,065.38 41,088 35,952
Kansas.............. 9,666.00 8,080.44 22,711 18,995.48
LEGAL PROCEEDINGS
In November 2001, we signed a credit facility with Bank One, N.A. in
Houston, Texas whereby Bank One extended to us a revolving line of credit of up
to $35 million. The initial borrowing base under the facility was $10 million.
In April 2002, we received a notice from Bank One stating that it had
redetermined and reduced the then-existing borrowing base under the credit
agreement by $6 million to approximately $3.1 million. Bank One demanded that we
pay the $6 million within thirty days. In May 2002, we filed suit in federal
court in the Eastern District of Tennessee, Northeastern Division at Greeneville
to restrain Bank One from taking any steps to enforce its demand that we reduce
our loan obligation or else be deemed in default and for damages resulting from
the demand. We sought a jury trial and actual damages sustained by it as a
result of the wrongful demand in the amount of $51 million plus punitive damages
in the amount of $100 million.
In July 2002, Bank One filed its answer and counterclaim, alleging that its
actions were proper under the terms of the credit agreement and seeking to
recover all amounts it alleges to be owed under the credit agreement, including
principal, accrued interest, expenses and attorney's fees in the approximate
amount of $9 million. Discovery has begun and a hearing have been scheduled on
certain disputed discovery issues. We have continued to pay $200,000 per month
of principal due under the original terms of the credit agreement, plus
interest, and have reduced the principal now outstanding to approximately $4.7
million. Although the parties continue to discuss settlement of all outstanding
issues, no settlement has been concluded. The Court has adjusted the procedural
schedule to lead to a trial date on December 7, 2004 in the event settlement is
not reached.
In November 2002, we and our then Chief Executive Officer, Malcolm E.
Ratliff, were served with a complaint filed in the United States District Court
for the Eastern District of Tennessee, Knoxville, entitled PAUL MILLER V. M. E.
RATLIFF AND TENGASCO, INC., DOCKET NUMBER 3:02-CV-644. The complaint seeks
certification of a class action to recover on behalf of the class of all persons
who purchased shares of our common stock between August 1, 2001 and April 23,
2002, damages in an amount not specified that were allegedly caused by
violations of the federal securities laws, specifically Rule 10b-5 under the
Securities Exchange Act of 1934 as to us and Mr. Ratliff, and Section 20(a) of
that Act as to Mr. Ratliff. The complaint alleges that documents and statements
made to the investing public by us and Mr. Ratliff misrepresented material facts
regarding our business and finances. We believe that the allegations in the
complaint are without merit. We intend to vigorously defend against all of the
allegations. A full settlement of this case has been reached, subject to court
approval. As of January 30, 2004, a written stipulation of settlement
documenting the settlement terms has been signed by counsel for all parties. The
stipulation of settlement will be presented to the court on February 27, 2004
for a determination of initial fairness and initiation of other procedures
leading to a final hearing following a settlement administration period of
approximately 120 days. Any settlement would be subject to court approval before
becoming effective. Under the proposed settlement, we would pay into a
settlement fund the amount of $37,500 including all costs of administration, and
would contribute 150,000 shares of stock of Miller Petroleum, Inc. that is
currently owned by us and that had been accepted in payment of an obligation
owed to the us by Miller Petroleum. We would also contribute to the settlement
fund our agreement to issue 300,000 warrants to purchase company stock for a
period of three years from date of issue at $1 per share. The number or price of
the warrants is to be adjusted to account for the additional shares sold
pursuant to a rights offering or other stated events. All expenses including
attorneys' fees as are awarded by the court on final hearing are to be paid out
of the settlement funds. The parties stipulate the existence of a class for
settlement purposes only and the existing lawsuit would be dismissed when the
settlement becomes final, and the class members fully release their claims when
the settlement becomes final.
We, our former Chief Executive Officer, Malcolm E. Ratliff, and one of our
attorneys, Morton S. Robson, were named as defendants in an action commenced on
June 18, 1998 in the Supreme Court of the State of New York, New York County
entitled MAUREEN COLEMAN, JOHN O. KOHLER, CHARLES MASSOUD, JONATHAN SARLIN, VON
GRAFFENRIED A.G. AND VPM VERWATUNGS A.G., PLAINTIFFS V. TENGASCO, INC., MORTON
S. ROBSON AND MALCOLM E. RATLIFF, DEFENDANTS, INDEX NO. 603009/98. In that
action, the plaintiffs, stockholders of the Company, allege that they were
entitled to sell their shares of our common stock in the open market pursuant to
Rule 144 promulgated under the Securities Act of 1933, but they were precluded
from doing so by the defendants' purported wrongful refusal to remove the
restrictive legends from their shares. The plaintiffs own in the aggregate
35,000 shares of our common stock. The plaintiffs are seeking damages in an
amount equal to the difference between the amount for which they would have been
able to sell their shares if the defendants had acted to remove the restrictive
legends when requested and the amount they will receive on the sale of their
shares. The plaintiffs are also seeking punitive damages in an amount they claim
to be in excess of $500,000, together with interest, costs and disbursements of
bringing the action, including reasonable attorneys fees. We do not believe that
we wrongfully withheld our approval of the removal of the restrictive legends at
the times such removal was requested by the stockholders. The plaintiffs have
not taken any action in this matter for several years.
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information regarding our executive
officers and directors.
NAME AGE POSITION
---- --- --------
Richard T. Williams(3)(4) 52 Chairman of the Board and Chief Executive
Officer
Jeffrey R. Bailey(3)(4) 46 President and Director
Mark A. Ruth 45 Chief Financial Officer
Robert M. Carter 66 President - Tengasco Pipeline Corporation
Cary V. Sorensen 55 General Counsel, Vice President and Secretary
Stephen W. Akos(1)(2) 49 Director
Joseph Earl Armstrong(3) 46 Director
John A. Clendening(1)(2)(4) 70 Director
Robert L. Devereux(1) (2) 43 Director
Bill W. Harbert 80 Director
Peter E. Salas 49 Director
Charles M. Stivers(1) 41 Director
(1) Audit Committee, Compensation Committee and Special Committee Member
(2) Stock Option Committee Member
(3) Field Safety Committee Member
(4) Frontier Exploration Committee Member
DR. RICHARD T. WILLIAMS has been a member of the faculty of the Department
of Geological Sciences at The University of Tennessee in Knoxville, Tennessee,
since 1987, after holding faculty positions at West Virginia University and the
University of South Carolina since 1979. He has been engaged in reflection
seismology and geophysical studies in the Appalachian Overthrust since 1980. He
earned his Ph.D. in Geophysics from Virginia Tech in 1979. Dr. Williams was
elected as a director effective June 28, 2002. He was appointed Chief Operating
Officer on January 10, 2003, and on February 3, 2003, he was elected our Chief
Executive Officer.
JEFFREY R. BAILEY graduated in 1980 from New Mexico Institute of Mining and
Technology with a B.S. degree in Geological Engineering. Upon graduation he
joined Gearhart Industries as a field engineer working in Texas, New Mexico,
Kansas, Oklahoma and Arkansas. Gearhart Industries later merged with Halliburton
Company. In 1993 after 13 years working in various field operations and
management roles primarily focused on reservoir evaluation, log analysis and log
data acquisition he assumed a global role with Halliburton as a Petrophysics
instructor in Fort Worth, Texas. His duties were to teach Halliburton personnel
and customers around the world log analysis and competition technology and to
review analytical reservoir problems. In this role Mr. Bailey had the
opportunity to review reservoirs in Europe, Latin America, Asia Pacific and the
Middle East developing a special expertise in carbonate reservoirs. In 1997 he
became technical manager for Halliburton in Mexico focusing on finding
engineering solutions to the production challenges of large carbonate reservoirs
in Mexico. Mr. Bailey left Halliburton and joined us as our Chief Geological
Engineer on March 1, 2002. He was elected our President on July 17, 2002 and as
a director on February 28, 2003.
MARK A. RUTH is a certified public accountant with 22 years accounting
experience. He received a B.S. degree in accounting with honors from the
University of Tennessee at Knoxville. He has served as a project controls
engineer for Bechtel Jacobs Company, LLC; business manager and finance officer
for Lockheed Martin Energy Systems; settlement department head and senior
accountant for the Federal Deposit Insurance Corporation; senior financial
analyst/internal auditor for Phillips Consumer Electronics Corporation; and, as
an auditor for Arthur Andersen and Company. From December 14, 1998 to August 31,
1999 he served as the Company's Chief Financial Officer. On August 31, 1999 he
was elected as a Vice-President of the Company and on November 8, 1999 he was
again appointed as the Company's Chief Financial Office, which office he has
occupied since then.
ROBERT M. CARTER attended Tennessee Wesleyan College and Middle Tennessee
State College between 1954 and 1957. For 35 years he was an owner of Carter
Lumber & Building Supply Company and Carter Warehouse in Loudon County,
Tennessee. He has been with us since 1995 and during that time has been involved
in many phases of our business, including pipeline construction, leasing,
financing and the negotiation of acquisitions. Mr. Carter was elected
Vice-President in March, 1996, Executive Vice-President in April 1997 and
President on March 13, 1998 until he resigned from that position on October 19,
1999. On August 8, 2000 he again was elected as President and served in that
capacity until July 31, 2001. He has served as President of Tengasco Pipeline
Corporation, our wholly-owned subsidiary, from June 1, 1998 to the present.
CARY V. SORENSEN is a 1976 graduate of the University of Texas School of
Law and has undergraduate and graduate degrees from North Texas State University
and Catholic University in Washington, D.C. Prior to joining us in July 1999, he
had been continuously engaged in the practice of law in Houston, Texas relating
to the energy industry since 1977, both in private law firms and a corporate law
department, most recently serving for seven years as senior counsel with the
litigation department of a major Houston energy corporation before entering
private practice in June 1996 and continuing a general civil law practice until
June 1999. He has represented many of the major oil companies headquartered in
Houston, as well as local distribution companies and electric utilities in a
variety of litigation and administrative cases before state and federal courts
and agencies in numerous states. These matters involved gas contracts, gas
marketing, exploration and production disputes involving royalties or operating
interests, land titles, oil pipelines and gas pipeline tariff matters at the
state and federal levels, and general operation and regulation of interstate and
intrastate gas pipelines. He has served as General Counsel of the Company since
July 9, 1999.
STEPHEN W. AKOS has over twenty years experience in the financial services
industry with an expertise in fixed income securities. Since August of 2000, he
has been First Vice President, Institutional Fixed Income Sales, Robert W. Baird
& Co., St. Louis, Missouri. Between February 2000 and June 2000, Mr. Akos was
employed at J.C. Bradford & Co., an investment bank, as a Vice President and
Investment Limited Partner. Prior thereto commencing in 1993, he was a Vice
President with Mercantile Bank of St. Louis and its predecessor, Mark Twain
Bank. Before 1993 he was a broker, among other things, at brokerage firms Dean
Witter, Shearson Lehman Hutton, Drexel Burnham Lambert, and Kidder Peabody. He
received an MBA in Finance from Washington University in 1979, and a B.S. in
Business Administration, Accounting, from Washington University in 1976. He was
elected as a director on February 28, 2003.
JOSEPH EARL ARMSTRONG is a resident of Knoxville, Tennessee. He is a
graduate of the University of Tennessee and Morristown College where he received
a Bachelor of Science Degree in Business Administration. From 1988 to the
present, he has been an elected State Representative for Legislative District 15
in Tennessee. He has served as director since 1997.
DR. JOHN A. CLENDENING received B.S (1958), M.S. (1960) and Ph. D. (1970)
degrees in geology from West Virginia University. He was employed as a
Palynologist-Coal Geologist at the West Virginia Geological Survey from 1960
until 1968. He joined Amoco in 1968 and remained with Amoco as a senior
geological associate until 1992. Dr. Clendening has served as President and
other offices of the American Association of Stratigraphic Palynologists and the
Society of Organic Petrologists. From 1992 - 1998 he was engaged in association
with Laird Exploration Co., Inc. of Houston, Texas, directing exploration and
production in south central Kentucky. In 1999 he purchased all the assets of
Laird Exploration in south central Kentucky and operates independently. While
with Amoco Dr. Clendening was instrumental in Amoco's acquisition in the early
1970's of large land acreage holdings in Northeast Tennessee, based upon his
geological studies and recommendations. His work led directly to the discovery
of what is now our Paul Reed # 1 well. He further recognized the area to have
significant oil and gas potential and is credited with discovery of the field
which is now known as our Swan Creek Field. Dr. Clendening previously served as
a director from September 1998 to August 2000. He was again elected as a
director on February 28, 2003.
ROBERT L. DEVEREUX graduated in 1982 from St. Louis University with a
Bachelor's Degree in Business Administration with a major in finance. He
received his law degree from St. Louis University in 1985. For the past eighteen
years, Mr. Devereux has been actively engaged in the practice of law,
specializing in commercial litigation. Since 1994, he has been a principal in
the law firm of Devereux Murphy LLC located in St. Louis, Missouri. For the past
eight years Mr. Devereux has also been a principal of and has served as the
Chief Executive Officer of Gateway Title Company, Inc. He was elected as a
director on February 28, 2003.
BILL L. HARBERT earned a B.S. degree in civil engineering from Auburn
University in 1948. In 1949 he was one of the founders of Harbert Construction
Company. He managed that company's construction operations, both domestic and
foreign, and served as our Executive Vice-President until 1979. From 1979 until
July, 1990 he served as President and Chief Operating Officer and from July 1990
through December 1991 he served as Vice Chairman of the Board of Harbert
International, Inc. He then purchased a majority of the international operations
of Harbert International, Inc. and formed Bill Harbert International
Construction, Inc. He served as Chairman and Chief Executive Officer of that
corporation until retiring from us in 2000. Mr. Harbert's companies built
pipeline projects in the United States and throughout the world. They also built
many other projects including bridges, commercial buildings, waste water
treatment plants, airports, including an air base in Negev, Israel and embassies
for the United States government in, among other places, Tel Aviv, Hong Kong,
and Baku. Mr. Harbert has also served as president (1979) and Director (1980) of
the Pipe Line Contractors Association, USA and for seven years as Director,
Second Vice-President and First Vice-President (2001-2002) of the International
Pipe Line Contractors Association. Mr. Harbert has been active in service to a
variety of business associations, charities and the arts in the Birmingham area
for many years. He was elected as a director on April 2, 2002.
PETER E. SALAS has been President of Dolphin Asset Management Corp. and
associated companies since 1988. Prior to establishing Dolphin, he was with J.P.
Morgan Investment Management, Inc. for ten years, becoming Co-manager, Small
Company Fund and Director-Small Cap Research. He received an A.B. degree in
Economics from Harvard in 1978. Mr. Salas was elected as a director on October
8, 2002.
CHARLES M. STIVERS is a Certified Public Accountant with 18 years
accounting experience. In 1984 he received a B.S. degree in accounting from
Eastern Kentucky University. From 1983 through July 1986 he served as Treasurer
and CEO for Clay Resource Company. From August 1986 through August 1989 he
served as a senior tax and audit specialist for Gallaher and Company. From
September 1989 to date he has owned and operated Charles M. Stivers, C.P.A., a
regional accounting firm. Mr. Stiver's firm specializes in the oil and gas
industry and has clients in eight states. The oil and gas work performed by his
firm includes all forms of SEC audit work, SEC quarterly financial statement
filings, oil and gas consulting work and income tax services. Mr. Stiver's firm
has also represented oil and gas companies with respect to Federal and State
income tax disputes in 15 states over the past 12 years. In September 2001, he
was elected as a director and is the chairman of our audit committee.
Executive Compensation
The following sets forth certain information regarding compensation awarded
to, earned by or paid to, and options granted to, repriced or exercised by, the
Company's Chief Executive Officers during fiscal years ended December 31, 2002,
December 31, 2001 and December 31, 2000. During that period, none of the
Company's other executive officers earned compensation in excess of $100,000 per
annum for services rendered to us in any capacity.
Summary Compensation Table
Securities
Restricted Underlying
Name and Other Annual Stock Options/ All Other
Principal Position(1) Year Salary Bonus Compensation Awards SARS(#) Payouts Compensation
------------------------- ---- --------- ----- ------------ ---------- ----------- ------- ------------
Malcolm E. Ratliff 2002 $80,000 $0 $0 -0- 59,062 -0- -0-
Chief Executive Officer 2001 $80,000 $0 $1,000 -0- 52,500 -0- -0-
2000 $70,000 $0 $500 -0- 52,500 -0- -0-
--------------
(1) Malcolm E. Ratliff served as our Chief Executive Officer throughout 2002.
Richard T. Williams, our current Chief Executive Officer replaced Mr.
Ratliff on February 3, 2003.
OPTION GRANTS FOR FISCAL 2002
The following table sets forth information concerning options to purchase
shares of our common stock granted to the named executive officer in 2002.
INDIVIDUAL GRANTS
-----------------
Number of Percent of Total Potential Realizable
Securities Options/SARs Value At Assumed
Underlying Granted to Exercise or Annual Rates of Stock
Options/SARs Employees in Base Price Expiration PRICE APPRECIATION(1)
NAME Granted (#) Fiscal 2002 ($/Sh) Date 5%($) 10%($)
----- ----------- ----------- ------ ---- ------- -------
Malcolm E. Ratliff 6,562 4% $2.86 8/4/05 $2,952 $6,233
------------
(1) These options expired by their terms 90 days following the resignation
on March 10, 2003 of Mr. Ratliff from our Board of Directors.
AGGREGATE OPTION EXERCISES FOR FISCAL 2002 AND YEAR END OPTION VALUES
The following table sets forth the number of shares received upon exercise
of stock options by the names executive officer during the last completed fiscal
year and the aggregate options to purchase shares of our common stock held by
the named executive officer at December 31, 2002.
Number of Securities (1)
Underlying Unexercised Value (2) of Unexercised
Options/SARs at In-the-Money Options/SARs
Shares December 31, 2002 at December 31,2002
Acquired Value ($)
Name On Exercise Realized (3) Exercisable/unexercisable Exercisable/unexercisable(4)
---- ----------- ------------ ------------------------- ----------------------------
Malcolm E. Ratliff -0- -0- 59,062/-0- $-0-/-0-
------------
(1) Number of shares underlying the unexercised options has been retroactively
adjusted for a 5% stock dividend declared by us as of September 4, 2001.
(2) Unexercised options are in-the-money if the fair market value of the
underlying securities exceeds the exercise price of the option. The fair market
value of the Common Stock was $1.10 per share on December 31, 2002, as reported
by The American Stock Exchange. The exercise price of the unexercised options
granted to Malcolm E. Ratliff, the Chief Executive Officer of the Company, were
$8.69 and $2.86 per share. As a result, the unexercised options are for purposes
of this table deemed to have no value.
(3) Value realized in dollars is based upon the difference between the fair
market value of the underlying securities on the date of exercise, and the
exercise price of the option.
(4) These options expired by their terms 90 days following the resignation on
March 10, 2003 of Mr. Ratliff from our Board of Directors.
LONG TERM INCENTIVE PLANS
We do not have any long-term incentive programs or plans. We adopted an
employee health insurance plan in August 2001. We do not presently have a
pension or similar plan for our directors, executive officers or employees.
Management is considering adopting a 401(k) plan and full liability insurance
for directors and executive officers. However, there are no immediate plans to
do so at this time.
COMPENSATION OF DIRECTORS
The Board of Directors has resolved to compensate members of the Board of
Directors for attendance at meetings at the rate of $250 per day, together with
direct out-of-pocket expenses incurred in attendance at the meetings, including
travel. The Directors, however, have waived such fees due to them as of this
date for prior meetings.
Members of the Board of Directors may also be requested to perform
consulting or other professional services for us from time to time. The Board of
Directors has reserved to itself the right to review all directors' entitlement
to compensation on an ad hoc basis.
Directors who are on our Audit, Compensation and Stock Option Committees
are independent and therefore, do not receive any consulting, advisory or
compensatory fees from us. However, such board members may receive fees from us
for their services on those committees. The Company intends to implement a plan
for the payment of those committee members for their services on an annual
basis.
EMPLOYMENT CONTRACTS
We have entered into an employment contract with our Chief Executive
Officer, Richard T. Williams, for a period of two years through December 31,
2004 at an annual salary of $80,000. There are presently no other employment
contracts relating to any member of management. However, depending upon our
operations and requirements, we may offer long term contracts to directors,
executive officers or key employees in the future.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
From time to time, we have entered into transactions with related parties.
Certain of those transactions are described below. Our Board of Directors has
not adopted any general policy with respect to these transactions, many of which
were effected on our behalf by senior management prior to consideration by our
Board of Directors in light of senior management's perceived urgency of the
funding requirements, the availability of alternative sources and the terms of
such transactions, which senior management viewed as at least as favorable to us
as could have been obtained through arms-length negotiations with unaffiliated
third parties. In each of the loans to us by Dolphin as described below, Peter
Salas, a member of our Board, negotiated with our senior management as to the
terms thereof and did not participate in any Board action with respect thereto.
In 2002, Dolphin Offshore Partners, L.P., which we refer to as Dolphin and
which owns more than 10% of our outstanding common stock and whose general
partner, Peter E. Salas, is a director, loaned $750,000 to us to fund operating
cash flow needs and to finance continued development of the Swan Creek field.
Also in 2002, Michael E. Ratliff, then a director, chief executive officer and
more than 10% stockholder of us, loaned us $110,000 on a non-interest bearing
basis, which loan was repaid in July 2002. In 2000-2002, Mr. Ratliff, Nick
Nishiwaki, then a stockholder of us, and Ed Gray, then a director of us, loaned
the Company various amounts, which amounts were repaid by us using the proceeds
from our line of credit with Bank One. In 2000, we paid $270,000 of consulting
fees and commissions to Morita Properties, Inc., a principal of which was
Shigemi Morita, who then was a director of us.
On each of January 21, 2002 and April 9, 2002, Bill L. Harbert, who owns
more than ten percent of our outstanding common stock and is now, but was not at
those dates, a director, purchased from us in a private placement, 100,000
shares of our common stock, at prices of $6.32 and $4.80 per share,
respectively. The proceeds from those private placements were used as working
capital. The market prices of our common stock as measured by the closing prices
on the American Stock Exchange on January 21 and April 9, 2002 were $7.74 and
$5.80 per share, respectively. We believe that these sales were made on terms at
least as favorable to us as could have been obtained through arm's length
negotiations with unaffiliated third parties.
On July 5, 2002 and July 23, 2002, Dolphin purchased from us in a private
placement, 400,000 and 250,000 shares of our common stock, respectively, at a
price of $2.50 per share. The proceeds from those private placements were used
as working capital. The market prices of our common stock as measured by the
closing prices on the American Stock Exchange on July 5 and 23, 2002 were $2.80
and $2.50 per share, respectively. We believe that these sales were made on
terms at least as favorable to us as could have been obtained through arm's
length negotiations with unaffiliated third parties.
On August 8, 2002, Dolphin purchased 718,820 shares of our common stock in
an open market transaction. In connection with that purchase, Dolphin entered
into an agreement, which was later amended in October 2002, with Industrial
Resources Corporation, which we refer to as IRC, which owns more than ten
percent of our outstanding common stock and whose sole stockholder and
president, Malcolm E. Ratliff, was at the time of this transaction our Chief
Executive Officer and a director. Pursuant to that agreement, Dolphin granted
IRC an option commencing on April 11, 2003 and expiring on May 12, 2003 to
purchase up to 373,900 shares of our common stock that had been purchased by
Dolphin at a price of $2.386 per share. The agreement further provided that if
the option were not exercised during the option period, then IRC could then be
required by Dolphin to purchase from Dolphin at price of $2.495 per share the
same number of shares that had been the subject of the option. We were not a
party to this agreement. As a result of IRC's default on this obligation, in
June 2003, Dolphin received 400,000 shares of our common stock from an escrow
account established by IRC with IRC's shares of our common stock as security for
IRC's obligations to Dolphin.
In October 2002, Dolphin in consideration of a loan to us was issued an
unsecured convertible promissory note from us in the principal amount of
$500,000 bearing 8% interest, with interest only payable quarterly and principal
due on January 4, 2004. The principal amount of the note is convertible into our
common stock at the rate of $2.88 per share. The proceeds from this loan were
used to provide working capital for our operations. The market price of our
common stock as measured by the closing prices on the American Stock Exchange
during October 2002 ranged from $2.20 to $2.90 per share. We believe that this
sale was made on terms at least as favorable to us as could have been obtained
through arm's length negotiations with unaffiliated third parties.
In December 2002, Dolphin loaned us the sum of $250,000, which funds were
used to pay the principal and interest due that month from us to Bank One and to
provide working capital. We issued a promissory note to Dolphin bearing interest
at the rate of 12% per annum, with interest only payable quarterly and the
principal balance due on January 4, 2004. The obligations under the loan are
secured by an undivided 10% interest in our Tennessee and Kansas pipelines.
In January 2003, Bill L. Harbert, a director, purchased 227,275 shares of
our common stock from us in a private placement at a price of $1.10 per share.
The proceeds from this sale were used by us to pay the principal and interest
due that month from us to Bank One and to provide working capital. The market
price of our common stock as measured by the closing price on the American Stock
Exchange on January 7, 2003, the date of the transaction, was $1.20 per share.
We believe that this sale was made on terms at least as favorable to us as could
have been obtained through arm's length negotiations with unaffiliated third
parties.
On each of February 3, 2003 and February 28, 2003, Dolphin loaned us the
sum of $250,000, which we used to pay the principal and interest due from us to
Bank One for February and March 2003, respectively, and for working capital.
Each of these loans is evidenced by a separate promissory note bearing interest
at the rate of 12% per annum, with payments of interest only payable quarterly
and the principal balance due on January 4, 2004. The obligations under the
loans are secured by an undivided 10% interest in our Tennessee and Kansas
pipelines.
On May 20, 2003, Dolphin loaned us the sum of $750,000 and Jeffrey R.
Bailey, our President and a director, loaned us $84,000, which aggregate amount
of $834,000 we used to pay the principal and interest due from us to Bank One
for June 2003 and for working capital. These loans are evidenced by separate
promissory notes bearing interest at the rate of 12% per annum, with payments of
interest only payable quarterly and the principal balance due on January 4,
2004. The obligations under the loans are secured by an undivided 30% and 3.36%
interest, respectively, in our Tennessee and Kansas pipelines.
On August 6, 2003, Dolphin loaned us the sum of $150,000, which we used for
working capital. This loan is evidenced by a separate promissory note bearing
interest at the rate of 12% per annum, with payments of interest only payable
quarterly and the principal balance due on January 4, 2004. The obligations
under the loan are secured by an undivided 6% interest in our Tennessee and
Kansas pipelines
From December 2002 through December 9, 2003, Dolphin acquired a total of
85% undivided interest in our Tennessee and Kansas pipelines as collateral for a
series of seven loans. In the first five of these transactions, Peter E. Salas,
a member of our board and the general partner and controlling person of Dolphin,
negotiated the terms of the loans directly with our management, which terms were
approved by our management in view of our immediate needs, financial condition
and prospective alternatives and under circumstances in which Dolphin was not
generally engaged in the business of lending money. These loans were made on
terms that we believe were at least as favorable to us as we could have obtained
through arm's length negotiations with unaffiliated third parties. Our board
approved the sixth and seventh loans on December 3 and 9, 2003, in the amounts
of $225,000 and $250,000, respectively, with no participation by Mr. Salas in
the meeting or the vote, which was unanimous by the seven other directors
present at the meeting. In addition, we have entered into a continuing security
agreement, which was approved by our board with no participation by Mr. Salas in
the meeting or vote, which was unanimous by the seven other directors present at
the meeting, providing the terms of Dolphin's security interest collateralizing
all of its loans.
On December 24, 2003, Dolphin loaned us the sum of $1,000,000 which we used
for working capital and to pay all interest and principal in full of the 1998
convertible loan to the Company refereed to as the Lutheran note then being held
by several persons. This loan is evidenced by a separate promissory note bearing
interest at the rate of 12% per annum, with payments of interest only payable
quarterly and the principal balance payable on April 4, 2004. The obligations
under the loan are secured by an undivided interest in our Tennessee and Kansas
pipelines and the security agreement referred to above.
On February 2, 2004, Dolphin loaned us the sum of $225,000 which we used
for making payment of principal and interest to Bank One for February, 2004.
This loan is evidenced by a separate promissory note bearing interest at the
rate of 12% per annum, with payments of interest only payable quarterly and the
principal balance payable on April 4, 2004. The obligations under the loan are
secured by an undivided interest in our Tennessee and Kansas pipelines and the
security agreement referred to above.
From April 1 through June 30, 2003, we issued 10,363 shares of our common
stock to holders of our Series A 8% Cumulative Convertible Preferred Stock in
lieu of cash quarterly interest payments due to those holders, with such shares
valued at the market price thereof. Also during that period, certain members of
our board of directors exercised options granted to them pursuant to the
Tengasco, Inc. Stock Incentive Plan and purchased the following number of shares
of our common stock at the exercise price of $0.50 per share. Richard T.
Williams - 10,000 shares, Bill L. Harbert - 24,000 shares and John A. Clendening
- 24,000 shares.
In this offering Dolphin, as well as our directors (certain of whom are
also officers), will have the right to purchase additional shares of common
stock at the offering. Dolphin and these officers and directors will receive the
same terms as the other stockholders in this rights offering. See "The Rights
Offering - Effects of Rights Offering on Dolphin's Securities and Ownership."
PRINCIPAL STOCKHOLDERS
The following table sets forth information, as of February 9, 2004,
concerning the beneficial ownership of our common stock by (a) each director,
(b) each executive officer named in our summary compensation table above, (c)
all directors and executive officers as a group, and (d) each person known by us
to beneficially own more than five percent of our common stock. Unless otherwise
indicated, each of the persons named below has sole voting power and sole
investment power with respect to the shares set forth opposite his or her name
and has an address at c/o Tengasco, Inc. 603 Main Avenue, Knoxville, Tennessee
37902.
Name of Amount Beneficially Percent of
BENEFICIAL OWNER OWNED(1)(2) CLASS (%)
---------------- ------------ ---------
Stephen W. Akos................................. 47,439(1) *
Joseph Earl Armstrong........................... 39,450(2) *
Jeffrey R. Bailey............................... 83,125(3) *
John A. Clendening.............................. 24,000 *
Robert L. Devereux.............................. 80,882(4) *
Dolphin Offshore Partners, L.P.................. 2,441,019(5) 19.8
Bill L. Harbert................................. 1,513,496(6) 12.5
Malcolm E. Ratliff.............................. 2,250,487(7) 18.7
Peter E. Salas.................................. 2,465,019(8) 19.9
Charles M. Stivers.............................. 13,125(9) *
Richard T. Williams............................. 73,125(10) *
All Officers and Directors as a group........... 4,339,661 34.5
------------
* Indicates holdings of less than 1%.
(1) Consists of 14,081 shares held directly (certain of which are jointly owned
with spouse); options to purchase 24,000 shares and 9,358 shares underlying
convertible promissory notes owned jointly with his spouse and by a limited
partnership. The shares underlying the note held by the limited partnership
have been adjusted to reflect Mr. Akos' ownership interest in the limited
partnership.
(2) Consists of 4,950 shares held directly and options to purchase 34,500
shares.
(3) Consists of 10,000 shares held directly and options to purchase 73,125
shares.
(4) Consists of 34,562 shares held directly and jointly with his spouse;
options to purchase 24,000 shares; 12,448 shares underlying a convertible
note held jointly with his spouse; 6,753 shares owned by a limited
liability company; and 3,119 shares underlying a convertible promissory
note held by a limited liability company. The shares owned by the limited
liability company and underlying the note held by the limited liability
company have been adjusted to reflect Mr. Devereux's ownership interest in
the limited liability company.
(5) Mr. Salas, a director, is the general partner and controlling person of
Dolphin. The share amount indicated consists of 2,139,720 shares held by
Dolphin; 10,500 shares underlying a warrant held by Dolphin; 173,611 shares
underlying a convertible promissory note held by Dolphin; and 117,188
shares underlying 9,000 shares of our series B 8% cumulative convertible
preferred stock held directly by Dolphin that are convertible into our
common stock. The indicated amount includes 400,000 shares transferred in
May 2003 to Dolphin from Industrial Resources Corporation, a corporation
that we believe is affiliated with M.E. Ratliff, pursuant to the terms of
an agreement between that corporation and Dolphin. The Company was not a
party to that agreement.
(6) Consists of 1,428,942 shares held directly, 71,429 shares underlying 5,000
shares of our series A 8% cumulative convertible preferred stock held
directly, which shares are convertible into our common stock, and an option
to purchase 13,125 shares.
(7) Includes 80,171 shares owned directly by Mr. Ratliff and 849,744 shares
owned by Industrial Resources Corporation, which is controlled by Mr.
Ratliff, 1,289,072 shares owned by Ratliff Farms, Inc., which is controlled
by Mr. Ratliff, and 31,500 shares owned directly by a trust of which Mr.
Ratliff's wife is a trustee and the children of Mr. Ratliff are the
beneficiaries. The information regarding these shares was previously
provided to us by Mr. Ratliff when he was our Chairman of the Board and
Chief Executive Officer. We are not aware of any changes in the
information, except for the transfer of 400,000 shares from Industrial
Resources Corporation to Dolphin described in footnote 5 above.
(8) Mr. Salas, a director, is the general partner and controlling person of
Dolphin. Consists of 2,139,720 shares held by Dolphin; 24,000 shares held
by Mr. Salas; a warrant held by Dolphin to purchase 10,500 shares at $7.68
per share; 173,611 shares underlying a convertible promissory note held by
Dolphin; and 117,188 shares underlying 9,000 shares of our series B 8%
cumulative convertible preferred stock held by Dolphin, which shares are
convertible into our common stock at the rate of $7.68 per share.
(9) Consists of options to purchase 13,125 shares.
(10) Consists of 10,000 shares and options to purchase 63,125 shares.
THE RIGHTS OFFERING
BACKGROUND OF THE RIGHTS OFFERING
Our Board of Directors proposed that we attempt to raise equity capital
through a rights offering to all of our stockholders. The primary reason for the
rights offering is to pay non-bank indebtedness in the approximate amount of up
to six million dollars (including up to $3,850,000 in principal amount plus
accrued interest to Dolphin with the balance of the net proceeds, if any, to be
used to pay bank indebtedness to some extent and/or for working capital
purposes, possibly including the drilling of wells. See "Certain Relationships
and Related Transactions." The board's proposal was based upon our financial,
operating and other circumstances and the limited prospects of capital-raising
alternatives.
In originally proposing and on December 23, 2003 approving the terms of the
rights offering, our Board of Directors considered a number of factors,
including the following:
o the need to pay our outstanding indebtedness, including to Dolphin,
and repaying certain other outstanding indebtedness, including
perhaps a portion of our credit facility with Bank One and/or
providing certain, albeit not necessarily sufficient, capital usable
toward resuming our drilling program;
o the historic and then-current price of our common stock;
o the difficulty of refinancing our outstanding indebtedness;
o our recent and anticipated operating results;
o general conditions in the securities markets;
o alternatives available to us for raising capital;
o the amount of proceeds desired;
o the pricing of similar transactions;
o the liquidity of our stock;
o our business prospects;
o the possible need to refinance all or a portion of the credit
facility in light of the impediment to other capital-raising created
by the dispute with Bank One;
o the commercial and other risks and uncertainties associated with a
restructuring or recapitalization and the impact of those
alternatives on our shareholders and our creditors; and
o the belief that the transaction was the best alternative reasonably
available to us from the perspective of our public shareholders.
The preceding discussion of the information and factors considered and
given weight by our Board of Directors includes all the material factors
considered by the Board of Directors in its determination to propose, and then
in its determination to approve, the rights offering. In reaching its decision
to propose the rights offering and its subsequent decision to approve the rights
offering, our Board of Directors did not assign any relative or specific weights
to the factors they considered. Individual directors may have given different
weights to different factors.
Following its proposal of a rights offering, our Board of Directors formed
a special committee consisting of Stephen W. Akos, John A. Clendening, Robert L.
Devereux and Charles M. Stivers. None of these directors is an employee of us
nor has any personal interest in the rights offering. The special committee was
charged by the Board with determining the financial and other terms and
feasibility of the rights offering and making recommendations regarding such
matters to the Board of Directors. Although Mr. Salas participated in our
Board's preliminary discussions regarding the proposed rights offering, he did
not participate in any Board discussions in connection with the receipt of the
special committee's determinations and recommendations regarding the terms
hereof and did not participate in any Board discussions in connection with the
receipt on December 23, 2003 of the special committee's final determinations and
recommendations regarding the terms hereof.
The subscription price per share was recommended to our Board by the
special committee. The special committee considered all of the factors
enumerated above in making its determination. In addition, the special committee
also considered its negotiations with a representative of Dolphin, of which Mr.
Salas is the controlling person, regarding a subscription price at which Dolphin
might participate in the offering, although Dolphin has not proposed or entered
into any agreement or understanding with the special committee or us with
respect to such participation.
In connection with all of the foregoing considerations by the special
committee, it received the advice of a financial advisor and counsel, each of
which was engaged specifically by the special committee for these purposes. The
financial advisor has not yet rendered a final written report to the special
committee but did participate in the pricing negotiations or discussions between
the special committee and Dolphin. However, following notification to the
financial advisor of all such negotiations and discussions and the special
committee's proposed terms of the offering, the financial advisor advised the
special committee that those terms were fair to our stockholders from a
financial point of view. The special committee's recommendations regarding
subscription price per share and the other terms of the offering were finally
presented to, and approved by, our Board of Directors (with Mr. Salas not
participating with respect to these matters) on December 23, 2003.
An investment in our common stock must be made according to your own
evaluation of your best interests. Accordingly, our Board of Directors does not
make any recommendation to you about whether you should exercise your rights. In
addition, we have not retained a financial advisor to make any recommendation to
you about whether you should exercise your rights.
FINANCIAL ADVISOR
The special committee retained Mercer Capital Management, Inc. ("Mercer")
to serve as its independent financial advisor in connection with the proposed
rights offering. Mercer is a business valuation and financial advisory firm
located in Memphis, Tennessee. Mercer is regularly engaged to provide valuation
services in connection with mergers and acquisitions, corporate transaction,
share repurchases, tax compliance, ESOPs and employee benefit plans and related
purposes. As part of its advisory business, Mercer has experience reviewing the
fairness of transactions to shareholders from a financial point of view. The
special committee was introduced to Mercer by way of recommendations solicited
in the Tennessee investment banking community and selected Mercer following an
interview by committee members and their consideration of other prospective
candidates. Factors considered by the special committee in its selection
included experience (particularly with similar transactions), reputation and
cost.
In connection with this engagement, the special committee requested that
Mercer evaluate the fairness of the rights offering from the financial
perspective of our stockholders. Following the negotiation by the special
committee of the terms of the offering, Mercer gave an oral report to the
special committee, which report was supported by delivery of the preliminary
written report to the effect that, based on and subject to the considerations
described in its report, the rights offering is fair to our stockholders from a
financial point of view. Mercer was not engaged to and did not participate in
the negotiations and determinations as to the terms of the rights offering,
including pricing, except that Mercer was present during one teleconference
during which special committee members negotiated certain terms of the offering.
Otherwise, the special committee itself conducted such negotiations and made
such determinations as to terms as described above, which terms were submitted
to Mercer for their review and report.
In arriving at its conclusion, Mercer:
o reviewed our capital structure
o performed market analysis of our common stock
o reviewed our key business issues
o performed a liquidation analysis, noting that our equity is not
sufficient to redeem is common stock shareholders; and
o reviewed our financial data.
In addition, Mercer noted the following considerations:
o A successful offering moves Tengasco forward with a significant
restructuring that improves potential for future success. The
proceeds from a successful rights offering will be used to retire
non-bank debt, to reduce indebtedness to Bank One, and for working
capital purposes.
o Tengasco does not have another plan to obtain long-term debt or to
raise capital. Without other options, the rights offering provides
the only plan for Tengasco to obtain the necessary funds to
strengthen its ability to continue to operate as a going concern.
o Each shareholder has the right to fully participate in the rights
offering and avoid dilution.
o Based on Tengasco's estimated liquidation analysis, proceeds from
liquidation are not sufficient to redeem the common or preferred
shareholders. The rights offering improves the potential to provide
value to the shareholders.
o By requiring approval, the Board is given certain authority to turn
down oversubscription requests which could result in a change of
control.
o The fairness of the price from a financial point of view.
o Shareholders either accept the rights offering which requires
injecting additional money into Tengasco or their position becomes
diluted in ownership and in market capitalization.
o The price per share under the rights offering is lower than the
current trading price of the shares.
o The rights will have no value.
The following are valuation analyses performed by Mercer in connection with
preparing its preliminary report. The Asset-Based Approach and Discounted Cash
Flows Analysis were each considered by Mercer and found inappropriate for
Tengasco's case.
MARKET APPROACH - TRANSACTIONS IN TENGASCO'S SHARES
From the perspective that the rights offering occurs at $0.25 per share
($0.50 less than the then-current market price of $0.75), Mercer considered that
the market price of Tengasco's shares may decline. Mercer further felt that the
market is currently pricing the stock at a premium and that the current market
price is not supported by the earnings expectations of Tengasco.
MARKET APPROACH - GUIDELINE COMPANY METHOD
The guideline company method derives common stock valuation multiples from
publicly traded companies in the same general line of business as Tengasco.
Mercer's initial search for comparable companies yielded a group of 124
companies (including Tengasco). These companies were divided into two
categories: the 25 selected guideline companies which are comparable to Tengasco
and 99 less similar companies noted as "also considered."
The 25 selected companies were then subdivided into two groups. Group A,
which was made up of seven comparable companies which have similar earnings
patterns to Tengasco (i.e., they are losing money at the valuation date), and
Group B, three companies which Tengasco's management indicated were directly
comparable to Tengasco.
For the group of 25 and subgroups A and B, Mercer derived indications of
value for Tengasco based on the ratios of total capital/revenues and total
capital/EBITDA (only subgroups A and B). The base guideline capitalization
factor for each of the multiples is the average of the median multiples for each
of the subgroups. Based upon its analysis, Mercer found that a minimum
fundamental adjustment to the public multiples in the range of 10% - 20% is
appropriate for Tengasco.
TOTAL CAPITAL / REVENUE
Multiplying the Tengasco's most recent revenues by the guideline company
capitalization factor and then subtracting debt provides an indicated value of
total equity Such method taking into account fundamental adjustments of up to
20% implies a total common equity value of $0.10 per share to $0.50 per
share.
TOTAL CAPITAL / EBITDA
Mercer applied the same methodology in determining the total capital/EBITDA
indication of value as the total capital/revenue method. EBITDA is defined as
earnings before interest expenses, taxes, depreciation and amortization. Mercer
found that the total capital/EBITDA indication of value does not indicate a
positive equity value. In the derivation of the value, the reported EBITDA is
from the trailing twelve month period ended September 30, 2003, which was the
highest reported EBITDA over the period analyzed. The current EBITDA measure is
due to the favorable pricing environment for oil and gas sales. Based on the
capitalized EBITDA indication, the available equity is sufficient to pay down
the debt but not to redeem all of the preferred stock. Thus, this method does
not provide value to all of preferred shareholders or to the common
shareholders.
Under the terms of its engagement, the special committee agreed to pay
Mercer an estimated professional fee of $25,000. In addition, the special
committee agreed to reimburse certain out-of-pocket expenses, including the
report preparation, research, travel and communication. Aside from the current
engagement, no material relationship has ever existed between us (including the
special committee) and either Mercer or any of its affiliates, nor has any such
relationship understood to be contemplated.
THE RIGHTS
We will distribute to each holder of record of our common stock on February
27, 2004, at no charge, one nontransferable subscription right for each share of
our common stock they own. The rights will be evidenced by rights certificates.
Each right will allow such holder to purchase three additional shares of our
common stock at a price of $0.25 per such purchased share.
LIMITATION ON EXERCISE OF THE RIGHTS
In no event may any subscriber purchase shares of our common stock in the
offering that, when aggregated with all of the shares of our common stock
otherwise owned by the subscriber and his, her or its affiliates, would
immediately following the closing represent more than 50% of our issued and
outstanding shares.
EXPIRATION OF THE RIGHTS OFFERING
You may exercise your subscription privilege at any time before 5:00 p.m.,
New York City time, on March 18, 2004, the expiration date for the rights
offering. If you do not exercise your rights before the expiration date, your
unexercised rights will be null and void. We will not be obligated to honor your
exercise of rights if the subscription agent receives the documents relating to
your exercise after the rights offering expires, regardless of when you
transmitted the documents, except when you have timely transmitted the documents
under the guaranteed delivery procedures described below. We may extend the
expiration date by up to 30 days by giving oral or written notice to the
subscription agent on or before the scheduled expiration date. If we elect to
extend the expiration of the rights offering, we will issue a press release
announcing the extension no later than 9:00 a.m., New York City time, on the
next business day after the most recently announced expiration date.
NO INTEREST ON SUBSCRIPTION AMOUNTS
Once you send in your subscription certificate and payment, you cannot
revoke the exercise of your rights, even if you later learn information about us
that you consider to be unfavorable and even if the market price of our common
stock is below the $0.25 per share subscription price, unless we amend the
offering. During this period of no revocation, subscription amounts received
will be held by the subscription agent until completion, expiration or
termination of the rights offering, during which period the rights holders will
not earn interest on those subscription amounts. Further, we may terminate the
offering at any time, for any reason at our sole discretion. Circumstances under
which we may terminate the rights offering include without limitation
insufficient subscription levels.
SUBSCRIPTION PRIVILEGES
BASIC SUBSCRIPTION PRIVILEGE. With your basic subscription privilege, you
may purchase three shares of our common stock per right, upon delivery of the
required documents and payment of the subscription price of $0.75 in the
aggregate, or $0.25 per share. You must purchase all three shares underlying a
right if you want to exercise that right. Fractional rights will be rounded up
to the next higher whole right. The number of rights subject to the rights
offering has been arbitrarily increased to 12,100,000, which number exceeds the
number of outstanding shares of our common stock on the record date of
12,049,977, to cover increases resulting from rounding up. You are not required
to exercise all of your rights. We will deliver to you certificates representing
the shares that you purchased with your basic subscription privilege as soon as
practicable after the rights offering has expired.
OVER-SUBSCRIPTION PRIVILEGE. If you exercise your basic subscription
privilege in full, you may also subscribe for additional shares that other
shareholders have not purchased under their basic subscription privilege. You
may purchase a percentage of the unsubscribed shares equal to the percentage of
shares purchased by you under the basic subscription privilege, as compared to
the total number of shares purchased by all shareholders, including you, who are
exercising their oversubscription privilege. If there are not enough shares
available to fill all subscriptions for additional shares, then the available
shares will be allocated pro rata, in successive rounds, based on the number of
shares each subscriber for additional shares has purchased under his, her or its
basic subscription privilege.
For example, if there are 900,000 available shares under the
oversubscription privilege and the only oversubscribing shareholders are a 10%
shareholder subscribing for 500,000 additional shares and a 5% shareholder
subscribing for 500,000 additional shares, then the 10% shareholder would
receive 500,000 shares and the 5% shareholder would receive the remaining
400,000 shares, as follows: the subscription agent will initially allocate
500,000 shares to the 10% shareholder and 250,000 to the 5% shareholder
according to their relative 2:1 ownership percentages and, thereafter, will
allocate the remaining shares to the 5% shareholder since he, she or it was the
only shareholder to subscribe for these shares. We will not allocate to you more
than the number of shares you have actually subscribed and paid for. As soon as
practicable after the expiration date, Mellon Bank, N.A., acting as our
subscription agent, will determine the number of shares that you may purchase
pursuant to the oversubscription privilege.
You are not entitled to exercise the oversubscription privilege unless you
have fully exercised your basic subscription privilege. For this purpose, you
would only count the shares you own in your own name, and not other shares that
might, for example, be jointly held by you with a spouse, held as a custodian
for someone else, or held in an individual retirement account.
You can elect to exercise the oversubscription privilege only at the same
time you exercise your basic subscription privilege in full.
In exercising the oversubscription privilege, you must pay the full
subscription price for all of the shares you are electing to purchase. If we do
not allocate to you all of the shares you have subscribed for under the
oversubscription privilege, we will refund to you, by mail, any payment you have
made for shares which are not being made available to you, promptly after
completion of this offering. Interest will not be payable on amounts refunded.
Banks, brokers and other nominees who exercise the oversubscription
privilege on behalf of beneficial owners of shares must report certain
information to us and the subscription agent, Mellon Bank, N.A., and report
certain other information received from each beneficial owner exercising shares.
Generally, banks, brokers and other nominees must report:
o the number of shares held on the record date on behalf of each
beneficial owner;
o the number of shares as to which the basic subscription privilege
has been exercised on behalf of each beneficial owner;
o that each beneficial owner's basic subscription privilege, held in
the same capacity, has been exercised in full; and
o the number of shares subscribed for, pursuant to the
oversubscription privilege, by each beneficial owner, if any.
If you complete the portion of the subscription certificate required for
you to exercise the oversubscription privilege, you will be representing and
certifying that you have fully exercised your basic subscription privilege as
described above. You must exercise your oversubscription privilege at the same
time you exercise your basic subscription privilege.
In some circumstances, in order to comply with applicable state securities
laws, we may not be able to honor your basic and/or oversubscription privileges,
even if we have shares available and the above conditions are met.
NON-TRANSFERABILITY OF THE RIGHTS
Except in the limited circumstances described below, only you may exercise
the basic subscription privilege and the over-subscription privilege. You may
not sell, give away or otherwise transfer the basic subscription privilege or
the over-subscription privilege.
Notwithstanding the foregoing, you may transfer your rights to any
affiliate of yours and your rights also may be transferred by operation of law;
for example a transfer of rights to the estate of the recipient upon the death
of the recipient would be permitted. If the rights are transferred as permitted,
evidence satisfactory to us that the transfer was proper must be received by us
prior to the expiration date of the rights offering.
METHOD OF SUBSCRIPTION--EXERCISE OF RIGHTS
You may exercise your rights by delivering the following to the
subscription agent, at or prior to 5:00 p.m., New York City time, on March 18,
2004, the date on which the rights expire:
o your properly completed and executed rights certificate with any
required signature guarantees or other supplemental documentation;
and
o your full subscription price payment for each share subscribed for
under your basic subscription privilege and your over-subscription
privilege.
MAILING OF SUBSCRIPTION CERTIFICATES AND RECORD HOLDERS
We are sending a subscription certificate to each record holder, together
with this prospectus and related instructions to exercise the rights. In order
to exercise rights, you must fill out and sign the subscription certificate and
timely deliver it to the subscription agent, together with full payment for the
shares to be purchased. Only the holders of record of our common stock as of the
close of business as of the record date may exercise rights.
A depository bank, trust company or securities broker or dealer which is a
record holder for more than one beneficial owner of shares may divide or
consolidate subscription certificates to represent shares held as of the record
date by their beneficial owners, upon providing the subscription agent with
certain required information.
If you own shares held in a brokerage, bank or other custodial or nominee
account, in order to exercise your rights you must promptly send the proper
instruction form to the person holding your shares. Your broker, dealer,
depository or custodian bank or other person holding your shares is the record
holder of your shares and will have to act on your behalf in order for you to
exercise your rights. We have asked your broker, dealer or other nominee holder
of our common stock to contact the beneficial owner(s) thereof and provide them
with instructions concerning the rights the beneficial owner(s) it represents
are entitled to exercise.
PROCEDURES TO EXERCISE RIGHTS
Please do not send subscription certificates or related forms to us. Please
send the properly completed and executed form of subscription certificate with
full payment to the subscription agent for this offering, Mellon Bank, N.A., or
to the record holder of your shares (such as your broker, nominee or other
custodial holder, if applicable).
You should read carefully the subscription certificate and related
instructions and forms which accompany this prospectus. You should contact
Mellon Investor Services LLC, the information agent for this offering, at the
address and telephone number listed below under the caption "The Rights Offering
- Questions and Assistance Concerning the Rights," promptly with any questions
you may have.
You may exercise your rights by delivering to the subscription agent (or to
the record holder of your shares, if applicable), at the address specified below
and in the instructions accompanying this prospectus, on or prior to the
expiration date, the following:
o Properly completed and executed subscription certificate(s) which
evidence your rights. See "The Rights Offering - Delivery of
Subscription Certificates" below, for instructions on where to send
these;
o Any required signature guarantees; and
o Payment in full of the subscription price for each share you wish to
purchase under your basic subscription privilege and your
oversubscription privilege. See "The Rights Offering - Required
Forms of Payment of Subscription Price" below, for payment
instructions.
REQUIRED FORMS OF PAYMENT OF SUBSCRIPTION PRICE
The subscription price is $0.25 per share subscribed for, payable in cash.
All payments must be cleared on or before the expiration date.
If you exercise any rights, you must deliver to the subscription agent (or
the record holder of your shares, if applicable) full payment in the form of a
personal check, certified or cashier's check or bank draft drawn upon a U.S.
bank, or a U.S. postal money order, payable to Mellon Investor Services LLC
(acting on behalf of Mellon Bank, N.A. as subscription agent).
In order for you to timely exercise your rights, the subscription agent
must actually receive good funds, in payment of the subscription price, before
the expiration date.
Funds paid by uncertified personal check may take at least five business
days to clear. Accordingly, if you pay the subscription price by means of
uncertified personal check, you should make payment sufficiently in advance of
the expiration date to ensure that your check actually clears and the payment is
received before such date. We are not responsible for any delay in payment by
you and suggest that you consider payment by means of certified or cashier's
check or bank draft drawn upon a U.S. bank, or a U.S. postal money order.
DELIVERY OF SUBSCRIPTION CERTIFICATES
All subscription certificates, payments of the subscription price and
nominee holder certifications and Depository Trust Company participant
oversubscription exercise forms, to the extent applicable to your exercise of
rights, must be delivered to the subscription agent, Mellon Bank, N.A., as
follows:
BY MAIL: BY HAND:
Mellon Bank, N.A. Mellon Bank, N.A.
c/o Mellon Investor Services LLC c/o Mellon Investor Services LLC
P.O. Box 3301 120 Broadway, 13th Floor
South Hackensack, NJ 07606 New York, New York 10271
Attention: Reorganization Dept. Attention: Reorganization Dept
BY OVERNIGHT COURIER:
Mellon Bank, N.A.
c/o Mellon Investor Services LLC
85 Challenger Road
Overpeck Centre
Ridgefield Park, NJ 07660
Attention: Reorganization Dept.
PROHIBITION ON FRACTIONAL SHARES
Each right entitles you to purchase three shares at the subscription price.
We will accept any inadvertent subscription indicating a purchase of fractional
shares, by rounding down to the nearest whole share and promptly refunding,
without interest, any payment received for a fractional share.
INSTRUCTIONS TO NOMINEE HOLDERS
If you are a broker, trustee, depository for securities or other nominee
holder for beneficial owners of our common stock, we are requesting that you
contact such beneficial owners as soon as possible to obtain instructions and
related certifications concerning their rights. Our request to you is further
explained in the suggested form of letter of instructions from nominee holders
to beneficial owners accompanying this prospectus.
To the extent so instructed, nominee holders should complete appropriate
subscription certificates on behalf of beneficial owners and, in the case of any
exercise of the oversubscription privilege, the related form of "Nominee Holder
Certification", and submit them on a timely basis to the subscription agent,
Mellon Bank, N.A., with the proper payment.
RISK OF LOSS ON DELIVERY OF SUBSCRIPTION CERTIFICATE FORMS AND PAYMENTS
Each holder of rights bears all risks of the method of delivery, to the
subscription agent, of subscription certificates and payments of the
subscription price. If subscription certificates and payments are sent by mail,
you are urged to send these by registered mail, properly insured, with return
receipt requested, and to allow a sufficient number of days to ensure delivery,
to the subscription agent, and clearance of payment prior to the expiration
date.
Because uncertified personal checks may take at least five business days to
clear, you are strongly urged to pay, or arrange for payment, by means of
certified or cashier's check or bank draft drawn upon a U.S. bank, or a U.S.
postal money order.
HOW PROCEDURAL AND OTHER QUESTIONS ARE RESOLVED
We are entitled to resolve all questions concerning the timeliness,
validity, form and eligibility of any exercise of rights. Our determination of
such questions will be final and binding. We, in our reasonable discretion, may
waive any defect or irregularity, or permit a defect or irregularity to be
corrected within such time as we may determine, or reject the purported exercise
of any right because of any defect or irregularity.
Subscription certificates will not be considered received or accepted until
all irregularities have been waived or cured within such time as we determine,
in our reasonable discretion. Neither we nor the subscription agent have any
duty to give you notification of any state required pre-clearance or approval,
nor any defect or irregularity in connection with the submission of subscription
certificates or any other required document or payment, although we may elect to
do so. Neither we nor the subscription agent will incur any liability for
failure to give such notification.
We reserve the right to reject any exercise of rights if the exercise does
not comply with the terms of this offering, is not in proper form, or if the
exercise of rights would be unlawful or materially burdensome to us.
ISSUANCE OF SHARES OF OUR COMMON STOCK
Shares of our common stock purchased in this offering will be issued as
soon as practicable after the expiration date. The subscription agent will
deliver subscription payments to us only after consummation of this offering and
the issuance of certificates to our shareholders that exercised rights.
FEES AND EXPENSES
We will pay all fees charged by the subscription agent and information
agent. You are responsible for paying any other commissions, fees, taxes or
other expenses incurred in connection with the exercise of your subscription
rights. None of the subscription agent, the information agent or us will pay
these expenses.
SUBSCRIPTION AGENT
We have appointed Mellon Bank, N.A. as subscription agent for this
offering. The subscription agent's addresses for packages sent by hand, mail or
overnight courier are:
BY MAIL: BY HAND:
Mellon Bank, N.A. Mellon Bank, N.A.
c/o Mellon Investor Services LLC c/o Mellon Investor Services LLC
P.O. Box 3301 120 Broadway, 13th Floor
South Hackensack, NJ 07606 New York, New York 10271
Attention: Reorganization Dept. Attention: Reorganization Dept.
BY OVERNIGHT COURIER:
Mellon Bank, N.A.
c/o Mellon Investor Services LLC
85 Challenger Road
Overpeck Centre
Ridgefield Park, NJ 07660
Attention: Reorganization Dept.
The subscription agent's telephone number is 800-932-6798. You should
deliver your subscription certificate and payment of the subscription price only
to the subscription agent, except if your shares are held on record by a broker,
dealer, nominee or other custodial. We will pay the fees and expenses of the
subscription agent, information agent and printer, which we estimate will total
$15,000. We have also agreed to indemnify the subscription agent from any
liability which it may incur in connection with the offering.
IMPORTANT
Please carefully read the instructions accompanying the subscription
certificate and follow those instructions in detail. Do not send subscription
certificates directly to us. You are responsible for choosing the payment and
delivery method for your subscription certificate, and you bear the risks
associated with such delivery. If you choose to deliver your subscription
certificate and payment by mail, we recommend that you use registered mail,
properly insured, with return receipt requested. We also recommend that you mail
your subscription certificate and payment a sufficient number of days prior to
the record date. Because uncertified personal checks may take at least five
business days to clear, we strongly urge you to pay, or arrange for payment, by
means of certified or cashier's check or bank draft drawn upon a U.S. bank, or a
U.S. postal money order.
QUESTIONS AND ASSISTANCE CONCERNING THE RIGHTS
If you have any questions or need assistance concerning the procedures for
exercising your subscription rights, or if you would like additional copies of
this prospectus or the instructions, you should contact us or the information
agent, as follows:
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| | |
| TENGASCO, INC. | MELLON INVESTOR SERVICES LLC |
| 603 Main Avenue | 85 Challenger Road |
| Suite 500 | Overpeck Centre |
| Knoxville, TN 37902 | Ridgefield Park, NJ 07660 |
| 865-523-1124 | 800-932-6798 |
| | |
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Calculation Of Rights Exercised
If you do not indicate the number of rights being exercised, or do not
forward full payment of the total subscription price for the number of rights
that you indicate are being exercised, then you will be deemed to have exercised
your basic subscription privilege with respect to the maximum number of rights
that may be exercised with the aggregate subscription price payment you
delivered to the subscription agent. If we do not apply your full subscription
price payment to your purchase of shares of our common stock, we will return the
excess amount to you by mail without interest or deduction as soon as
practicable after the expiration date of the rights offering.
DETERMINATIONS REGARDING THE EXERCISE OF YOUR RIGHTS
We will decide all questions concerning the timeliness, validity, form and
eligibility of your exercise of your rights and our determinations will be final
and binding. We, in our sole discretion, may waive any defect or irregularity,
or permit a defect or irregularity to be corrected within such time as we may
determine. We may reject the exercise of any of your rights because of any
defect or irregularity. We will not receive or accept any subscription until all
irregularities have been waived by us or cured by you within such time as we
decide, in our sole discretion.
Neither we nor the subscription agent will be under any duty to notify you
of any defect or irregularity in connection with your submission of rights
certificates and we will not be liable for failure to notify you of any defect
or irregularity. We reserve the right to reject your exercise of rights if your
exercise is not in accordance with the terms of the rights offering or in proper
form. We will also not accept your exercise of rights if our issuance of shares
of our common stock to you could be deemed unlawful under applicable law or is
materially burdensome to us.
REGULATORY LIMITATION
We will not be required to issue to you shares of common stock pursuant to
the rights offering if, in our opinion, you would be required to obtain prior
clearance or approval from any state or federal regulatory authority to own or
control such shares if, at the time the subscription rights expire, you have not
obtained such clearance or approval.
EXPIRATION DATE, EXTENSIONS AND TERMINATION
We may extend the rights offering and the period for exercising your rights
for up to 30 days, in our sole discretion. The rights will expire at 5:00 p.m.,
New York City time, on March 18, 2004, unless we decide to extend the rights
offering. If the commencement of the rights offering is delayed, the expiration
date will be similarly extended. If you do not exercise your basic subscription
privilege prior to that time, your rights will be null and void. We will not be
required to issue shares of common stock to you if the subscription agent
receives your subscription certificate or your payment after that time,
regardless of when you sent the subscription certificate and payment, unless you
send the documents in compliance with the guaranteed delivery procedures
described above.
SHARES OF COMMON STOCK OUTSTANDING AFTER THE RIGHTS OFFERING
Approximately 48.2 million shares of our common stock will be issued and
outstanding after the rights offering, assuming exercise in full of all rights.
Approximately 12.1 million shares of our common stock are issued and outstanding
as of the date hereof.
EFFECTS OF RIGHTS OFFERING ON OUR STOCK OPTION PLANS AND OTHER PLANS
As of February 1, 2004, there were outstanding options to purchase
approximately 453,000 shares of our common stock issued or committed to be
issued pursuant to stock options granted by the Company and its predecessors.
None of the outstanding options has antidilution or other provisions for
adjustment to exercise price or number of shares which will be automatically
triggered by the rights offering. Each outstanding and unexercised option will
remain unchanged and will be exercisable for the same number of shares of common
stock and at the same exercise price as before the rights offering.
EFFECTS OF RIGHTS OFFERING ON OUR PREFERRED STOCK
As of February 1, 2004, there were issued and outstanding an aggregate of
70,720 shares of our preferred stock as follows:
o 28,679 shares of our Series A Cumulative Convertible Preferred
Stock, with each share having a liquidation preference of $100 and
convertible into shares of our common stock at an initial conversion
rate of $7.00 of liquidation preference per one share of common
stock. As a result of adjustments made to date pursuant to the
anti-dilution provisions of such preferred stock, the current
conversion rate is $5.13 of liquidation preference per one share of
common stock. Assuming that the rights offering is exercised in
full, as a result of such anti-dilution provisions the conversion
rate will be further reduced to $1.49 of liquidation preference per
one share of common stock.
o 27,550 shares of our Series B Cumulative Convertible Preferred
Stock, with each share having a liquidation preference of $100 and
convertible into shares of our common stock at an initial conversion
rate of $9.00 of liquidation preference per one share of common
stock. As a result of adjustments made to date pursuant to the
anti-dilution provisions of such preferred stock, the current
conversion rate is $7.68 or $11.04 of liquidation preference per one
share of common stock, depending upon when such preferred stock was
issued. Assuming that the rights offering is exercised in full, as a
result of such anti-dilution provisions the conversion rate will be
further reduced to $3.01 or $2.11 of liquidation preference per one
share of common stock, depending on when such preferred stock was
issued.
o 14,491 shares of our Series C Cumulative Convertible Preferred
Stock, with each share having a liquidation preference of $100 and
convertible into shares of our common stock at an initial conversion
rate of $5.00 of liquidation preference per one share of common
stock. As a result of adjustments made to date pursuant to the
anti-dilution provisions of such preferred stock, the current
conversion rate is $4.69 of liquidation preference per one share of
common stock. Assuming that the rights offering is exercised in
full, as a result of such anti-dilution provisions the conversion
rate will be further reduced to $1.38 of liquidation preference per
one share of common stock.
See "Description of Capital Stock."
EFFECTS OF RIGHTS OFFERING ON DOLPHIN'S AND/OR OUR BOARD'S SECURITIES AND
OWNERSHIP.
Discussed below, for illustrative purposes only, are scenarios which
indicate the effect the rights offering and related share issuance could have on
Dolphin's and/or our entire Board's relative voting and economic interest.
Dolphin, which is controlled by Peter E. Salas, is discussed here in light of
his the status as one of our Board members and the controlling person of
Dolphin, which is our largest stockholder and a creditor to which we owe loans
in an aggregate principal amount of $3,850,000, plus accrued interest. As of the
date hereof, Dolphin owns approximately 17.8% of our outstanding common stock
and is deemed to beneficially own approximately 19.8% of our common stock. As of
the date hereof, our entire Board of Directors as a group, including Mr. Salas,
controls approximately 30.6% of our outstanding common stock and is deemed to
beneficially own approximately 34.5% of our common stock.
In the event that all shares of common stock offered in the rights offering
are fully subscribed, then Dolphin would purchase 6,419,160 shares in the
offering and would, immediately following closing, continue to own approximately
17.8% of our outstanding common stock and continue to be deemed to beneficially
own 19.8% of our common stock. In the event that Dolphin were the only rights
holder to acquire shares in the offering, then its ownership of outstanding
shares would be limited by the terms of this offering to not more than 50% of
all outstanding shares immediately following the closing. In the absence of this
limitation, Dolphin might have been able to obtain ownership of up to
approximately 79% of our outstanding shares in the event that it were the only
rights holder to exercise its rights.
In the event that all shares of common stock offered in the rights offering
are fully subscribed, then our entire board of directors collectively would
purchase 17,468,184 shares in the offering and would, immediately following
closing, continue to own approximately 30.6% of our outstanding common stock and
continue to be deemed to beneficially own approximately 34.5% of our common
stock. In the event that the entire board were the only rights holders to
acquire shares in the offering, then its aggregate ownership of outstanding
shares would be approximately 81.9%.
OTHER MATTERS
We are not making this rights offering in any state or other jurisdiction
in which it is unlawful to do so, nor are we selling or accepting any offers to
purchase any shares of our common stock from rights holders who are residents of
those states or other jurisdictions. We may delay the commencement of the rights
offering in those states or other jurisdictions, or change the terms of the
rights offering, in order to comply with the securities law requirements of
those states or other jurisdictions. We may decline to make modifications to the
terms of the rights offering requested by those states or other jurisdictions,
in which case, if you are a resident in those states or jurisdictions, you will
not be eligible to participate in the rights offering.
DESCRIPTION OF CAPITAL STOCK
As of February 1, 2004, our authorized capital stock consisted of
50,000,000 shares of common stock, par value $0.001 per share, and 25,000,000
shares of preferred stock, par value $0.001 per share. As of that date, we had
12,049,977 shares of common stock outstanding and an aggregate of 70,720 shares
of preferred stock outstanding. The following is a summary of the material terms
of our capital stock. This summary does not purport to be complete or to contain
all the information that may be important to you, and is qualified in our
entirety by reference to our articles of incorporation, as amended, and bylaws,
as amended. We encourage you to read the provisions of these documents to the
extent they relate to your individual investment strategy.
PREFERRED STOCK
Our articles of incorporation authorize us to issue preferred stock in one
or more series having designations, rights, and preferences determined from time
to time by our Board of Directors. Accordingly, subject to applicable stock
exchange rules and the terms of existing preferred stock, our Board of Directors
is empowered, without the approval of the holders of common stock, to issue
shares of preferred stock with dividend, liquidation, conversion, voting, or
other rights that could adversely affect the voting power or other rights of the
holders of common stock. In some cases, the issuance of preferred stock could
delay a change of control of us or make it harder to remove incumbent
management. Preferred stock could also restrict dividend payments to holders of
our common stock. To date, we have issued shares of preferred stock as described
below.
SERIES A 8% CUMULATIVE CONVERTIBLE PREFERRED STOCK. We have outstanding
28,679 shares of our Series A Preferred Stock, with each share having a
liquidation preference of $100. The Series A Preferred Stock has no voting
rights prior to the conversion of such shares into shares of our common stock.
Each $100 liquidation preference of Series A Preferred Stock is convertible at
the election of the holder into shares of our common stock at an initial rate of
$7.00 of liquidation preference of the Series A Preferred Stock per one share of
our common stock. The conversion price will be adjusted downwards in the event
of the issuance of any new shares of our common stock, or options or securities
exercisable, convertible or exchangeable into new shares of our common stock, at
a price per share of common stock less than $7.00, subject to further
adjustment. As a result of adjustments already made to date to the initial
conversion rate, the current conversion rate is $5.13 of liquidation preference
of the Series A Preferred Stock per one share of our common stock. Assuming that
the rights offering is exercised in full, as a result thereof the conversion
rate of the Series A Preferred Stock will be further reduced to $1.49 of
liquidation preference per one share of our common stock.
The holders of the Series A Preferred Stock are entitled to a cumulative
dividend at a rate of 8% of the liquidation preference per share per annum,
payable quarterly on each March 31, June 30, September 30 and December 31, but
only when, as and if declared by the Board of Directors out of funds legally
available therefor. All accrued but unpaid dividends accrue interest after the
respective payment date at a rate of 8% per annum. In the event that we fail to
make any two of six consecutive quarterly dividend payments on the Series A
Preferred Stock, the holders of the Series A Preferred Stock have the right to
appoint directors that will constitute a majority of our board of directors.
That appointed majority of our board of directors would remain until all accrued
and unpaid dividends on the Series A Preferred Stock have been paid. During
2002, we failed to pay the third and fourth quarterly dividend payments on the
Series A Preferred Stock. In February 2003, the holders of the Series A
Preferred Stock designated four members of the board of directors, who were
elected to vacancies on the board and who currently serve.
We may redeem all, but not less than all, of the outstanding shares of
Series A Preferred Stock upon the payment of the per share liquidation
preference, plus accrued and unpaid dividends, subject to certain circumstances,
including that our common stock has a closing sale price greater than 150% of
the then conversion rate for the Series A Preferred Stock for sixty consecutive
trading days prior to the date of redemption. In addition, we are required to
redeem one-twentieth of the maximum number of shares of Series A Preferred Stock
outstanding commencing on October 1, 2003 and each quarterly date thereafter
that such shares are outstanding.
If we adopt a plan of liquidation or of dissolution, or commence a
voluntary case under the federal bankruptcy laws or similar laws or upon the
occurrence of specified similar events, then the holders of Series A Preferred
Stock shall have a liquidation preference over all other outstanding shares of
our preferred stock.
SERIES B 8% CUMULATIVE CONVERTIBLE PREFERRED STOCK. We have outstanding
27,550 shares of our Series B Preferred Stock, with each share having a
liquidation preference of $100. The Series B Preferred Stock has no voting
rights prior to the conversion of such shares into shares of our common stock.
Each $100 liquidation preference of Series B Preferred Stock is convertible at
the election of the holder into shares of our common stock at an initial rate of
$9.00 of liquidation preference of the Series B Preferred Stock per one share of
our common stock. In addition, such conversion may be required by us as to all,
but not less than all, of the outstanding Series B Preferred Stock in the event
that our common stock has a closing sale price greater than 150% of the then
conversion rate for the Series B Preferred Stock for twenty consecutive trading
days prior to such forced conversion. The conversion price will be adjusted
downwards in the event of the issuance of any new shares of common stock, or
options or securities exercisable, convertible or exchangeable into new shares
of our common stock, at a price per share of common stock less than $9.00,
subject to further adjustment. As a result of adjustments already made to date
to the initial conversion price, the current conversion rate is either $7.68 or
$11.04 per one share of our common stock, depending upon when the Series B
Preferred Stock was issued. Assuming that the rights offering is exercised in
full, as a result thereof the conversion rate of the Series B Preferred Stock
will be further reduced to either $3.01 or $2.11 of liquidation preference per
one share of our common stock, depending on when the Series B Preferred Stock
was issued.
The holders of the Series B Preferred Stock are entitled to a cumulative
dividend at a rate of 8% of the liquidation preference per share per annum,
payable quarterly on each March 31, June 30, September 30 and December 31, but
only when, as and if declared by the Board of Directors out of funds legally
available therefor. All accrued but unpaid dividends accrue interest after the
respective payment date at a rate of 8% per annum.
We may redeem all, but not less than all, of the outstanding shares of
Series B Preferred Stock upon the payment of the per share liquidation
preference, plus accrued and unpaid dividends, subject to certain circumstances,
including that our common stock has a closing sale price greater than 150% of
the then conversion rate for the Series B Preferred Stock for sixty consecutive
trading days prior to the date of redemption. In addition, we are required to
redeem all of the outstanding Series B Preferred Stock at a price per share
equal to the liquidation preference, plus any and all accrued and unpaid
dividends, on the fifth anniversary of the first issuance of the Series B
Preferred Stock, which anniversary will be in March 2005.
If we adopt a plan of liquidation or of dissolution, or commence a
voluntary case under the federal bankruptcy laws or similar laws or upon the
occurrence of specified similar events, then the holders of Series B Preferred
Stock shall have a liquidation preference equal to the liquidation preference of
all other outstanding shares of our preferred stock, other than the Series A
Preferred Stock, which is senior to the Series B Preferred Stock in this
respect.
SERIES C 6% CUMULATIVE CONVERTIBLE PREFERRED STOCK. We have outstanding
14,491 shares of our Series C Preferred Stock, with each share having a
liquidation preference of $100. The Series C Preferred Stock has no voting
rights prior to the conversion of such shares into shares of our common stock.
Each $100 liquidation preference of Series C Preferred Stock is convertible at
the election of the holder into shares of our common stock at an initial rate of
$5.00 of liquidation preference of the Series C Preferred Stock per one share of
our common stock. In addition, such conversion may be required by us as to all,
but not less than all, of the outstanding Series C Preferred Stock in the event
that our common stock has a closing sale price greater than 150% of the then
conversion rate for the Series C Preferred Stock for twenty consecutive trading
days prior to such forced conversion. The conversion price will be adjusted
downwards in the event of the issuance of any new shares of common stock, or
options or securities exercisable, convertible or exchangeable into new shares
of our common stock, at a price per share of common stock less than $5.00,
subject to further adjustment. As a result of adjustments already made to date
to the initial conversion price, the current conversion rate is $4.69 per one
share of our common stock. Assuming that the rights offering is exercised in
full, as a result thereof the conversion rate of the Series C Preferred Stock
will be further reduced to $1.38 of liquidation preference per one share of our
common stock.
The holders of the Series C Preferred Stock are entitled to a cumulative
dividend at a rate of 6% of the liquidation preference per share per annum,
payable quarterly on each March 31, June 30, September 30 and December 31, but
only when, as and if declared by the Board of Directors out of funds legally
available therefor. All accrued but unpaid dividends accrue interest after the
respective payment date at a rate of 6% per annum.
We may redeem all, but not less than all, of the outstanding shares of
Series C Preferred Stock upon the payment of the per share liquidation
preference, plus accrued and unpaid dividends, subject to certain circumstances,
including that our common stock has a closing sale price greater than 150% of
the then conversion rate for the Series C Preferred Stock for sixty consecutive
trading days prior to the date of redemption. In addition, we are required to
redeem all of the outstanding Series C Preferred Stock at a price per share
equal to the liquidation preference, plus any and all accrued and unpaid
dividends, on the fifth anniversary of the first issuance of the Series C
Preferred Stock, which anniversary will be in July 2006.
If we adopt a plan of liquidation or of dissolution, or commence a
voluntary case under the federal bankruptcy laws or similar laws or upon the
occurrence of specified similar events, then the holders of Series B Preferred
Stock shall have a liquidation preference equal to the liquidation preference of
all other outstanding shares of our preferred stock, other than the Series A
Preferred Stock, which is senior to the Series C Preferred Stock in this
respect.
COMMON STOCK
VOTING RIGHTS. Each share of our common stock is entitled to one vote in
the election of Directors and other matters. A majority of shares of our voting
stock constitute a quorum at any meeting of stockholders. Common stockholders
are not entitled to cumulative voting rights.
DIVIDENDS. Subject to the preferential rights of any outstanding shares of
preferred stock and the restrictive terms of our credit agreement, which
prohibit the payment of dividends, dividends may be paid to holders of common
stock as may be declared by our Board of Directors out of funds legally
available for that purpose. We do not intend to pay dividends at the present
time or in the foreseeable future.
LIQUIDATION. If we liquidate, dissolve or wind-up our business, either
voluntarily or not, common stockholders will receive pro rata all assets
remaining after we pay our creditors and the holders of our preferred stock as
described above.
UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following discussion is a summary of the material federal income tax
consequences of the rights offering to holders of common stock that hold such
stock as a capital asset for federal income tax purposes. This discussion is
based on laws, regulations, rulings and decisions in effect on the date hereof,
all of which are subject to change (possibly with retroactive effect) and to
differing interpretations. This discussion applies only to holders that are U.S.
persons, which is defined as a citizen or resident of the United States, a
domestic partnership, a domestic corporation, any estate the income of which is
subject to U.S. federal income taxation regardless of its source, and any trust
so long as a court within the United States is able to exercise primary
supervision over the administration of the trust and one or more U.S. persons
have the authority to control all substantial decisions of the trust.
This discussion does not address all aspects of federal income taxation
that may be relevant to holders in light of their particular circumstances or to
holders who may be subject to special tax treatment under the Internal Revenue
Code of 1986, as amended, including holders who are dealers in securities or
foreign currency, foreign persons (defined as all persons other than U.S.
persons), insurance companies, tax-exempt organizations, banks, financial
institutions, broker-dealers, holders who hold common stock as part of a hedge,
straddle, conversion or other risk reduction transaction, or holders that
acquired common stock pursuant to the exercise of compensatory stock options or
warrants or otherwise as compensation.
We have not sought, and will not seek, an opinion of counsel or a ruling
from the Internal Revenue Service regarding the federal income tax consequences
of the rights offering or the related share issuance. The following summary does
not address the tax consequences of the rights offering or the related share
issuance under foreign, state, or local tax laws. ACCORDINGLY, EACH HOLDER OF
COMMON STOCK SHOULD CONSULT ITS TAX ADVISOR WITH RESPECT TO THE PARTICULAR TAX
CONSEQUENCES OF THE RIGHTS OFFERING OR THE RELATED SHARE ISSUANCE TO SUCH
HOLDER.
The federal income tax consequences for a holder of common stock on a
receipt of subscription rights under the rights offering are as follows:
A holder will not recognize taxable income for federal income tax purposes
in connection with the receipt of subscription rights in the rights offering.
Except as provided in the following sentence, the tax basis of the
subscription rights received by a holder in the rights offering will be zero. If
either (i) the fair market value of the subscription rights on the date such
subscription rights are distributed is equal to at least 15% of the fair market
value on such date of the common stock with respect to which the subscription
rights are received or (ii) the holder elects, by attaching a statement to its
federal income tax return for the taxable year in which the subscription rights
are received, to allocate part of the tax basis of such common stock to the
subscription rights, then upon exercise or transfer of the subscription rights,
the holder's tax basis in the common stock will be allocated between the common
stock and the subscription rights in proportion to their respective fair market
values on the date the subscription rights are distributed. A holder's holding
period for the subscription rights received in the rights offering will include
the holder's holding period for the common stock with respect to which the
subscription rights were received. We do not expect that the value of the rights
will exceed 15% of the fair market value of the common stock with respect to
which the subscription rights are received.
A holder that allows the subscription rights received in the rights
offering to expire will not recognize any gain or loss, and the tax basis of the
common stock owned by such holder with respect to which such subscription rights
were distributed will be equal to the tax basis of such common stock immediately
before the receipt of the subscription rights in the rights offering.
A holder will not recognize any gain or loss upon the exercise of the
subscription rights received in the rights offering.
The tax basis of the common stock acquired through exercise of the
subscription rights will equal the sum of the subscription price for the common
stock and the holder's tax basis, if any, in the rights as described above.
The holding period for the common stock acquired through exercise of the
subscription rights will begin on the date the subscription rights are
exercised.
PLAN OF DISTRIBUTION
On or about March 1, 2004, we will distribute the subscription rights,
subscription certificates, and copies of this prospectus to persons that owned
shares of common stock on February 27, 2004. If you wish to exercise your
subscription rights and purchase shares of common stock, you should complete the
subscription certificate and return it with payment for the shares, to the
subscription agent, Mellon Investor Services LLC, at the address on page 63. If
you have any questions, you should contact.
We have agreed to pay the subscription agent a fee plus certain expenses,
which we estimate will total approximately $15,000. We estimate that our total
expenses in connection with the rights offering will be approximately $150,000.
TENNESSEE ANTI-TAKEOVER LAW
The Tennessee Control Share Acquisition Act strips a purchaser's shares of
voting rights any time an acquisition of shares in a Tennessee corporation
brings the purchaser's voting power to one-fifth, one-third or a majority of all
voting power. The purchaser's voting rights can be reinstated only after a
majority vote of the other stockholders. The purchaser may demand a special
meeting of stockholders to conduct such a vote. A corporation may or may not
redeem the purchaser's shares if the purchaser's shares are not granted voting
rights. The Tennessee Control Share Acquisition Act applies only to a Tennessee
corporation that has adopted a provision in its charter or bylaws expressly
declaring that the Tennessee Control Share Acquisition Act applies to it. The
Tennessee Control Share Acquisition Act currently does not apply to the Company
..
The Tennessee Investor Protection Act applies to tender offers directed at
corporations that have substantial assets in Tennessee and that are either
incorporated in or have a principal office in Tennessee. The Act requires an
offeror making a tender offer for such a corporation to file a registration
statement with the Commissioner of Commerce and Insurance. If the offeror
intends to gain control of the corporation, the registration statement must
indicate any plans the offeror has for the corporation. The Commissioner may
require additional information material to the takeover offer and may call for
hearings. The Act does not apply to an offeror if the target corporation's board
of directors recommends the offer to its stockholders. We do not believe that
the Act applies to us and that in any event this offering is exempt. The
Tennessee Investor Protection Act also requires the offeror and the corporation
to deliver to the Commissioner all solicitation materials used in connection
with the tender offer. This act also prohibits fraudulent, deceptive or
manipulative acts or practices by the offeror or the target corporation. The
Tennessee Business Combination Act requires a five-year moratorium on
transactions between certain Tennessee corporations and an "interested
stockholder" (generally, a 10% or greater stockholder) unless the transaction or
the stockholder's becoming an "interested stockholder" is approved by the
directors before the stockholder attains the status of "interested stockholder."
A corporation that would otherwise be covered by this Act may exempt itself from
the Act by adopting a charter provision specifically stating the corporation's
option to be exempt.
LIMITATION OF LIABILITY OF DIRECTORS
[All directors are indemnified by us, both by operation of Tennessee Code
Annotated Sections 48-18-501 through 509 and since 1995 by resolution of our
board of directors, against liability and expenses including attorney's fees
incurred by them as a result of serving on our board of directors. The statutory
provisions require a finding that the conduct of the director was in good faith
and in the best interest of the company and does not extend to cases where a
director is found to be liable to the company itself. Such a finding may be made
by uninvolved directors, a committee of the board or independent counsel.
Tennessee Code Annotated Section 48-15-503 provides for the indemnification
of directors and of corporate officers where the director or officer is
successful in defense of any proceeding he or she became involved in as a result
of being or having been in such position, unless the corporate charter forbids
such indemnification. Our corporate charter contains no such bar or prohibition
of indemnification of our directors or officers.
Tennessee statutes further provide that the rights to indemnification of a
director do not preclude other bases of indemnification, whether such rights
arise by charter, bylaws, shareholder resolution, agreement or board resolution,
provided there is no breach of duty of loyalty to the company, bad faith,
intentional misconduct or knowing violation of law. Accordingly, our board of
directors on August 17, 1995, unanimously resolved to indemnify directors and
executive officers on a mandatory basis to the fullest extent of the laws
referenced above for the entire period a party is subject to any possible legal
action or claim by reason of having so served.
Tennessee law permits, but does not require, insurance to be obtained to
fund indemnity obligations. We do not have any such insurance.
Holders of common stock have no preemptive, subscription, redemption, or
conversion rights.
The transfer agent and registrar for the common stock is Mellon Investor
Services LLC.
LEGAL MATTERS
Certain legal matters with respect to the validity of the issuance of the
shares of common stock offered by this Prospectus will be passed upon for us by
Cary V. Sorensen, Esq.
EXPERTS
Our consolidated financial statements as of December 31, 2002 and 2001 and
for each of the three years in the period ended December 31, 2002 included in
this Prospectus and in the Registration Statement on Form S-1 have been so
included in reliance upon the reports of BDO Seidman LLP, independent certified
public accountants to the extent and for the periods set forth in their reports
(which contain an explanatory paragraph regarding the Company's ability to
continue as a going concern), given upon the authority of said firm as experts
in accounting and auditing.
Reserve analyses and information as of December 31, 2002 and 2003, included
in this Prospectus and the Registration Statement on Form S-1 have been so
included in reliance on the reserve reports dated February 10, 2003, March 28,
2002, February 10, 2003 and February 10, 2004, respectively, prepared by Ryder
Scott Company, L.P. of Houston, Texas.
Information regarding Mercer Capital of Memphis, Tennessee, and said firm's
engagement by and service as financial advisor to the Special Committee of our
Board of Directors has been included in this Prospectus and in the Registration
Statement on Form S-1 in reliance upon the information provided to us by said
firm.
WHERE YOU CAN FIND MORE INFORMATION
We are subject to the informational requirements of the Securities Exchange
Act of 1934. Accordingly, we file reports, proxy statements and other
information with the SEC. You may read and copy any materials that we file with
the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549 upon payment of the prescribed fees. You may obtain
information on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. The SEC also maintains an Internet site that contains reports,
proxy information statements and other materials that are filed through the
SEC's Electronic Data Gathering, Analysis, and Retrieval, or EDGAR, system. You
can access this web site at http://www.sec.gov.
We have filed a registration statement on Form S-1 with the SEC with
respect to this rights offering. This prospectus is a part of the registration
statement, but does not contain all of the information included in the
registration statement. You may wish to inspect the registration statement and
the exhibit to that registration statement for further information with respect
to us and the securities offered in this prospectus. Copies of the registration
statement and the exhibit to such registration statement are on file at the
offices of the SEC and may be obtained upon payment of the prescribed fee or may
be examined without charge at the public reference facilities of the SEC
described above. Statements contained in this prospectus concerning the
provisions of documents are necessarily summaries of the material provisions of
such documents, and each statement is qualified in our entirety by reference to
the copy of the applicable document filed with the SEC.
INDEX TO FINANCIAL STATEMENTS
Independent Auditors' Report.............................. F-2
Consolidated Financial Statements
Consolidated Balance Sheets........................... F-3 and F-4
Consolidated Statements of Loss....................... F-5
Consolidated Statements of Stockholders' Equity....... F-6 and F-7
Consolidated Statements of Cash Flows................. F-8 through F-10
Notes to Consolidated Financial Statements............ F-11 through F-34
Independent Auditors' Report
Board of Directors
Tengasco, Inc. and Subsidiaries
Knoxville, Tennessee
We have audited the accompanying consolidated balance sheets of Tengasco, Inc.
and Subsidiaries as of December 31, 2002 and 2001, and the related consolidated
statements of loss, stockholders' equity and cash flows for each of the three
years in the period ended December 31, 2002. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Tengasco, Inc. and
Subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002 in conformity with accounting principles generally accepted in
the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
and has an accumulated deficit of $27,776,726. Additionally, during 2002, the
Company's primary lender has classified the remaining amount of $7,501,777 as
immediately due and payable, resulting in a significant working capital
deficiency. Such matters raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 1. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ BDO Seidman, LLP
Atlanta, Georgia
February 27, 2003
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 2001 SEPTEMBER 30, 2003
-------------------------------------------------------------------------------------------------------------
(unaudited)
Assets (Note 1)
Current
Cash and cash equivalents $ 184,130 $ 393,451 $ 332,185
Investments 34,500 150,000 34,500
Accounts receivable 730,667 661,475 795,916
Participant receivables 70,605 84,097 63,297
Inventory 262,748 159,364 262,748
Current portion of loan fees, net 323,856 - 210,380
Other - - 67,352
--------------------------------------------------------------------------------------------------------
Total current assets 1,606,506 1,448,387 1,766,378
Oil and gas properties, net (on the basis
Of full cost accounting) (Note 4) 13,864,321 13,269,930 13,096,898
Completed pipeline facilities, net (Note 5) 15,372,843 15,039,762 15,312,212
Other property and equipment, net (Note 6) 1,685,950 1,680,104 1,482,202
Restricted cash 0 120,872 0
Loan fees, net of accumulated amortization
of $13,384 and $21,590, respectively 40,158 496,577 0
Other assets 14,613 72,613 5,213
--------------------------------------------------------------------------------------------------------
$32,584,391 $ 32,128,245 $ 31,662,903
--------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2002 2001 SEPTEMBER 30, 2003
----------------------------------------------------------------------------------------------------------
(unaudited)
Liabilities and Stockholders' Equity
Current liabilities
Current maturities of long-term debt
(Note 1) $ 7,861,245 $ 6,399,831 $ 6,724,998
Accounts payable - trade 1,396,761 1,208,164 839,553
Accrued interest payable 61,141 54,138 167,227
Accrued dividends payable (Note 9) 254,389 112,458 470,543
Current maturities of long term debt to related
parties - - 2,234,000
Other accrued liabilities 31,805 - 627,016
----------------------------------------------------------------------------------------------------------
Total current liabilities 9,605,341 7,774,591 11,063,337
Long term debt to related parties (Note 7) 750,000 - -
Asset retirement obligations (Note 16) - - 666,421
Long term debt, less current maturities (Note 7) 1,256,209 3,902,757 590,055
----------------------------------------------------------------------------------------------------------
Total liabilities 11,611,550 11,677,348 12,319,813
----------------------------------------------------------------------------------------------------------
Commitments and contingencies (Notes 1 and 8)
Mandatorily redeemable preferred stock, $.001 par
value; authorized 25,000,000 shares (Note 9):
Series A 8% cumulative, convertible,
mandatorily redeemable; 28,679 and shares
outstanding; redemption value $2,867,900 2,867,900 2,867,900 2,867,900
Series B 8% cumulative, convertible,
mandatorily redeemable; 27,550 shares
outstanding; redemption value $2,755,000,
net of related commissions 2,591,150 2,591,150 2,591,150
Series C 6% cumulative, convertible,
mandatorily redeemable; 14,491 shares
outstanding; redemption value $1,449,100,
net of related commissions 1,303,168 - 1,425,207
----------------------------------------------------------------------------------------------------------
Total mandatorily redeemable preferred stock 6,762,218 5,459,050 6,884,257
----------------------------------------------------------------------------------------------------------
Stockholders' equity (Notes 10 and 11)
Common stock, $.001 par value; authorized
50,000,000 shares; 11,459,279, 10,560,605
And 12,018,477 shares issued, respectively 11,460 10,561 12,065
Additional paid-in capital 42,237,276 39,242,555 42,855,693
Accumulated deficit (27,776,726) (24,115,382) (30,147,538)
Accumulated other comprehensive loss (115,500) - (115,500)
Treasury Stock, at cost, 14,500 shares (145,887) (145,887) (145,887)
----------------------------------------------------------------------------------------------------------
Total stockholders' equity 14,210,623 14,991,847 12,458,833
----------------------------------------------------------------------------------------------------------
$ 32,584,391 $ 32,128,245 $31,662,903
----------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
CONSOLIDATED STATEMENTS OF LOSS
NINE MONTHS ENDED JUNE 30,
YEAR ENDED DECEMBER 31, 2002 2001 2000 2003 2002
------------------------------------------------------------------------------------------------------------------
(unaudited)
Revenues and other income
Oil and gas revenues $5,437,723 $6,656,758 $5,241,076 $4,907,216 $3,859,050
Pipeline transportation
revenues 259,677 296,331 - 145,472 197,333
Interest Income 3,078 43,597 45,905 766 2,782
------------------------------------------------------------------------------------------------------------------
Total revenues and other
income 5,700,478 6,996,686 5,286,981 5,053,454 4,059,165
------------------------------------------------------------------------------------------------------------------
Costs and expenses
Production costs and
taxes 3,094,731 2,951,746 2,614,414 2,571,898 2,084,597
Depreciation, depletion
and amortization
(Notes 4, 5 and 6) 2,413,597 1,849,963 371,249 1,887,333 1,731,182
General and
administrative costs 1,868,141 2,957,871 2,602,311 1,112,289 1,527,988
Interest expense 578,039 850,965 415,376 462,518 448,046
Public relations 193,229 293,448 106,195 29,131 176,098
Professional fees 707,296 355,480 719,320 485,270 539,198
------------------------------------------------------------------------------------------------------------------
Total costs and expenses 8,855,033 9,259,473 6,828,865 6,548,439 6,507,109
------------------------------------------------------------------------------------------------------------------
Net loss before cumulative
effect of a change in
accounting principle (3,154,555) (2,262,787) (1,541,884) (1,494,985) (2,447,944)
Cumulative effect of a
change in accounting
principle (Note 16) - - - (351,204) -
------------------------------------------------------------------------------------------------------------------
Net loss (3,154,555) (2,262,787) (1,541,884) (1,846,189) (2,447,944)
Dividends on preferred
Stock (506,789) (391,183) (257,557) 402,583 372,595
------------------------------------------------------------------------------------------------------------------
Net loss attributable to
common stockholders $(3,661,344) $ (2,653,970) $(1,799,441) $(2,248,772) $(2,820,539)
------------------------------------------------------------------------------------------------------------------
Earnings per share data:
Net loss before cumulative
effect of a change in
accounting principle $ (0.29) $ (0.22) $ (0.17) $ (0.13) $ (0.22)
Cumulative effect of change
in accounting principle - - - $ (0.03) -
Net loss $ (0.29) $ (0.22) $ (0.17) $ (0.16) $ (0.22)
Dividends on preferred stock $ (0.04) $ (0.04) $ (0.02) $ (0.03) $ (0.04)
Net loss attributable to
common stockholder $ (0.33) $ (0.26) $ (0.19) $ (0.19) $ (0.26)
Weighted average shares
Outstanding 11,062,436 10,235,253 9,253,622 11,919,477 10,933,588
------------------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK ADDITIONAL
----------------------- PAID-IN
SHARE AMOUNT CAPITAL
----- ------ -------
Balance, January 1, 2000 8,532,882 $ 8,533 $20,732,759
Net loss - - -
Common stock issued on conversion of debt 73,669 74 449,920
Common stock issued for exercised options 20,715 21 179,992
Common stock issued on conversion of preferred stock 8,818 9 49,991
Stock option awards for professional services - - 242,000
Common stock issued in private placements, net of related expense 654,098 654 4,245,054
Stock issued for services 5,376 5 41,993
Dividends on convertible redeemable preferred stock - - -
------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 9,295,558 9,296 25,941,709
Net loss - - -
Common stock issued with 5% stock dividend (Note 10) 498,016 498 6,374,111
Common stock issued on conversion of debt 93,069 93 523,157
Common stock issued for exercised options 274,932 275 2,340,725
Common stock issued on conversion of preferred stock 12,347 13 70,988
Common stock issued for services 10,000 10 69,990
Common stock issued in private placements, net of
related expense 374,733 374 3,899,624
Common stock issued as a charitable donation 1,950 2 22,251
Treasury stock purchased - - -
Dividends on convertible redeemable preferred stock - - -
------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 10,560,605 10,561 39,242,555
Net loss - - -
Comprehensive loss
Net loss - - -
Other comprehensive loss - - -
Comprehensive loss - - -
Common stock issued in private placements, net of
related expenses 850,000 850 2,676,150
Common stock issued on conversion of debt 20,592 20 119,980
Common stock issued in purchase of equipment 19,582 20 149,980
Common stock issued for services 8,500 9 48,611
Dividends on convertible redeemable preferred stock - - -
------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 11,459,279 $11,460 $42,237,276
Net loss (unaudited) - - -
Common stock issued in private placement net of
related expenses (unaudited) 227,275 227 249,773
Common stock issued for exercised options (unaudited) 94,000 94 46,906
Common stock issued in conversion of debt (unaudited) 60,528 61 69,538
Common stock issued for preferred dividend in arrears (unaudited) 154,824 154 170,155
Common stock issued for charity (unaudited) 3,571 4 5,710
Accretion of issue cost on preferred stock (unaudited) - -
Common stock issued for services (unaudited) 55,000 55 69,945
Common stock issued for litigation settlement (unaudited) 10,000 10 6,390
Dividends on convertible redeemable preferred stock (unaudited) - - -
Cumulative effect of a change in accounting principle (unaudited) - - -
------------------------------------------------------------------------------------------------------------
Balance, September 30, 2003 (unaudited) 12,064,477 12,065 42,855,693
------------------------------------------------------------------------------------------------------------
ACCUMULATED
OTHER TREASURY STOCK
COMPREHENSIVE ACCUMULATED COMPREHENSIVE -------------------------------
INCOME (LOSS) DEFICIT LOSS SHARES AMOUNT TOTAL
------------- ----------- ------------- -------------- ----------------
$ - $(13,287,362) - $ $ 7,453,930
-
- (1,541,884) - - (1,541,884)
- - - - 449,994
- - - - 180,013
- - - - 50,000
- - - - 242,000
- - - - 4,245,708
- - - - 41,998
- (257,557) - - (257,557)
-------------------------------------------------------------------------------------------------------
- (15,086,803) - - 10,864,202
(2,262,787) - - (2,262,787)
- (6,374,609) - - -
- - - - 523,250
- - - - 2,341,000
- - - - 71,001
- - - 70,000
- - - - 3,899,998
- - - - 22,253
- - 14,500 (145,887) (145,887)
- (391,183) - - (391,183)
-------------------------------------------------------------------------------------------------------
- (24,115,382) 14,500 (145,887) 14,991,847
- (3,154,555) - - (3,154,555)
- - (3,154,555) - - -
(115,500) - (115,500) - - (115,500)
----------------
- - (3,270,055) - - -
- - - 2,677,000
- - - 120,000
- - - 150,000
- - - 48,620
- (506,789) - - (506,789)
-------------------------------------------------------------------------------------------------------
(115,500) $(27,776,726) 14,500 $(145,887) $14,210,623
- (1,494,985) - - (1,494,985)
- - - - 250,000
- - - - 47,000
- - - - 69,599
- - - - 170,309
- - - - 5,714
- (122,040) - - (122,040)
- - - - 70,000
- - - - 6,400
- (402,583) - - (402,583)
- (351,204) - - (351,204)
-------------------------------------------------------------------------------------------------------
$(115,500) $(30,147,538) 14,500 $(145,887) $12,458,833
-------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
YEARS ENDED DECEMBER 31, 2002 2001 2000 2003 2002
-------------------------------------------------------------------------------------------------------------------
(unaudited)
Operating activities:
Net loss $(3,154,555) $(2,262,787) $(1,541,884) $(1,494,985) $(2,447,944)
Adjustments to reconcile net
loss to net cash used in
operating activities:
Cumulative effect of
change in accounting
principle - - - - -
Depreciation, depletion
and amortization 2,413,597 1,849,963 371,249 1,887,333 1,731,182
Charitable donation and
services paid in stock or
stock options - - - 122,714 48,620
Compensation and
services paid in stock
options, stock warrants
and common stock 48,620 92,253 284,000 - -
Gain on sale of equipment - (132,943) - - -
Changes in assets and
liabilities:
Accounts receivable (69,192) 3,814 (301,421) (65,249) (41,340)
Participant receivables 13,492 - - 7,308 -
Inventory (103,384) 91,981 8,408 - -
Other assets 58,000 - - - -
Accounts payable -
Trade 188,597 191,702 364,553 (557,208) (5,021)
Accrued interest
Payable 7,003 (2,519) 135,435 106,086 (9,581)
Other accrued liabilities 31,805 (52,640) (140,955) 595,211 -
Other - - - (57,952) -
-------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in)
operating activities (566,017) (221,176) (820,615) 543,258 (724,084)
-------------------------------------------------------------------------------------------------------------------
Investing activities:
Additions to other property
and equipment (214,897) (285,722) (1,276,783) - (154,526)
Net additions to oil and gas
Properties (1,982,529) (4,821,883) (1,456,996) (45,312) (1,796,600)
Additions to pipeline (841,750) (4,213,095) (6,834,196) (341,369) (739,162)
facilities
Decrease (increase) in
restricted cash 120,872 (120,872) 625,000 - 120,872
Other 28,367 32,888 6,112 - 19,432
-------------------------------------------------------------------------------------------------------------------
Net cash used in investing
activities (2,889,937) (9,408,684) (8,936,863) (386,681) (2,549,984)
-------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED
SEPTEMBER 30,
YEARS ENDED DECEMBER 31, 2002 2001 2000 2003 2002
-------------------------------------------------------------------------------------------------------------------
(unaudited)
Financing activities:
Proceeds from exercise of
Options $ - $ 2,341,000 $ 180,013 - -
Proceeds from borrowings 2,063,139 10,442,068 6,493,563 1,484,000 1,703,103
Repayments of borrowings (2,378,273) (8,833,325) (1,720,856) (1,742,522) (2,129,259)
Net proceeds from issuance of
common stock 2,677,000 3,900,000 4,245,700 250,000 2,677,000
Proceeds from private
placements of convertible
redeemable preferred stock,
net 1,303,168 1,591,150 2,000,000 - 1,303,168
Dividends on convertible
redeemable preferred stock (364,858) (357,503) (257,557) - (350,859)
Purchase of treasury stock - (145,887) - - -
Payment of loan fees (53,543) (518,167) - - -
-------------------------------------------------------------------------------------------------------------------
Net cash provided by financing
activities 3,246,633 8,419,336 10,940,863 (8,522) 3,203,156
-------------------------------------------------------------------------------------------------------------------
Net change in cash and cash
equivalents (209,321) (1,210,524) 1,183,385 148,055 (70,912)
Cash and cash equivalents,
beginning of year 393,451 1,603,975 420,590 184,130 393,451
-------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end
of period $ 184,130 $ 393,451 $ 1,603,975 $332,185 $322,539
-------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of non-
cash investing and financing
activities:
During 2001, the Company
issued a 5% stock
dividend of 498,016
shares $ - $ 6,374,609 $ - $ - $ -
During 2001 and 2000, the
Company converted
preferred stock to
common stock $ - $ 71,000 $ 50,000 $ - $ -
During 2002, 2001 and
2000, respectively,
the Company issued
common stock on
conversion of debt $ 120,000 $ 523,250 $ 450,000 $ 69,599 $ 120,000
During 2002, 2001 and
2000, respectively,
the Company issued
common stock and
stock options for
services received and
charitable contributions
made $ 48,620 $ 92,253 $ 284,000 $ 122,714 $ 48,620
During 2001, the Company
sold equipment
for equity investments $ - $ 150,000 $ - $ - $ 150,000
During 2002, the Company
purchased equipment
by issuing common stock $ 150,000 $ - $ - $ 150,000 $ -
NINE MONTHS ENDED
SEPTEMBER 30,
YEARS ENDED DECEMBER 31, 2002 2001 2000 2003 2002
-------------------------------------------------------------------------------------------------------------------
(unaudited)
During 2003, the Company
issued stock for preferred
dividends in arrears $ - $ - $ - $ 170,309 $ -
During 2003, the Company
incurred accretion of issue
cost on preferred stock $ - $ - $ - $ (122,040) $ -
During 2003, the Company
declared dividends on
preferred stock $ - $ - $ - $ (402,583) $ -
--------------------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
1. GOING CONCERN The accompanying consolidated financial statements
UNCERTAINTY have been prepared in conformity with accounting
principles generally accepted in the United States
of America, which contemplate continuation of the
Company as a going concern and assume realization
of assets and the satisfaction of liabilities in
the normal course of business. The Company
continues to be in the early stages of its oil and
gas related operating history as it endeavors to
expand its operations through the continuation of
its drilling program in the Tennessee Swan Creek
Field. Accordingly, the Company has incurred
continuous losses through these operating stages
and had an accumulated deficit of $27,776,726 and
a working capital deficit of $7,998,835, as of
December 31, 2002, and an accumulated deficit of
$30,147,538 and a working capital deficit of
$9,296,959, as of September 30, 2003. During 2002,
the Company was informed by its primary lender
that the entire amount of its outstanding credit
facility was immediately due and payable, as
provided for in the Credit Agreement (see Note 7).
These circumstances raise substantial doubt about
the Company's ability to continue as a going
concern.
The Company has disputed its obligation to make
this payment and is attempting to resolve the
dispute or to obtain alternative refinancing
arrangements to repay this current obligation.
There can be no assurance that the Company will be
successful in its plans to obtain the financing
necessary to satisfy their current obligations.
2. SUMMARY OF ORGANIZATION
SIGNIFICANT ACCOUNTING
POLICIES Tengasco, Inc. (the "Company"), a publicly held
corporation, was organized under the laws of the
State of Utah on April 18, 1916, as Gold Deposit
Mining and Milling Company. The Company
subsequently changed its name to Onasco Companies,
Inc.
Effective May 2, 1995, Industrial Resources
Corporation, a Kentucky corporation ("IRC"),
acquired voting control of the Company in exchange
for approximately 60% of the assets of IRC.
Accordingly, the assets acquired, which included
certain oil and gas leases, equipment, marketable
securities and vehicles, were recorded at IRC's
historical cost. The transaction was accomplished
through the Company's issuance of 4,000,000 shares
of its common stock and a $450,000, 8% promissory
note payable to IRC. The promissory note was
converted into 83,799 shares of Tengasco, Inc.
common stock in December 1995.
The Company changed its domicile from the State of
Utah to the State of Tennessee on May 5, 1995 and
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
its name was changed from "Onasco Companies, Inc."
to "Tengasco, Inc."
The Company's principal business consists of oil
and gas exploration, production and related
property management in the Appalachian region of
eastern Tennessee and in the state of Kansas. The
Company's corporate offices are in Knoxville,
Tennessee. The Company operates as one reportable
business segment, based on the similarity of
activities.
During 1996, the Company formed Tengasco Pipeline
Corporation ("TPC"), a wholly-owned subsidiary, to
manage the construction and operation of a 65-mile
gas pipeline as well as other pipelines planned
for the future. During 2001, TPC began
transmission of natural gas through its pipeline
to customers of Tengasco.
BASIS OF PRESENTATION
The consolidated financial statements include the
accounts of the Company, Tengasco Pipeline
Corporation and Tennessee Land and Mineral, Inc.
All significant intercompany balances and
transactions have been eliminated.
USE OF ESTIMATES
The accompanying financial statements are prepared
in conformity with accounting principles generally
accepted in the United States of America which
require management to make estimates and
assumptions that affect the reported amounts of
assets and liabilities and disclosure of
contingent assets and liabilities at the date of
the financial statements and the reported amounts
of revenues and expenses during the reporting
period. The actual results could differ from those
estimates.
REVENUE RECOGNITION
The Company recognizes revenues at the time of
exchange of goods and services.
CASH AND CASH EQUIVALENTS
The Company considers all investments with a
maturity of three months or less when purchased to
be cash equivalents.
INVESTMENT SECURITIES
Investment securities available for sale are
reported at fair value, with unrealized gains and
losses, when material, reported as a separate
component of stockholders' equity, net of the
related tax effect. Other comprehensive losses of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
$115,500 were recorded during the year ended
December 31, 2002 resulting from a decrease in the
fair value of the securities.
INVENTORY
Inventory consists primarily of crude oil in tanks
and is carried at market value.
OIL AND GAS PROPERTIES
The Company follows the full cost method of
accounting for oil and gas property acquisition,
exploration and development activities. Under this
method, all productive and nonproductive costs
incurred in connection with the acquisition of,
exploration for and development of oil and gas
reserves for each cost center are capitalized.
Capitalized costs include lease acquisitions,
geological and geophysical work, delay rentals and
the costs of drilling, completing and equipping
oil and gas wells. Gains or losses are recognized
only upon sales or dispositions of significant
amounts of oil and gas reserves representing an
entire cost center. Proceeds from all other sales
or dispositions are treated as reductions to
capitalized costs.
The capitalized costs of oil and gas properties,
plus estimated future development costs relating
to proved reserves and estimated costs of plugging
and abandonment, net of estimated salvage value,
are amortized on the unit-of-production method
based on total proved reserves. The costs of
unproved properties are excluded from amortization
until the properties are evaluated, subject to an
annual assessment of whether impairment has
occurred. These reserves were estimated by Ryder
Scott Company, Petroleum Consultants in 2000, 2001
and 2002.
The capitalized oil and gas property, less
accumulated depreciation, depletion and
amortization and related deferred income taxes, if
any, are generally limited to an amount (the
ceiling limitation) equal to the sum of: (a) the
present value of estimated future net revenues
computed by applying current prices in effect as
of the balance sheet date (with consideration of
price changes only to the extent provided by
contractual arrangements) to estimated future
production of proved oil and gas reserves, less
estimated future expenditures (based on current
costs) to be incurred in developing and producing
the reserves using a discount factor of 10% and
assuming continuation of existing economic
conditions; and (b) the cost of investments in
unevaluated properties excluded from the costs
being amortized. No ceiling writedown was recorded
in 2002, 2001 or 2000.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
PIPELINE FACILITIES
Phase I of the pipeline was completed during 1999.
Phase II of the pipeline was completed on March 8,
2001. Both phases of the pipeline were placed into
service upon completion of Phase II. The pipeline
is being depreciated over its estimated useful
life of 30 years, beginning at the time it was
placed in service.
OTHER PROPERTY AND EQUIPMENT
Other property and equipment are carried at cost.
The Company provides for depreciation of other
property and equipment using the straight-line
method over the estimated useful lives of the
assets which range from five to ten years.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED
ASSETS TO BE DISPOSED OF
Management believes that carrying amounts of all
of the Company's long-lived assets will be fully
recovered over the course of the Company's normal
future operations. Accordingly, the accompanying
financial statements reflect no charges or
allowances for impairment.
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No.
123, ("SFAS 123"), "Accounting for Stock-Based
Compensation" was implemented in January 1996. As
permitted by SFAS 123, the Company has continued
to account for stock compensation to employees by
applying the provisions of Accounting Principles
Board Opinion No. 25. If the accounting provisions
of SFAS 123 had been adopted, net loss and loss
per share would have been as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
Nine Months Ended Nine Months Ended
2002 2001 2000 September 30, 2003 September 30, 2002
---------------------------------------------------------------------------------------------------------------
(unaudited) (unaudited)
Net loss attributable
to common
shareholders
as reported $(3,661,344) $(2,653,970) $(1,799,441) $(2,248,772) $(2,820,539)
Stock based
compensation (77,821) (257,328) 2,253,011 (47,209) (202,846)
Pro forma $(3,739,165) (2,911,298) (4,052,452) $(2,295,981) $(3,023,335)
---------------------------------------------------------------------------------------------------------------
Basic and diluted loss
per share
As reported $ (0.33) $ (0.26) $ (0.19) $(0.19) $(0.26)
Pro forma (0.34) (0.28) (0.44) $(0.19) $(0.28)
---------------------------------------------------------------------------------------------------------------
ACCOUNTS RECEIVABLE
Senior management reviews accounts receivable on a
monthly basis to determine if any receivables will
potentially be uncollectible. We include any
accounts receivable balances that are determined
to be uncollectible, along with a general reserve,
in our overall allowance for doubtful accounts.
After all attempts to collect a receivable have
failed, the receivable is written off against the
allowance. Based on the information available to
us, we believe no allowance for doubtful accounts
as of December 31, 2002 is necessary. However,
actual write-offs may occur.
INCOME TAXES
The Company accounts for income taxes using the
"asset and liability method." Accordingly,
deferred tax liabilities and assets are determined
based on the temporary differences between the
financial reporting and tax bases of assets and
liabilities, using enacted tax rates in effect for
the year in which the differences are expected to
reverse. Deferred tax assets arise primarily from
net operating loss carryforwards. Management
evaluates the likelihood of realization of such
assets at year end reserving any such amounts not
likely to be recovered in future periods.
CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially subject
the Company to concentrations of credit risk,
consist principally of cash and accounts
receivable. At times, such cash in banks is in
excess of the FDIC insurance limit.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
The Company's primary business activities include
oil and gas sales to several customers in the
states of Tennessee and Kansas. The related trade
receivables subject the Company to a concentration
of credit risk within the oil and gas industry.
The Company has entered into contracts to supply
two manufacturers with natural gas from the Swan
Creek field through the Company's pipeline. These
customers are the Company's primary customers of
natural gas sales. Additionally, the Company sells
a majority of its crude oil primarily to two
customers, one each in Tennessee and Kansas.
Although management believes that customers could
be replaced in the ordinary course of business, if
the present customers were to discontinue business
with the Company, it could have a significant
adverse effect on the Company's projected results
of operations.
LOSS PER COMMON SHARE
Basic loss per share is computed by dividing loss
available to common shareholders by the weighted
average number of shares outstanding during each
year. Shares issued during the year are weighted
for the portion of the year that they were
outstanding. Diluted loss per share does not
differ from basic loss per share since the effect
of all common stock equivalents is anti-dilutive.
Basic and diluted loss per share are based upon
11,062,436 shares for the year ended December 31,
2002, 10,235,253 shares for the year ended
December 31, 2001, and 9,253,622 shares for the
year ended December 31, 2000.
Basic and diluted loss per share are based upon
11,919,477 and 10,933,588 weighted average shares
outstanding for the nine months ended September
30, 2003 and 2002, respectively. Diluted loss per
share does not consider approximately 1,473,000,
1,473,000, 943,000 and 1,001,000 potential
weighted average common shares for the nine months
ended September 30, 2003 and the years ended
December 31, 2002, 2001 and 2000, respectively,
related primarily to common stock options and
convertible preferred stock and debt. These shares
were not included in the computation of the
diluted loss per share amount because the Company
was in a net loss position and, thus, any
potential common shares were anti-dilutive. All
share and per share amounts have been adjusted to
reflect the 5% stock dividend.
FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair values of cash and cash equivalents,
investments and short-term debt approximate their
carrying values due to the short period of time to
maturity. Fair values of long-term debt are based
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
on quoted market prices or pricing models using
current market rates, which approximate carrying
values.
RECENT ACCOUNTING PRONOUNCEMENTS
A reporting issue has arisen regarding the
application of certain provisions of SAFS No. 141
and SFAS No. 142 to companies in the extracting
industries including oil and gas companies. The
issue is whether SFAS No. 142 regulates
registrants to classify the costs of mineral
rights held under lease or other contractual
arrangement associated with extracting oil and gas
as intangible assets in the balance sheet, apart
from other capitalized oil and gas property owned
and provide specific footnote disclosures.
Historically, the Company had included the costs
of such mineral rights associated with extracting
oil and gas as a component of oil and gas
properties. If it is ultimately determined that
SFAS No. 142 requires oil and gas companies to
classify cost of mineral rights held under lease
or other contractual arrangement associated with
extracting oil and gas as a separate intangible
asset line item on the balance sheet, the Company
would be required to reclassify approximately
$453,000 at September 30, 2003 and $346,000 at
December 31, 2002, respectively, out of oil and
gas properties and into a separate intangible
asset line item. The Company's cash flows and
results of operations would not be affected since
such intangible assets would continue to be
depleted and amortized for impairment in
accordance with full cost accounting rules.
Further, the Company does not believe the
classification of the cost of mineral rights
associated with extracting oil and gas as
intangible assets would have any impact on
compliance with covenants under its debt
agreements.
In June 2001, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial
Accounting Standards ("SFAS") No. 143, "Accounting
for Asset Retirement Obligations "SFAS No. 143
addresses financial accounting and reporting for
obligations associated with the retirement of
tangible long-lived assets and the associated
asset retirement cost. This statement requires
companies to record the present value of
obligations associated with the retirement of
tangible long-lived assets in the periods in which
it is incurred. The liability is capitalized as
part of the related long-lived assets carrying
amount. Over time, accretion of the liability is
recognized as an operating expense and the
capitalized cost is depreciated over the expected
useful life of the related asset. The Company's
asset retirement obligations relate primarily to
the plugging, dismantlement, removal site
reclamation and similar activities of its oil and
gas properties. Prior to adoption of this
statement, such obligations were accrued ratably
over the productive lives of the assets through
its depreciation, depletion and amortization for
oil and gas properties without recording a
separate liability for such amounts. The impact of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
applying this statement as of January 1, 2003 and
September 30, 2003 is discussed in footnote 10.
In April 2002, the Financial Accounting Standards
Board issued SFAS No. 145, "Rescission of SFAS No.
4, 44, 64, Amendment of SFAS No. 13, and Technical
Corrections" ("SFAS 145"). SFAS 4, which was
amended by SFAS 64, required all gains and losses
from the extinguishment of debt to be aggregated
and, if material, classified as an extraordinary
item, net of related income tax effect. As a
result of SFAS 145, the criteria in Accounting
Principles Board opinion 30 will now be used to
classify those gains and losses. SFAS 13 was
amended to eliminate an inconsistency between the
required accounting for sale-leaseback
transactions and the required accounting for
certain lease modifications that have economic
effects that are similar to sale-leaseback
transactions. The adoption of SFAS 145 will not
have a current impact on the Company's
consolidated financial statements.
In July 2002, FASB issued SFAS No. 146, Accounting
for Cost Associated with Exit or Disposal
Activities. The standard requires companies to
recognize cost associated with exit or disposal
activities when they are incurred rather than at
the date of commitment to an exit or disposal
plan. Examples of cost covered by the standard
include lease termination costs and certain
employee severance costs that are associated with
restructuring, discontinued operation, plant
closing, or other exit or disposal activity.
Previous accounting guidance was provided by EITF
Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to
Exit an Activity (including Certain Costs Incurred
in a Restructuring)." Statement 146 replaces Issue
94-3. Statement 146 is to be applied prospectively
to exit or disposal activities initiated after
December 31, 2002. The Company does not currently
have any plans for exit or disposal activities,
and therefore does not expect this standard to
have a material effect on the Company's
consolidated financial statements upon adoption.
In November 2002, the FASB issued FASB
Interpretation ("FIN") No. 45. "Guarantor's
Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of
Indebtedness of Others", which clarifies
disclosure and recognition/measurement
requirements related to certain guarantees. The
disclosure requirements are effective for
financial statements issued after December 15,
2002 and here cognition/measurement requirements
are effective on a prospective basis for
guarantees issued or modified after December 31,
2002. The application of the requirements of FIN
45 did not have an impact on the Company's
financial position or results of operations.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
In December 2002, the FASB issued SFAS No. 148,
Accounting for Stock-Based compensation --
Transition and Disclosure -- an amendment of FASB
Statement No. 123 ("Statement 148"). This
amendment provides two additional methods of
transition for a voluntary change to the fair
value based method of accounting for stock-based
employee compensation. Additionally, more
prominent disclosures in both annual and interim
financial statements are required for stock-based
employee compensation. The transition guidance and
annual disclosure provisions of Statement 148 are
effective for fiscal years ending after December
15, 2002. The interim disclosure provisions are
effective for financial reports containing
financial statements for interim periods beginning
after December 15, 2002. The adoption of Statement
148 did not have a material impact on the
Company's consolidated financial statements.
In January 2003, the FASB issued FASB
Interpretation No. (FIN) 46, "Consolidation of
Variable Interest Entities." This interpretation
of Accounting Research Bulletin No. 51
"Consolidated Financial Statements" consolidation
by business enterprises of variable interest
entities, which possess certain characteristics.
The Interpretation requires that if a business
enterprise has a controlling financial interest in
a variable interest entity, the assets,
liabilities, and results of the activities of the
variable interest entity must be included in the
consolidated financial statements with those of
the business enterprise. This Interpretation
applies immediately to variable interest entities
created after January 31, 2003 and to variable
interest entities in which an enterprise obtains
an interest after that date. The Company does not
have any ownership in any variable interest
entities.
In May 2003, the FASB issued Statement No. 150,
"Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity".
SFAS No. 150 requires three types of freestanding
financial instruments to be classified as
liabilities in statements of financial position.
One type is mandatory redeemable shares, which the
issuing company is obligated to buy back in
exchange for cash or other assets. A second type,
which includes put options and forward purchase
contracts, involves instruments that do or may
require the issuer to buy back some of its shares
in exchange for cash or other assets. The third
type of instrument is obligations that can be
settled with shares, the monetary value of which
is fixed, tied solely or predominately to a
variable such as a market index, or varies
inversely with the value of the issuer's shares.
The majority of the guidance in SFAS No. 150 is
effective for all financial instruments entered
into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim
period beginning after June 15, 2003. In
accordance with SFAS No. 150, the Company adopted
this standard on July 1, 2003. Adoption of SFAS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
No. 150 did not have a material impact on the
Company's consolidated financial position and
results of operations.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified
to conform with current year presentation.
3. RELATED PARTY During 2002 the Company received debt financing
TRANSACTIONS from a director totaling $750,000 to fund
operating cash flow needs and to finance continued
development of the Swan Creek field. Interest
incurred on this debt was approximately $15,000
for the year ended December 31, 2002. See Note 7.
During 2002, the Company borrowed $110,000 from a
former director. The advance was non-interest
bearing and was repaid in July 2002.
During 2001, the Company repaid all principal and
interest due to related parties, using the
proceeds from the line of credit with Bank One.
Interest incurred to related parties was
approximately $15,000, $546,000 and $135,000 for
the years ended December 31, 2002, 2001 and 2000,
respectively.
During 2001, the Company converted debt of
$200,000 payable to a director into 42,017 shares
of common stock.
During 2000, the Company paid approximately
$270,000 in consulting fees and commissions on
equity transactions to a member of the Board of
Directors.
On February 3, 2003 and February 28, 2003, Dolphin
Offshore Partners, LP which owns more than 10% of
the Company's outstanding common stock and whose
general partner, Peter E. Salas, is a Director of
the Company, loaned the Company the sum of
$250,000 on each such date (cumulatively,
$500,000) which the Company used to pay the
principal and interest due to Bank One for
February and March 2003 and for working capital
needs. On May 20, 2003 an additional loan of
$834,000 was loaned by a combination of Dolphin
($750,000) and Jeffrey R. Bailey who is a Director
and President ($84,000) of the Company. On August
6, 2003 an additional loan of $150,000 was loaned
by Dolphin. Each of these loans is evidenced by a
separate promissory note each bearing interest at
the rate of 12% per annum, with payments of
interest only payable quarterly and the principal
balance payable on January 4, 2004. Each of the
February and March 2003 promissory notes is
secured by an undivided 10% interest in the
Company's pipelines. The May 20, 2003 loans
provides Dolphin with a 30% interest and Bailey
with a 3.36% interest in the Company's pipelines.
The August note provides Dolphin with a 6%
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
interest in the Company's pipelines.
4. OIL AND GAS The following table sets forth information
PROPERTIES concerning the Company's oil and gas properties:
DECEMBER 31, 2002 2001
--------------------------------------------------------------
Oil and gas properties, at cost $17,099,753 $15,117,224
Accumulation depreciation,
depletion and amortization (3,235,432) (1,847,294)
--------------------------------------------------------------
Oil and gas properties, net $13,864,321 $13,269,930
--------------------------------------------------------------
During the years ended December 31, 2002, 2001 and
2000, the Company recorded depletion expense of
approximately $1,388,000, $1,342,000 and $197,000,
respectively.
5. PIPELINE FACILITIES In 1996, the Company began construction of a
65-mile gas pipeline (1) connecting the Swan Creek
development project to a gas purchaser and (2)
enabling the Company to develop gas distribution
business opportunities in the future. Phase I, a
30-mile portion of the pipeline, was completed in
1998. Phase II of the pipeline, the remaining 35
miles, was completed in March 2001. The estimated
useful life of the pipeline for depreciation
purposes is 30 years. The Company recorded
approximately $220,000 and $509,000, respectively
in depreciation expense related to the pipeline
for the years ended December 31, 2002 and 2001. No
depreciation expense was recorded in 2000 as the
pipeline was not yet complete.
In January 1997, the Company entered into an
agreement with the Tennessee Valley Authority
("TVA") whereby the TVA allows the Company to bury
the pipeline within the TVA's transmission line
rights-of-way. In return for this right, the
Company paid $35,000 and agreed to annual payments
of approximately $6,200 for 20 years. This
agreement expires in 2017 at which time the
parties may renew the agreement for another 20
year term in consideration of similar
inflation-adjusted payment terms.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
6. OTHER PROPERTY Other property and equipment consisted of the
AND EQUIPMENT following:
DECEMBER 31, 2002 2001
----------------------------------------------------------------
Machinery and equipment $1,887,190 $1,737,189
Vehicles 675,411 610,510
Other 63,734 63,739
----------------------------------------------------------------
2,626,335 2,411,438
Less accumulated depreciation (940,385) (731,334)
----------------------------------------------------------------
Other property and equipment - net $1,685,950 $1,680,104
----------------------------------------------------------------
7. LONG TERM DEBT Long-term debt to unrelated entities consisted of
the following:
September
DECEMBER 31, 2002 2001 30, 2003
----------------------------------------------------------------
(unaudited)
Revolving line of credit
with a bank, due November
2004. The loan agreement
provides for increases or
decreases to the borrowing
base as changes in proved
oil and gas reserves or
other production levels
arise. Borrowings bear
interest at the bank's
prime rate plus 0.25%
(4.5% at December 31,
2002). Collateralized by
the oil and gas properties
and the related operations
and revenues. $7,501,777 $9,101,777 $5,701,777
Unsecured note payable to
an institution, with
$65,000 principal payments
due quarterly beginning
January 1, 2000; remaining
balance due October 2004;
with interest payable
monthly at 8% per annum.
Note is convertible into
common stock of the
Company at a rate of $6.25
per share of common stock. 480,000 720,000 300,000
Convertible notes payable
to five individuals; due
January 2004, with
interest payable quarterly
at 8% per annum. Notes are
convertible into common
stock of the Company at a
rate of $3.00 per share of
common stock. 650,000 - 650,000
Unsecured note payable to
an institution due May 1,
2004, with interest
payable annually at 4.75%
per annum. - - 297,171
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
Note payable to a
financial institution,
with $1,773 principal
payments due monthly
beginning January 7, 2002
through December 7, 2006.
Interest is payable
monthly commencing on
January 7, 2002 at 7.5%
per annum. Note is
guaranteed by a major
shareholder and is
collateralized by certain
assets of the Company. 73,335 87,500 61,202
Installment notes bearing
interest at the rate of
3.9% to 11.95% per annum
collateralized by vehicles
and equipment with monthly
payments including
interest of approximately
$10,000 due various
periods through 2006. 412,342 393,311 304,904
----------------------------------------------------------------
Total long term debt 9,117,454 10,302,588 7,315,054
Less current maturities (7,861,245) (6,399,831) (6,724,999)
----------------------------------------------------------------
Long term debt, less
current maturities $ 1,256,209 $3,902,757 590,055
----------------------------------------------------------------
The Company is subject to certain financial
(ratio) covenants and restrictions on
indebtedness, dividend payments, financial
guarantees, business combinations, reporting
requirements and other related items on the
revolving line of credit with a bank. As of
December 31, 2002, the Company is not in
compliance with all covenants. During 2002, as a
result of ongoing negotiations to refinance or
repay the debt, the bank declared all amounts
immediately due and payable. The Company is
presently paying $200,000 per month. As a result
of ongoing negotiations with Bank One, management
has reclassified the loan fees associated with
this note to a current asset as it is likely that
these fees will be fully amortized in 2003.
Long-term debt to related parties consisted of the
following:
September
DECEMBER 31, 2002 2001 30, 2003
----------------------------------------------------------------
(unaudited)
Unsecured note payable to
a director due January
2004, with interest
payable quarterly at 8%
per annum. Note is
convertible into common
stock of the Company at a
rate of $2.88 per share of
common stock. $500,000 $ - $ 500,000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
Notes payable to a
director due January 2004,
with interest payable
quarterly at 12% per
annum. Note is secured by
10% of the pipeline. 250,000 - 1,734,000
----------------------------------------------------------------
Total long term debt to
related Parties 750,000 - 2,234,000
Less current maturities - - (2,234,000)
----------------------------------------------------------------
Long term debt to related
parties, less current
maturities $750,000 $ - $ -
----------------------------------------------------------------
The aggregate maturities of long term debt due to
related parties and others as of December 31,
2002, are as follow:
Year Amount
-------------------------------------------------
2003 $7,861,245
2004 1,720,463
2005 101,468
2006 101,803
Thereafter 82,470
-------------------------------------------------
$9,867,454
-------------------------------------------------
8. COMMITMENTS AND The Company is a party to lawsuits in the ordinary
CONTINGENCIES course of its business. While the damages sought
in some of these actions are material, the Company
does not believe that it is probable that the
outcome of any individual action will have a
material adverse effect, or that it is likely that
adverse outcomes of individually insignificant
actions will be significant enough, in number or
magnitude, to have a material adverse effect in
the aggregate on its financial statements.
In the ordinary course of business the Company has
entered into various equipment and office leases
which have remaining terms ranging from one to
four years. Approximate future minimum lease
payments to be made under noncancellable operating
leases are as follows:
Year Amount
-------------------------------------------------
2003 $ 60,158
2004 59,210
2005 56,970
2006 500
-------------------------------------------------
$176,838
-------------------------------------------------
Office rent expense was approximately $84,000,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
$91,000 and $86,000 for each of the three years
ended December 31, 2002, 2001 and 2000,
respectively.
9. CUMULATIVE CONVERTIBLE Shares of both Series A and B Preferred Stock are
REDEEMABLE PREFERRED or will be immediately convertible into shares of
STOCK Common Stock. Each $100 liquidation preference
share of preferred stock is convertible at a rate
of $7.00 for the Series A per share of common
stock. For the Series B, the conversion rate is
the average market price of the Company's common
stock for 30 days before the sale of the Series B
preferred stock with a minimum conversion price of
$9.00 per share. The conversion rate is subject to
downward adjustment if the Company subsequently
issues shares of common stock for consideration
less than $7.00 and $9.00 for the Series A and
Preferred Stock, respectively, per share. The
conversion prices will be adjusted prospectively
for stock dividends and splits.
The holders of both the Series A and Series B
Preferred Stock are entitled to a cumulative
dividend of 8% per quarter. However, the payment
of the dividends on the Series B Preferred Stock
is subordinate to that of the Series A Preferred
Stock. In the event that the Company does not make
any two of six consecutive quarterly dividend
payments, the holders of the Series A Preferred
Stock may appoint those directors which would
constitute of majority of the Board of Directors.
In such a scenario, the holders of the Preferred
Shares would be entitled to elect a majority of
the Board of Directors until all accrued and
unpaid dividends have been paid.
The Company failed to pay the 3rd and 4th
quarterly dividend payments of the Series A
preferred stock during 2002. As a result, in
February 2003, the Series A shareholders exercised
their rights to place four new members on the
Board of Directors. As of September 30, 2003,
cumulative accrued and unpaid dividends on the
Series A and B Preferred Stock amounted to
$405,334.
The Company may redeem both of the Series A and B
Preferred Stock upon payment of $100 per share
plus any accrued and unpaid dividends. Further,
with respect to the Series A Preferred Stock,
commencing on October 1, 2003 and at each
quarterly date thereafter while the Series A
Preferred Stock is outstanding, the Company is
required to redeem one-twentieth of the maximum
number of Series A Preferred Stock outstanding.
With respect to the Series B Preferred Stock, on
the fifth anniversary after issuance (March 2005),
the Company is required to redeem all outstanding
Series B Preferred Stock.
During 2002, the Board of Directors authorized the
sale of up to 50,000 shares of Series C Preferred
Stock at $100 per share. The Company issued 14,491
shares, resulting in net proceeds after
commissions of $1,303,168. The Series C Preferred
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
Stock accrues a 6% cumulative dividend on the
outstanding balance, payable quarterly. As of
September 30, 2003, cumulative accrued and unpaid
dividends on the Series C Preferred Stock amounted
to $65,209. These dividends are subordinate to the
dividends payable to the Series A and Series B
Preferred Stock holders. This stock is convertible
into the Company's common stock at the average
stock trading price 30 days prior to the closing
of the sales of all the Series C Preferred Stock
being offered or $5.00 per share, whichever is
greater. The Company is required to redeem any
remaining Series C Preferred Stock and any accrued
and unpaid dividends in July 2006.
10. STOCK DIVIDEND On August 1, 2001, the Company paid a 5% stock
dividend distributable on October 1, 2001 to
shareholders of record of the Company's common
stock on September 4, 2001. Based on the number of
common shares outstanding on the record date, the
Company issued 498,016 new shares. All references
in the accompanying financial statements to the
number of common shares and per share amounts are
based on the increased number of shares giving
retroactive effect to the stock dividend.
11. STOCK OPTIONS In October 2000, the Company approved a Stock
Incentive Plan. The Plan is effective for a
ten-year period commencing on October 25, 2000 and
ending on October 24, 2010. The aggregate number
of shares of Common Stock as to which options and
Stock Appreciation Rights may be granted to
Employees under the plan shall not exceed
1,000,000. Options are not transferable, fully
vest after two years of employment with the
Company, are exercisable for three months after
voluntary resignation from the Company, and
terminate immediately upon involuntary termination
from the Company. The purchase price of shares
subject to this Nonqualified Stock Option Plan
shall be determined at the time the options are
granted, but are not permitted to be less than 85%
of the Fair Market Value of such shares on the
date of grant. Furthermore, an employee in the
plan may not, immediately prior to the grant of an
Incentive Stock Option hereunder, own stock in the
Company representing more than ten percent of the
total voting power of all classes of stock of the
Company unless the per share option price
specified by the Board for the Incentive Stock
Options granted such and Employee is at least 110%
of the Fair Market Value of the Company's stock on
the date of grant and such option, by its terms,
is not exercisable after the expiration of five
years from the date such stock option is granted.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
Stock option activity in 2002, 2001 and 2000 is
summarized below:
2002 2001 2000
-------------------------- -------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
-----------------------------------------------------------------------------------------------------------
Outstanding,
beginning
of year 516,028 $9.23 1,017,450 $ 8.54 530,250 $6.91
Granted 160,742 2.86 78,750 12.39 855,451 8.69
Exercised - - (256,772) 8.69 (21,751) 8.69
Expired/canceled - - (323,400) 7.85 (346,500) 6.91
------------- ------------- -------------
Outstanding,
end of year 676,770 7.71 516,028 9.23 1,017,450 8.54
-----------------------------------------------------------------------------------------------------------
Exercisable,
end of year 676,770 $7.71 474,889 $ 9.21 930,258 $8.49
-----------------------------------------------------------------------------------------------------------
The share information disclosed above has been
adjusted to reflect the 5% stock dividend declared
during 2001. See note 10 above.
The following table summarizes information about
stock options outstanding at December 31, 2002:
------------------------------------------------ --------------
OPTIONS OPTIONS
OUTSTANDING EXERCISABLE
------------------------------------------------ --------------
WEIGHTED
AVERAGE
WEIGHTED REMAINING
AVERAGE CONTRACTUAL
EXERCISE PRICE SHARES LIFE (YEARS) SHARES
------------------------------------------------ --------------
$ 2.86 160,742 2.67 160,742
$ 8.69 437,278 0.85 437,278
$ 14.44 21,000 1.13 21,000
$ 11.05 47,250 1.30 47,250
$ 12.70 10,500 1.71 10,500
----------------
Total $ 7.71 676,770 676,770
------------------------------------------------------------------------
The weighted average fair value per share of
options granted during 2002, 2001 and 2000 is
$1.45, $3.62, and $3.41 respectively, calculated
using the Black-Scholes Option-Pricing model.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
No compensation expense related to stock options
were incurred in 2002, 2001 or 2000. The Company
issued 70,715 options to non-employees and
non-directors in 2000. The expense of $242,000 for
these options has been included in professional
fees expense because the options were issued to
providers of such services. The expense was
calculated using a fair market value of the
options based on the Black-Scholes option-pricing
model assumptions discussed below.
For employees, the fair value of stock options
used to compute pro forma net loss and loss per
share disclosures is the estimated present value
at grant date using the Black-Scholes
option-pricing model with the following weighted
average assumptions for 2002, 2001 and 2000;
Expected volatility of 74.2% for 2002, 50% for
2001 and 50% for 2000; a risk free interest rate
of 3.67% in 2002, 3.67% in 2001 and 5.86% in 2000;
and an expected option life of 3 years for 2002,
2001 and 2000.
12. INCOME TAXES The Company had no taxable income during the three
year period ended December 31, 2002.
A reconciliation of the statutory U.S. Federal
income tax and the income tax provision included
in the accompanying consolidated statements of
loss is as follows:
DECEMBER 31, 2002 2001 2000
--------------------------------------------------------------------------------
Statutory rate 34% 34% 34%
Tax benefit at statutory rate $(1,073,000) $ (769,000) $ (452,500)
State income tax benefit (189,000) (136,000) (75,500)
Other - - 24,000
Increase in deferred tax asset
Valuation allowance 1,262,000 905,000 504,000
--------------------------------------------------------------------------------
Total income tax provision $ - $ - $ -
--------------------------------------------------------------------------------
DECEMBER 31, 2002 2001 2000
--------------------------------------------------------------------------------
Net operating loss carryforward $ 7,139,000 $ 5,877,000 $ 4,972,000
Capital loss carryforward 263,000 263,000 263,000
--------------------------------------------------------------------------------
7,402,000 6,140,000 5,235,000
Valuation allowance (7,402,000) (6,140,000) (5,235,000)
--------------------------------------------------------------------------------
Net deferred taxes $ - $ - $ -
--------------------------------------------------------------------------------
The Company recorded a valuation allowance at
December 31, 2002, 2001 and 2000 equal to the
excess of deferred tax assets over deferred tax
liabilities as management is unable to determine
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
that these tax benefits are more likely than not
to be realized. Potential future reversal of the
portion of the valuation allowance relative to
deferred tax asset resulting from the exercise of
stock options will be recorded as additional paid
in capital realized As of December 31, 2002, the
Company had net operating loss carryforwards of
approximately $18,217,000, which will expire
between 2010 and 2022, if not utilized.
13. SUPPLEMENTAL CASH The Company paid approximately $571,000, $853,500
FLOW INFORMATION and $544,000 for interest in 2002, 2001 and 2000,
respectively. The Company capitalized
approximately $148,000 and $128,000 of this amount
in 2001 and 2000, respectively. No interest was
capitalized during 2002. The Company paid no
income taxes in 2002, 2001 and 2000.
14. QUARTERLY DATA AND The following table sets forth, for the fiscal
SHARE INFORMATION periods indicated, selected consolidated financial
(UNAUDITED) data.
FISCAL YEAR ENDING DECEMBER 31, 2003
----------------------------------------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------------------------------------------------------------------------------------------------------
Revenues $1,971,603 $1,482,390 $ 1,599,461 -
Net Income (loss) (659,350) (678,592) (508,247) -
Net Income (loss) attributable to
common Stockholders (793,545) (812,786) (642,441) -
Earnings (loss) per common share
Basic and diluted $ (0.07) $ (0.07) $ (0.05) -
----------------------------------------------------------------------------------------------------------
FISCAL YEAR ENDED DECEMBER 31, 2002
----------------------------------------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------------------------------------------------------------------------------------------------------
Revenues $ 1,176,482 $ 1,297,668 $1,507,308 $1,719,020
Net loss (818,341) (858,197) (721,879) (756,138)
Net loss attributable to common
Stockholders (930,799) (984,139) (856,074) (890,332)
----------------------------------------------------------------------------------------------------------
Loss per common share
Basic and diluted $ (0.09) $ (0.09) $ (0.08) $ (0.07)
----------------------------------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
FISCAL YEAR ENDED DECEMBER 31, 2001
----------------------------------------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------------------------------------------------------------------------------------------------------
Revenues $1,448,318 $1,863,068 $2,583,758 $1,101,542
Net loss (368,768) (336,034) (378,597) (1,179,388)
Net loss attributable to common
Stockholders (447,546) (423,523) (491,055) (1,291,846)
----------------------------------------------------------------------------------------------------------
Loss per common share
Basic and diluted $ (0.05) $ (0.04) $ (0.05) $ (0.12)
----------------------------------------------------------------------------------------------------------
Third quarter 2001 results reflect the effect on
depletion expense that resulted from a decrease in
reserve estimates provided in a study performed by
Ryder Scott Company, L.P. and issued August 10,
2001. The amount recorded during this quarter was
$562,000 higher than the quarterly estimates made
by management during the first three quarters as a
result of a change in estimate arising from new
information provided in the Ryder Scott Company,
L.P. Report. Amounts disclosed above differ from
those filed with the SEC during the third quarter
of 2001 as a result of an error in recording this
change in estimate to depletion at the time of the
filing. Management amended the September 30, 2001
SEC Form 10-Q filing during 2002.
15. SUPPLEMENTAL OIL AND Information with respect to the Company's oil and
GAS INFORMATION gas producing activities is presented in the
following tables. Estimates of reserve quantities,
as well as future production and discounted cash
flows before income taxes, were determined by
Ryder Scott Company, L.P. as of December 31, 2002,
2001 and 2000.
OIL AND GAS RELATED COSTS
The following table sets forth information
concerning costs related to the Company's oil and
gas property acquisition, exploration and
development activities in the United States during
the years ended December 31, 2002, 2001 and 2000:
2002 2001 2000
----------------------------------------------------------------------
Property acquisition
Proved $ - $ - $ -
Unproved - - 5,702
Less - proceeds from
sales of properties (100,000) (750,000) (1,176,411)
Development costs 2,082,529 5,571,883 2,627,705
----------------------------------------------------------------------
$ 1,982,529 $ 4,821,883 $ 1,456,996
----------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
RESULTS OF OPERATIONS FROM OIL AND GAS PRODUCING
ACTIVITIES
The following table sets forth the Company's
results of operations from oil and gas producing
activities for the years ended:
December 31, 2002 2001 2000
----------------------------------------------------------------------
Revenues $ 5,437,723 $ 6,656,758 $ 5,241,076
Production costs and taxes (3,094,731) (2,951,746) (2,614,414)
Depreciation, depletion
and amortization (1,388,138) (1,342,000) (197,000)
----------------------------------------------------------------------
Income from oil and gas
producing activities $ 954,854 $ 2,363,012 $ 2,429,662
----------------------------------------------------------------------
In the presentation above, no deduction has been
made for indirect costs such as corporate overhead
or interest expense. No income taxes are reflected
above due to the Company's tax loss carryforwards.
OIL AND GAS RESERVES (UNAUDITED)
The following table sets forth the Company's net
proved oil and gas reserves at December 31, 2002,
2001 and 2000 and the changes in net proved oil
and gas reserves for the years then ended. Proved
reserves represent the estimated quantities of
crude oil and natural gas which geological and
engineering data demonstrate with reasonable
certainty to be recoverable in the future years
from known reservoirs under existing economic and
operating conditions. The reserve information
indicated below requires substantial judgment on
the part of the reserve engineers, resulting in
estimates which are not subject to precise
determination. Accordingly, it is expected that
the estimates of reserves will change as future
production and development information becomes
available and that revisions in these estimates
could be significant. Reserves are measured in
barrels (bbls) in the case of oil, and units of
one thousand cubic feet (Mcf) in the case of gas.
OIL (BBLS) GAS (MCF)
----------------------------------------------------------------------
Proved reserves:
Balance, January 1, 2000 3,227,203 74,795,287
Discoveries and extensions 56,103 1,059,147
Revisions of previous estimates (1,309,366) (27,998,986)
Production (159,035) (315,577)
----------------------------------------------------------------------
Balance, December 31, 2000 1,814,905 47,539,871
Discoveries and extensions 62,254 4,915,431
Revisions of previous estimates (672,443) (25,263,634)
Production (148,041) (1,311,466)
----------------------------------------------------------------------
Balance, December 31, 2001 1,056,675 25,880,202
Discoveries and extensions 34,968 937,000
Revisions of previous estimates 542,229 786,430
Production (157,973) (1,004,899)
----------------------------------------------------------------------
Proved reserves at, December 31, 2002 1,475,899 26,598,733
----------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
Proved developed producing
reserves at, December 31, 2002 1,108,293 6,592,711
----------------------------------------------------------------------
Proved developed producing
reserves at, December 31, 2001 767,126 7,157,183
----------------------------------------------------------------------
Proved developed producing
reserves at, December 31, 2000 1,553,759 2,888,769
----------------------------------------------------------------------
Of the Company's total proved reserves as of
December 31, 2002 and 2001 and 2000, approximately
37%, 36% and 21%, respectively, were classified as
proved developed producing, 19%, 26% and 34%,
respectively, were classified as proved developed
non-producing and 44%, 37% and 45%, respectively,
were classified as proved undeveloped. All of the
Company's reserves are located in the continental
United States.
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH
FLOWS (UNAUDITED)
The standardized measure of discounted future net
cash flows from the Company's proved oil and gas
reserves is presented in the following table:
AMOUNTS IN THOUSANDS
-----------------------------------------
December 31, 2002 2001 2000
----------------------------------------------------------------------
Future cash inflows $152,180 $ 78,296 $ 505,733
Future production
costs and taxes (41,870) (26,083) (41,689)
Future development costs (11,348) (6,384) (8,225)
Future income tax expenses - - (122,881)
----------------------------------------------------------------------
Net future cash flows 98,962 45,829 332,938
Discount at 10% for
timing of cash flows (52,314) (24,095) (97,195)
----------------------------------------------------------------------
Discounted future net
cash flows from
proved reserves $ 46,648 $ 21,734 $ 235,743
----------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
The following unaudited table sets forth the
changes in the standardized measure of discounted
future net cash flows from proved reserves during
2002, 2001 and 2000:
AMOUNTS IN THOUSANDS
--------------------------------------
2002 2001 2000
----------------------------------------------------------------------
Balance, beginning of year $ 21,734 $ 235,743 $ 100,882
Sales, net of production costs
and taxes (2,343) (3,705) (2,627)
Discoveries and extensions 1,686 4,167 1,778
Changes in prices and
production costs 20,586 (299,527) 360,082
Revisions of quantity 6,120 (33,449) (186,289)
estimates
Development costs incurred - 1,236
Interest factor - accretion
of discount 2,173 32,198 13,355
Net change in income taxes - 86,237 (53,572)
Changes in future
development costs (4,860) 2,666 (3,237)
Changes in production rates
and other 1,552 (2,596) 4,135
----------------------------------------------------------------------
Balance, end of year $ 46,648 $ 21,734 $ 235,743
----------------------------------------------------------------------
Estimated future net cash flows represent an
estimate of future net revenues from the
production of proved reserves using current sales
prices, along with estimates of the operating
costs, production taxes and future development and
abandonment costs (less salvage value) necessary
to produce such reserves. The average prices used
at December 31, 2002, 2001 and 2000 were $27.25,
$17.03 and $25.62 per barrel of oil and $4.01,
$2.33 and $9.66 per MCF of gas, respectively. No
deduction has been made for depreciation,
depletion or any indirect costs such as general
corporate overhead or interest expense.
Operating costs and production taxes are estimated
based on current costs with respect to producing
gas properties. Future development costs are based
on the best estimate of such costs assuming
current economic and operating conditions. The
estimates of reserve values include estimated
future development costs that the company does not
currently have the ability to fund. If the company
is unable to obtain additional funds, it may not
be able to develop its oil and natural gas
properties as estimated in its December 31, 2002
reserve report.
Income tax expense is computed based on applying
the appropriate statutory tax rate to the excess
of future cash inflows less future production and
development costs over the current tax basis of
the properties involved, less applicable
carryforwards, for both regular and alternative
minimum tax.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(Amounts presented relating to September 30, 2003 and the
nine months ended September 30, 2003 and 2002 are unaudited)
The future net revenue information assumes no
escalation of costs or prices, except for gas
sales made under terms of contracts which include
fixed and determinable escalation. Future costs
and prices could significantly vary from current
amounts and, accordingly, revisions in the future
could be significant.
16. CUMULATIVE EFFECT OF A Effective January 1, 2003, the Company implemented
CHANGE IN ACCOUNTING the requirements of Statement of Financial
PRINCIPLE Accounting Standards No. 143 (SFAS 143),
"Accounting for Asset Retirement Obligations".
Among other things, SFAS 143 requires entities to
record a liability and corresponding increase in
long-lived assets for the present value of
material obligations associated with the
retirement of tangible long-lived assets. Over the
passage of time, accretion of the liability is
recognized as an operating expense and the
capitalized cost is depleted over the estimated
useful life of the related asset. Additionally,
SFAS 143 requires that upon initial application of
these standards, the Company must recognize a
cumulative effect of a change in accounting
principle corresponding to the accumulated
accretion and depletion expense that would have
been recognized had this standard been applied at
the time the long-lived assets were acquired or
constructed. The Company's asset retirement
obligations relate primarily to the plugging,
dismantling and removal of wells drilled to date.
Using a credit-adjusted risk free rate of 12%, an
estimated useful life of wells ranging from 30-40
years, and estimated plugging and abandonment
costs ranging from $5,000 per well to $10,000 per
well, the Company has recorded a non-cash charge
related to the cumulative effect of a change in
accounting principle of $351,204 in its statement
of loss. Oil and gas properties were increased by
$260,191, which represents the present value of
all future obligations to retire the wells at
January 1, 2003, net of accumulated depletion on
this cost through that date. A corresponding
obligation totaling $611,395 has also been
recorded as of January 1, 2003.
For the nine month period ended September 30,
2003, the Company recorded accretion and depletion
expenses of $77,952 associated with this liability
and its corresponding asset. These expenses are
included in depletion, depreciation, and
amortization in the consolidated statements of
loss. Had the provisions of this statement been
reflected in the financial statements for the year
ended December 31, 2002, an asset retirement
obligation of $476,536 would have been recorded as
of January 1, 2002.
The following is a roll-forward of activity
impacting the asset retirement obligation for the
nine months ended September 30, 2003:
Balance, January 1, 2003: $611,395
Accretion expense through
September 30, 2003 55,026
--------
Balance, September 30, 2003 $666,421
========