UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
___________________
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year ended: December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 0-17204
______________________
INFINITY, INC.
(Exact Name of Small Business Issuer as Specified in its Charter)
Colorado 84-1070066
(State or of Incorporation) (I.R.S. Employer Identification Number)
211 West 14th Street, Chanute, Kansas 66720
(Address of Principal Executive Offices, Including Zip Code)
(620) 431-6200
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K, is not contained herein and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer(as
defined in Rule 12B-2 of the Act). Yes [ ] No [X]
As of April 12, 2004, 9,396,091 of the Registrant's $0.0001 Par Value
Common Stock were outstanding. The aggregate market value of voting and
non-voting common equity held by non-affiliates as of June 30, 2003 was
approximately $49,456,971 based upon a closing price of $6.05 per share as
reported on the NASDAQ National Market.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Definitive Proxy Statement to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A in connection
with the 2004 Annual Meeting of Shareholders are incorporated by reference in
Part III of this Report on Form 10-K.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
BUSINESS DEVELOPMENT
Infinity, Inc. ("Infinity") was organized as a Colorado corporation on
April 2, 1987. Infinity is an independent energy company primarily engaged in
the operation, development, production, exploration and acquisition of North
American unconventional natural gas properties and providing oil field services
in eastern Kansas, northeastern Oklahoma and the Powder River Basin of Wyoming.
As used herein, "Infinity", "we" and "our" refer collectively to Infinity,
Inc., its predecessors, subsidiaries and affiliates as to one or more of them as
the context may require.
The following table sets forth the operating subsidiaries of Infinity by
type of business activity. Each of these subsidiaries is 100% owned. Additional
information about the activities of each subsidiary follows:
OIL AND GAS OIL FIELD CORPORATE
EXPLORATION AND PRODUCTION SERVICE SERVICES
- -------------------------- ------------------- -------------
Infinity Oil and Gas Consolidated Oil CIS-Oklahoma,
of Wyoming, Inc. Well Services, Inc. Inc.
Infinity Oil and Gas
of Kansas, Inc.
Consolidated Oil Well Services, Inc. ("Consolidated") acquired assets
necessary to provide oil field services in Eastern Kansas and Northeastern
Oklahoma in January 1994. Consolidated expanded its operations into
northeastern Wyoming with the acquisition of Powder River Cementers, LLC during
September 1999. In November 2001 Consolidated expanded its operations into
South Central Wyoming by leasing operating facilities near, and transferring
service equipment to Rock Springs, Wyoming. Due to the decrease in the number
of wells being drilled by an affiliated company, Consolidated closed its Rock
Springs, Wyoming facility, terminated its lease on the operating facilities and
transferred its service equipment to its other locations in December 2003. This
entity provides fracturing, cementing, and acidizing services as well as
trucking of fluids to its oil field customers.
Infinity Oil and Gas of Kansas, Inc. ("Infinity-Kansas") owns a 31.25%
interest through a capital contribution in the Little Bear Creek prospect in
southwest Kansas. This prospect is an undeveloped, 5,120 acre river sand
prospect operated by an unrelated third party, IGWT, Inc. Infinity-Kansas has
invested approximately $56,000 in leasehold and approximately $187,000 in 3-D
seismic and the drilling of three wells on the prospect during the years ended
December 31, 2003 and 2002. None of the wells drilled to date have been economic
and the operator is evaluating the results of drilling programs on adjacent
acreage before taking any further action. The results of the drilling programs
on the adjacent acreage should be available in the second quarter of 2004.
Depending on the results of those programs there is a potential that that the
operator will abandon the prospect and Infinity-Kansas will reclassify the
$56,000 in leasehold investment to the full cost pool subject to depletion.
Infinity-Kansas does not have investment in any other oil and gas prospects.
Infinity Oil & Gas of Wyoming, Inc. ("Infinity-Wyoming") is an independent
energy company engaged in the acquisition, exploration, development,
exploitation and production of crude oil and natural gas in the continental
United States.
Infinity-Wyoming was incorporated in January 2000 for the purpose of
acquiring properties with the intent of exploring for coal bed methane.
Historically, we have developed our proven oil and gas reserves and increased
production primarily through acquiring oil and gas leaseholds and drilling wells
to exploit and develop tight sand and coalbed methane properties. We believe the
probability that such properties have hydrocarbons in place is relatively high
and the viability of establishing commercially producible reserves is largely
dependent on several factors, including: the market price for oil and gas; the
costs of development, production and marketing; and determination of the amount
of recoverable reserves and the rate at which such reserves can be extracted. To
a lesser extent, we have added proved reserves through acquisition of properties
with proved developed reserves.
At December 31, 2003, Infinity-Wyoming had 8.7 billion cubic feet
equivalent ("Bcfe") of proved reserves having a pretax present value based upon
a discount rate of 10% of approximately $23.0 million based upon unescalated
prices and costs. This valuation reflected average wellhead prices of $6.06 per
Mcf for natural gas and $31.34 per barrel for crude oil at year-end.
Approximately 95% of our proved oil and gas reserves were associated with
tight sand properties on the Wamsutter Arch in the Greater Green River Basin in
Wyoming. The balance of our proved reserves at the end of 2003 related to one
property in the Sand Wash Basin in Colorado.
At December 31, 2003, Infinity-Wyoming operated 13 of the 15 properties
that were assigned proved developed oil and gas reserves. Effective March 1,
2004, Infinity-Wyoming assumed operations of the two previously non-operated
properties which contained proved developed oil and gas reserves. An additional
11 properties were assigned proved undeveloped reserves at December 31, 2003.
Operating the oil and gas properties in which it owns an interest allows
Infinity-Wyoming to exercise greater control over operating costs, capital
expenditures and the timing of exploration, development and exploitation
activities.
During 2003, Infinity-Wyoming produced 1.4 Bcfe of gas, comprised of 1.1
Bcf of natural gas and 57,700 barrels of crude oil. Approximately 98% of this
production was from the Pipeline field on the Wamsutter Arch in the Greater
Green River Basin. Total revenue from product sales totaled $6.6 million,
comprised of natural gas sales of $4.8 million, or $4.47 per mcf, and crude oil
sales of $1.8 million, or $30.51 per barrel.
CIS-Oklahoma, Inc. owns the real property and facilities that Infinity and
Consolidated occupy in Chanute and Ottawa, Kansas, Bartlesville, Oklahoma and
Gillette, Wyoming. In addition to the purchase of the original facilities, the
Bartlesville, Oklahoma facility was expanded in 2002 with the completion of a
new office and shop facility at a cost of approximately $438,000. These
properties were purchased with the proceeds from and serve as collateral for
loans that were established with a local bank.
Infinity Nicaragua Ltd. and Infinity Nicaragua Offshore Ltd. (the Infinity
Nicaragua companies) are wholly owned subsidiaries of Infinity and incorporated
in the Bahamas. The Infinity Nicaragua companies together own a majority
interest in Rio Grande Resources S.A. ("Rio Grande"). Rio Grande is a Nicaraguan
company. Pursuant to Nicaraguan law, Nicaraguan companies must have a minimum of
three shareholders and there are three shareholders of Rio Grande. The Infinity
Nicaraguan companies own 98.2% of Rio Grande. Rio Grande was awarded concessions
to develop two offshore blocks in Nicaragua. The Instituto Nicaraguense de
Energia ("INE"), the Nicaraguan governmental entity regulating oil and gas
activities, refused to recognize the concessions awarded to Rio Grande and the
Nicaragua Supreme Court declared them void. As a result, the Infinity Nicaragua
companies currently hold no ownership interest in valid leases in Nicaragua and
are no longer active subsidiaries of Infinity. However, the relationships that
were built with INE and the geological and geophysical research that was done
helped Infinity to become one of only six companies qualified to bid on the
first international bidding round held by INE in January 2003. Infinity was
awarded the bid on 24 blocks of acreage, comprised of over one million acres,
and immediately entered into negotiations with INE to finalize the initial
exploration plan for the Tyra and Perlas prospects. Infinity anticipates the
completion of the negotiations and the assignment of the concessions during
2004.
For a discussion of the development of the Company's business and a
description of the oil field service properties and oil and gas properties by
geographic area, see "Item 2. Properties".
BUSINESS ACTIVITIES
Infinity is primarily engaged in providing oil and gas well services
through Consolidated and in the identification, acquisition, and development of
oil and gas properties through Infinity-Kansas and Infinity-Wyoming.
Consolidated also operates a wastewater treatment facility on a limited
basis.
2
Consolidated provides services associated with drilling and completion of
oil and gas wells, including cementing, acidizing, fracturing, nitrogen pumping
and water hauling. Consolidated previously provided on-site remediation services
for hazardous and non-hazardous waste, and operated a centralized water
treatment facility and facilities to treat brine water produced by oil and gas
wells. The Cheyenne, Wyoming waste-water treatment facility operates on a
limited basis.
The Infinity-Kansas and Infinity-Wyoming subsidiaries are engaged in the
acquisition and development of oil and gas properties. Infinity-Kansas' current
interest is in a partner operated River Sand property in southwest Kansas.
Infinity-Wyoming owns and operates the Pipeline and Labarge gas prospects in the
Greater Green River Basin of southwest Wyoming and the Sand Wash and Piceance
Basins of Colorado. For a complete description of the properties and the
activities related to these properties see "Item 2. Description of Property -
Oil and Gas Interest in Leasehold Acreage."
Specific information about the revenue, profitability and assets of each
business segment can be found in Note 14 to the Consolidated Financial
Statements contained in this Form 10-K at page F-1.
CUSTOMERS AND MARKETS
Oil Field Services
Consolidated provides its services to oil and gas developers and lease
operators throughout eastern Kansas and northeast Oklahoma which includes the
Forest City and Cherokee Basins and in the Powder River Basin of Wyoming.
Consolidated also provides these services in the Arkoma basin of eastern
Oklahoma and provides well cementing services to water well drillers in
Missouri, Kansas and Oklahoma.
Consolidated provided services to approximately 400 customers during the
calendar year ended December 31, 2003, to approximately 380 customers for the
calendar year ended December 31, 2002 and to over 350 customers during the nine
month transition period ended December 31, 2001. The following table sets out
information about Consolidated's major customers during each of these periods:
PERCENT PERCENT OF
OF OILFIELD
CUSTOMER AREAS OF OPERATION REVENUE TOTAL SERVICE
- ---------------------- --------------------- ------------ ------- ----------
2003
----
A Northeastern Oklahoma $1.1 million 6% 10%
B Eastern Kansas $0.9 million 5% 8%
2002
----
C Eastern Kansas/ $1.6 million 14% 18%
Northeastern Oklahoma
2001 TRANSITION PERIOD
----------------------
D Northeastern Oklahoma $1.3 million 11% 14%
E Powder River, Wyoming $1.3 million 11% 14%
Consolidated also provided services to Infinity-Wyoming which resulted in
eliminated inter-company revenue of approximately $2.1 million in the year ended
December 31, 2002 and $0.5 million for the nine months ended December 31, 2001.
The amount of revenue earned by Consolidated from inter-company sales was less
than $20,000 during the year ended December 31, 2003. Consolidated has no
long-term service contracts with any customers and we do not believe that a loss
of any one of our customers will have a prolonged material adverse effect on
Consolidated's business. However, the loss of several customers in any location
or a rapid, significant change in oil and gas prices to the extent that
customers curtail their development activities could have a material adverse
impact on our financial and operating results.
3
EXPLORATION AND PRODUCTION
Infinity-Wyoming sells gas from the Pipeline project to Duke Energy Field
Services ("Duke"). A portion of its gas is sold to Duke on a forward contract
basis with the remainder being sold at the Inside FERC, first of the month CIG
Index, a published pricing index on which gas sales contracts in the Rocky
Mountains are generally based. Infinity-Wyoming enters into the contracts to
hedge its production when market conditions are deemed favorable in order to
manage price fluctuations and achieve a more predictable cash flow. The
following table identifies the three contracts that were in place during the
year ended December 31, 2003 and the two contracts that were put in place
subsequent to that date.
DAILY
BEGINNING ENDING CONTRACT CONTRACT
DATE DATE VOLUME PRICE
- ---------------- ------------------ ----------- -----------
October 1, 2002 September 30, 2003 1,000 MMBTU $2.97/MMBTU
November 1, 2002 March 31, 2003 1,000 MMBTU $3.00/MMBTU
April 1, 2003 March 31, 2004 3,500 MMBTU $4.71/MMBTU
April 1, 2004 March 31, 2005 2,000 MMBTU $4.40/MMBTU
April 1, 2005 March 31, 2006 2,000 MMBTU $4.15/MMBTU
(1) MMBTU of gas is equivalent to 1,000,000 British thermal units, a standard
measure of the heating value of the gas. The gas produced from the Pipeline
project contains about 1,100 British Thermal Units ("BTU") per cubic foot of
gas.)
Oil production from the Pipeline wells is sold at the NYMEX posted price
less $0.75 per barrel. For December 2003 this was a price of $31.51 per barrel
of oil.
The following table shows the total sales of oil and gas production and the
percentage of consolidated revenue that the value represented for each of the
years ended December 31, 2003 and 2002 and nine month transition period ended
December 31, 2001.
OIL AND GAS PERCENTAGE OF
PERIOD REVENUE TOTAL REVENUE
- ------ ------------ --------------
2003 $6.6 million 36%
2002 $2.4 million 22%
2001 $1.8 million 15%
Based on the general demand for oil and natural gas, Infinity does not
believe that a loss of any customer would have a material adverse effect on its
business.
COMPETITION
Infinity and its subsidiaries compete in virtually all facets of their
businesses with numerous other companies, including many that have significantly
greater financial and other resources. Such competitors may be able to pay more
for desirable oil and gas leases and to evaluate, bid for, and purchase a
greater number of properties than the financial or personnel resources of
Infinity permit. The oil field service competitors may be able to invest more
resources in research and development of new completion techniques and acquire
additional equipment to allow them to dedicate resources to a customer in a way
that Consolidated is unable to.
Consolidated's competition in eastern Kansas consist mainly of Cudd Pumping
Services and Blue Star Acid Services. In northeastern Oklahoma, Consolidated
competes with Cudd Pumping Services, BJ Services, Oklahoma Oil Well Fracturing
and several small local companies. Consolidated believes that its bulk materials
facilities, experienced work force, and well maintained fleet of service
vehicles puts it in a competitive position to maintain revenues in these
locations.
4
Consolidated continues to see competition from three major service
companies: Halliburton, BJ Services, and Schlumberger throughout Wyoming; and
numerous smaller cementing companies in northeastern Wyoming. Consolidated may
be at a competitive disadvantage when compared to the major companies that are
well established with substantial financial resources. These companies can
redirect assets and manpower, much like Consolidated has done, to insure that
resources to meet the growing demand are available. Some of the exploration and
development companies in this area also have the resources available to develop
their own service providers. Consolidated's ability to provide services that
meet the market demand in a timely manner while providing quality service to the
wells will be crucial to its ability to compete in this market.
Infinity's growth strategy includes the acquisition of oil and gas
properties. There can be no assurance, however, that Infinity or its
subsidiaries will be able to successfully acquire identified targets, or have
the financing available for the acquisitions. We operate in the highly
competitive areas of oil and natural gas exploration, exploitation, acquisition
and production with other companies. We face intense competition from a large
number of independent companies as well as major oil and gas companies in a
number of areas such as:
- Acquisition of desirable producing properties or new leases for
future exploration;
- Marketing our oil and natural gas production; and
- Seeking to acquire the equipment, labor and materials necessary
to operate and develop those properties.
Many of our competitors have financial and technological resources
substantially exceeding those available to Infinity. Many oil and gas
properties are sold in a competitive bidding process in which we may lack
technological information or expertise available to other bidders. We cannot be
sure that we will be successful in acquiring and developing profitable
properties in the face of this competition.
GOVERNMENT REGULATION OF THE OIL AND GAS INDUSTRY
General
Infinity's business is affected by numerous laws and regulations,
including, among others, laws and regulations relating to energy, environment,
conservation and tax. Failure to comply with these laws and regulations may
result in the assessment of administrative, civil and/or criminal penalties, the
imposition of injunctive relief or both. Moreover, changes in any of these laws
and regulations could have a material adverse effect on our business. In view
of the many uncertainties with respect to current and future laws and
regulations, including their applicability to Infinity, we cannot predict the
overall effect of such laws and regulations on our future operations.
Infinity believes that its operations comply in all material respects with
applicable laws and regulations and that the existence and enforcement of such
laws and regulations have no more restrictive effect on our method of operations
than on other similar companies in the energy industry.
The following discussion contains summaries of certain laws and regulations
and is qualified as mentioned above.
Federal Regulation of the Sale of Oil and Gas
Various aspects of the Infinity's oil and natural gas operations are
regulated by agencies of the federal government. The Federal Energy Regulatory
Commission ("FERC") regulates the transportation and sale for resale of natural
gas in interstate commerce pursuant to the Natural Gas Act of 1938 ("NGA") and
the Natural Gas Policy Act of 1978 ("NGPA"). In the past, the federal
government has regulated the prices at which oil and gas could be sold. While
"first sales" by producers of natural gas and all sales of crude oil, condensate
and natural gas liquids can currently be made at uncontrolled market prices,
Congress could reenact price controls in the future. Deregulation of wellhead
sales in the natural gas industry began with the enactment of the NGPA in 1978.
In 1989, Congress enacted the Natural Gas Wellhead Decontrol Act (the "Decontrol
Act"). The Decontrol Act removed all NGA and NGPA price and non-price controls
affecting wellhead sales of natural gas effective January 1, 1993.
Commencing in April 1992, the FERC issued Orders Nos. 636, 636-A, 636-B,
636-C and 636-D ("Order No. 636"), which require interstate pipelines to provide
transportation services separate, or "unbundled," from the pipelines' sales of
gas. Also, Order No. 636 requires pipelines to provide open access
transportation on a nondiscriminatory basis that is equal for all natural gas
shippers. Although Order No. 636 does not directly regulate Infinity's
production activities, FERC has stated that it intends for Order No. 636 to
foster increased competition within all phases of the natural gas industry.
5
Infinity conducts certain operations on federal oil and gas leases, which
are administered by the Minerals Management Service ("MMS"). Federal leases
contain relatively standard terms and require compliance with detailed MMS
regulations and orders, which are subject to change. Among other restrictions,
the MMS has regulations restricting the flaring or venting of natural gas, and
the MMS has proposed to amend such regulations to prohibit the flaring of liquid
hydrocarbons and oil without prior authorization. Under certain circumstances,
the MMS may require any company operations on federal leases to be suspended or
terminated. Any such suspension or termination could materially and adversely
affect Infinity's financial condition, cash flows and operations. The MMS issued
a final rule that amended its regulations governing the valuation of crude oil
produced from federal leases. This rule, which became effective June 1, 2000,
provides that the MMS will collect royalties based on the market value of oil
produced from federal leases. On August 20, 2003, the MMS issued a proposed rule
that would change certain components of its valuation procedures for the
calculation of royalties owed for crude oil sales. The proposed changes included
changing the valuation basis for transactions not at arm's-length from spot to
NYMEX prices adjusted for locality and quality differentials, and clarifying the
treatment of transactions under a joint operating agreement. Final comments on
the proposed rule were due on November 10, 2003. Infinity has no way of knowing
whether the MMS will implement the proposed changes in a final rule or what
effect such changes, if implemented, will have on Infinity's results of
operations, However, we do not believe that this proposed rule would affect us
any differently than other producers of crude oil.
Additional proposals and proceedings that might affect the oil and gas
industry are pending before Congress, the FERC, the MMS, state commissions and
the courts. Infinity cannot predict when or whether any such proposals and
proceedings may become effective. In the past, the natural gas industry has been
heavily regulated. There is no assurance that the regulatory approach currently
pursued by various agencies will continue indefinitely. Notwithstanding the
foregoing, Infinity does not anticipate that compliance with existing federal,
state and local laws, rules and regulations will have a material or
significantly adverse effect upon the capital expenditures, earnings or
competitive position of Infinity or its subsidiaries.
Environmental Matters
Consolidated, Infinity-Kansas, and Infinity-Wyoming currently own or lease
properties that are being used for the disposal of drilling and produced fluids
from exploration, development and production of oil and gas and for other uses
associated with the oil and gas industry. Although these subsidiaries follow
operating and disposal practices that it considers appropriate under applicable
laws and regulations, hydrocarbons or other wastes may have been disposed of or
released on or under the properties owned or leased by the subsidiaries or on or
under other locations where such wastes were taken for disposal. Infinity could
incur liability under the Comprehensive Environmental Response, Compensation and
Liability Act or comparable state statutes for contamination caused by wastes it
generated or for contamination existing on properties it owns or leases, even if
the contamination was caused by the waste disposal practices of the prior owners
or operators of the properties. In addition, it is not uncommon for landowners
and other third parties to file claims for personal injury and property damage
allegedly caused by the release of produced fluids or other pollutants into the
environment.
The operations of Consolidated routinely involve the handling of
significant amounts of oil field related materials, some of which are classified
as hazardous substances. Consolidated's transportation operations are regulated
under the Federal Motor Carrier Safety Regulations of the Department of
Transportation as administered by the Kansas Department of Transportation,
Oklahoma Department of Transportation, and Wyoming Department of Transportation.
The operation of salt-water disposal wells by Consolidated is regulated by the
Kansas Department of Health and Environment. Consolidated will incur an
estimated $100,000 in costs associated with operating within current
environmental regulations this fiscal year primarily related to transportation
of hazardous substances.
The Federal Water Pollution Control Act of 1972 (the "FWPCA") imposes
restrictions and strict controls regarding the discharge of wastes, including
produced waters and other oil and gas wastes, into navigable waters. These
controls have become more stringent over the years, and it is probable that
additional restrictions will be imposed in the future. Permits must be obtained
to discharge pollutants into state and federal waters. The FWPCA provides for
6
civil, criminal and administrative penalties for unauthorized discharges of oil
and other hazardous substances and imposes substantial potential liability for
the costs of removal or remediation. State laws governing discharges to water
also provide varying civil, criminal and administrative penalties and impose
liabilities in the case of a discharge of petroleum or its derivatives, or other
hazardous substances, into state waters. In addition, the Environmental
Protection Agency has adopted regulations that require many oil and gas
production sites, as well as other facilities, to obtain permits to discharge
storm water runoff.
Exploration and production operations of Infinity-Wyoming and
Infinity-Kansas are subject to various types of regulation at the federal,
state, and local levels. Such regulations include requiring permits and drilling
bonds for the drilling of wells, regulating the location of wells, the method of
drilling and casing wells, and the surface use and restoration of properties
upon which wells are drilled. Many states also have statutes or regulations
addressing conservation matters, including provisions for the unitization or
pooling of oil and gas properties, the establishment of maximum rates of
production from oil and gas wells and the regulation of spacing, plugging and
abandonment of such wells. The operation and production of Infinity-Wyoming's
properties is subject to the rules and regulations of the Wyoming Oil and Gas
Conservation Commission (WYOGCC) and the Colorado Oil and Gas Conservation
Commission (COGCC). In addition a portion of the properties are on federal lands
and are subject to Onshore Orders 1 and 2, The National Historic Preservation
Act (NHPA), National Environmental Policy Act (NEPA) and the Endangered Species
Act.
Infinity-Wyoming is producing up to 750 barrels of water per day from coal
bed methane wells that it operates. Infinity-Wyoming currently uses injection
wells to dispose of the water into underground rock formations and plans to
continue to use this method for disposal of the water produced from its operated
wells. If the future wells produce water of lesser quality than allowed under
state law for injection in underground rock formations or at a volume greater
than can be injected into the current disposal wells, Infinity-Wyoming could
incur costs of up to $7.50 per barrel of water to dispose of the produced water.
At current production rates, this would cost Infinity-Wyoming approximately an
additional $165,000 a month in water disposal costs. If Infinity-Wyoming's wells
produce water in excess of the limits of its permitted facilities,
Infinity-Wyoming may have to drill additional disposal wells. Each additional
disposal well could cost Infinity-Wyoming up to $1,200,000. It costs
Infinity-Wyoming approximately $50,000 per year to operate these disposal wells.
Bureau of Land Management
Of Infinity-Wyoming's Pipeline acreage, approximately 14,200 gross acres,
are leases that the Company acquired through the auction process and are
administered by the Bureau of Land Management ("BLM"). Approximately 3,080
acres of 11,200 total acres of Infinity-Wyoming's Labarge acreage are part of
federal units for which Infinity-Wyoming is the operator for the development of
the resources to certain depths. The Piceance and Sandwash Basin acreage also
include acreage that is administered by the BLM.
TITLE TO PROPERTIES
As is customary in the oil and gas industry, only a preliminary title
examination is conducted at the time Infinity acquires leases of properties
believed to be suitable for drilling operations. Prior to the commencement of
drilling operations, a thorough title examination of the drill site tract is
conducted by independent attorneys. Once production from a given well is
established, Infinity prepares a division order title report indicating the
proper parties and percentages for payment or production proceeds, including
royalties. Infinity believes that the titles to its leasehold properties are
good and defensible in accordance with standards generally acceptable in the oil
and gas industry.
EMPLOYEES
Infinity and its subsidiaries currently have approximately 107 employees.
Consolidated has 96 employees in its oil field services business,
Infinity-Wyoming has 7 employees in its oil and gas exploration business, and
Infinity has 4 employees in administrative positions.
7
RISK FACTORS
We have a history of operating losses and we may be unable to achieve long-term
profitability.
We incurred a loss in our fiscal years ended December 31, 2003 and 2002 of
approximately $9,925,000 and $1,557,000, respectively. Our losses may impair
our ability to obtain financing for drilling and other business activities on
favorable terms. It may also impair our ability to attract investors if we
attempt to raise additional capital by selling additional securities in a
private or public offering. If needed in the future, we may not be able to
obtain additional capital for our business to grow.
Our ability to achieve a profit from operations on a long-term basis will
depend on whether we are successful in exploring for and producing oil and gas
from our existing properties. We face the following potential risks in
developing our oil and gas properties:
- prices for oil and gas we produce may be lower than expected;
- the capital required to develop the leases for production may not be
available;
- we may not find oil and gas reserves in the quantities anticipated;
- the reserves we find may not produce oil and gas at the rate
anticipated;
- the cost of producing oil and gas may be higher than expected; and
- there are many operating risks associated with drilling for and
producing oil and gas.
Oil and gas prices are volatile, and an extended decline in prices would hurt
our ability to achieve profitable operations.
Our future oil and gas revenues, operating results, profitability, future
rate of growth and the carrying value of oil and gas properties will depend
heavily on prevailing market prices for oil and gas. We expect the market for
oil and gas to continue to be volatile. During the year ended December 31, 2003
we received revenue per barrel of oil as low as $28.12 in May 2003 and as high
as $35.63 in February 2003. The Inside FERC, first of the month CIG Index, the
pricing index on which our gas sales are based, fluctuated from a low of $3.14
per 1,000 cubic feet (MCF) in January 2003 to a high of $5.01 per MCF during
March 2003. At March 15, 2004 production levels, each $1.00 decrease in the
price of crude oil would reduce Infinity's oil revenue by approximately $3,000
per month and if none of the gas produced were being sold under fixed price
contracts, each $0.10 decrease in natural gas price would reduce Infinity's gas
revenue by approximately $10,000 per month. Revenue generated from oil field
services provided by Consolidated has increased to as much as $1.6 million per
month when oil prices have been above $31.50 per barrel compared to revenue of
$400,000 to $450,000 per month when prices reached historic lows of
approximately $8.00 per barrel of oil in 1998. Any substantial or extended
decline in the price of oil or gas would reduce our cash flow and borrowing
capacity, as well as the value and the amount of our oil and gas reserves.
Most of our proved reserves are natural gas. Therefore, the volatility in
the price of natural gas will have the greatest impact on us. Various factors
beyond our control affect prices of oil and gas, including:
- worldwide and domestic supplies of oil and gas;
- the ability of the members of the Organization of Petroleum Exporting
Countries to agree to and maintain oil prices;
- production controls;
- political instability or armed conflict in oil or gas producing
regions;
- the price and level of foreign imports;
8
- worldwide economic conditions;
- marketability of production;
- the level of consumer demand;
- the price, availability and acceptance of alternative fuels;
- the price, availability and capacity of commodity processing and
gathering, and pipeline transportation;
- weather conditions; and
- actions of federal, state, local and foreign authorities.
These external factors and the volatile nature of the energy markets
generally make it difficult to estimate future prices of oil and gas.
Significant declines in oil and natural gas prices for an extended period may
cause various negative effects on our business, including:
- impairing our financial condition, cash flows and liquidity;
- limiting our ability to finance planned capital expenditures;
- reducing our revenues and operating income; and
- reducing the carrying value of our oil and natural gas properties.
A charge to earnings and book value would occur if there is a further
ceiling write down of the carrying value of Infinity-Wyoming's or
Infinity-Kansas' oil and gas properties. Impairments can occur when oil and gas
prices are depressed or unusually volatile. Once incurred, a ceiling write-down
of oil and gas properties is not reversible at a later date. Infinity-Wyoming
and Infinity-Kansas review, on a quarterly basis, the carrying value of their
oil and gas properties under the full cost accounting rules of the Securities
and Exchange Commission ("SEC"). Under these rules, costs of proved oil and gas
properties may not exceed the present value of estimated future net revenues
from proved reserves, after giving effect to cash flow from hedges, discounted
at 10%, net of taxes less the liability for asset retirement obligations.
Application of the ceiling test generally requires pricing future revenue at the
un-escalated prices in effect as of the end of each fiscal quarter, after giving
effect to the Company's cash flow hedge positions, and requires a write-down for
accounting purposes if the ceiling is exceeded, even if prices were depressed
for only a short period of time.
Revenues may be affected by the gas prices in the Rocky Mountain Region.
The prices to be received for the natural gas production from our Wyoming
and Colorado properties will be determined mainly by factors affecting the
regional supply of and demand for natural gas. Based on recent experience,
regional differences could cause a negative basis differential of $0.30 per MCF
(1,000 cubic feet) and $1.50 per MCF between the published indices generally
used to establish the price received for regional natural gas production and the
actual price received by Infinity for its natural gas production.
Forward sales transactions may limit our potential gains or expose us to loss.
To manage our exposure to price risks in the marketing of our natural gas,
we enter into natural gas fixed price physical delivery contracts from time to
time with respect to a portion of our current or future production. These
transactions could limit our potential gains if natural gas prices were to rise
substantially over the price established by the contracts. In addition, such
transactions may expose us to the risk of financial loss in certain
circumstances, including instances in which:
- our production is less than expected;
9
- the counterparties to our futures contracts fail to perform under the
contracts; or
- our production costs on the hedged production significantly increase.
Development of our oil and gas projects will require large amounts of capital
which we may not be able to obtain.
Full development of Infinity's properties would require drilling a maximum
of 740 production wells, 160 disposal wells to handle produced water, and the
construction of 130 production facilities. This would require capital
expenditures of approximately $600 million. Currently, our potential sources of
financing for these activities are cash generated by operations, future sales of
equity or debt securities, obtaining additional debt financing or additional
borrowings on the existing line of credit with U.S. Bank through the expansion
of our borrowing base. The additional borrowing base is dependent on a number
of factors including the price of natural gas, our ability to hedge future
production, cost of operations and proved reserves. Additional borrowings on
the line of credit may not be available if the borrowing base cannot be
expanded, and other financing may not be available to Infinity on terms that are
acceptable. Future cash flows and the availability of financing are subject to
a number of variables, such as:
- our coalbed methane gas projects in the Green River Basin of Wyoming
and Sandwash and Piceance Basins of Colorado achieving a level of
production that provides sufficient cash flow to support additional
borrowings;
- our success in locating and producing new reserves;
- prices of crude oil and natural gas; and
- the level of production from existing wells.
Issuing equity securities to satisfy our financing requirements could cause
substantial dilution to existing shareholders. Debt financing could lead to:
- a substantial portion of our operating cash flow being dedicated to
the payment of principal and interest;
- an increase in interest expense as the amount of debt outstanding
increases or as variable interest rates increase;
- Infinity being more vulnerable to competitive pressures and economic
downturns; and
- restrictions on our operations that may be contained in any contract
entered into with lenders.
We could also consider entering into a partnership with another oil and gas
company or companies in which we would maintain a carried or reduced working
interest in the oil and gas properties to provide the funds for future capital
needs on the projects. However this would reduce our ownership and control over
the projects and could significantly reduce our future revenues generated from
gas production.
If projected revenues were to decrease due to lower oil and natural gas
prices, decreased production or other reasons, and if we were not able to obtain
the necessary capital, our ability to execute development plans or maintain
production levels could be limited.
Our leverage and debt service obligations may adversely affect our cash flow and
our ability to make payments on our long-term debt.
As of December 31, 2003, we had total long-term debt of approximately $28.0
million and stockholders' equity of approximately $22.9 million. Our level of
debt could have important consequences to our business, including the following:
- it may be more difficult for us to satisfy our debt repayment
obligations;
- future covenant violations, if any, could result in accelerated
payment terms on existing debt;
10
- we may have difficulties borrowing money in the future for
acquisitions, to meet our operating expenses or for other purposes;
- the amount of our interest expense may increase because certain of our
borrowings are at variable rates of interest, which, if interest rates
increase, could result in higher interest expense;
- we will need to use a portion of the money we earn to pay principal
and interest on our debt which will reduce the amount of money we have
to finance our operations and other business activities;
- significantly all of our properties are pledged as collateral to
lenders and failure to pay could result in foreclosure and loss of
assets;
- we may have a higher level of debt than some of our competitors, which
may put us at a competitive disadvantage;
- we may be more vulnerable to economic downturns and adverse
developments in our industry; and
- our debt level could limit our flexibility in planning for, or
reacting to, changes in our business and the industry in which we
operate.
Information concerning our reserves, future net revenue estimates, and potential
future ceiling write-downs are uncertain.
There are numerous uncertainties inherent in estimating quantities of
proved oil and natural gas reserves and their values. Actual production,
revenues and reserve expenditures will likely vary from estimates.
Estimates of oil and natural gas reserves, by necessity, are projections
based on available geologic, geophysical, production and engineering data, and
there are uncertainties inherent in the interpretation of such data as well as
the projection of future rates of production and the timing of development
expenditures. Estimates of economically recoverable oil and natural gas reserves
and future net cash flows necessarily depend upon a number of factors and
assumptions based on existing conditions, all of which may vary considerably
from actual future results and from one professional engineer to another.
In addition, investors should not construe the present value of future cash
flows as the current market value of the estimated oil and natural gas reserves
attributable to our properties. The estimated discounted future net cash flows
from proved reserves are based on prices and costs as of the date of the
estimate, in accordance with applicable regulations, whereas actual future
prices and costs may be materially higher or lower. Factors that will affect
actual future net cash flows include:
- the amount and timing of actual production;
- the price for which that oil and gas production can be sold for
- supply and demand for natural gas;
- curtailments or increases in consumption by natural gas purchasers;
and
- changes in government regulations or taxation.
As a result of these and other factors, we will be required to periodically
reassess the amount of our reserves, which may require us to recognize a ceiling
write-down of our oil and gas properties. Such factors could cause us to have
to write down the value of some of our properties in future periods.
Infinity-Wyoming has approximately $9.4 million invested in unproved oil
and gas properties not subject to amortization on its Labarge project and
expects to incur an additional $3.6 million in costs under an agreement to
further develop the property. In order to further evaluate and develop the
Labarge project, Infinity-Wyoming entered into an agreement with Schlumberger
Technology Corporation ("Schlumberger") and Red Oak Capital Management LP ("Red
Oak"). At the conclusion of the 2004 evaluation activity, a significant portion
of the investment in unproved oil and gas properties will be reclassified to the
full cost pool subject to depletion and the ceiling test. If
11
the 2004 evaluation and exploration activity at Labarge do not result in
additional proved reserves, or if proved reserves are not significant, Infinity
could be required to write-down a portion of the full cost pool of oil and gas
properties subject to amortization upon reclassification of the Labarge unproved
oil and gas property costs.
The oil and gas exploration business involves a high degree of business and
financial risk.
The business of exploring for and developing oil and gas properties is an
activity that involves a high degree of business and financial risk. Property
acquisition decisions generally are based on assumptions about the quantity,
quality, cost to produce, market availability and sales price for the reserves
being acquired. Although available geological and geophysical information can
provide information about the potential of a property, it is impossible to
predict accurately the ultimate production potential, if any, of a particular
property or well. Any decision to acquire a property is also influenced by our
subjective judgment as to whether we will be able to locate the reserves, drill
and equip the wells to produce the reserves, operate the wells economically, and
market the production from the wells.
The successful completion of an oil or gas well does not ensure a profit on
investment. A variety of geophysical factors may negatively affect the
commercial viability of any particular well, including:
- the absence of producible quantities of oil and gas;
- insufficient formation attributes, such as porosity, to allow
production;
- excess water production requiring disposal; and
- improperly pressured reservoirs from which to produce the reserves.
In addition, market-related factors may cause a well to become uneconomic
or only marginally economic, such as:
- availability of transportation for the production;
- demand for the oil and gas produced; and
- price for the oil and gas produced.
Our business is subject to operating hazards that could result in substantial
losses.
The oil and natural gas business involves operating hazards such as:
- well blowouts;
- craterings;
- explosions;
- uncontrollable flows of oil, natural gas or well fluids;
- fires;
- formations with abnormal pressures;
- pipeline ruptures or spills;
- pollution; and
12
- releases of toxic gas and other environmental hazards and risks any of
which could cause substantial losses.
As protection against operating hazards, we maintain insurance coverage
against some, but not all, potential losses. This insurance has deductibles or
self-insured retentions and contains certain coverage exclusions. Infinity's
insurance premiums can be increased or decreased based on the claims made by
Infinity under its insurance policies. The insurance does not cover damages
from breach of contract by Infinity or based on alleged fraud or deceptive trade
practices. Whenever possible, Infinity obtains agreements from customers that
limit its liability; however, insurance and customer agreements do not provide
complete protection against losses and risks and losses could occur for
uninsurable or uninsured risks, or in amounts in excess of existing insurance
coverage. The occurrence of an event that is not fully covered by insurance
could harm our financial conditions and results of operations.
Our operations are dependent upon the availability of certain resources,
including drilling rigs, water, chemicals, and other materials necessary to
support our capital development plans and maintenance requirements. The lack of
availability of one or more of these resources at an acceptable price could have
a material adverse affect on our business.
In addition, we may be liable for environmental damage caused by previous
owners of property we own or lease. As a result, we may face substantial
potential liabilities to third parties or governmental entities that could
reduce or eliminate funds available for exploration, development or acquisitions
or cause Infinity to incur losses. An event that is not fully covered by
insurance -- for instance, losses resulting from pollution and environmental
risks that are not fully insured -- could cause us to incur material losses.
Exploratory drilling is an uncertain process with many risks.
Exploratory drilling involves numerous risks, including the risk that we
will not find any commercially productive natural gas or oil reservoirs. The
cost of drilling, completing and operating wells is often uncertain, and a
number of factors can delay or prevent drilling operations, including:
- unexpected drilling conditions;
- pressure or irregularities in formations;
- equipment failures or accidents;
- adverse weather conditions;
- compliance with governmental requirements, rules and regulations; and
- shortages or delays in the availability of drilling rigs and the
delivery of equipment.
Infinity's future drilling activities may not be successful, and we cannot
be sure of our overall drilling success rate. Unsuccessful drilling activities
would result in significant expenses being incurred without any financial gain.
Our business will depend on transportation facilities owned by others.
The marketability of gas production will depend in part on the
availability, proximity and capacity of pipeline systems owned by third parties.
Federal and state regulation of gas and oil production and transportation, tax
and energy policies, changes in supply and demand, pipeline pressures, and
general economic conditions could adversely affect our ability to gather and
transport natural gas.
The oil and gas industry is heavily regulated and we must comply with complex
governmental regulations.
Federal, state and local authorities extensively regulate the oil and gas
industry and the drilling and completion of oil and gas wells. Legislation and
regulations affecting the industry are under constant review for amendment or
expansion, raising the possibility of changes that may affect, among other
13
things, the pricing or marketing of oil and gas production. Noncompliance with
statutes and regulations may lead to substantial penalties, and the overall
regulatory burden on the industry increases the cost of doing business and, in
turn, decreases profitability. State and local authorities regulate various
aspects of oil and gas drilling and production activities, including the
drilling of wells through permit and bonding requirements, the spacing of wells,
the unitization or pooling of oil and gas properties, environmental matters,
safety standards, the sharing of markets, production limitations, plugging and
abandonment, and restoration.
Infinity's operations are subject to complex and constantly changing
environmental laws and regulations adopted by federal, state and local
government authorities. Infinity-Wyoming estimates it will spend approximately
$10,000 per well for containment facilities during drilling operations and
approximately $3.6 million to obtain permits for, drilling and equipping up to
three water disposal wells to handle water produced from oil and gas wells
during the current fiscal year. It will cost Infinity-Wyoming approximately
$50,000 per year to operate each disposal well. In addition to the environmental
costs that will be incurred by our oil and gas production operations,
Consolidated will incur an estimated $100,000 in costs associated with operating
within current environmental regulations this fiscal year. New laws or
regulations, or changes to current requirements, could result in Infinity having
to incur significant additional costs. We could face significant liabilities to
the government and third parties for discharges of oil, natural gas or other
pollutants into the air, soil or water, and we could have to spend substantial
amounts on investigations, litigation and remediation.
Our well service operations routinely involve the handling of significant
amounts of waste materials, some of which are classified as hazardous
substances. Our operations and facilities are subject to numerous environmental
laws, rules and regulations, including laws concerning:
- the containment and disposal of hazardous substances, oilfield waste
and other waste materials;
- the use of underground storage tanks; and
- the use of underground injection wells.
Laws protecting the environment are becoming stricter. Sanctions for
failure to comply with these laws, rules and regulations, many of which may be
applied retroactively, may include:
- administrative, civil and criminal penalties;
- revocation of permits; and
- corrective action orders.
In the United States, environmental laws and regulations typically impose
strict liability. Strict liability means that in some situations we could be
exposed to liability for cleanup costs and other damages as a result of our
conduct that was lawful at the time it occurred or conduct of prior operators or
other third parties. Cleanup costs, natural resource damages and other damages
arising as a result of environmental laws, and costs associated with changes in
environmental laws and regulations, could be substantial. From time to time,
claims have been made against us and our subsidiaries under environmental laws.
Changes in environmental regulations may also negatively impact oil and natural
gas exploration and production companies, which in turn could reduce the demand
for our well services.
Large volumes of water produced from coalbed methane wells and discharged
onto the surface in the Powder River Basin of Wyoming have drawn the attention
of government agencies, gas producers, citizens and environmental groups which
may result in new regulations for the disposal of produced water.
Infinity-Wyoming intends to use injection wells to dispose of water into
underground rock formations. If our wells produce water of lesser quality than
allowed under Wyoming state law for injection into underground rock formations,
Infinity-Wyoming could incur costs of up to $7.50 per barrel of water to dispose
of the produced water. At current production rates, this would cost Infinity an
additional $165,000 a month in water disposal costs. If Infinity's wells produce
water in excess of the limits of its disposal facilities, Infinity may have to
drill additional disposal wells. Each additional disposal well could cost
Infinity up to $1,200,000.
14
The oil and gas industry is highly competitive.
We operate in the highly competitive areas of oil and natural gas
exploration, exploitation, acquisition and production with other companies. We
face intense competition from a large number of independent companies as well as
both major and other independent oil and natural gas companies in a number of
areas such as:
- acquisition of desirable producing properties or new leases for future
exploration;
- marketing our oil and natural gas production; and
- seeking to acquire the equipment, labor and materials necessary to
operate and develop those properties.
Many of our competitors have financial and technological resources
substantially exceeding those available to Infinity. Many oil and gas
properties are sold in a competitive bidding process in which we may lack
technological information or expertise available to other bidders. We cannot be
sure that we will be successful in acquiring and developing profitable
properties in the face of this competition.
We depend on key personnel.
The loss of key members of our management team, or difficulty attracting
and retaining experienced technical personnel, could reduce our competitiveness
and prospects for future success. Infinity's success will depend on the
continued services of its executive officers and a limited number of other
senior management and technical personnel. Loss of the services of any of these
people could have a material adverse effect on our operations. Infinity
maintains "key man" life insurance on the lives of Stanton E. Ross and Jon D.
Klugh, but only in the amount of $250,000 each. Infinity does not have
employment agreements with any of its executive officers. Infinity's
exploratory drilling success and the success of other activities integral to our
operations will depend, in part, on our ability to attract and retain
experienced explorationists, engineers and other professionals. Competition for
experienced explorationists, engineers and some other professionals is extremely
intense. If we cannot retain our technical personnel or attract additional
experienced technical personnel, our ability to compete could be harmed.
FORWARD-LOOKING STATEMENTS
This report on Form 10-K, including information incorporated by reference,
contains forward-looking statements as defined in the Private Securities
Litigation Reform Act of 1995. The use of any statements containing the words
"anticipate," "intend," "believe," "estimate," "project," "expect," "plan,"
"should" or similar expressions are intended to identify such statement.
Forward-looking statements include, among other items:
- Infinity's growth strategies,
- anticipated trends in Infinity's business and its future results
of operations,
- market conditions in the oil and gas industry,
- the ability of Infinity to make and integrate acquisitions,
- the availability of financing on acceptable terms,
- the impact of governmental regulation,
- the timing of engineering studies and permitting, and
- world financial market conditions.
Forward-looking statements inherently involve risks and uncertainties that
could cause actual results to differ materially from the forward-looking
statements. Factors that could cause or contribute to such differences include,
but are not limited to:
- fluctuations in oil and natural gas production,
15
- fluctuations in oil and natural gas prices,
- incorrect estimations of required capital expenditures,
- uncertainties inherent in estimating quantities of oil and gas
reserves and projecting future rates of production and timing of
development activities,
- increases in the cost of drilling and completing wells,
- an increase in the cost of oil and gas production operations,
- the availability, conditions and timing of required government
approvals,
- the availability, conditions and timing of third party financing,
- an increase in materials, fuel and labor costs,
- a decline in demand for Infinity's oil and gas production or oil
field services, and
- changes in general economic conditions.
ITEM 2. DESCRIPTION OF PROPERTY
BUSINESS PROPERTIES
Infinity's headquarters are located at 211 West 14th Street, Chanute,
Kansas 66720, along with the headquarters and some of the operating facilities
of Consolidated. This facility and other Consolidated facilities in
Bartlesville, Oklahoma and Ottawa, Kansas were purchased in November of 1999 by
the CIS-Oklahoma, Inc. subsidiary. CIS-Oklahoma also acquired facilities in
Gillette, Wyoming for $140,000 during 2001, which includes office and shop
facilities for Consolidated's operations. Funds for the acquisitions were
obtained through a loan from a local bank, secured by the Kansas and Wyoming oil
field service facilities. The loan was for $350,000 for a period of seven years
with an initial adjustable interest rate of 8.5% per annum based on Wall Street
Prime plus 1%. Effective November 2003, the interest rate was reduced to 4.25%.
Payments on this loan are currently $5,635 per month, including interest, with
an outstanding loan balance of approximately $185,000 at December 31, 2003. The
shop and office facility that were built in Bartlesville, Oklahoma during 2001
for the operations of Consolidated were financed from cash flow and with a
ten-year, 9.25% note with a local bank. The note had an outstanding balance of
approximately $330,000 at December 31, 2003, requires monthly payments of
approximately $4,900, and is collateralized by the Bartlesville, Oklahoma
facility.
Consolidated provides numerous services associated with drilling and
completion of oil and gas wells, including cementing, acidizing, fracturing,
nitrogen pumping and water hauling. Consolidated provides these services out of
service facilities it owns in Chanute and Ottawa, Kansas; Bartlesville,
Oklahoma; and Gillette, Wyoming. Due to the decrease in the number of wells
being drilled and the schedule on which wells would be drilled by
Infinity-Wyoming and an increase in service requests and equipment demand in
other services areas, Consolidated closed its Rock Springs, Wyoming facility,
terminated its lease on the operating facilities and transferred its service
equipment to its other locations in December 2003.
Consolidated operates a fleet of approximately 150 vehicles specifically
designed to provide service to oil and gas well operators working at depths
ranging from 100 to 5,000 feet as is usually the case in eastern Kansas,
northeastern Oklahoma, and the coal bed methane development of the Powder River
Basin of Wyoming. The service vehicles are part of the collateral for a
revolving note, capital expenditures note and term loan due in January 2005 with
outstanding balances on the revolving note, capital expenditures note and term
loan of approximately $0.1 million, $0.4 million and $0.9 million, respectively
at December 31, 2003. The capital expenditures and term loan require monthly
payments totaling approximately $0.1 million per month. Consolidated has also
purchased vehicles using financing from manufacturers. These loans and leases
typically have terms of 12 to 60 months with interest rates ranging from 6.0% to
9.5%. As of December 31, 2003, Consolidated was making monthly payments of
approximately $24,000 under these loans and leases.
16
Consolidated leases property near Cheyenne, Wyoming, which is the site of
the brine water treatment facility. Rent on this land lease is $1,000 per year.
The lease is for a term of twenty-five years beginning July 1994, but may be
terminated by Consolidated at any time on written notice. In February of 2003
Consolidated signed a letter of intent to sell these facilities and transfer the
lease on the property to the new owner. However, the potential purchaser to the
letter of intent was unable to finance the acquisition and the sale has not been
completed. Consolidated is working with the potential purchaser to identify a
structure which will allow the sale to be completed. We do not know when the
sale might be completed.
Oil and Gas Interest in Leasehold Acreage
Infinity-Wyoming engaged Netherland, Sewell & Associates, Inc., independent
petroleum engineers to prepare estimates of proved reserves, projected future
production and related future net revenue for our properties as of December 31,
2003. Estimates prepared by Netherland, Sewell & Associates, Inc. were based
upon review of production histories and other geologic, economic, ownership,
volumetric and engineering data. In estimating reserve quantities that are
economically recoverable, oil and gas prices and estimated development and
production costs as of December 31, 2003 were utilized.
The following table sets forth estimates as of December 31, 2003 derived
from the Netherland, Sewell & Associates, Inc. reserve report. The present value
(discounted at 10 percent) of estimated future net revenue before income taxes
shown in the table is not intended to represent the current market value of our
estimated proved oil and gas reserves. For additional information concerning the
present value of future net revenue from these proved reserves, see Note 19 -
Supplemental Oil and Gas Information (Unaudited) in the Notes to the
Consolidated Financial Statements.
Developed Undeveloped Total
----------- ------------ -----------
Natural gas (mcf) 4,724,523 2,786,372 7,510,895
Crude oil (barrels) 124,968 68,170 193,138
Total (mcfe) 5,474,331 3,195,392 8,669,723
Future net revenue before income
taxes $21,557,500 $ 10,916,700 $32,474,200
Present value of future net revenue
before income taxes $16,383,600 $ 6,561,500 $22,945,100
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" under the caption "Overview of Oil and Gas Production
Activity" for a discussion of the variables that resulted in the reduction of
reserves at December 31, 2003.
There are numerous uncertainties inherent in estimating quantities of
proved reserves and in projecting future rates of production and timing of
development expenditures, including many factors beyond the control of the
producer. The reserve data set forth herein represents only estimates. Reserve
engineering is a subjective process of estimating underground accumulations of
oil and gas that cannot be measured in an exact way, and the accuracy of any
reserve estimate is a function of the quality of available data and of
engineering and geological interpretation and judgment and the existence of
development plans. In addition, results of drilling, testing and production
subsequent to the date of an estimate may justify revision of such estimates.
Accordingly, the reserve estimates are often different from the quantities of
oil and gas that are ultimately recovered. Further, the estimated future net
revenue from proved reserves and the present value thereof are based upon
certain assumptions, including future geologic success, prices, production
levels and costs that may not prove correct. Predictions about prices and
future production levels are subject to great uncertainty and the meaningfulness
of such estimates is highly dependent upon the accuracy of the assumptions upon
which they are based. Oil and gas prices have fluctuated widely in recent
years. There is no assurance that prices will not be materially higher or lower
than the prices utilized in estimating the reserves of Infinity-Wyoming.
The weighted average sales prices utilized for purposes of estimating our
proved reserves and future net revenue therefrom as of December 31, 2003 were
$6.06 per Mcf of natural gas and $31.34 per barrel of crude oil.
As an operator of domestic oil and gas properties, Infinity-Wyoming
annually files Department of Energy Form EIA-23, "Annual Survey of Oil and Gas
Reserves," as required by Public Law 93-275. There are differences between the
reserves as reported in Form EIA-23 and as reported herein. The differences are
attributable to the fact that Form EIA-23 requires that an operator report total
reserves attributable to wells that it operates; without regard to ownership
(i.e. reserves are reported on a gross operated basis, rather than on a net
interest basis).
17
Acreage
The following table sets forth the gross and net acres of developed and
undeveloped oil and gas leases held by Infinity-Wyoming as of December 31, 2003.
Developed acreage is acreage assigned to producing wells for the spacing unit of
the producing formation.
Developed Acreage Undeveloped Acreage
------------------ ------------------
Gross Net Gross Net
-------- -------- -------- --------
Greater Green River Basin
Wamsutter Arch 3,520 3,360 16,030 15,790
Labarge 1,763 1,763 9,967 9,436
Sand Wash Basin 640 640 160,689 112,193
Piceance Basin - - 20,020 20,020
-------- -------- -------- --------
Total 5,923 5,763 206,706 157,439
======== ======== ======== ========
Leases covering 57,097 gross (45,705 net) undeveloped acres included as a
part of the Sand Wash Basin prospect above expire during the year ending
December 31, 2004, and therefore the related capitalized costs were reclassified
to the full cost pool at December 31, 2003.
Infinity-Wyoming held options on an additional 26,330 gross acres as of
December 31, 2003. Options on approximately 8,300 of such acres were
relinquished on February 29, 2004, and therefore the related capitalized costs
were reclassified to the full cost pool at December 31, 2003.
Major properties
Greater Green River Basin - Wamsutter Arch
At December 31, 2003, Infinity-Wyoming held leases on approximately 19,000
net acres on the Wamsutter Arch in the Greater Green River Basin of South
Central Wyoming. Infinity-Wyoming currently seeks to exploit hydrocarbons in
the Cretaceous-aged Upper Almond sand at varying depths between 2,900 and 3,600
feet. At December 31, 2003, Infinity-Wyoming operated 36 wells in the field, of
which 10 were active producers, 13 were shut-in, 6 were waiting completion
operations, 3 were water disposal wells, and 4 were waiting plugging and
abandonment. All six wells waiting completion at year end have been completed
as producers during the first quarter of 2004. During March 2004,
Infinity-Wyoming assumed operations of two additional wells in the field
following the acquisition of additional working interests in those wells.
During 2003, Infinity-Wyoming produced approximately 1,051,200 mcf of
natural gas and 57,400 barrels of crude oil, or 1,395,700 mcfe from the field.
Production during 2003 represented a 62% increase over 2002, but production has
declined on a quarterly basis since the quarter ended March 31, 2003 when
production reached 408,100 mcfe.
At December 31, 2003, Infinity-Wyoming held options on an additional 8,300
gross acres in the field. The options were relinquished on February 29, 2004.
Greater Green River Basin - Labarge
At December 31, 2003, Infinity-Wyoming held leases on approximately 11,000
net acres located on the northern extension of the Moxa Arch in southwestern
Wyoming. Infinity-Wyoming currently seeks to exploit hydrocarbons in the
Cretaceous Upper Mesaverde coals at varying depths between 3,400 and 4,200 feet.
At December 31, 2003, Infinity-Wyoming operated 12 wells in the field, of which
2 were active producers, 5 were shut-in, 3 were waiting completion operations,
and 2 were water disposal wells.
During 2003, Infinity-Wyoming produced approximately 29,000 mcf of natural
gas and 300 barrels of crude oil, or 30,700 mcfe from the field. Production
during 2003 represented a 27% decrease as compared to 2002, and production has
declined on a quarterly basis since the quarter ended September 30, 2002 when
production reached 20,600 mcfe. Production at Labarge has continued to be
uneconomic. Infinity-Wyoming believes that this may be due in part to down-hole
operational problems and as a result in December 2003, Infinity-Wyoming entered
into an agreement with Schlumberger Technology Corporation and Red Oak Capital
Management LLC for the further evaluation and development of the Labarge
acreage.
18
Sand Wash Basin
At December 31, 2003, Infinity-Wyoming held leases on approximately 112,000
net undeveloped acres in the Sand Wash Basin of northwest Colorado and south
central Wyoming. This prospect seeks to exploit the Williams Fork and Iles
coals at varying depths between 2,500 and 3,000 feet. Secondary objectives
include hydrocarbons in the fractured Niobrara calcareous shale. Leases
covering 57,097 gross (45,705 net) undeveloped acres included as a part of the
Sand Wash Basin prospect expire during the year ending December 31, 2004.
Infinity-Wyoming is currently seeking offers from other industry operators for
interests in the acreage in exchange for cash and a carried-interest in drilling
operations. No assurance can be given that any such transactions will be
consummated on terms acceptable to Infinity-Wyoming. At December 31, 2003,
Infinity-Wyoming operated 4 wells in the field, all of which were shut-in.
Piceance Basin
At December 31, 2003, Infinity-Wyoming held leases on approximately 20,000
net undeveloped acres in the northeastern corner of the Piceance Basin in
northwestern Colorado. This prospect seeks to exploit the Williams Fork and
Iles coals at varying depths between 1,000 and 3,000 feet. Under the terms of
the lease agreement covering approximately 16,000 acres, Infinity-Wyoming is
required to drill and complete five wells by November 20, 2005, or relinquish
the acreage to the seller. Infinity-Wyoming is currently seeking offers from
other industry operators for interests in the acreage in exchange for cash and a
carried-interest in drilling operations. No assurance can be given that any
such transactions will be consummated on terms acceptable to Infinity-Wyoming.
Stanton County, Kansas
Infinity-Kansas acquired a 31.25% interest in a 5,120 acre river sand
prospect in Stanton County, Kansas for $56,000, or $35.00 per acre, in November
2001. Infinity-Kansas has incurred approximately $187,000 for the drilling of
three exploratory wells and for a 3-D seismic study across the acreage. The
three exploratory wells have been uneconomical and the operator of the property
is evaluating the results of drilling programs on adjacent acreage before taking
any further action. The results of the drilling programs on the adjacent
acreage should be available in the second quarter of 2004. Depending on the
results of those programs, there is a potential that that the operator will
abandon the prospect and Infinity-Kansas will write off its investment in the
additional acreage. Infinity-Kansas does not have investment in any other oil
and gas prospects.
Offshore Nicaragua
During 2003 and into the first quarter of 2004, Infinity has renegotiated a
number of key terms and conditions of the exploration contract covering the
approximate 1,400,000-acre Tyra and Perlas concession areas offshore Nicaragua,
including an extension of the exploration period from six to eight years with
four sub-phases, and is awaiting final approvals by the Nicaraguan government.
Upon approval, the initial capital cost during the first twelve months would be
approximately $800,000, with an additional $1,600,000 during the second twelve
months to cover the costs of environmental studies, geological and geophysical
analysis, acquisition of seismic data and other operational expenses.
Exploration offshore Nicaragua will focus on Eocene and Cretaceous
carbonate reservoirs and Infinity's management and consultants believe (i)
numerous analogies can be made between the Infinity concession block and
production from fractured Cretaceous carbonates in Mexico, Venezuela and
Guatemala, and (ii) the presence of Cretaceous source rocks onshore Honduras and
Nicaragua can be projected into the offshore Caribbean Shelf.
19
Production
The following table sets forth Infinity-Wyoming's net oil and gas
production, average sales prices, and costs and expenses associated with such
production during the periods indicated. Information presented for 2001
pertains to the nine-month transition period ended December 31, and includes
results for Infinity-Kansas. Information presented for 2002 and 2003 pertains
to the years ended December 31, and includes only the results for
Infinity-Wyoming.
2003 2002 2001
---------- -------- --------
Production:
Natural gas (mcf) 1,080,456 676,879 128,998
Crude oil (barrels) 57,654 53,122 74,812
Total (mcfe) 1,426,380 995,611 577,870
Average daily production:
Natural gas (mcf) 2,960 1,854 469
Crude oil (barrels) 158 145 270
Total (mcfe) 3,908 2,727 2,101
Average sales price per unit:
Natural gas (mcf) $ 4.47 $ 1.88 $ 1.76
Crude oil (barrels) 30.51 $ 17.14 $ 20.46
Total (mcfe) $ 4.62 $ 2.38 $ 3.04
Production costs per mcfe $ 2.05 $ 1.83 $ 1.97
Infinity-Wyoming owned 14 gross (12 net) producing wells and 5 gross (5
net) service wells as of December 31, 2003. Infinity-Wyoming owned an
additional 33 gross (33 net) wells which were shut in, waiting completion or
plugging and abandonment as of December 31, 2003.
Development, Exploration and Acquisition Expenditures
The following table sets forth certain information regarding the costs
incurred by Infinity in its development, exploration and acquisition activities
during the periods indicated. Information presented for 2001 pertains to the
nine-month transition period ended December 31. Information presented for 2002
and 2003 pertains to the years ended December 31.
2003 2002 2001
---------- ----------- ----------
Property acquisition costs:
Proved $1,099,120 $ 72,383 $ 223,319
Unproved 661,224 2,279,587 1,291,126
---------- ----------- ----------
Total acquisitions costs 1,760,344 2,351,970 1,514,445
Development costs 3,167,700 786,095 721,760
Exploration costs 3,491,953 11,955,351 6,957,735
---------- ----------- ----------
Total $8,419,997 $15,093,416 $9,193,940
========== =========== ==========
Drilling Activity
The following table sets forth certain information regarding the wells
completed during the periods indicated. Frequently wells are spud or drilled in
one period and completed in the subsequent period. Information presented for
2001 pertains to the nine-month transition period ended December 31.
Information presented for 2002 and 2003 pertains to the years ended December 31.
Certain 2002 and 2001 information has been restated to conform to the current
year presentation.
20
2003 2002 2001
---- ---- ----
GROSS NET GROSS NET GROSS NET
----- ---- ----- ---- ----- ----
Development:
Service 1 1 2 2 1 1
Productive - - 2 2 - -
Non-productive - - - - - -
----- ---- ----- ---- ----- ----
Total 1 1 4 4 1 1
===== ==== ===== ==== ===== ====
Exploratory:
Productive - - 13 13 - -
Non-productive - - 9 9 1 1
----- ---- ----- ---- ----- ----
Total - - 22 22 1 1
===== ==== ===== ==== ===== ====
As of December 31, 2003, Infinity-Wyoming had an additional thirteen wells which
were awaiting completion, including four wells waiting plugging and abandonment
operations and six others that were completed by March 19, 2004.
Delivery Commitments
Infinity-Wyoming entered into a gas gathering and transportation contract
with Duke in which Duke will build gas gathering laterals and install
compression facilities to deliver gas produced from the Pipeline wells to the
Overland Trail Transmission pipeline. During 2002, the contract was amended to
include additional compression and gathering facilities installed by Duke and
delivery points for the additional production being generated by
Infinity-Wyoming. Infinity-Wyoming will pay a gathering fee of $0.40 per MCF
until 7,500,000 MCF have been produced at which time the fee is reduced to $0.25
per MCF. Infinity-Wyoming was obligated to deliver 600,000 MCF the first year,
1,600,000 MCF the second year and 2,000,000 the third and fourth years and
1,800,000 in the fifth and final year of the contract. To date, Infinity-Wyoming
has delivered approximately 2,060,000 MCF on this contract. The Pipeline sales
volumes will also be subject to a $0.15 per Million British Thermal Units
(MMBTU) charge for access onto the Overland Trail Transmission line. While
Infinity-Wyoming has failed to deliver the volumes required under the terms of
the contract, the pipeline operator has also not provided the compression and
gathering capabilities they were required to provide under the contract.
Management has received a verbal commitment from the operator that the volume
commitments will be adjusted and management does not believe there will be a
contract shortfall under the renegotiated volumes.
Beginning April 1, 2003 and effective through March 31, 2004,
Infinity-Wyoming had contracted to sell 3,500 MMBTU per day to Duke at a price
of $4.71 per MMBTU, which equates to $5.16 per MCF. Subsequent to December 31,
2003 Infinity-Wyoming entered into two additional contracts with Duke for the
sale of 2,000 MCF per day. The first contract is for the period April 1, 2004
through March 31, 2005 and sets a price of $4.40 per MCF. The second contract is
for the period beginning April 1, 2005 and ending March 31, 2006 and is for
$4.15 per MCF. Infinity-Wyoming will receive the Colorado Interstate Gas (CIG)
Pipeline first of the month index price for each MCF of gas in excess of the
contracted volume delivered onto the Overland Trail Transmission line. Infinity
and its subsidiaries presently have no agreements or commitments, other than
those shown above, to provide quantities of oil or gas in the future.
ITEM 3. LEGAL PROCEEDINGS
There are currently no pending material legal proceedings to which we are a
party.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders during
the fourth quarter of 2003.
21
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Principal Market and Price Range of Common Stock
Infinity's Common Stock began trading on the Nasdaq Small-Cap Market on
June 29, 1994, under the symbol "IFNY." In August 2002, Infinity became listed
on the Nasdaq National Market. The following table sets forth the high and low
closing sale prices for Infinity's Common Stock as reported by the Nasdaq Stock
Market. The closing price of the Common Stock on March 31, 2004 was $3.36.
Quarter Ended High Low
- ------------------ ------- ------
March 31, 2002 $ 7.34 $ 5.03
June 30, 2002 11.38 7.72
September 30, 2002 8.19 5.95
December 31, 2002 9.00 7.11
March 31, 2003 9.74 7.75
June 30, 2003 8.83 5.50
September 30, 2003 6.01 4.30
December 31, 2003 4.90 3.31
APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK
The number of record holders of Infinity's $0.0001 par value Common Stock
at April 12, 2004, was 187 and the Company believes it has over 1,500 beneficial
owners of such stock.
DIVIDENDS
Holders of common stock are entitled to receive such dividends as may be
declared by Infinity's Board of Directors. Infinity has not declared nor paid
and does not anticipate declaring or paying an dividends on its common stock in
the near future. Any future determination as to the declaration and payment of
dividends will be at the discretion of Infinity's board of directors and will
depend on then-existing conditions, including Infinity's financial condition,
results of operations, contractual restrictions, capital requirements, business
prospects and such other factors as the board deems relevant. Pursuant to the
terms of the Loan Agreement with LaSalle Bank, N.A., Consolidated is prohibited
from paying any dividends to Infinity during the term of the agreement and under
the terms of the Loan Agreement with U.S. Bank National Association,
Infinity-Wyoming is restricted in the amount of distributions it can make to
Infinity, Inc.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial information presented below for the
years ended December 31, 2003 and 2002 and March 31, 2001 and 2000 and, the nine
month transition period ended December 31, 2001 is derived from the audited
consolidated financial statements of Infinity for all periods. Infinity changed
its fiscal year end to December 31 fiscal year end from a March 31 fiscal year
end effective December 31, 2001. Certain reclassifications have been made to
prior financial statements to conform with the current presentation. The table
gives effect to the two-for-one split of Infinity's common stock effective May
13, 2002 for all periods presented.
22
FOR THE PERIOD ENDED
DECEMBER 31, MARCH 31,
----------------------------- ------------------
2003 2002 2001 2001 2000
-------- --------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
STATEMENT OF OPERATIONS DATA
Revenue:
Oil field service revenue $11,634 $ 8,570 $ 9,854 $ 8,476 $ 5,122
Oil and gas revenue 6,589 2,368 1,759 376 8
-------- --------- -------- -------- --------
Total revenue $18,223 $ 10,938 $11,613 $ 8,852 $ 5,130
======== ========= ======== ======== ========
Expenses:
Oil and gas service operations $ 6,223 $ 4,621 $ 5,154 $ 4,666 $ 3,027
Oil and gas production expense 2,161 1,583 1,074 207 7
Production taxes 759 238 66 14 -
Operating expenses 5,311 4,647 2,789 2,460 2,231
Depreciation, depletion and amortization 3,074 1,783 1,063 922 781
Ceiling write-down of oil and gas properties 2,975 - - - -
-------- --------- -------- -------- --------
Total expenses $20,503 $ 12,872 $10,146 $ 8,269 $ 6,046
======== ========= ======== ======== ========
Other income (expense)
Interest expense and amortization of loan costs $(7,794) $ ( 837) $(1,866) $(1,062) $ (517)
Impairment of other assets $ - $ - $( 600) $ - $ -
Gain on sale of securities $ - $ - $ 5,128 $ 2,780 $ -
Other, net $ 149 $ 69 $ 1 $ 176 $ 40
Income (loss) before income taxes $(9,925) $ (2,701) $ 4,130 $ 2,477 $(1,393)
Income tax (expense) benefit - 1,144 (1,590) (710) 641
-------- --------- -------- -------- --------
Net income (loss) $(9,925) $ (1,557) $ 2,540 $ 1,767 $ (752)
======== ========= ======== ======== ========
Basic income (loss) per common share $ (1.23) $ (0.22) $ 0.39 $ 0.29 $ (0.13)
Diluted income (loss) per common share $ (1.23) $ (0.22) $ 0.37 $ 0.27 $ (0.13)
STATEMENT OF CASH FLOWS DATA
Net cash provided by (used in):
Operating activities $ 2,845 $ 136 $ 1,361 $ 1,157 $ (996)
Investing activities $(6,902) $(16,218) $(3,232) $ (715) $(3,691)
Financing activities $ 3,917 $ 16,283 $ 2,381 $(1,003) $ 5,367
BALANCE SHEET DATA
Cash and cash equivalents $ 727 $ 867 $ 666 $ 155 $ 716
Accounts receivable, net of allowance $ 1,767 $ 1,514 $ 1,600 $ 1,488 $ 588
Investment in securities $ - $ - $ - $ 8,509 $10,885
Net property and equipment $10,169 $ 10,315 $10,343 $ 6,107 $ 4,231
Net oil and gas properties $36,262 $ 32,284 $17,191 $ 8,127 $ 1,959
Net intangible assets $ 3,953 $ 5,300 $ 1,527 $ 305 $ 298
Total assets $55,266 $ 53,130 $33,097 $26,013 $19,379
Current portion of long-term debt $ 1,763 $ 2,227 $ 3,342 $ 3,520 $ 2,174
Accounts payable $ 2,645 $ 2,876 $ 2,591 $ 1,879 $ 510
Long-term debt, net of current portion $26,230 $ 24,247 $10,421 $ 5,552 $ 6,411
Stockholders' equity $22,911 $ 22,810 $15,207 $13,596 $ 9,982
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the
Consolidated Financial Statements and Notes presented elsewhere in the this Form
10-K. Infinity follows the full-cost method of accounting for oil and gas
properties. See "Organization and Summary of Significant Accounting Policies,"
included in Note 1 to the Consolidated Financial Statements.
Infinity and its operating subsidiaries Infinity-Wyoming, Infinity-Kansas
and Consolidated are engaged in identifying and acquiring oil and gas acreage,
exploring and developing acquired acreage, and providing oil and gas well
services. Infinity's primary focus is on the development of its properties in
the Green River Basin of Wyoming, Piceance Basin of Colorado and in the Sand
Wash Basin of Wyoming and Colorado. Infinity's involvement in the wastewater
disposal industry through its wastewater division has been scaled back
significantly with only maintenance operations occurring at the Cheyenne,
Wyoming facility. Infinity expects to dispose of these facilities and has signed
a letter of intent to sell the properties contingent upon the purchaser
obtaining financing.
OVERVIEW OF OIL FIELD SERVICE OPERATIONS
Consolidated continued to develop its business relationships as the largest
oil field service provider in eastern Kansas and northeastern Oklahoma by
servicing over 400 customers during the year ended December 31, 2003. The
continued strong price of natural gas and the focus on development of the coal
bed methane potential of the Cherokee basin in southeast Kansas and northeast
Oklahoma contributed to the overall increase in activity for Consolidated.
During the year ended December 31, 2003 Consolidated achieved several
operational milestones:
- provided services to over 400 customers,
- achieved gross sales of $11.6 million,
- subsidiary level earnings before interest, taxes, depreciation and
amortization of approximately $2.8 million, and
- subsidiary level income before taxes of over $1.0 million
Consolidated is actively seeking opportunities through acquisitions or
mergers to expand its service area, increase its market share or enhance the
services it provides to its customers. At December 31, 2003, Consolidated had
outstanding debt of approximately $2.9 million secured by its fleet of service
trucks and real estate with an appraised market value in excess of $10.0
million. Management believes that it can use the excess value as collateral to
quickly fund acquisitions as they might occur.
OVERVIEW OF OIL AND GAS PRODUCTION ACTIVITY
In the Fall of 2002, Infinity began working with First Albany Corporation
to identify and evaluate strategic divestiture, financing and merger
alternatives for Infinity. Infinity was approached about the possible sale of
our interest in certain of Infinity-Wyoming's properties, the merger of Infinity
with another public company, or the acquisition of Infinity by a third party.
After several months of evaluation, Infinity was contacted about a potential
merger. Management believed the potential merger would be beneficial and entered
into detailed negotiations with the third party. After several months of
negotiations and reaching what Infinity believed to be satisfactory terms for a
merger, the third party withdrew from the discussions in April 2003. Infinity
had believed that the merger would provide adequate resources for the future
development of its assets and had focused its limited resources on completing
the merger. Subsequently, when the negotiations were terminated, Infinity was
not in a position to act timely on any alternatives to the merger and was
limited on the resources it could immediately bring to the development of its
properties.
Facing deadlines under the Labarge farm out agreement for earning acreage
through drilling wells while at the same time in detailed negotiations with the
potential merger partner and with the anticipation that additional resources
would be available upon the completion of the merger, Infinity-Wyoming drilled
five production wells and one injection well on acreage it had acquired adjacent
to the Labarge acreage it currently owned. When the merger negotiations were
terminated, Infinity had outstanding unsecured past due payables associated with
the drilling activities of approximately $1.8 million. Due to a lack of
financial resources, the wells were not completed. Three of these wells have
been included in the initial recompletion phase under the Schlumberger
agreement.
24
As Infinity was unable to complete the merger and the fact that Infinity
needed resources to continue development of its acreage, in June 2003, Infinity
began discussions with several traditional lending institutions in order to
develop a credit relationship that would recognize the value of
Infinity-Wyoming's developing assets. The intent was to find a financial partner
that would allow for future expansion as the assets were developed and to
provide cash to pay Infinity's current outstanding payables. Understanding that
the future success of development activities on its properties were dependent on
its relationships with the service providers in the area of its operations,
Infinity-Wyoming worked diligently to secure financing that would allow payment
of its past due obligations. On June 5, 2003 Infinity-Wyoming entered into a
$3.8 million loan agreement secured by its interest in the producing properties.
The proceeds were used to pay $1.0 million of outstanding bridge loan notes,
outstanding payables related to the development of the gas properties of
Infinity-Wyoming, and for additional development work on the properties. The
loan was repaid on September 4, 2003 when Infinity-Wyoming entered a credit
agreement with U.S. Bank National Association that provided a three year, $25.0
million revolving line of credit based principally on the production and
reserves associated with Infinity-Wyoming's Pipeline project. The initial
borrowing base on the facility was $5.5 million. Infinity-Wyoming immediately
drew the full amount available on the facility and repaid the June 5 loan and
began drilling six additional wells on its Pipeline acreage. All of these wells
were completed subsequent to December 31, 2003 and have began production.
In 2003, Infinity faced several financing, development and operating issues
associated with drilling, completing and operating its coal bed methane wells on
its acreage in the Greater Green River Basin of Wyoming:
- Limited capital resources for the further development of the projects,
- Production volumes on the Labarge property had declined dramatically
after work was done on the wells in December 2002,
- The disposal well on the Labarge property was experiencing increasing
injection pressures,
- Significant production was occurring from only a limited number of
wells on the Pipeline acreage, and
- Reservoir tests on the Almond coals in the Pipeline project were
indicating permeability issues.
Each of these issues potentially had a significant impact on
Infinity-Wyoming's ability to develop the properties, attract potential partners
for future development and to fund future development activities. Production
from the original five wells drilled on the Labarge acreage continues to be
uneconomical due to what management believes are down hole mechanical issues
related to high parifin oil that was encountered in the wells and down hole
treatments that were done in December 2002. The uneconomic results of these
wells along with the lack of resources to address the mechanical issues on the
wells has forced the reclassification of the reserves associated with the wells
and the surrounding drilling locations from proved to probable and possible,
resulting in a substantial reduction in Infinity-Wyoming's proved reserves at
December 31, 2003. In order to further evaluate and develop the Labarge project,
Infinity-Wyoming entered into an agreement with Schlumberger and Red Oak. The
agreement calls for re-completion of five existing wells and the drilling of up
to 90 additional wells on the Labarge acreage over the next five years. The
first 10 wells will be drilled in a bundle and the remaining 80 wells will be
drilled in bundles of 20 wells. Schlumberger has the exclusive right to provide
certain of its services on a risked basis and may withdraw its participation
after the completion of any bundle of wells or after the re-completion of five
of the 10 existing wells. Red Oak has the right to provide financing on a
portion of the cost of drilling and completing the wells. Disclosure of the
terms of this agreement is restricted by provisions in the agreement.
Infinity-Wyoming has approximately $9.4 million invested in unproved oil and gas
properties not subject to amortization on its Labarge project and expects to
incur an additional $3.6 million during 2004 in costs under an agreement to
further explore the property. At the conclusion of the 2004 evaluation and
exploration activity, a significant portion of the investment in unproved oil
and gas properties not subject to amortization will be reclassified to
properties subject to depletion and the ceiling test. If the 2004 evaluations
and exploration activity at Labarge do not result in additional proved reserves,
or if proved reserves are not significant, Infinity could be required to
write-down a portion of the full cost pool of oil and gas properties subject to
amortization upon the reclassification of the Labarge unproved oil and gas
property costs.
Although operations at Pipeline continue to be profitable, production has
not met management's expectations. Infinity-Wyoming has been unable to
consistently produce gas from all of the wells in the project. However, certain
wells have been very successful with production from those wells exceeding 1,500
MCF per day. Further evaluation of the geology associated with the successful
wells indicates that these wells appear to be producing from the Almond Sand
rather than from the Almond Coals. The Almond Sand is a geological sandstone
formation that lays directly on top of the Almond Coals. This sandstone
formation is much more porous than the Almond Coals allowing hydrocarbons
trapped within the geological formation to be produced. However, the Almond Sand
formation developed in channels through the geological formations and does not
cover the entire area like coals traditionally cover. Drilling logs from the
25
Pipeline drilled wells and the further evaluation of additional seismic data
have allowed Infinity-Wyoming to better define the area that contains the Almond
Sand. Since management currently believes the Almond Sand to be the major gas
producing formation, Infinity will be aggressively developing the remaining
acreage where there is sufficient geological information to indicate the
presence of the sand formation. The change in classification from a coal bed
methane play to a conventional sand play has had a significant impact on the
acreage from which hydrocarbons will be producible and accordingly on the
reserves associated with the project. As a result, in 2004, management
determined it was not economically beneficial to re-new an option on
approximately 8,300 acres of undeveloped acreage.
The above operational, geological and geophysical, financial, and other
issues resulted in significant revisions to year end reserves. As a result of
these revisions and other economic decisions, Infinity-Wyoming realized a
$2,975,000 ceiling write-down during 2003.
Infinity-Wyoming has selected Netherland, Sewell and Associates, Inc. to
prepare its January 1, 2004 third party reserve evaluation. Results of this
evaluation are disclosed in the "Supplemental Oil and Gas Disclosures" in
Infinity's Consolidated Financial Reports and in the "Oil and Natural Gas
Reserves" section of Item 2. Description of Properties. Wells, Chappel and
Company, Inc. prepared the reserve evaluation for the periods ended December 31,
2002 and December 31, 2001.
2004 OPERATIONAL AND FINANCIAL OBJECTIVES
Oil Field Services
Consolidated expects to increase its oil field service revenue during 2004
due to the increase in the number of wells being drilled by property owners in
our service areas and through strategic acquisitions. These acquisitions would
be done in order to:
- expand the services that are provided,
- expand the area that is serviced,
- gain market share by providing complimentary services to our existing
services, and
- gain market share by eliminating competition.
Revenues from oil field services are expected to be between $12.5 million and
$14.5 million with income before taxes of approximately $1.7 to $2.2 million
from existing business. Management expects that it will make acquisitions that
will cost between $1.2 million and $2.0 million during 2004 and expects to fund
the acquisitions through financing secured by the acquired assets. Consolidated
also expects to have other capital expenditures of about $1.0 million related to
equipment and facilities. These capital expenditures would be financed through
cash flow or vendor financing.
Oil and Gas Production
Infinity-Wyoming will focus on increasing production through development of
acreage and acquiring additional interest in wells within its Pipeline area of
operations. Subsequent to December 31, 2003, Infinity-Wyoming completed six
wells drilled during the fourth quarter of 2003 and acquired an additional 49%
working interest in two existing wells and 960 acres of undeveloped leasehold
adjacent to the Pipeline project. With the acquisition, Infinity-Wyoming
assumed operations of the two wells. Infinity-Wyoming expects to drill two
wells on the newly acquired acreage during 2004. Infinity-Wyoming anticipates
capital expenditures will be approximately $0.5 million to drill the two wells.
In the first quarter of 2004, Schlumberger began re-completion activities
on two of the original Riley Ridge wells on the Labarge project by perforating
additional areas of the well bore and re-fracing the wells. Schlumberger also
began completion activities on one of the wells on the Thompson acreage that had
been drilled in the fourth quarter of 2002. Depending on the results of these
activities, Infinity-Wyoming, through the agreement, could drill an additional
five to six wells on the Thompson acreage during 2004. Infinity-Wyoming also
expects to complete the Environmental Impact Study ("EIS") on the Labarge
acreage during the fourth quarter of 2004 or early in 2005. Management believes
that it will require between $4.0 million and $4.5 million in capital to pay for
the un-risked services for the drilling and completion work on wells drilled in
2004, if any, and the completion of the EIS.
26
The ability of Infinity-Wyoming to complete these activities is dependent
on a number of factors including, but not limited to:
- The availability of the capital resources required to fund the
activity. Infinity completed a private placement of 1,000,000 shares
of Infinity common stock in January 2004 which generated proceeds of
approximately $4.0 million (before offering costs) a portion of which
will help fund the development activities. Infinity-Wyoming also
expects to generate between $4.0 and $5.0 million in cash flow from
operations in 2004.
- The availability of third party contractors for drilling rigs and
completion services. Infinity-Wyoming has reduced the impact this
could have by contracting with Schlumberger to provide certain of
these services for the development of the Labarge acreage.
- The success of the completion efforts on the existing Labarge wells.
If Schlumberger is not satisfied with, or successful in its efforts
then they may elect not to risk their services and Red Oak may be
unwilling to secure financing for the further development of the
property. If this occurs, Infinity-Wyoming will be required to fund
the all of the development activities and may not be able to do so on
terms that are acceptable to management.
Infinity, Inc. Activity
Infinity continues to negotiate the final development agreement with INE
for the Perlas and Tyra blocks offshore Nicaragua. Management believes that it
should be able to complete the negotiations sometime in 2004. Upon completion
of the negotiations, Infinity will be required to post a performance bond for
the initial work to be done on the leases which will include an environmental
study and the development of geological information developed from additional
seismic evaluation. Infinity estimates the performance bond will approximate
$0.7 million and that Infinity will incur additional costs to complete the
negotiations and finalize the leases of approximately $0.1 million.
Infinity is also pursuing the acquisition of 25,000 acres in the Fort Worth
Basin of Texas. Development opportunities on the acreage will target principally
the Barnett Shale formation. As final terms of the agreement have not been
reached Infinity cannot determine what financial resources might be required to
complete the acquisition and exploration.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2003 COMPARED TO THE YEAR
ENDED DECEMBER 31, 2002
Infinity incurred a net loss after taxes of $9.9 million, or $1.23 per
fully diluted share, in the year ended December 31, 2003 compared to a net loss
after taxes of $1.6 million, or $0.22 per fully diluted share in the year ended
December 31, 2002.
Infinity achieved a $4.6 million increase in gross profit to $9.1 million
in the year ended December 31, 2003 from $4.5 million for the year December 31,
2002. The increase in gross profit during the period ended December 31, 2003
compared to the period ended December 31, 2002 was the result of a $3.0 million,
or approximately 36%, increase in oil field service revenue to $11.6 million
from $8.6 million. The increase in revenue was partially offset by a $1.6
million, or 35%, increase in oil field service cost of services provided (See
"Oil Field Services" discussion below). Oil field service revenue for the year
ended December 31, 2002 was reduced by the elimination of $2.1 million of oil
field service sales that were provided to Infinity-Wyoming by Consolidated for
the development of its oil and gas properties and the cost of services
provided was reduced by $1.1 million for the cost of those services provided to
Infinity-Wyoming. The oilfield service subsidiary provided minimal services to
Infinity-Wyoming in the period ended December 31, 2003. Additionally, gross
profit comparisons were affected by a $4.2 million, or approximately 178%
increase in sales of oil and gas from $2.4 million for the period ended December
31, 2002 to $6.6 million in the period ended December 31, 2003 with a
corresponding increase of $0.6 million in oil and gas production costs and $0.5
million increase in production taxes in the 2003 period (See "Oil and Gas
Production" discussion below).
27
Operating expenses for the year ended December 31, 2003 increased $0.7
million from $4.6 million in the 2002 period to $5.3 million in the 2003 period.
In 2003, Infinity incurred approximately $0.6 million in expenses associated
with the detailed negotiations relating to a potential merger, which
negotiations were terminated in April 2003, and the process leading up to those
negotiations in which Infinity solicited and reviewed strategic alternatives.
Infinity and its subsidiaries also recognized additional depreciation, depletion
and amortization ("DD&A") expense of approximately $1.3 million during the year
ended December 31, 2003, an increase to approximately $3.1 million for the
period compared to DD&A of approximately $1.8 million for the period ended
December 31, 2002. The increase in DD&A was due to the increase in the
investment in Consolidated's fleet in 2002 and the increase in the depletion
rate on the oil and gas producing properties. Infinity-Wyoming also recognized a
$3.0 million ceiling write-down of its oil and gas properties based on the full
cost ceiling test for oil and gas properties subject to depletion. As a result,
Infinity recognized an operating loss of $2.3 million for the period ended
December 31, 2003, compared to an operating loss of $1.9 million for the period
ended December 31, 2002.
Interest expense and finance charges increased by $7.0 million to $7.8
million for the year ended December 31, 2003 compared to $0.8 million for the
year ended December 31, 2002. The increase was primarily due to the recognition
of $5.6 million of amortization of loan costs associated with the value of
warrants and options granted in conjunction with obtaining new debt financing
and the amortization of $0.6 million of cash loan costs paid when those same
loans were obtained. Infinity also experienced a $0.9 million increase in
interest expense in the 2003 period compared to the 2002 period due to the
increase in debt outstanding, higher interest rates on certain of the new notes
and a decrease in the amount of interest that was capitalized to undeveloped
properties as Infinity experienced a period of development inactivity during a
significant portion of 2003.
Infinity recognized a deferred income tax benefit of $1.1 million in the
year ended December 31, 2002. The net operating losses generated in the year
ended December 31, 2003 increased Infinity's net deferred tax asset. Due to
uncertainty as to the ultimate utilization of the net operating losses, the net
deferred tax asset has been fully reserved by a valuation allowance as discussed
in Note 11 of the consolidated financial statements. Therefore, Infinity has
reflected no net tax expense or benefit for the year ended December 31, 2003.
Oil Field Services
Sales for the year ended December 31, 2003 increased to $11.6 million from
$8.6 million, net of inter-company eliminations, in the year ended December 31,
2002. Infinity eliminated oil field services sales of $2.1 million from
revenues for sales of services to Infinity-Wyoming during the year ended
December 31, 2002. There were no material inter-company sales in 2003. Sales
of cementing services from Consolidated's Bartlesville, Oklahoma camp increased
by approximately $0.8 million and revenue from fracturing services from that
camp increased by approximately $1.3 million in the year December 31, 2003
compared to the comparable period in 2002. The increase in revenue was
primarily due to an increase in development activity during the second and third
quarters of 2003 as customers moved from the evaluation of their prospects to
the full scale development of their prospects in areas serviced from the
Bartlesville facility. Revenue from cementing services provided from
Consolidated's Gillette, Wyoming facility increased by approximately $1.3
million, due to the Powder River Basin of Wyoming becoming an active coal bed
methane development play again. Crews from the Gillette facility cemented over
400 wells in the twelve months ended December 31, 2003 compared to 78 in the
comparable period of 2002. The following table details the increase in gross
revenue in millions of dollars, before discounts and inter-company eliminations,
for the periods, based on the number and type of core service jobs performed
(due to rounding the sum of the individual amounts presented may not equal the
totals):
OIL FIELD SERVICE STATISTICS
($ IN MILLIONS, BEFORE DISCOUNTS)
2003 2002 CHANGE
----------------- ----------------- ------------------
JOB TYPE JOBS REVENUE JOBS REVENUE JOBS REVENUE
Cementing 1,740 $ 4.8 1,002 $ 3.4 738 $ 1.4
Acidizing 931 1.4 773 1.1 158 0.3
Fracturing 1,011 6.1 981 6.5 30 (0.4)
Discounts and Eliminations (0.7) (2.4) 1.7
--------- --------- ---------
$ 11.6 $ 8.6 $ 3.0
========= ========= =========
The increase in the number of cementing jobs performed reflects the
increase in the number of wells being drilled in eastern Kansas and northeastern
Oklahoma as well as in Wyoming. As well testing is completed on the newly
drilled wells, completion and stimulation activities such as acidizing and
28
fracturing should increase. Management believes that the increase in the number
of wells cemented by Consolidated during the year and the continued high prices
for oil and natural gas are good indicators of future increases in its acidizing
and fracturing activities as well.
The additional activity also led to an increase in the cost of goods sold
of approximately $1.6 million. The increase in cost of goods sold was primarily
due to the increase in materials of approximately $0.7 million, labor expense of
approximately $0.4 million, and an increase in equipment operating costs and
maintenance of approximately $0.3 million. General and administrative expenses
for oil field services for 2003 were comparable to the same period in 2002.
Oil and Gas Production
During the year ended December 31, 2003, Infinity-Wyoming recorded
approximately $1.8 million in revenue on the sale of 57,654 barrels of oil,
(345,924 MCF equivalents) and approximately $4.8 million in revenue on the gas
sales of 1,080,456 MCF from its Pipeline and Labarge projects. Infinity-Wyoming
incurred $1.4 million in lease operating expenses, $0.8 million in production
taxes, and $0.7 million in transportation fees to produce the oil and gas during
the year ended December 31, 2003. The total production expense, transportation
and production taxes of approximately $2.9 million equates to approximately
$2.04 in lifting costs on total MCF equivalents of 1,426,380. Infinity-Wyoming
also incurred $0.8 million in general and administrative costs and $1.6 million
in DD&A expense, or approximately $1.63 per MCF equivalent for the period. The
general and administrative expense included approximately $0.2 million in costs
associated with the detailed negotiations relating to a potential merger, which
negotiations were terminated in May 2003, and the process leading up to those
negotiations in which Infinity solicited and reviewed strategic alternatives.
Excluding these costs, general and administrative expenses for Infinity-Wyoming
were unchanged when compared to the prior year period. DD&A costs for the period
increased by $1.3 million due to the increased depletion rate associated with
the investment in developed oil and gas properties. The higher rate was the
result of the increase in oil and gas production and the decrease in the proved
reserves from 2002 to 2003.
Infinity also recognized a ceiling write-down of its oil and gas properties
under the full cost ceiling test of approximately $3.0 million. Under the full
cost accounting rules of the SEC, Infinity reviews, on a quarterly basis, the
carrying value of its oil and gas properties. Under these rules, capitalized
costs of proved oil and gas properties, as adjusted for estimated asset
retirement obligations, may not exceed the present value of estimated future
revenue at the un-escalated prices in effect as of the end of each fiscal
quarter, after giving effect to Infinity-Wyoming's cash flow hedge positions,
and requires a write-down for accounting purposes if the ceiling is exceeded.
Infinity-Wyoming is also required to evaluate the value of its approved oil and
gas properties and adjust the value to the lower of the cost or market value of
the properties. Due to the limited availability of capital for development of
its properties, the decision not to re-new a portion of Infinity-Wyoming's
leases during 2004, and the condemnation of leases due to geological and
geophysical evaluation, Infinity-Wyoming reclassified approximately $5.0 million
of its investment in oil and gas properties not subject to depletion to subject
to amortization.
During the year ended December 31, 2002, Infinity-Wyoming recorded $0.9
million in revenue on the sale of 42,525 barrels of oil, (255,150 MCF
equivalent) and $1.3 million in revenue on the sale of 648,160 MCF of natural
gas from its Pipeline and Labarge projects. Infinity-Wyoming incurred
approximately $1.1 million in lease operating expenses, $0.2 million in
production taxes and $0.3 million in transportation fees to produce the oil and
gas during the period ended December 31, 2002. The total production expense,
transportation and production taxes of approximately $1.6 million equates to
$1.79 in lifting costs on total MCF equivalents of 903,310. Infinity-Wyoming
also incurred approximately $0.7 million in general and administrative costs and
$0.2 million in DD&A expense, or approximately $1.00 per MCF equivalent for the
period.
29
The following table provides statistical information by field for
production volumes, revenue and production costs for the year ended December 31,
2003 and 2002 (due to rounding and other operating expenses the sum of the
individual amounts presented may not equal the totals):
INFINITY-WYOMING
PRODUCTION STATISTICS
PIPELINE LABARGE TOTAL
------------------ -------------- ------------------
2003 2002 2003 2002 2003 2002
-------- -------- ------ ------ -------- --------
Volumes in 000's:
- -----------------
Oil Sales Volumes (bls) 57.4 42.2 0.3 0.3 57.7 42.5
Gas Sales Volumes (mcf) 1,051.2 607.9 29.0 40.2 1,080.5 648.2
MCF Equivalent 1,395.7 861.2 30.7 42.1 1,426.4 903.3
Values in 000's:
- ----------------
Oil Revenue $1,751.6 $ 899.1 $ 7.2 $ 11.5 $1,758.8 $ 910.6
Gas Revenue $4,701.4 $1,198.9 $129.1 $ 74.8 $4,830.5 $1,273.7
Production Expense $ 573.6 $ 543.3 $819.9 $463.7 $1,393.5 $1,007.0
Production Taxes $ 739.0 $ 227.4 $ 31.2 $ 9.3 $ 770.3 $ 236.7
Transportation Expense $ 737.0 $ 279.2 $ 11.3 $ 14.9 $ 748.3 $ 294.1
Per MCF Equivalent:
- -------------------
Revenue $ 4.62 $ 2.44 $ 4.45 $ 2.05 $ 4.62 $ 2.42
Production Expense $ 0.41 $ 0.63 $26.75 $11.02 $ 0.98 $ 1.11
Production Taxes $ 0.53 $ 0.26 $ 1.02 $ 0.22 $ 0.54 $ 0.26
Transportation Expense $ 0.53 $ 0.32 $ 0.37 $ 0.35 $ 0.52 $ 0.33
The increase in production was primarily a result of the increased
production time for wells in each period. Several wells began production in the
third and fourth quarters of 2002. These wells produced for all of 2003 while
producing for only a short period and at lower volumes during 2002.
Infinity-Kansas recorded net revenue of $0.2 million from its Kansas
properties and operating expenses and production taxes of $0.2 million during
the year ended December 31, 2002. Effective May 1, 2002 Infinity-Kansas sold its
interest in the Owl Creek and Manson properties to West Central Oil, LLC for
cash and a note receivable. Under the full cost method of accounting for oil and
gas properties, Infinity and its subsidiaries did not recognize a gain or loss
on the sale of its oil and gas properties since the sale did not have a material
impact on the relationship between the oil and gas property values and the value
of the reserves associated with those properties. Infinity reduced its
investment in the remaining oil and gas properties by approximately $244,000 on
the sale of the property.
During 2003, production, oil and gas prices, operating expenses and
development expenditures, for Infinity-Wyoming's Labarge and Pipeline projects
have varied from those estimated in reserve reports at December 31, 2002 and
additional geological, geophysical, and engineering data has become available
and been analyzed. Production at Labarge continues to be uneconomic.
Infinity-Wyoming believes that this may be due in part to down-hole operational
problems and as a result in December 2003, Infinity-Wyoming entered into an
agreement with Schlumberger and Red Oak for the further evaluation and
development of the Labarge acreage. Additional information about that agreement
was discussed in the "Overview of Oil and Gas Production Activity" section of
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations." Quantities of proved oil and gas reserves as evaluated by
Netherland Sewell and Associates at December 31, 2003 were substantially less
than our previous estimates which in turn resulted in a higher depletion rate
for the last part of 2003.
The 58% increase in production during 2003 combined with the significant
reduction in proved reserves at January 1, 2004 resulted in a $1.2 million
increase in depletion of developed oil and gas properties in 2003 compared to
the 2002 period. At current production levels of approximately 3,400 MCFE per
day and proved reserves of 8,669,723 MCFE, Infinity-Wyoming will experience
approximately a 14% depletion of its proved oil and gas property investment in
2004.
30
Infinity-Wyoming experienced a $0.3 million increase in administrative
expenses in the year ended December 31, 2003 compared to the year ended December
31, 2002. This increase in administrative expense was primarily legal,
accounting, and consulting fees associated with the detailed negotiations
relating to a potential merger, which negotiations were terminated in May 2003,
and the process leading up to those negotiations in which Infinity solicited and
reviewed strategic alternatives.
Corporate Activities
Infinity and its subsidiaries incurred approximately $2.1 million in
expenses associated with corporate activities during the year ended December 31,
2003 compared to approximately $1.9 million in the period ended December 31,
2002. Included in the $0.2 million increase was approximately $0.3 million in
legal, accounting, and consulting fees associated with the detailed negotiations
relating to a potential merger, which negotiations were terminated in May 2003,
and the process leading up to those negotiations in which Infinity solicited and
reviewed strategic alternatives.
Other Income and Expenses
Other income and expenses was a net expense of $7.6 million for the year
ended December 31, 2003 compared to $0.8 million for the year ended December 31,
2002. Infinity recognized a $7.0 million increase in interest expense of which
$6.0 million was associated with the amortization of financing costs. $5.4
million of the increase in amortization of loan costs was associated with
non-cash compensation related to options and warrants granted in conjunction
with obtaining new debt financing and the remainder of the increase was related
to cash loan costs paid when those same loans were obtained. There was also a
$0.9 million increase in interest expense in the 2003 period compared to the
2002 period due to the increase in debt outstanding, higher interest rates on
certain of the new notes and a decrease in the amount of interest that was
capitalized to undeveloped properties as Infinity experienced a period of
development inactivity during a significant portion of 2003.
Income Tax
Infinity recognized a deferred tax benefit of approximately $1.1 million in
the year ended December 31, 2002. The net operating losses generated in the year
ended December 31, 2003 increased Infinity's net deferred tax asset. Due to
uncertainty as to the ultimate utilization of the net operating losses, the net
deferred tax asset has been fully reserved by a valuation allowance as described
in Note 11 of the consolidated financial statements. Therefore, Infinity has
reflected no net tax expense or benefit for the year ended December 31, 2003.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE
NINE-MONTH TRANSITION PERIOD ENDED DECEMBER 31, 2001
Infinity incurred a net loss of $1.6 million, or $0.22 per fully diluted
share, in the year ended December 31, 2002 compared to net income of $2.5
million, or $0.37 per fully diluted share in the nine-month transition period
ended December 31, 2001.
Infinity's gross profit decreased by $0.8 million to gross profit of $4.5
million in the year ended December 31, 2002 from $5.3 million for the nine-month
transition period ended December 31, 2002. The decrease in gross profit during
the period ended December 31, 2002 compared to the period ended December 31,
2001 was the result of a $1.3 million, or approximately 13%, decrease in oil
field service revenue to $8.6 million from $9.9 million. The decrease in revenue
was partially offset by a $0.5 million, or 10%, decrease in oil field service
cost of services provided (See "Oil Field Services" discussion below). Oil field
service revenue for the year ended December 31, 2002 was reduced by the
elimination of $2.1 million of oil field service sales that were provided to
Infinity-Wyoming by Consolidated for the development of its oil and gas
properties and the cost of services provided was reduced by $1.1 million for
those services provided to Infinity-Wyoming. In the nine-month transition period
ended December 31, 2001, $0.5 million of oil field service revenue and $0.4
million in costs for providing those services were eliminated for inter-company
sales. Additionally, gross profit comparisons were affected by a $0.7 million
increase in production costs and taxes associated with a $0.6 million increase
in revenue from the sale of oil and gas production in the year ended December
31, 2002 compared to the nine-month transition period ended December 31, 2001.
(See "Oil and Gas Production" discussion below).
31
Operating expenses for the year ended December 31, 2002 increased $1.9
million from $2.8 million in the nine month transition period ended December 31,
2001 to $4.6 million in the 2002 period. Infinity and its subsidiaries also
recognized depreciation, depletion and amortization ("DD&A") expense of
approximately $1.8 million during the year ended December 31, 2002, an increase
of approximately $0.7 million for the period compared to DD&A of approximately
$1.1 million for the nine month period ended December 31, 2001. The increase in
DD&A was due to the increase in the investment in Consolidated's fleet, the
increase in depreciation associated with aviation assets and the increase in the
depletion associated with the increased investment in oil and gas properties.
Infinity recognized an operating loss $1.9 million for the period ended December
31, 2002 compared to operating income of $1.5 million for the nine month period
ended December 31, 2001.
Interest expense and finance charges decreased by $1.0 million to $0.8
million for the year ended December 31, 2002 compared to $1.9 million for the
nine month period ended December 31, 2001. The decrease was primarily due to the
increased capitalization of interest expense to undeveloped properties in the
2002 period while in 2001 Infinity had interest expense associated with the
payoff of debt tied to investment stock that was sold during the 2001 period.
During the nine-month transition period ended December 31, 2001, Infinity
recognized a gain of $5.1 million on the sale of 225,000 shares of Evergreen
Resources common stock. The gain on the sale of the Evergreen Resources stock
was partially offset by $1.8 million in interest expense on the loans that were
secured by the securities in the none-month transition period. Costs of $1.0
million were also incurred for unwinding the financing agreements secured by the
Evergreen Resources common stock, which were capitalized to undeveloped
properties of Infinity-Wyoming.
Infinity recognized a deferred income tax benefit of $1.1 million, or 42.4%
of the pre-tax loss, in the year ended December 31, 2002 compared to an income
tax expense of $1.6 million, or 38.5% of pre-tax income in the nine-month
transition period ended December 31, 2001.
Oil Field Services
During the year ended December 31, 2002, Consolidated generated $8.6
million in net revenue and cost of goods sold of $4.6 million compared to $9.9
million in net revenue and cost of goods sold of $5.2 million for the nine-month
transition period ended December 31, 2001. Revenue for the year ended December
31, 2002 on sales to third parties was negatively impacted by environmental
issues in the Powder River Basin of Wyoming which is serviced by the Gillette,
Wyoming camp. Due to the requirement for an Environmental Impact Study across
the Powder River Basin, very few drilling permits were issued for new wells.
Consolidated performed approximately 770 less cement jobs in the 12 month period
ended December 31, 2002 than in the nine-month transition period ended December
31, 2001. Because of the lack of drilling activities revenue from the Gillette,
Wyoming, operations of Consolidated were reduced by $1.9 million from $2.3
million in the nine month transition period ended December 31, 2001 compared to
$0.4 million in the year ended December 31, 2002. Cost of goods sold were
reduced to $0.7 million for the year ended December 31, 2002, a $0.7 million
decrease from $1.4 million in the nine month transition period ended December
31, 2001. Revenue for the period ended December 31, 2002 increased by $0.6
million at Consolidated's facilities in Kansas and Oklahoma while the cost of
goods sold increased by $0.2 million due to the longer period recognized during
2002 compared to the nine-month transition period in 2001. For the year ended
December 31, 2002 Consolidated also generated $2.1 million in revenue and $1.1
million in cost of goods sold related to inter-company sales to Infinity-Wyoming
compared to inter-company sales and cost of goods sold for the nine-month
transition period ended December 31, 2001 of $0.5 million and $0.4 million. The
sales to Infinity-Wyoming are eliminated in the accompanying consolidated
statement of operations. The following table details the change in gross revenue
in millions of dollars, before discounts and inter-company eliminations, for the
periods based on the number and type of core service jobs performed (due to
rounding the sum of the individual amounts presented may not equal the totals):
32
OIL FIELD SERVICE STATISTICS
($ IN MILLIONS, BEFORE DISCOUNTS)
2001
2002 (9 MONTH PERIOD) CHANGE
----------------- ----------------- -------------------
JOB TYPE JOBS REVENUE JOBS REVENUE JOBS REVENUE
Cementing 1,002 $ 3.4 1,781 $ 5.2 (779) $ (1.8)
Acidizing 773 1.1 665 0.9 108 0.2
Fracturing 981 6.5 776 4.6 205 1.9
Discounts and Eliminations (2.4) (0.8) (1.6)
-------- -------- ---------
$ 8.6 $ 9.9 $ (1.3)
======== ======== =========
Oil and Gas Production
During the year ended December 31, 2002, Infinity-Wyoming recorded $0.9
million in revenue on the sale of oil and $1.3 million in revenue on the sale of
natural gas from its Pipeline and Labarge projects. Infinity-Wyoming incurred
approximately $1.0 million in lease operating expenses, $0.2 million in
production taxes and $0.3 million in transportation fees to produce the oil and
gas during the period ended December 31, 2002. The total production expense,
transportation and production taxes of approximately $1.5 million equates to
$1.70 in lifting costs on total MCF equivalents of 903,310. Infinity-Wyoming
also incurred approximately $0.7 million in general and administrative costs and
$0.2 million in DD&A expense, or approximately $1.00 per MCF equivalent for the
period. Infinity-Wyoming began selling oil and gas production from its Pipeline
project and generated $1.1 million in revenue and incurred operating and
transportation expenses of approximately $0.6 million and production taxes of
approximately $0.1 million for the nine-month transition period ended December
31, 2001. Due to the sporadic production associated with the new wells
calculation of a per MCFE lifting or overhead cost for the nine-month transition
period is meaningless. Statistics based on a per MCFE basis for the year ended
December 31, 2002 can be found in the previous discussion comparing the 2003
operations to the 2002 operations.
Infinity-Kansas recorded net revenue of $0.2 million for sales of oil
production from its Kansas properties and operating expenses and production
taxes of $0.2 million during the year ended December 31, 2002. Effective May 1,
2002 Infinity-Kansas sold its interest in the Owl Creek and Manson properties to
West Central Oil, LLC for cash and a note receivable. During the nine-month
transition period ending December 31, 2001, Infinity-Kansas recorded net revenue
of $0.6 million from its Kansas properties and operating expenses and production
taxes of $0.5 million.
Infinity-Wyoming experienced a $0.2 million increase in administrative
expense in the year ended December 31, 2002 compared to the nine-month
transition period ended December 31, 2002. This increase in administrative
expense was primarily related to an increase in costs associated with increased
staffing such as auto expenses, computer services and rent.
Corporate Activities
Infinity and its subsidiaries incurred approximately $1.9 million in
expenses associated with corporate activities during the year ended December 31,
2002 compared to approximately $0.8 million in the nine-month transition period
ended December 31, 2001. Included in the $1.1 million increase in corporate
costs were approximately $0.4 million in increased shareholder maintenance
costs, $0.1 million increase in legal and accounting fees and $0.3 million in
increased staffing costs including salaries, benefits, and travel costs.
Other Income and Expense
Other income and expense was a net expense of $0.8 million for the year
ended December 31, 2002 compared to other income of approximately $2.7 million
for the nine-month transition period ended December 31, 2001. Interest expense
and finance charges decreased by $1.1 million to $0.8 million for the year ended
December 31, 2002 compared to $1.9 million for the nine month period ended
December 31, 2001. The decrease was primarily due to the increased
capitalization of interest expense to undeveloped properties in the 2002 period
and an increased expense associated with the payoff of debt associated with
investment stock that was sold during the 2001 period. During the nine-month
transition period ended December 31, 2001, Infinity recognized a gain of $5.1
million on the sale of 225,000 shares of Evergreen Resources common stock. The
33
gain on the sale of the Evergreen Resources stock was partially offset by $1.8
million in interest expense on the loans that were secured by the securities in
the none-month transition period. Costs of $1.0 million were also incurred for
unwinding the financing agreements secured by the Evergreen Resources common
stock, which were capitalized to undeveloped properties of Infinity-Wyoming.
Infinity recognized a deferred income tax benefit of $1.1 million, or 42.4%
of the pre-tax loss, in the year ended December 31, 2002 compared to an income
tax expense of $1.6 million, or 38.5% of the pre-tax income, in the nine-month
transition period ended December 31, 2001.
LIQUIDITY AND CAPITAL RESOURCES
Infinity's primary sources of liquidity are cash provided by operations,
debt financing, and the equity market. Infinity's primary needs for cash are
for the operation, development, production, exploration and acquisition of oil
and gas properties, for fulfillment of working capital obligations, and for the
operation and development through acquisitions of the oil field service
business.
As of December 31, 2003, the Company had a working capital deficit of $2.2
million compared to a working capital deficit of $3.0 million at December 31,
2002. The increase in the working capital was the result of an increase in
current assets of $0.2 million and a decrease in current liabilities of $0.3
million. The increase in current assets was mainly due to an increase of $0.2
million in oil field service receivables and an increase of $0.1 million in oil
and gas revenue receivables during the period. These increases in receivables
were partially offset by a reduction in cash of approximately $0.1 million from
December 31, 2003 to December 31, 2002. In addition to the increase in current
assets, Infinity also reduced its current liabilities through payment of
accounts payable which resulted in a net decrease of $0.2 million, repayments of
long term debt and refinancing current notes into long term debt which resulted
in a reduction in current liabilities of approximately $0.5 million. These
decreases in current liabilities were partially offset by a $0.4 million
increase in accrued expenses associated with oil and gas revenues payable and
production and severance taxes payable as production increased.
During the year ended December 31, 2003, cash provided by operations was
$2.8 million compared to cash provided by operating activities during the year
ended December 31, 2002 of $0.1 million. The increase is primarily due to the
increase in income/(loss) before non-cash expenses of $3.0 million from a loss
before non-cash expenses of $0.7 million in 2002 to income of $2.3 million in
2003. There was also a $0.2 million decrease in the amount of cash provided as a
result of the changes in operating assets (accounts receivable, inventories and
prepaid expenses) and operating liabilities (accounts payable and accrued
expenses) during the 2003 period compared to the 2002 period. Infinity utilized
cash of approximately $0.5 million due to the change in operating assets and
liabilities in the year ended December 31, 2003 compared to generating $0.8
million in the comparable 2002 period.
During the year ended December 31, 2003, Infinity used $6.9 million in
investing activities by investing $5.7 million in developing oil and gas
properties, $1.1 million in property and equipment, and $0.2 million in other
assets and intangibles. This compares to Infinity investing $14.4 million in oil
and gas properties, $2.7 million in property and equipment, and $0.1 million in
other assets and intangibles during the year ended December 31, 2002. Offsetting
the use of cash in investing activities in 2002 was the receipt of $0.8 million
from the sale of marketable securities and $0.2 million from the sale of
property and equipment and oil and gas properties. As a result, Infinity used a
total of $16.2 million in investing activities during the year ended December
31, 2002.
Infinity received $11.5 million from financing activities and $0.8 million
from the exercise of options which was used to pay $8.4 million in outstanding
debt, to pay interest on convertible notes, and development costs related to its
oil and gas properties during the year ended December 31, 2003. During the
comparable period of 2002, Infinity received $21.7 million from financing
activities (including the sale of the 7% convertible notes) and $1.9 million
from the exercise of options which was used to pay $7.4 million on outstanding
debt and development exploration and development costs on its oil and gas
properties.
In January 2002, Consolidated established a three year term loan
collateralized by substantially all of its oil field service equipment, a
revolving line of credit secured by the eligible receivables of Consolidated and
a $1.0 million capital expenditures line of credit with LaSalle Bank, N.A. The
notes bear interest at 1% over the prime rate with the notes due January, 2005.
At December 31, 2003 Consolidated owed $1.4 million on the notes to LaSalle
34
Bank. Principal payments of $80,626 and $15,626 are made monthly on the term
loan and capital expenditures loan respectively. Consolidated expects to utilize
the excess equity in its equipment that secures this loan to expand its
borrowing base in order to fund future equipment needs and to provide working
capital to the parent and affiliates.
On July 3, 2003 Infinity borrowed $3.85 million to pay outstanding
payables, $1.0 million outstanding on the 12% bridge loan notes that were
issued in April 2003, and to pay for completion work on existing gas wells.
These notes were repaid from the proceeds of the U.S. Bank National Association
Facility discussed below.
On September 4, 2003, Infinity-Wyoming established a Secured Revolving
Borrowing Base Credit Facility ("Facility") whereby U.S. Bank National
Association ("U.S. Bank") will provided debt financing. The Facility provides
for funding of up to $25.0 million. The total amount made available to
Infinity-Wyoming under the Facility was based on an initial borrowing base
determination which was in turn based on the volume of oil and gas production
expected, the term and price of hedging contracts in place, and the costs
associated with producing the oil and gas and associated general and
administrative expense. The facility is subject to semi-annual borrowing base
determinations based on the same criteria as the original determination.
Infinity-Wyoming and U.S. Bank will each have the option to request one
additional re-determination during each calendar year. U.S. Bank has the sole
discretion on increasing the borrowing base if the semi-annual determination
indicates that there is additional borrowing base available. The initial amount
made available under the facility and drawn by the Company was $5.5 million.
Interest on the Facility accrues and is payable monthly at the rate of the U.S.
Bank Prime Rate plus 100 basis points. Interest is currently 5% per annum on the
Facility. The initial advance on the Facility was used to repay $3.85 million in
bridge loans issued in July 2003, $0.75 million notes issued in January, 2003,
initial loan costs and legal fees associated with the negotiation and closing of
the Facility, property development costs, and working capital. Subsequent to
December 31, 2003 Infinity-Wyoming re-paid $0.4 million of the debt associated
with this facility and requested a $0.3 million letter of credit to secure our
gas marketing contracts. The loan is subject to various restrictive and
financial covenants. At December 31, 2003, the Company was in violation of the
working capital covenant. Subsequent to December 31, 2003, the Company was
granted a waiver of the violation as of December 31, 2003 and through April 30,
2004 at which time management believes it will be in compliance and remain in
compliance for the remainder of the year. Infinity's anticipated cash needs for
2004 do not contemplate any acceleration of all or part of the payment of the
outstanding balance due to a future violation, if any.
At December 31, 2003, Infinity had $2.8 million of 8% Subordinated
Convertible Notes outstanding. During the year ended December 31, 2003 the
holders of approximately $1.5 million of the notes, which are due in June 2006,
converted their notes to common stock. Subsequent to December 31, 2003 an
additional $0.1 million of the notes were converted, leaving approximately $2.7
million in notes outstanding at March 31, 2004. These notes accrue approximately
$19,000 in interest monthly which is payable in June and December. There are no
payment obligations, other than interest, on the notes until June 2006.
Subsequent to December 31, 2003, in accordance with the provisions of the notes,
the conversion price of the notes was adjusted to $4.88 per share of common
stock. The original conversion price of $5.00 per share was adjusted in
accordance with anti-dilution provisions of the note agreement upon the private
placement of 1,000,000 shares of Infinity common stock for $4.00 per share.
As of December 31, 2003 Infinity had $11.2 million in 7% Subordinated
Convertible Notes Payable outstanding. Infinity issued $379,000 in additional
notes in lieu of cash to pay accrued interest on the outstanding notes on
October 15, 2003. There are no payment obligations, other than interest, on the
notes until April of 2007. Including the additional $379,000 in notes issued on
October 15, 2003, interest on these notes accrues at approximately $65,500 per
month and is due in April and October. Due to current cash constraints, Infinity
expects that it will issue additional notes in lieu of a cash interest payment
on April 15, 2004. Subsequent to December 31, 2003 in accordance with the
provisions of the notes, the conversion price of the notes was adjusted to
$8.067 per share of common stock. The original conversion price of $8.625 per
share was adjusted in accordance with anti-dilution provisions of the note
agreement upon the private placement of 1,000,000 shares of Infinity common
stock for $4.00 per share.
In November 2002, Infinity borrowed $3.0 million from a stockholder in
order to pay current payables. The bridge loan, which was originally due January
5, 2004 and had a 5.25% interest rate, was extended until January 30, 2005 and
the interest rate was adjusted to 7% in September 2003. Subsequent to December
31, 2003, Infinity repaid $1,250,000 of this loan with $750,000 in cash and
125,000 shares of Infinity common stock valued at $4.00 per share. Interest on
the loan is paid monthly with current payments being approximately $10,000 per
month. In conjunction with the amendments to extend the due date, waive rights
to early payment and subordinate to other lenders, Infinity issued options to
purchase 375,000 shares of Infinity, Inc. common stock at $8.75 per share for
five years during 2003.
35
Infinity, Inc. and its subsidiaries owe approximately $4.0 million for real
estate and equipment loans secured by assets of Infinity and its subsidiaries.
These notes mature in one to eighteen years and bear interest from 6.0% to 9.50%
and have monthly payments of approximately $34,800. One of the notes requires a
payment of 5% of the outstanding loan balance each January which resulted in a
payment of approximately $123,000 in January of 2004.
Infinity received proceeds from the issuance of common stock, upon the
exercise of 146,169 options, of $0.8 million during the year ended December 31,
2003.
Beginning in June of 2001 with the issuance of the 8% Subordinated
Convertible Notes, Infinity has utilized stock options and warrants as an
inducement to lenders to lend money to Infinity and its subsidiaries. The
options and warrants are non-cash compensation and are valued using the
Black-Scholes valuation model. The value is recorded as capitalized loan costs
and amortized as interest expense using the effective interest method. When a
loan is repaid, the loan costs associated with that loan are fully amortized in
that period. Infinity has capitalized $7.0 million, $5.0 million, and $0.9
million of non-cash compensation during the years ended December 31, 2003 and
2002, and the nine month period ended December 31, 2001, respectively. In
addition to the non-cash compensation, Infinity has capitalized $0.5 million,
$1.0 million, and $0.7 million in cash loan costs in the respective periods
which are also amortized to interest expense using the effective interest
method. During the period ended December 31, 2003, Infinity recognized interest
expense for the amortization of non-cash loan costs of $5.4 million and of cash
loan costs of $0.6 million. Infinity also capitalized $2.7 million in
amortization to undeveloped oil and gas properties as capitalized interest.
Subsequent to December 31, 2003, Infinity repaid $1.25 million, or 42%, of
$3.0 million loans due January 5, 2005. As a result of the partial payment,
Infinity will amortize 42%, or $0.7 million, of the remaining unamortized loan
costs, as interest expense in January, 2004. The remaining unamortized loan
costs will be amortized using the effective interest method. Infinity expects to
recognize approximately $0.2 million per month in interest expense during 2004
in association with amortization of capitalized loan costs based on loans
currently outstanding.
In the first quarter of 2004, Infinity-Wyoming completed six wells drilled
during the fourth quarter of 2003 and acquired an additional 49% working
interest in two existing wells and 960 acres of undeveloped leasehold adjacent
to the Pipeline project at a cost of approximately $1.0 million. With the
acquisition, Infinity-Wyoming assumed operations of the wells.
In the first quarter of 2004, Schlumberger began re-completion activities
on two of the original Riley Ridge wells on the Labarge project by perforating
additional areas of the well bore and re-fracing the wells. Schlumberger also
began completion activities on one of the wells on the Thompson acreage that had
been drilled in the fourth quarter of 2002. Depending on the results of these
activities, Infinity-Wyoming, through the agreement, could drill an additional
five to six wells on the Thompson acreage during 2004. Infinity-Wyoming also
expects to complete the Environmental Impact Study ("EIS") on the Labarge
acreage during the fourth quarter of 2004 or early in 2005. Management believes
that it will require between $4.0 million and $4.5 million in capital to pay for
the un-risked services for the drilling and completion work on wells drilled in
2004, if any, and the completion of the EIS.
Infinity anticipates it will incur approximately $1.6 million in interest
on its current outstanding notes, incur $1.0 million in other corporate usage,
and an additional $0.8 million related to the Nicaragua leases (when finalized)
during 2004.
Infinity, Inc. issued 1,000,000 shares of common stock in January of 2004
in a private placement for which it received net proceeds after offering costs
of approximately $3.9 million. The proceeds of this offering, after making a
$750,000 payment on notes, are being used to pay costs associated with the
completion of the Pipeline wells drilled in the fourth quarter of 2003, to pay
for the un-risked services associated with the Labarge well completion
activities and for working capital.
Consolidated expects to generate approximately $3.6 million in operating
cash flow from the oil field service business through the next twelve months.
The cash flow from this business segment is expected to be driven by an increase
in business in the Powder River Basin of Wyoming as drilling activity increases
as a result of the completion of the Powder River environmental impact study and
an increase in oil field service operations in eastern Kansas and northeastern
Oklahoma as customers move forward with development activities on leases that
will be expiring within the next two years.
36
Infinity-Wyoming is also expected to generate approximately $4.0 to $5.0
million in operating cash flow from oil and gas production operations during the
same period. Infinity-Wyoming estimates production to be approximately 3,500 MCF
per day of gas and approximately 120 barrels of oil per day through December
2004. Infinity-Wyoming has a contract in place to sell the first 3,500 MMBTU per
day at $4.71 per MMBTU through March, 2004, 2,000 MMBTU per day for $4.40 per
MMBTU through March 2005, and 2,000 MMBTU per day through March 2006. The
volumes represented by these contracts are subject to a $0.55 per MCF gathering
and transportation fee. Infinity utilized a Henry Hub futures price of $5.67 on
the date of its estimate of expected 2004 operating cash flow, less $0.70
estimated pricing differential for location and $0.55 gathering and
transportation fee for calculating the revenue for April 2004 until December
2004 on estimated volumes in excess of the contracted volumes. Infinity-Wyoming
also used an average oil price of $34.42 based on a NYMEX strip price less the
$0.75 contract differential. Production expenses and overhead are expected to
comparable in 2004 to what was experienced in 2003.
The following amounts represent management's current estimates of certain
expenses and sources of cash, from which actual expenditures and cash may vary
materially. There can be no assurance that Infinity will not be required to
obtain additional external financing in 2004. It does not include the Nicaragua
lease which is not currently completed, nor acquisitions, capital expenditures,
or other development and exploration activities that are not currently
completed:
Recap of Expected Minimum Cash Requirements
For the Year Ending December 31, 2004
(In millions)
Current working capital deficit $ 2.2
Pipeline development and acquisition 1.0
Labarge development and exploration 3.7
Labarge environmental impact study 0.3
Interest on notes 1.6
Corporate cash usage 1.3
Lease rental and farm out agreement 0.1
--------
Total requirements 10.2
Sources of Cash
Consolidated operations 3.6
Infinity-Wyoming operations 4.0
Anticipated issuance of notes in lieu of
cash payment of interest 0.8
Proceeds available from equity placement
net of costs and payment of long-term debt 3.2
--------
Total sources $ 11.6
--------
Potential Surplus $ 1.4
========
Depending on its success in negotiations and the availability of
acquisition candidates, Consolidated anticipates making strategic acquisitions
of approximately $1.2 million to $2.0 million over the next year and having
capital expenditures of approximately $1.0 million related to equipment and
facilities. Management is also negotiating to increase its borrowings through
its existing facility with LaSalle Bank or a new facility with LaSalle Bank.
Consolidated believes it will be able to borrow an additional $1.5 million on
this facility, which, along with credit available to Consolidated through local
sources and vendors will be sufficient to meet Consolidated's anticipated
capital expenditure needs, including acquisitions, of approximately $3.0
million.
37
In addition to the acquisition in 2004 discussed above, Infinity-Wyoming
expects to drill two wells on the newly acquired acreage during 2004 at a cost
of approximately $0.5 million. To the extent the potential surplus from
operations is not available, Infinity will be required to obtain additional debt
or equity financing to complete these wells.
Infinity-Wyoming could potentially have capital expenditures, subject to
permitting requirements, of up to approximately $10.6 million as follows:
- drill and complete eight wells in the Pipeline field for the
development of reserves at a cost of $3.8 million;
- complete five additional production wells and two disposal wells
and install the related facilities on the Labarge acreage at a
cost of approximately $4.2 million;
- drill and complete an exploratory well and one disposal well and
the related facilities on the Sand Wash Basin at a cost of $1.6
million;
- drill and complete an exploratory well and one disposal well and
the related facilities on the Antelope acreage at a cost of $1.0
million.
In order to fund Infinity-Wyoming's potential additional capital
expenditures of $10.6 million, Infinity-Wyoming will be required to pursue
funding through the increase of the borrowing base on the U.S. Bank Facility or
other conventional bank financing, the forward sale of its oil and gas
production, partnerships or strategic alliances for the development of its
undeveloped acreage or through the public or private equity or debt market
pursued by the parent. The amount of progress that Infinity-Wyoming will be
able to make on the development of its properties will be dependent upon its
ability to obtain the proper permits for the development and to fund the
development. Obtaining permits and sufficient funding to meet these additional
capital expenditures cannot be assured.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Infinity believes the following critical accounting policies affect its
more significant judgments and estimates used in the preparation of its
consolidated financial statements.
Reserve Estimates
Infinity's estimated quantities of proved reserves at December 31, 2003
were prepared by independent petroleum engineers Netherland, Sewell and
Associates, Inc. and at December 31, 2002 and 2001 were prepared by independent
petroleum engineers Wells Chappell and Company, Inc. Infinity's estimates of
oil and natural gas reserves, by necessity, are projections based on geologic
and engineering data, and there are uncertainties inherent in the interpretation
of such data as well as the projection of future rates of production and the
timing of development expenditures. Reserve engineering is a subjective process
of estimating underground accumulation of oil and natural gas that are difficult
to measure. The accuracy of any reserve estimate is a function of the quality
of available data, engineering and geological interpretation and judgment.
Estimates of economically recoverable oil and natural gas reserves and future
net cash flows necessarily depend upon a number of variable factors and
assumptions, such as historical production from the area compared with
production from other producing areas, the assumed effects of regulations by
governmental agencies and assumptions governing future oil and natural gas
prices, future operating costs, severance, ad-valorem and excise taxes,
development costs and work-over and remedial costs, all of which may in fact
vary considerably from actual results. For these reasons, estimates of the
economically recoverable quantities of oil and natural gas attributable to any
particular group of properties, classifications of such reserves based on risk
of recovery, and estimates of the future net cash flows expected there from may
vary substantially. Any significant variance in the assumptions could
materially affect the estimated quantity and value of the reserves, which could
affect the carrying value of Infinity's oil and gas properties and the rate of
depletion of the oil and gas properties. Actual production, revenues and
expenditures with respect to Infinity's reserves will likely vary from
estimates, and such variances may be material.
38
Oil and Gas Properties, Depreciation and Full Cost Ceiling Test
Infinity follows the full-cost method of accounting for oil and gas
properties. Under this method, all productive and nonproductive costs incurred
in connection with the exploration for and development of oil and gas reserves
are capitalized. Such capitalized costs include lease acquisition, geological
and geophysical work, delay rentals, drilling, completing and equipping oil and
gas wells, and salaries, benefits and other internal salary-related costs
directly attributable to these activities. The capitalized costs are amortized
over the life of the reserves associated with the assets with the amortization
being expensed as depletion in the period that the reserves are produced. This
depletion expense is calculated by dividing the period's production volumes by
the estimated volume of reserves associated with the investment and multiplying
the calculated percentage by the capitalized investment. Costs 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.
If the net investment in oil and gas properties less asset retirement
obligations, exceeds an amount equal to the sum of (1) the standardized measure
of discounted future net cash flows from proved reserves including the effect of
cash flow hedges, and (2) the lower of cost or fair market value of properties
in process of development and unexplored acreage, the excess is charged to
expense as additional depletion. Infinity is required to review the carrying
value of its oil and gas properties each quarter under the full cost accounting
rules of the Securities and Exchange Commission. Under these rules, capitalized
costs of proved oil and gas properties, less asset retirement obligations, may
not exceed the present value of estimated future net revenues from proved
reserves, discounted at 10%. Application of the ceiling test generally requires
pricing future revenue at the un-escalated prices in effect as of the last day
of the quarter, including the effects of cash flow hedges, and requires a
write-down for accounting purposes if the ceiling is exceeded. Unproved oil and
gas properties are not amortized, but are assessed for impairment either
individually or on an aggregated basis using a comparison of the carrying values
of the unproved properties to net future cash flows. Infinity recognized a
ceiling write down of $2,975,000 during 2003. A decline in prices received for
oil and gas sales or an increase in operating costs subsequent to December 31,
2003 or reductions in estimated economically recoverable quantities could result
in a requirement that Infinity recognize an additional ceiling write-down of oil
and gas properties in a future period. Normal dispositions of oil and gas
properties are accounted for as adjustments of capitalized costs, with no gain
or loss recognized.
Property, Equipment And Depreciation
Equipment utilized in the oil field service business and to support
operations on Infinity's oil and gas properties is stated at cost. This
equipment is depreciated using the straight-line method over the estimated
useful lives of the assets of three to 30 years.
Valuation of Tax Asset
The deferred tax assets and liabilities represent the future tax return
consequences of those temporary differences, which will either be taxable or
deductible when the assets and liabilities are recovered or settled. The
measurement of deferred tax assets is reduced, if necessary, by the amount of
any tax benefits that are not expected to be realized based on available
evidence that is more likely than not to be realized in the form of a deferred
tax valuations allowance.
OFF-BALANCE SHEET ARRANGEMENTS
Infinity has no material off-balance sheet arrangements.
CONTRACTUAL OBLIGATIONS
Infinity's contractual obligations, including those of its consolidated
subsidiaries, include long-term debt, equipment and operating leases and other
non-current obligations. The following table lists Infinity's significant
contractual obligations at December 31, 2003.
- -------------------------------------------------------------------------------------------------
Payments Due by Period
- -------------------------------------------------------------------------------------------------
Contractual Obligations Total Less than 1-3 years 3-5 years After
1 year 5 years
- -------------------------------------------------------------------------------------------------
(in thousands)
- -------------------------------------------------------------------------------------------------
7% and 8% subordinated convertible notes $13,977 $ - $ 2,793 $ 11,184 $ -
- -------------------------------------------------------------------------------------------------
Revolving credit facilities 5,596 96 5,500 - -
- -------------------------------------------------------------------------------------------------
Term loans 5,215 1,619 1,224 451 1,921
- -------------------------------------------------------------------------------------------------
Note payable - related party 3,000 - 3,000 - -
- -------------------------------------------------------------------------------------------------
Asset retirement obligations 521 - - - 521
- -------------------------------------------------------------------------------------------------
Office lease 334 89 184 61 -
- -------------------------------------------------------------------------------------------------
Equipment leases 232 61 171 - -
- -------------------------------------------------------------------------------------------------
Non-current production and property taxes 230 230 - - -
------- ---------- ---------- ----------- --------
- -------------------------------------------------------------------------------------------------
Total contractual obligations $29,105 $ 2,095 $ 12,872 $ 11,696 $ 2,442
======= ========== ========== =========== ========
- -------------------------------------------------------------------------------------------------
For purposes of this table, Infinity is assuming that the holders of the 7% and
8% subordinated convertible notes will not exercise the conversion feature. In
addition periodic interest payments required under the credit facilities and the
7% and 8% subordinated convertible notes are not reflected in the table.
This table does not reflect the obligations associated with the gas gathering
contract that Infinity-Wyoming has related to its Pipeline property. That
contract is subject to certain delivery commitments that Infinity-Wyoming has
not met. However, the gas gatherer has also not been able to supply the
additional system capacity to allow Infinity-Wyoming to meet its delivery
obligations and, therefore, discussions are under way to amend the contract to
volumes that are consistent with deliveries.
Recently Issued Accounting Pronouncements
Proposed FASB Staff Positions ("FSP") No. FAS 141-a and FAS 142-a were
recently issued with a comment deadline of April 16, 2004. These proposed FSPs
would amend SFAS No. 141, "Business Combinations" and No. 142, "Goodwill and
Intangible Assets" in order to resolve a recent reporting issue. There is an
inconsistency between the recent Financial Accounting Standards Board ("FASB")
consensus that such mineral rights should be considered tangible assets for
accounting purposes and the characterization of mineral rights as intangible
assets in SFAS No. 141 and No. 142. Under the proposed FSPs, mineral rights
would continue to be considered tangible assets for accounting purposes with
disclosure of the amount of the mineral rights disclosed on the balance sheet or
in the notes to the consolidated financial statements.
Assuming that the proposed FSPs are finalized, the guidance would be
effective for the quarter ended June 30, 2004 and prior period amounts would
also need to be disclosed in the consolidated financial statements. At December
31, 2003 and 2002, the Company has included $9,500,000 and $7,500,000, including
capitalized interest, in oil and gas properties in the accompanying consolidated
balance sheets of which approximately $3,972,000 and $684,000 respectively are
subject to amortization.
39
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Infinity's major market risk exposure is in the pricing applicable to its
oil and gas production. Realized pricing is primarily driven by the prevailing
price for crude oil and spot prices applicable to Infinity's United States crude
oil and natural gas production. Historically, prices received for gas
production have been volatile and unpredictable. Pricing volatility is expected
to continue. Gas price realizations ranged from a low of $3.27 to a high of
$5.51 per MCF during the year ended December 31, 2003. Oil price realizations
ranged from a low of $27.37 per barrel to a high of $35.08 per barrel during the
period.
Infinity-Wyoming periodically enters into hedging activities on a portion
of its projected natural gas production in accordance with its Energy Risk
Management Policy. These activities are intended to support cash flow at certain
levels in order to manage Infinity-Wyoming's cash flow by reducing the exposure
to gas price fluctuations. Realized gains or losses from Infinity-Wyoming's cash
flow risk management activities are recognized in gas production revenues. In
the year ended December 31, 2003, the effect of Infinity-Wyoming hedging its gas
production compared to if it had sold the gas on the spot market was an increase
in revenue of approximately $133,000. At December 31, 2003 Infinity-Wyoming had
a derivative asset of approximately $97,000.
ITEM 8. FINANCIAL STATEMENTS.
The consolidated financial statements and supplementary information filed
as part of this Item 8 are listed under Part IV, Item 15, "Exhibits, Financial
Statement Schedules, and Reports on Form 8-K" and contained in this Form 10-K at
page F-1.
ITEM 9. CHANGE IN INDEPENDENT ACCOUNTANTS
Infinity's previous auditor, Sartain Fischbein & Co., was dismissed as
our independent auditor on January 24, 2002. The reports on Infinity's financial
statements for the fiscal years ended March 31, 2001 and 2000 prepared by
Sartain Fischbein & Co. did not contain any adverse opinion or disclaimer of
opinion nor were they qualified as to audit scope or accounting principles. In
connection with the prior audits for the fiscal years ended March 31, 2001 and
2000, and from March 31, 2001 to January 25, 2002, there were no disagreements
with Sartain Fischbein & Co. on any matter of accounting principles or
practices, financial statement disclosure or auditing scope or procedure. The
decision to change accountants was not considered separately by Infinity's Audit
Committee but each member of the Audit Committee approved the decision.
Effective January 24, 2002, Ehrhardt Keefe Steiner & Hottman P.C. was engaged as
the Company's independent auditor.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
Infinity's Chief Executive Officer and the Chief Financial Officer
evaluated the effectiveness of Infinity's disclosure controls and procedures as
of December 31, 2003 in accordance with Rule 13a-15 under the Exchange Act.
Based on their evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that Infinity's disclosure controls and procedures enable
Infinity to:
- record, process, summarize and report within the time periods
specified in the Security and Exchange Commission's rules and forms,
information required to be disclosed by Infinity in the reports it
files or submits under the Exchange Act; and
- accumulate and communicate to management, as appropriate to allow
timely decisions regarding required disclosure, information required
to be disclosed by Infinity in the reports that it files or submits
under the Exchange Act.
40
Changes in internal control over financial reporting
There were no changes in Infinity's internal control over financial
reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred
during the quarter ended December 31, 2003 that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
41
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors of Infinity is incorporated by reference to
the section entitled "Election of Directors" in our definitive proxy statement
to be filed with the Securities and Exchange Commission pursuant to Regulation
14A in connection with the 2004 annual meeting of shareholders (the "Proxy
Statement").
ITEM 11: EXECUTIVE COMPENSATION
Reference is made to the information set forth under the caption "Executive
Compensation and Other Information" in our proxy statement, which information
(except for the report of the board of directors on executive compensation and
the performance graph) is incorporated by reference in this report on Form 10-K.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Reference is made to the information set forth under the caption "Security
Ownership of Principal Shareholders and Management" in our proxy statement,
which information is incorporated by reference in this report on Form 10-K.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is made to the information contained under the caption "Certain
Transactions" contained in our proxy statement, which information is
incorporated by reference in this report on Form 10-K.
ITEM 14: PRINCIPAL ACCOUNTANT FEES AND SERVICES
Reference is made to the information contained under the caption
"Appointment of Independent Accountant" contained in our proxy statement, which
information is incorporated by reference in this report on Form 10-K.
42
PART IV
ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report on Form 10-K or incorporated by
reference.
(1) Our consolidated financial statements are listed on the "index to
Financial Statements" on Page F-1 to this report.
(2) Financial Statement Schedules (omitted because not applicable or
not required. Information is disclosed in the notes to the
financial statements).
(3) The following exhibits are filed with this report on Form 10-K or
incorporated by reference.
EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------------------------------------------------------
3.1 Articles of Incorporation and Bylaws (1)
3.2 Articles and Amendment to Articles of Incorporation (1)
4.1 Form of 8% Convertible Subordinated Note (1)
4.2 Form of Trust Indenture for 8% Convertible Subordinated Notes with the
Wilmington Trust Company (3)
4.3 Form of Placement Agent Warrant in connection with 8% Convertible
Subordinated Notes (1)
4.4 Trust Indenture for 7% Convertible Subordinated Notes with Wilmington
Trust Company (1)
4.5 Form of Placement Agent Warrants in connection with 7% Convertible
Subordinated Notes (4)
4.6 Form of Warrant Agreement for 12% Bridge Note Financing (1)
10.1 Stock Option Plan (1)
10.2 1999 Stock Option Plan (2)
10.3 Assignment of Participation Agreement, Assignment of Participation
Agreement, Conveyance, and Bill of Sale between Infinity Oil and Gas,
Inc. and Infinity Oil and Gas of Wyoming, Inc. (2)
10.4 Participation Agreement between Wold Oil Properties, Inc. And
Infinity Oil and Gas, Inc. (2)
10.5 Assignment of Oil and Gas Leases, Operating Rights and Record Title,
Conveyance and Bill of Sale between Infinity Oil and Gas, Inc. And
Infinity Oil and Gas of Wyoming, Inc. (2)
10.6 Joint Operating Agreement, Manson Lease, between Verde Oil Company
and Infinity Oil and Gas of Kansas, Inc. (2)
10.7 2000 Stock Option Plan (1)
10.8 2001 Stock Option Plan (6)
10.9 Purchase and Sale Agreement dated November 3, 2000 between Antelope
Energy Company, LLC, Coyote Exploration Company and Melange
Associates, Inc. and Infinity Oil and Gas of Wyoming, Inc. (6)
10.10 Loan and Security Agreement between LaSalle Bank N.A. and
Consolidated Oil Well Services, Inc. and related guaranties (1)
10.11 2002 Stock Option Plan (7)
10.12 2003 Stock Option Plan (8)
10.13 Form of Assignment of Overriding Royalty Interest for 12% Bridge
Note Financing (5)
10.14 Credit agreement dated as of September 4, 2003 between Infinity
Oil and Gas of Wyoming, Inc. and U.S. Bank National Association (5)
10.15 Joint Value Enhancement Agreement dated December 3, 2003 among
Infinity Oil and Gas of Wyoming, Inc., Schlumberger Technology
Corporation and Red Oak Capital Management LLC*
21 Subsidiaries of the Registrant
23.1 Consent of Ehrhardt, Keefe, Steiner & Hottman, P.C.
23.2 Consent of Netherland Sewell and Associates, Inc.
31.1 Certification of Chief Executive Officer of Periodic Report Pursuant
to Rule 13a_14(a) and Rule 15d-14(a) (Section 302 of the
Sarbanes-Oxley act of 2002).
31.2 Certification of Chief Financial Officer of Periodic Report
Pursuant to Rule 13a_14(a) and Rule 15d-14(a) (Section 302
of the Sarbanes-Oxley act of 2002).
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
43
Section 1350 (Section 906 of the Sarbanes-Oxley Act of 2002)
32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350 (Section 906 of the Sarbanes-Oxley Act of 2002)
____________________
(1) Incorporated by reference to our Registration Statement (No. 33-17416-D)
(2) Incorporated by reference to our Annual Report on Form 10-KSB for the
fiscal year ended March 31, 2000.
(3) Incorporated by reference to our Registration Statement on Form S-3 (File
No. 333-69292).
(4) Incorporated by reference to our Registration Statement on Form S-3 (File
No. 333-96671).
(5) Incorporated by reference to our Quarterly Report on Form 10-QSB for the
quarter ended September 30, 2003.
(6) Incorporated by reference to our Annual Report on Form 10-KSB for the
fiscal year ended March 31, 2001.
(7) Incorporated by reference to our Annual Report on Form 10-KSB for the
transition period ended December 31, 2001.
(8) Incorporated by reference to our Annual Report on Form 10-KSB for the
fiscal year ended December 31, 2002.
* Portions of this exhibit have been omitted pursuant to a request for
confidential treatment.
(b) Reports on form 8-K.
Infinity filed a report on Form 8-K dated December 10, 2003 in
which Infinity reported under Item 5 an agreement with Schlumberger
Technology Corporation and Red Oak Capital Management LP to develop
Infinity's Labarge Property.
Infinity filed a report on Form 8-K dated November 14, 2003 in
which Infinity reported under Item 7 and Item 12 the financial
results for the third quarter of 2003.
44
SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, Infinity has duly caused this Report to be
signed on its behalf by the undersigned thereunto duly authorized.
INFINITY, INC.
Dated: April 14, 2004 By: /s/ Stanton E. Ross
-------------------------------
Stanton E. Ross, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of Infinity
and in the capacities and on the dates indicated:
Signature Capacity Date
--------- -------- ----
/s/ Stanton E. Ross President, Treasurer April 14, 2004
- --------------------------- (Principal Executive
Stanton E. Ross Officer) and Director
/s/ Jon D. Klugh Chief Financial April 14, 2004
- --------------------------- Officer and Secretary
Jon D. Klugh (Principal Financial and
Accounting Officer)
/s/ Robert O. Lorenz Director April 14, 2004
- ---------------------------
Robert O. Lorenz
/s/ Leroy C. Richie Director April 14, 2004
- ---------------------------
Leroy C. Richie
/s/ O. Lee Tawes Director April 14, 2004
- ---------------------------
O. Lee Tawes
45
TABLE OF CONTENTS
-----------------
Page
----
Independent Auditors' Report. . . . . . . . . . . . . . . . . . . . . . F-2
Financial Statements:
Consolidated Balance Sheets - December 31, 2003 and 2002. . . . . F-3
Consolidated Statements of Operations - For the Years Ended
December 31, 2003 and 2002 and the Nine Months Ended December 31,
2001. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-4
Consolidated Statements Changes in Stockholders' Equity - For the
Years Ended December 31, 2003 and 2002 and the Nine Months
Ended December 31, 2001 . . . . . . . . . . . . . . . . . . . . . F-5
Consolidated Statements of Cash Flows - For the Years Ended
December 31, 2003 and 2002 and the Nine Months Ended
December 31, 2001 . . . . . . . . . . . . . . . . . . . . . . . . F-7
Notes to Consolidated Financial Statements. . . . . . . . . . . . . . . F-9
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Infinity, Inc. and Subsidiaries
Chanute, Kansas
We have audited the consolidated balance sheets of Infinity, Inc. and
Subsidiaries as of December 31, 2003 and 2002 and the consolidated statements of
operations, changes in stockholders' equity and cash flows for the years ended
December 31, 2003 and 2002 and the nine months ended December 31, 2001. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
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 audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall consolidated 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 condition of Infinity, Inc. and
Subsidiaries, as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for the years ended December 31, 2003 and 2002
and the nine months ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, effective
January 1, 2003, the Company changed its method of accounting for asset
retirement obligations and effective April 1, 2001, the Company changed its
method of accounting for derivative instruments.
Ehrhardt Keefe Steiner & Hottman PC
April 8, 2004
Denver, Colorado
F-2
INFINITY INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
--------------------------
2003 2002
------------ ------------
ASSETS
Current assets
Cash and cash equivalents $ 727,134 $ 867,017
Accounts receivable, less allowance for doubtful
accounts of $80,000 (2003) and $25,000 (2002) 1,766,642 1,514,159
Inventories 351,197 340,217
Prepaid expenses and other 222,625 257,575
Derivative asset 97,624 -
------------ ------------
Total current assets 3,165,222 2,978,968
Property and equipment, at cost, less accumulated depreciation 10,169,159 10,315,068
Oil and gas properties, using full cost accounting
net of accumulated depreciation, depletion,
amortization and write-down
Subject to amortization 23,446,343 19,107,427
Not subject to amortization 12,815,834 13,176,850
Intangible assets, at cost, less accumulated amortization 3,952,989 5,299,881
Note receivable, less current portion 1,580,742 1,597,053
Other assets, net 135,989 655,022
------------ ------------
Total assets $55,266,278 $53,130,269
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Current portion of long-term debt $ 1,762,777 $ 2,227,195
Accounts payable 2,645,277 2,875,900
Accrued expenses 966,769 889,894
------------ ------------
Total current liabilities 5,374,823 5,992,989
Long-term liabilities
Production taxes payable 229,889 79,632
Asset retirement obligations 520,638 -
Long-term debt, less current portion 9,252,872 4,464,156
8% subordinated convertible notes payable 2,793,000 4,243,000
7% subordinated convertible notes payable 11,184,000 12,540,000
Note payable - related party 3,000,000 3,000,000
------------ ------------
Total liabilities 32,355,222 30,319,777
------------ ------------
Commitments and contingencies
Stockholders' equity
Common stock, par value $.0001, authorized
300,000,000 shares, issued and outstanding
8,204,032 (2003) and 7,558,462 (2002) shares 820 756
Additional paid-in-capital 32,720,904 22,870,449
Accumulated other comprehensive income (loss) 97,624 (77,301)
(Accumulated deficit) retained earnings (9,908,292) 16,588
------------ ------------
Total stockholders' equity 22,911,056 22,810,492
------------ ------------
Total liabilities and stockholders' equity $55,266,278 $53,130,269
============ ============
See notes to consolidated financial statements.
F-3
INFINITY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended For the Nine
December 31, Months Ended
-------------------------- December 31,
2003 2002 2001
------------ ------------ ------------
Revenue
Oil and gas service operations $11,634,457 $ 8,570,631 $ 9,853,624
Oil and gas sales 6,589,281 2,367,713 1,759,095
------------ ------------ ------------
Total revenue 18,223,738 10,938,344 11,612,719
Cost of revenue
Oil and gas service operations 6,222,919 4,620,663 5,154,495
Oil and gas production expenses 2,161,666 1,582,816 1,074,460
Oil and gas production taxes 758,827 237,876 66,290
------------ ------------ ------------
Total cost of revenue 9,143,412 6,441,355 6,295,245
------------ ------------ ------------
Gross profit 9,080,326 4,496,989 5,317,474
Operating expenses 5,311,080 4,647,062 2,789,026
Depreciation, depletion and
amortization 3,074,247 1,782,586 1,010,811
Ceiling write-down of oil and gas properties 2,975,000 - -
------------ ------------ ------------
11,360,327 6,429,648 3,799,837
------------ ------------ ------------
Operating (loss) income (2,280,001) (1,932,659) 1,517,637
Other (expense) income
Interest and other income 129,599 102,460 81,212
Amortization of loan costs (6,200,633) (234,680) (52,832)
Interest expense (1,593,765) (602,350) (1,866,155)
Impairment of other assets - - (600,050)
Gain on sale of investments - - 5,128,280
Gain (loss) on sale of other assets 19,920 (33,665) (77,641)
------------ ------------ ------------
Total other (expense) income (7,644,879) (768,235) 2,612,814
------------ ------------ ------------
(Loss) income before income taxes (9,924,880) (2,700,894) 4,130,451
Income tax benefit (expense) - 1,144,028 (1,590,056)
------------ ------------ ------------
Net (loss) income $(9,924,880) $(1,556,866) $ 2,540,395
============ ============ ============
Basic (loss) earnings per share $ (1.23) $ (.22) $ .39
============ ============ ============
Diluted (loss) earnings per share $ (1.23) $ (.22) $ .37
============ ============ ============
Weighted average basic shares
outstanding 8,047,688 7,202,844 6,501,104
============ ============ ============
Weighted average diluted shares outstanding 8,047,688 7,202,844 6,965,922
============ ============ ============
See notes to consolidated financial statements.
F-4
INFINITY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002 AND THE NINE MONTHS ENDED DECEMBER 31, 2001
Accumulated
(Accumulated Total Other
Common Stock Additional Deficit) Compre- Compre-
------------------ Paid-in Retained hensive hensive Stockholders'
Shares Amount Capital Earnings Loss Income(Loss) Equity
--------- ------- ----------- ------------ ------------ ------------- ------------
Balance, March 31, 2001 6,449,874 $ 644 $11,416,720 $ (966,941) $ 3,145,975 $13,596,398
Issuance of common stock for cash
upon the exercise of options 65,350 8 126,062 - - 126,070
Warrants granted in connection with
8% subordinated convertible notes - - 924,717 - - 924,717
Beneficial conversion feature - - 1,165,500 - - 1,165,500
Comprehensive loss:
Net income - - - 2,540,395 $ 2,540,395 - 2,540,395
Embedded derivative liability - - - - - (1,793,426) (1,793,426)
Other comprehensive income;
unrealized holding gains in
securities during the period, net
of income taxes of $123,587 - - - - 238,690 238,690 238,690
Reclassification gains on sales of
securities, net of taxes of
$1,743,615 - - - - (3,384,665) (3,384,665) (3,384,665)
Embedded derivative liability
reclassified to earnings - - - - - 1,793,426 1,793,426
--------- ------- ----------- ------------ ------------ ------------- ------------
Comprehensive loss $ (605,580)
============
Balance, December 31, 2001 6,515,224 652 13,632,999 1,573,454 - 15,207,105
Issuance of common stock for cash
upon the exercise of options and
warrants 588,264 58 1,947,147 - - 1,947,205
Conversion of 8% subordinated
convertible notes and accrued
interest into common stock 454,974 46 2,274,813 - - 2,274,859
Warrants granted in connection with
$2,000,000 bridge loan - - 1,347,728 - - 1,347,728
Warrants granted in connection with
7% subordinated convertible notes - - 1,386,044 - - 1,386,044
Warrants granted in connection with
$3,000,000 bridge loan - - 2,281,718 - - 2,281,718
Comprehensive loss:
Net loss - - - (1,556,866) $(1,556,866) - (1,556,866)
Change in fair value of
fixed price delivery contract,
net of tax benefit of $60,712 - - - - (96,981) (96,981) (96,981)
Reclassifications, net of income
tax expense of $12,320 - - - - 19,680 19,680 19,680
--------- ------- ----------- ------------ ------------ ------------- ------------
Comprehensive loss $(1,634,167)
============
Balance, December 31, 2002 7,558,462 756 22,870,449 16,588 (77,301) 22,810,492
Issuance of common stock upon the
exercise of options and warrants 146,169 15 824,219 - - 824,234
See notes to consolidated financial statements.
F-5
INFINITY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002 AND THE NINE MONTHS ENDED DECEMBER 31, 2001
Accumulated
(Accumulated Total Other
Common Stock Additional Deficit) Compre- Compre-
------------------ Paid-in Retained hensive hensive Stockholders'
Shares Amount Capital Earnings Loss (Loss) Equity
--------- ------- ----------- ------------ ------------ --------- -------------
Conversion of 8% subordinated
convertible notes and accrued
interest into common stock 295,689 29 1,478,521 - - 1,478,550
Conversion of 7% subordinated
convertible notes and accrued
interest into common stock 203,712 20 1,756,996 - - 1,757,016
Options granted in connection with
$1,050,000 of new bridge loans - - 1,050,000 - - 1,050,000
Options granted in connection with
amendments and agreements
related to a $3,000,000
bridge loan - - 2,493,329 - - 2,493,329
Warrants granted in connection with
$4,850,000 of bridge loans - - 2,247,390 - - 2,247,390
Comprehensive loss:
Net loss - - - (9,924,880) $(9,924,880) - (9,924,880)
Change in fair value of fixed
price delivery contract,
net of tax expense of
$151,573 - - - - 256,500 256,500 256,500
Reclassifications net of income
tax benefit of $51,068 - - - - (81,575) (81,575) (81,575)
--------- ------- ----------- ------------ ------------ --------- -------------
Comprehensive loss $(9,749,955)
============
Balance, December 31, 2003 8,204,032 $ 820 $32,720,904 $(9,908,292) $ 97,624 $(22,911,056)
========= ======= =========== ============ ========= =============
See notes to consolidated financial statements.
F-6
INFINITY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended For the Nine
December 31, Months Ended
--------------------------- December 31,
2003 2002 2001
------------ ------------- ------------
Cash flows from operating activities
Net (loss) income $(9,924,880) $ (1,556,866) $ 2,540,395
------------ ------------- ------------
Adjustments to reconcile net (loss) income
to net cash provided by operating activities
Depreciation, depletion, amortization,
impairment and ceiling write-down 6,049,247 1,782,586 1,610,861
Amortization of loan costs included
in interest expense 6,200,633 234,680 52,832
Deferred income taxes - (1,144,028) 1,590,056
Gain on sale of investments - - (5,128,280)
(Gain) loss on sale of other assets (19,920) 33,665 77,641
Change in assets and liabilities
(Increase) decrease in accounts receivable (252,483) 85,724 (111,393)
(Increase) decrease in inventories (10,980) 9,999 (85,967)
(Increase) decrease in prepaid expenses and other (12,234) (89,985) 4,541
Increase in accounts payable 32,758 284,657 712,671
Increase in accrued expenses 782,391 495,383 97,564
------------ ------------- ------------
12,769,412 1,692,681 (1,179,474)
------------ ------------- ------------
Net cash provided by operating activities 2,844,532 135,815 1,360,921
------------ ------------- ------------
Cash flows from investing activities
Purchase of property, equipment, and intangibles (1,089,863) (2,695,382) (3,432,959)
Proceeds from the sale of investments
and marketable securities - 750,000 8,871,017
Purchase of marketable securities - - (750,000)
Proceeds from sale of property and
equipment, oil and gas properties and other assets 104,911 235,000 143,808
Investment in oil and gas properties (5,743,649) (14,426,524) (7,845,918)
Payments on note receivable 15,103 7,844 -
Increase in other assets (188,093) (88,547) (217,459)
------------ ------------- ------------
Net cash used in investing activities (6,901,591) (16,217,609) (3,231,511)
------------ ------------- ------------
Cash flows from financing activities
Proceeds from borrowings on long-term debt 11,452,861 21,749,993 7,393,047
Sale of common stock 824,234 1,947,205 126,070
Principal payments on long-term debt (8,359,919) (7,414,285) (5,137,987)
------------ ------------- ------------
Net cash provided by financing activities 3,917,176 16,282,913 2,381,130
------------ ------------- ------------
Net (decrease) increase in cash and cash equivalents (139,883) 201,119 510,540
Cash and cash equivalents, beginning of period 867,017 665,898 155,358
------------ ------------- ------------
Cash and cash equivalents, end of period $ 727,134 $ 867,017 $ 665,898
============ ============= ============
See notes to consolidated financial statements.
F-7
INFINITY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Supplemental cash flow disclosures:
For the Years Ended For the Nine
December 31, Months Ended
---------------------- December 31,
2003 2002 2001
---------- ---------- ----------
Cash paid for interest, net of amounts capitalized $1,589,606 $ 383,449 $2,171,029
========== ========== ==========
Non-cash transactions:
Non-cash costs, including amortization of loan costs
included in full cost pool for oil and gas properties $2,714,974 $2,056,283 $1,570,377
========== ========== ==========
Property and equipment acquired through
capital leases or seller financed debt $ 967,975 $ - $2,437,138
========== ========== ==========
Oil and gas properties acquired through
seller financed debt $ 263,381 $ 607,236 $ -
========== ========== ==========
Stock-based compensation for options and warrants
granted in connection with debt, recorded as loan costs $5,790,719 $5,015,490 $ 924,717
========== ========== ==========
Conversion of 8% subordinated convertible
notes and accrued interest to common stock $1,478,550 $2,274,859 $ -
========== ========== ==========
Conversion of 7% subordinated convertible
notes and accrued interest to common stock $1,757,016 $ - $ -
========== ========== ==========
Issuance of additional notes in lieu of cash interest
payment on 7% subordinated convertible notes $ 379,000 $ - $ -
========== ========== ==========
Sale of oil and gas property for note receivable $ - $1,620,000 $ -
========== ========== ==========
Change in accumulated other
comprehensive loss, net of income taxes $ 174,925 $ 77,301 $3,145,975
========== ========== ==========
Reclassify other assets to oil and
gas properties not subject to amortization $ 707,126 $ - $ -
========== ========== ==========
Asset retirement obligation upon adoption $ 503,365 $ - $ -
========== ========== ==========
See notes to consolidated financial statements.
F-8
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 1 - Organization and Summary of Significant Accounting Policies
- --------------------------------------------------------------------
The Company and its subsidiaries are engaged in providing oil and gas production
enhancement services in northeastern Oklahoma, eastern Kansas, and the Powder
River Basin of Wyoming and in oil and gas exploration, development and
production activities in southeast Kansas, south central Wyoming, and
northwestern Colorado.
Effective with the period ended December 31, 2001, the Company elected to begin
utilizing a December 31 year-end. Therefore, the period ended December 31, 2001
represents a nine-month period and the years ended December 31, 2002 and 2003
represent twelve-month periods.
Basis of Presentation
- -----------------------
The consolidated financial statements include the accounts of Infinity, Inc. and
its wholly owned subsidiaries, Consolidated Oil Well Services, Inc., Infinity
Oil and Gas of Wyoming, Inc., Infinity Oil and Gas of Kansas, Inc., CIS -
Oklahoma, Inc., Infinity Research and Development, Inc., L.D.C. Food Systems,
Inc., Consolidated Pipeline Company, Inc., CIS Oil and Gas, Inc., Infinity
Nicaragua, Ltd., and Infinity Nicaragua Offshore, Ltd. Infinity Nicaragua,
Ltd., and Infinity Nicaragua Offshore, Ltd. own a 98.2% interest in Rio Grande
Resources, SA, which is also consolidated. All significant intercompany
balances and transactions have been eliminated in consolidation.
Reclassifications
- -----------------
Certain reclassifications have been made to the balances for the nine months
ended December 31, 2001 and the year ended December 31, 2002 to make them
comparable to those presented for the year ended December 31, 2003, none of
which change the previously reported net income (loss).
Accounts Receivable
- --------------------
Revenue producing activities are conducted primarily in Kansas, Oklahoma, and
Wyoming. The Company grants credit to all qualified customers which potentially
subjects the Company to credit risk resulting from, among other factors, adverse
changes in the industries in which the Company operates and the financial
condition of its customers. However, management regularly monitors its credit
relationships and provides adequate allowances for potential losses.
Hedging Activities
- -------------------
The Company accounts for derivative instruments or hedging activities under the
provisions of Statement of Financial Accounting Standards No 133, "Accounting
for Derivative Instruments and Hedging Activities" ("SFAS No 133"). SFAS No 133
requires the Company to record derivative instruments at their fair value. If
the derivative is designated as a fair value hedge, the changes in the fair
value of the derivative and of the hedged item attributable to the hedged risk
are recognized in earnings. If the derivative is designated as a cash flow
hedge, the effective portions of changes in the fair value of the derivative are
recorded in other comprehensive income (loss) and are recognized in the
statement of operations when the hedged item affects earnings. Ineffective
portions of changes in the fair value of cash flow hedges, if any, are
recognized in earnings.
The Company periodically enters into fixed price delivery contracts to manage
price risk with regard to a portion of its natural gas production. Fixed price
F-9
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
delivery contracts that do not meet certain requirements are accounted for using
cash flow hedge accounting. Under this method, realized gains and losses on
qualifying hedges are recognized in gas revenues when the associated revenue
stream occurs and the resulting cash flows are reported as cash flows from
operations. To qualify as a hedge, these contracts must be designated as a cash
flow hedge and changes in their value must correlate with changes in the price
of anticipated future production such that the Company's exposure to the effects
of commodity price is reduced. If the contract is not a hedge, changes in the
fair value are recorded in the Company's statement of operations currently. If
a derivative financial instrument, such as the contracts discussed above, is
settled before the date of the anticipated transaction, the Company carries
forward the accumulated change in value of the contract and includes it in the
measurement of the related transaction.
During the years ended December 31, 2003 and 2002, the Company had fixed price
delivery contracts that were designated as hedges as follows:
MMBTU Amount Per
Effective Dates Per Day MMBTU
- ------------------------------------ ------- -----------
April 1, 2002 - October 31, 2002 1,000 $ 1.80
October 1, 2002 - September 30, 2003 1,000 2.97
November 1, 2002 - March 31, 2003 1,000 3.00
April 1, 2003 - March 31, 2004 3,500 4.71
During the years ended December 31, 2003 and 2002, the Company reclassified out
of other comprehensive income, income of approximately $133,000 and losses of
approximately $32,000, respectively, on the contracts, which have been included
in natural gas revenues in the accompanying consolidated statement of operations
and in cash provided by operating activities in the accompanying consolidated
statement of cash flows. At December 31, 2003 and 2002, the Company had a
derivative asset of approximately $98,000 and a derivative liability of
$126,000, respectively, related to the financial hedges. The fair value of the
fixed price delivery contracts was calculated using the twelve month forecasted
sales price for the Henry Hub gas delivery point less a historical differential
for the actual delivery point and the quantities and prices fixed in the
contracts.
Upon the adoption of SFAS No 133 during the period ended December 31, 2001, the
Company recorded a derivative liability of approximately $1,800,000 related to
certain of the Company's debt obligations which were tied to the market value of
the Company's marketable securities. The adjustment was recorded as a reduction
in accumulated other comprehensive income on April 1, 2001, and the entire
amount was transferred to earnings in April 2001, when the related debt
instruments were satisfied.
Revenue Recognition
- --------------------
The Company recognizes sales of oil when the product is delivered and recognizes
enhancement service revenue when the services are performed. The Company uses
the sales method for recording natural gas sales. This method allows for
recognition of revenue, which may be more or less than the Company's share of
pro-rata production from certain wells. During the years ended December 31,
2003 and 2002 and the nine months ended December 31, 2001, there were no
material natural gas imbalances.
Environmental Costs
- --------------------
The Company expenses, on a current basis, recurring costs associated with
managing hazardous substances and pollution in ongoing operations. The Company
F-10
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
also accrues for costs associated with the remediation of environmental
pollution when it becomes probable that a liability has been incurred and its
proportionate share of the amount can be reasonably estimated.
Management Estimates
- ---------------------
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements, and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. Significant estimates with regard to the consolidated
financial statements include the estimated carrying value of unproved
properties, the estimate of proved oil and gas reserve volumes and the related
present value of estimated future net cash flows and the ceiling test applied to
capitalized oil and gas properties and the realization of deferred tax assets.
Inventories
- -----------
Inventories, consisting primarily of cement mix, sand, fuel and chemicals, are
stated at the lower of cost or market. Cost has been determined on the first-in,
first-out method.
Property and Equipment
- ------------------------
Depreciation and amortization are computed using the straight-line method over
the following estimated useful lives:
Assets Useful Lives
- --------------------------------- ------------
Buildings 30 years
Site improvements 15 years
Machinery, equipment and vehicles 5 - 10 years
Office furniture and equipment 5 - 10 years
Oil and Gas Properties
- -------------------------
The Company follows the full cost method of accounting for oil and gas
properties. Accordingly, all productive and non-productive costs associated
with acquisition, exploration, and development of oil and gas reserves,
including directly related internal costs, are capitalized. The Company
capitalized $49,221, $1,444,238 and $684,843 of internal costs during the years
ended December 31, 2003 and 2002 and the nine months ended December 31, 2001,
respectively. Costs associated with production and general corporate activities
are expensed in the period incurred.
The Securities and Exchange Commission's full cost accounting rules prohibit
recognition of income in current operations for services performed on oil and
natural gas properties in which the Company has an interest, but rather require
amounts to be treated as a reimbursement of costs with any excess of fees over
costs credited to the full cost pool and recognized through lower cost
amortization only as production occurs.
In addition, the capitalized costs are subject to a "ceiling test," which
basically limits such costs to the aggregate of the "estimated present value,"
F-11
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
discounted at a 10-percent interest rate of future net revenues from proved
reserves, adjusted for cash flow hedges, net of estimated future income taxes,
based on current economic and operating conditions, plus the lower of cost or
fair market value of unproved properties. For the period ended December 31,
2003 the Company had a ceiling write-down of $2,975,000. For purposes of
calculating the ceiling test, the Company has elected to subtract the fair value
of the estimated asset retirement obligation from the capitalized costs.
Depreciation and depletion of proved oil and gas properties is computed on the
units-of-production method based upon estimates of proved reserves with oil and
gas being converted to a common unit of measure based on their relative energy
content. Unproved oil and gas properties, including any related capitalized
interest expense, are not amortized, but are assessed for impairment either
individually or on an aggregated basis. At December 31, 2003, the Company
reclassified approximately $5,029,000 from unproved oil and gas properties to
oil and gas properties subject to amortization.
Sales of proved and unproved properties are accounted for as adjustments of
capitalized costs with no gain or loss recognized, unless such adjustments would
significantly alter the relationship between capitalized costs and proved
reserves of oil and gas, in which case the gain or loss is recognized in income.
Abandonments of properties are accounted for as adjustments of capitalized costs
with no loss recognized.
Capitalized Interest
- ---------------------
The Company capitalizes interest costs to oil and gas properties on expenditures
made in connection with exploration and development projects that are not
subject to current depreciation and depletion. Interest is capitalized only for
the period that activities are in progress to bring these projects to their
intended use. Total interest costs incurred for the years ended December 31,
2003 and 2002 and the nine months ended December 31, 2001 were $1,976,001,
$1,612,469 and $2,321,056 (including a $1,793,426 charge to interest expense
upon payoff of certain debt during the nine-month period ended December 31,
2001), respectively. Interest costs capitalized were $382,236, $1,010,119 and
$454,901 for the years ended December 31, 2003 and 2002 and the nine months
ended December 31, 2001, respectively.
Long-Lived Assets
- ------------------
Long-lived assets to be held and used in the Company's business are reviewed for
impairment whenever events or changes in circumstances indicate that the related
carrying amount may not be recoverable. When the carrying amount of the
long-lived assets exceeds the discounted expected future cash flows, the Company
records an impairment. The Company recorded a $600,050 impairment during the
nine months ended December 31, 2001 to write other assets down to estimated net
realizable value. No impairment was recorded during the years ended December
31, 2003 or 2002.
Transportation Costs
- ---------------------
The Company accounts for transportation costs under Emerging Issues Task Force
("EITF") 00-10, "Accounting for Shipping and Handling Fees and Costs," whereby
amounts paid for transportation costs are classified as operating expense and
not netted against natural gas revenues.
Intangible Assets
- ------------------
The Company has adopted SFAS No 142 "Goodwill and Other Intangible Assets,"
effective January 1, 2001. As a result, the Company no longer amortizes
F-12
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
goodwill, but instead, reviews goodwill for impairment on at least an annual
basis. Amortization costs for the nine months ended December 31, 2001 were
$8,438.
Other intangibles are recorded at cost and are amortized on the straight-line
basis over the contractual or estimated useful life of the asset, which ranges
from one to five years or the effective interest method.
Amortization of loan costs associated with debt obtained in connection with
exploration and development projects that are not subject to current
amortization is capitalized to oil and gas properties. Amortization of loan
costs is capitalized only for the period activities are in progress to bring
these projects to their intended use. Total loan amortization costs capitalized
for the years ended December 31, 2003 and 2002 and the nine months ended
December 31, 2001 were $2,714,974, $2,023,373 and $147,239, respectively (See
Note 5 for total loan costs classified as intangibles).
Per Share Information
- -----------------------
Basic earnings (loss) per common share are computed as net income (loss) divided
by the weighted average number of common shares outstanding during the period.
Diluted earnings (loss) per common share is computed as net income (loss)
divided by the weighted average number of common shares and potential common
shares, using the treasury stock method, outstanding during the period.
Cash and Cash Equivalents
- ----------------------------
For purposes of reporting cash flows, cash generally consists of cash on hand
and demand deposits with financial institutions. At times, the Company
maintains deposits in financial institutions in excess of federally insured
limits. Management monitors the soundness of the financial institutions and
believes the Company's risk is negligible.
The Company considers all highly liquid investments with an original maturity of
three months or less to be a cash equivalent.
Investment Securities
- ----------------------
Investment securities that are held for short-term resale are classified as
trading securities and carried at fair value. Debt securities that management
has the ability and intent to hold to maturity are classified as
held-to-maturity and carried at cost, adjusted for amortization of premium and
accretion of discounts using methods approximating the interest method. Other
marketable securities are classified as available-for-sale and are carried at
fair value, based on quoted market prices. Unrealized gains and losses on
securities available-for-sale are reported as a component of comprehensive
income, net of applicable income taxes. Costs of securities sold are recognized
using the specific identification method.
Stock Options
- --------------
The Company applies Accounting Principles Board Opinion No 25 "Accounting for
Stock Issued to Employees," and related interpretations in accounting for its
stock option plans. Accordingly, no compensation cost has been recognized for
options granted to employees under the stock option plans because the fair value
of the stock equaled or was less than the option exercise price at the date of
grant. Had compensation costs for employee stock options under the Company's
plan been determined based upon the fair value at the grant date for awards
under the plan consistent with the methodology prescribed under SFAS No 123,
"Accounting for Stock-Based Compensation", the Company's net income (loss) and
earnings (loss) per share would have been as follows (See Note 10):
F-13
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For the Years Ended For the Nine
December 31, Months Ended
------------------------- December 31,
2003 2002 2001
------------ ------------ -----------
Net (loss) income as reported $(9,924,880) $(1,556,866) $2,540,395
Deduct: Total stock-based employee
compensation expense, determined under
fair value based method for all awards, net of tax (26,244) (2,448,341) (684,265)
------------ ------------ -----------
Pro forma net (loss) income $(9,898,636) $(4,005,207) $1,856,130
============ ============ ===========
Basic (loss) earnings per share as reported $ (1.23) $ (.22) $ .39
Diluted (loss) earnings per share as reported $ (1.23) $ (.22) $ .37
Basic (loss) earnings per share - pro forma $ (1.23) $ (.56) $ .29
Diluted (loss) earnings per share - pro forma $ (1.23) $ (.56) $ .27
For options granted during the year ended December 31, 2003 and 2002 and the
nine months ended December 31, 2001, the estimated fair value of the options
granted utilizing the Black-Scholes pricing model under the Company's plan was
based on a weighted average risk-free interest rate of 1.5%, 1.5% and 8.0%,
expected option life of 5 years, expected volatility of approximately 131%, 117%
and 83% and no expected dividends.
The Company has adopted the disclosure requirements of SFAS 148, "Accounting for
Stock-Based Compensation Transition Disclosure" in its consolidated financial
statements. This statement amends SFAS No 123, "Accounting for Stock-Based
Compensation" to provide alternative methods of transition for an entity that
voluntarily changes to the fair value method of accounting for stock-based
compensation. In addition, SFAS 148 amends the disclosure provision of SFAS 123
to require more prominent disclosure about the effects of an entity's accounting
policy decisions with respect to stock-based employee compensation on reported
net income. The Company will continue to account for stock-based compensation
using the methods detailed in the stock-based compensation accounting policy as
described earlier.
Comprehensive Income (Loss)
- -----------------------------
The Company has elected to report comprehensive income (loss) in the
consolidated statement of stockholders' equity. Comprehensive income (loss) is
composed of net income (loss) and all changes to stockholders' equity, except
those due to investments by stockholders, changes in additional paid-in capital
and distributions to stockholders.
Income Taxes
- -------------
Income taxes are provided for the tax effects of the transactions reported in
the consolidated financial statements and consist of taxes currently due plus
deferred taxes related primarily to temporary differences between the tax and
financial basis of property and equipment and other assets, oil and gas
properties, and net operating loss carry forwards using enacted tax rates in
effect for the year in which the differences are expected to reverse.
F-14
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The deferred tax assets and liabilities represent the future tax return
consequences of those temporary differences, which will either be taxable or
deductible when the assets and liabilities are recovered or settled. The
measurement of deferred tax assets is reduced, if necessary, by the amount of
any tax benefits that are not expected to be realized based on available
evidence that it is more likely than not to be realized in the form of a
deferred tax valuations allowance.
Asset Retirement Obligations
- ------------------------------
Effective January 1, 2003, the Company adopted the provisions of SFAS No 143
"Accounting for Asset Retirement Obligations." SFAS No 143 requires the Company
to record the fair value of a liability for an asset retirement obligation in
the period in which it is incurred. When the liability is initially recorded,
the Company capitalizes cost by increasing the carrying amount of the related
long-lived asset. Over time, the liability is accreted each period towards its
future value, and the capitalized cost is depreciated over the useful life of
the related asset. Upon settlement of the liability, the Company will report a
gain or loss upon settlement to the extent the actual costs differ from the
recorded liability. Upon adoption of SFAS No 143, the Company recorded a
discounted liability of approximately $503,000 for future retirement obligations
and increased net oil and gas properties by approximately $503,000. The
adoption of SFAS No 143 had no material effect on earnings in all periods
presented. The majority of the asset retirement obligation to be recognized
relates to the projected costs to plug and abandon oil and gas wells.
Liabilities are also recorded for compressor and field facilities.
Recently Issued Accounting Pronouncements
- --------------------------------------------
Proposed FASB Staff Positions ("FSP") No. FAS 141-a and FAS 142-a were recently
issued with a comment deadline of April 16, 2004. These proposed FSPs would
amend SFAS No. 141, "Business Combinations" and No. 142, "Goodwill and
Intangible Assets" in order to resolve a recent reporting issue. There is an
inconsistency between the recent Financial Accounting Standards Board ("FASB")
consensus that such mineral rights should be considered tangible assets for
accounting purposes and the characterization of mineral rights as intangible
assets in SFAS No. 141 and No. 142. Under the proposed FSPs, mineral rights
would continue to be considered tangible assets for accounting purposes with
disclosure of the amount of the mineral rights disclosed on the balance sheet or
in the notes to the consolidated financial statements.
Assuming that the proposed FSPs are finalized, the guidance would be effective
for the quarter ended June 30, 2004 and prior period amounts would also need to
be disclosed in the consolidated financial statements. At December 31, 2003 and
2002, the Company has included $9,500,000 and $7,500,000, including capitalized
interest, in oil and gas properties in the accompanying consolidated balance
sheets of which approximately $3,972,000 and $684,000 respectively are subject
to amortization.
In May 2003, the FASB issued SFAS No 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No 150
establishes standards for how an issuer measures certain financial instruments
with characteristics of both liabilities and equity and requires that an issuer
classify a financial instrument within its scope as a liability (or asset in
some circumstances). SFAS No 150 was effective for financial instruments
entered into or modified after May 31, 2003 and otherwise was effective and
adopted by the Company on July 1, 2003. As the Company has no such instruments,
the adoption of this statement did not have an impact on the Company's financial
condition or results of operations.
F-15
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 2 - Continued Operations and Realization of Assets
- -------------------------------------------------------
During 2003, the Company had consolidated losses from operations of
approximately $2,280,000, and a working capital deficit at December 31, 2003 of
approximately $2,210,000.
Subsequent to December 31, 2003, the Company completed six wells drilled on its
Pipeline acreage during the fourth quarter of 2003 and acquired an additional
49% working interest in two existing wells and 960 acres of undeveloped
leasehold adjacent to the Pipeline acreage. Capital expenditures associated with
the development activities and acquisitions were approximately $1,000,000. The
Company expects capital expenditures for unrisked services on the development of
its Labarge property under an agreement with Schlumberger Technology Corporation
("Schlumberger") and Red Oak Capital Management LP ("Red Oak") (See Note 12)
related to the completion or recompletion of five existing wells and the
drilling of five or six new wells to be approximately $3,700,000 to $4,150,000.
The total unrisked services the Company anticipates it will incur is dependent
on the results of the initial rework and drilling activities. Additional costs
associated with the completion of the environmental impact study and leasehold
maintenance on the Labarge property during 2004 are anticipated to be
approximately $300,000. In addition to its capital expenditures requirements,
management estimates requirements of $1,600,000 for interest on notes,
$1,300,000 for general corporate purposes and approximately $100,000 for lease
rentals and farmout expenses. Thus, in total, the Company could have
requirements in 2004 of approximately $10,200,000 including the working capital
deficit at December 31, 2003.
In January 2004, the Company issued 1,000,000 shares of common stock through a
private placement for which it received approximately $3,900,000 in proceeds net
of offering costs (See Note 18). The Company paid approximately $750,000 in long
term debt with proceeds from the offering, leaving approximately $3,150,000
available for meeting its current development and working capital needs. In
addition to these funds, the Company expects to generate approximately
$3,600,000 in cash flow from oil field services and between $4,000,000 and
$5,000,000 in cash flow from oil and gas production activities during 2004.
Management anticipates issuing approximately $800,000 new 7% subordinated
convertible notes in lieu of cash payments due April 15 and October 15, 2004 for
interest due on the 7% subordinated convertible notes. Management believes it
will be able to fund its 2004 minimum requirements through proceeds from the
January 2004 private placement, cash flow from operations and the exercise of
its option to issue additional notes rather than expend cash to satisfy interest
on the 7% subordinated convertible notes.
Due to the timing of development activities on the Company's properties, the
Company may not have the funds available to pay for the operations immediately
and may be required to obtain short term loans to pay for the development
activity. It is expected that these loans would then be repaid with cash flow
from operations later in the year.
The Company is restricted on the amount that can be distributed to it by its
subsidiaries by terms of certain loan agreement. The terms of the loan
agreements for the oil field services subsidiary allow for additional amounts to
be distributed with consent of the lender. The Company believes it will be able
to restructure the terms of this loan agreement to allow additional funds to be
distributed, or obtain the necessary consent to allow the subsidiary to
distribute adequate funds to meet its general corporate needs.
Future reserve reductions or ceiling write-downs could hinder the Company's
ability to obtain future financing on terms acceptable to management or could
result in reductions in the borrowing base on existing obligations.
Note 3 - Accounts Receivable
- --------------------------------
Accounts receivable consists of the following:
F-16
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31,
------------------------
2003 2002
----------- -----------
Accounts receivable oil field services $1,171,886 $ 943,459
Revenue receivable oil and gas production 652,401 504,752
Other receivables 22,355 90,948
----------- -----------
Total receivables 1,846,642 1,539,159
Less allowance for doubtful accounts (80,000) (25,000)
----------- -----------
Net receivables $1,766,642 $1,514,159
=========== ===========
Note 4 - Property and Equipment
- -------------------------------
Property and equipment consists of the following:
December 31,
--------------------------
2003 2002
------------ ------------
Buildings, site costs and improvements $ 2,208,587 $ 2,207,245
Machinery, equipment, vehicles and aircraft 15,884,159 15,158,783
Office furniture and equipment 276,135 239,058
------------ ------------
Total cost 18,368,881 17,605,086
Less accumulated depreciation (8,199,722) (7,290,018)
------------ ------------
Net property and equipment $10,169,159 $10,315,068
============ ============
Note 5 - Intangibles
- -----------------------
Intangibles consist of the following:
December 31,
---------------------------
2003 2002
------------- ------------
Loan costs $ 15,245,263 $ 7,679,249
Non-compete 300,000 300,000
Goodwill 225,000 225,000
Other 55,870 55,871
------------- ------------
15,826,133 8,260,120
Less accumulated amortization (11,873,144) (2,960,239)
------------- ------------
Net intangibles $ 3,952,989 $ 5,299,881
============= ============
During the years ended December 31, 2003 and 2002 and the nine months ended
December 31, 2001, the Company recorded amortization expense related to
intangibles, excluding amounts capitalized, of $6,210,738, $241,272 and $75,763
respectively. Of the total amortization expense related to intangibles, the
Company recorded amortization of loan costs of $6,200,633, $234,680 and $52,832,
respectively, of which $5,620,300, $204,172 and $38,785 were related to non-cash
loan costs resulting from options, warrants and other non-cash compensation
granted in connection with obtaining financing.
F-17
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Loan costs consist of the following at December 31, 2003:
Accumulated
Description of Non-cash Cash Loan Total Loan Amortization Net Book
Notes or Agreement Loan Costs Costs Costs 12/31/2003 Value
- -------------------------- ----------- ---------- ----------- -------------- ----------
8% subordinated
convertible notes $ 1,375,464 $ 51,159 $ 1,426,623 $ (875,070) $ 551,553
Line of credit, term note
and equipment note - 192,572 192,572 (128,754) 63,818
7% subordinated
convertible notes 2,178,944 72,605 2,251,549 (912,771) 1,338,778
$3,000,000 bridge loan
and related amendments
and adjustments 4,775,047 - 4,775,047 (3,132,244) 1,642,803
$25,000,000
development credit
facility - 166,506 166,506 (8,442) 158,064
Bridge loans and other
debt paid in full 5,895,118 537,848 6,432,966 (6,432,966) -
----------- ---------- ----------- -------------- ----------
Total $14,224,573 $1,020,690 $15,245,263 $ (11,490,247) $3,755,016
=========== ========== =========== ============== ==========
F-18
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Aggregate future intangible amortization expense is as follows at December 31,
2003:
Other
Years Ending December 31, Loan Costs (1) Intangibles Total
- ------------------------- --------------- ------------ ----------
2004 $ 2,318,385 $ 5,452 $2,323,837
2005 759,196 - 759,196
2006 543,557 - 543,557
2007 133,878 - 133,878
--------------- ------------ ----------
$ 3,755,016 $ 5,452 $3,760,468
=============== ============ ==========
____________________
(1) Includes approximately $685,000 in January 2004 when the Company repaid
$1,250,000, or 42%, of the $3,000,000 bridge loans due January 30, 2005. (See
Notes 9 and 18).
Note 6 - Oil and Gas Properties
- -------------------------------------
Properties Subject to Amortization
- -------------------------------------
Pipeline
In July 2000 (original purchase) and subsequent periods (additional purchases),
the Company acquired 100% working interests and 82.5% net revenue interests in
leaseholds in the Greater Green River Basin of Wyoming ("Pipeline") for
approximately $3,666,000. The Company has incurred approximately $17,925,000 in
exploration and development costs through December 31, 2003 to develop the
Pipeline acreage.
In July 2003, the Company granted a 4% over-riding royalty in the property to a
lender in connection with obtaining bridge financing (See Note 9). The
estimated fair value of the 4% over-riding royalty of approximately $825,000 was
re-classified to loan cost.
The leasehold costs associated with 11,660 net acres of the original 19,150
total net acreage position and all development and exploration costs incurred to
date, totaling approximately $3,144,000 and $17,133,000, respectively, on the
11,660 net acres are subject to amortization.
Labarge
In March 2000 (original purchase) and subsequent periods (additional purchases),
the Company acquired a 100% working interest and 80.0% net revenue interests in
leaseholds in the Greater Green River Basin of Wyoming ("Labarge") for
approximately $2,463,000. The Company has incurred approximately $13,463,000 in
exploration and development costs through December 31, 2003 to develop the
Labarge acreage. The original lessor on a portion of the acreage has a 30%
participation election. If the original lessor chooses not to participate in
the drilling and completion of a well, then the 100% working interest and the
approximately 80% associated net revenue interest will remain with the Company
until the well has generated earnings to recover the well costs plus a 300%
non-consent penalty. In July 2003 the Company granted a 4% over-riding royalty
in the property to a lender in connection with obtaining bridge financing (See
Note 9). The estimated fair value of the 4% over-riding royalty of
approximately $425,000 was re-classified as loan cost. The leasehold costs
F-19
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
associated with 1,763 net acres of the 11,199 total net acreage position and all
development and exploration costs incurred to date, totaling approximately
$223,000 and $5,879,000, respectively, on the 1,763 net acres are subject to
amortization.
The Company is required to perform certain Environmental Impact Study and
Assessments on the Labarge and Pipeline properties. Management believes that the
results of these studies will not have a material adverse impact on the
continued development of these properties.
Sand Wash
During 2002 the Company acquired a working interest in leaseholds in the Sand
Wash Basin of Colorado and Wyoming. The Company has incurred total leasehold
and exploration costs of approximately $1,693,000 at December 31, 2003. The
leases on approximately 57,000 gross acres of the total 161,000 gross acres
expire in 2004 and, therefore, the Company has reclassified approximately
$605,000 in leasehold costs and all of the exploration costs, totaling
approximately $422,000, associated with that portion of the leaseholds as
subject to amortization at December 31, 2003.
Other Properties
In November 2001, the Company acquired a 31.25% working interest in an oil and
gas lease in southwest Kansas for approximately $56,000 and has incurred
exploration costs of approximately $187,000. The $187,000 in exploration costs
were to drill three wells which resulted in three dry holes and therefore, these
costs are included in oil and gas properties subject to amortization at December
31, 2003.
The Company also amortizes development and exploration costs of approximately
$98,000 and the asset related to the asset retirement obligation of
approximately $503,000.
Total
In total, the Company has approximately $3,972,000 in leasehold costs and
$24,222,000 in exploration and development costs subject to amortization. At
December 31, 2003 and 2002, the Company had accumulated depreciation, depletion,
amortization and ceiling write-down of approximately $4,748,000 and $304,000,
respectively.
Sales of Proved Oil and Gas Properties
In February 2000, the Company acquired a 100% working interest in a property in
eastern Kansas, through a joint venture with an operator in which a former
director of the Company is a partner and operations manager. The Company's
total investment in the property was approximately $1,100,000. In addition, the
Company had an active oil lease in the Owl Creek Field in Woodson County, Kansas
which was acquired for $510,000. Effective May 1, 2002, the Company sold its
interest in oil and gas properties in eastern Kansas for $180,000 cash and a
$1,620,000 note receivable (See Note 7). The transaction resulted in a gain of
approximately $244,000, which was recorded as a reduction in capitalized oil and
gas property costs under the full cost accounting method.
Ceiling Test
The Company evaluates its properties subject to amortization under the full cost
ceiling test on a quarterly basis. The ceiling test requires the Company to
compare the unamortized capitalized cost plus the lower of cost or fair market
value of the unproved properties, less any related deferred tax liability and
F-20
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
less the fair value of the asset retirement obligations with the ceiling. The
ceiling is calculated using present value, discounted at 10% of future net
revenue to be generated by the properties net of the estimated future income
taxes, plus the lower of cost or fair market value of the unproved properties.
If the capitalized cost of the properties exceeds the ceiling, then the Company
is required to permanently write down the value of the property to the ceiling.
During 2003, the Company experienced geological and geophysical, financial and
other issues which resulted in significant revisions to the year end reserves.
Therefore, during the fourth quarter of the year ended December 31, 2003, the
Company had a ceiling write-down of $2,975,000, which is included in accumulated
depreciation, depletion, amortization and write-down in the accompanying
consolidated balance sheet. There were no ceiling write-downs in the year ended
December 31, 2002 or the nine-month period ended December 31, 2001.
Properties Not Subject to Amortization
- ------------------------------------------
Pipeline
At December 31, 2003, the Company had approximately $4,491,000 in costs
associated with unproved Pipeline property. Options on approximately 8,300 acres
were relinquished on February 29, 2004 and therefore, approximately $4,002,000
previously reflected as not subject to amortization was reclassified to subject
to amortization at December 31, 2003. The Company currently has approximately
$489,000 in undeveloped leasehold costs associated with the Pipeline property
that are not subject to amortization. The development of the acreage and the
reclassification of the associated leasehold costs to properties subject to
amortization will be contingent upon the development of a future drilling plan.
Labarge
The Company has incurred approximately $2,210,000 of leasehold costs on the
Labarge prospects, and approximately $7,188,000 of exploration costs (including
$3,666,000 of capitalized interest and amortization of loan costs) on the
Labarge prospect, which are not subject to amortization, as the Company has not
completed the exploration and evaluation process on the related wells, which is
expected to be completed in the initial phase of the Schlumberger agreement (See
Note 12). The Company entered into an agreement with Schlumberger in December
2003 for the further development of the Labarge prospect. At the conclusion of
the 2004 evaluation and exploration activity a significant portion of the
investment in unproved oil and gas properties will be reclassified to the full
cost pool subject to depletion and the ceiling test. If proved reserves are not
found, or if proved reserves are not significant, the Company could be required
to write-down a portion of the full cost pool of oil and gas properties. A
significant portion of the remaining leasehold costs are anticipated to be
reclassified and subject to amortization during the remaining four years of the
agreement with Schlumberger. Reclassification of the remaining costs to
properties subject to amortization will be contingent on the development of a
future drilling plan.
Sand Wash
The Company has incurred leasehold costs of approximately $1,693,000 and initial
exploration costs of $422,000 on approximately 161,000 gross acres it has in the
Sand Wash Basin. The leases on approximately 57,000 gross acres under lease are
due to expire in 2004 and therefore, the Company has classified approximately
$605,000 in leasehold costs and all of the approximately $422,000 in exploration
costs associated with that portion of the leasehold as subject to amortization
at December 31, 2003. The Company has approximately $1,088,000 of leasehold
costs associated with the Sand Wash leases which are classified as not subject
to amortization.
F-21
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Reclassification of the remaining leasehold to properties subject to
amortization will be contingent upon the development of a future drilling plan.
Other Properties
In November 2000, the Company acquired a 100% working interest in a coal bed
methane property in northwestern Colorado for consideration of approximately
$593,000. The Company has incurred approximately $199,000 of leasehold costs to
acquire additional acreage, bringing the total leasehold costs to approximately
$792,000 and has capitalized exploration costs of approximately $107,000 as of
December 31, 2003. The lease requires the Company to drill a total of 5 wells
before November 20, 2005. No wells have been drilled to date. A portion of the
leasehold costs and the exploration costs associated with the drilling activity
on these five wells is anticipated to be reclassified to properties subject to
amortization in 2005. Reclassification of the remaining costs to properties
subject to amortization will be contingent upon the development of a future
drilling plan.
The Company has additional leasehold costs of approximately $56,000 on an
undeveloped, 5,120 acre river sand prospect in Kansas operated by an unrelated
third party. The Company expects the reclassification of these costs to
properties subject to amortization during 2004.
Infinity was awarded the bid on 24 blocks of acreage, comprised of over one
million acres in 2003, and immediately entered into negotiations with The
Instituto Nicaraguense de Energia ("INE"), the Nicaraguan governmental entity
that regulates oil and gas activities, to finalize the initial exploration plan
for the Tyra and Perlas prospects. The Company has approximately $885,000 in
undeveloped acreage costs associated with these prospects. Reclassification of
the costs incurred to properties subject to amortization will be contingent upon
the development of a future drilling plan after the terms of the lease are
completed.
Total
In total, the Company has approximately $5,520,000 in leasehold costs and
approximately $7,295,000 in exploration costs not subject to amortization.
These properties are not subject to amortization and are being, or will be
developed, completed and put into production when gas is located in apparent
reasonable quantities. The geological structures on the Wyoming and Colorado
properties are such that the amount of reserves cannot be evaluated with the
engineering certainty necessary to be judged proven reserves. As drilling of a
specific well is finished, a determination is made to complete the well and
begin production or treat the well as unsuccessful. Costs of successful wells
are added to the properties subject to amortization when the property is proven.
Costs of unsuccessful wells are added to the properties subject to amortization
when that determination is made.
The Company reviews the carrying value of its properties not subject to
amortization on at least an annual basis. The carrying value of the properties
not subject to amortization may not exceed the fair market value of such
properties. When the book value of an unevaluated property exceeds the fair
market value of the property the excess book value over fair value of the
property is reclassified into the properties subject to amortization.
F-22
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
During the year ended December 31, 2003 the Company reclassified approximately
$4,002,000 and $1,027,000 of unevaluated property cost to the properties subject
to amortization associated with its Pipeline and Sand Wash properties,
respectively.
No reclassification based on the fair market value review was recorded during
the year ended December 31, 2002 and the nine months ended December 31, 2001.
Any cost related to exploratory dry wells is included in properties subject to
amortization when that determination is made. Any costs associated with
geophysical and geological costs that are not associated with specific
unevaluated properties are included in the properties subject to amortization as
incurred.
The per equivalent MCF amount of depreciation, depletion and amortization
incurred during the years ended December 31, 2003 and 2002 and nine months ended
December 31, 2001 was $0.92, $1.11 and $2.56, respectively.
Recovery of the above acquisition and development costs is dependent on a
variety of factors including actual production results, market conditions, the
success of future exploration and development activities on the properties, and
the availability of future financing on terms acceptable to management.
Capitalized Financing Costs
- -----------------------------
From inception through December 31, 2003, the Company has capitalized the
following financing costs related to properties not subject to amortization. As
these properties are developed, the costs are transferred to properties subject
to amortization:
December 31,
----------------------
2003 2002
---------- ----------
Beneficial conversion feature related to
the 8% subordinated convertible notes $1,165,500 $1,165,500
Capitalized interest 2,246,019 1,863,783
Capitalized amortization of loan costs 4,885,586 2,170,612
---------- ----------
Total capitalized finance costs $8,297,105 $5,199,895
========== ==========
Note 7 - Notes Receivable
- -----------------------------
The Company issued a three year note for $1,620,000 when it sold its Kansas
producing properties in May 2002. The note had an outstanding balance as of
December 31, 2003 and 2002 of approximately $1,597,000 and $1,612,000,
respectively. Interest accrues on the note at 7.0% per annum with quarterly
payments, based on a 30 year amortization, of $35,000, including interest, due
on the first day of November, February, May and August with a balloon payment
due May 1, 2005. The note is collateralized by the oil producing properties that
were sold.
F-23
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Note 8 - Accrued Expenses
- -----------------------------
Accrued expenses consist of:
December 31,
------------------
2003 2002
-------- --------
Production taxes payable - current $282,752 $103,586
Oil and gas revenue payable to oil
and gas property owners 158,318 86,187
Accrued interest 223,060 218,901
Derivative liability - 125,693
Other accrued expense 302,639 355,527
-------- --------
Total accrued expenses: $966,769 $889,894
======== ========
Note 9 - Long-Term Debt
- ---------------------------
Long term debt consists of the following:
December 31,
-------------------------
2003 2002
------------ -----------
8% subordinated convertible notes payable,
convertible into 572,395(1) shares of
Company common stock. Due June 13, 2006. $ 2,793,000 $ 4,243,000
7% subordinated convertible notes payable,
convertible into 1,386,389(1) shares of
Company common stock.
Due April 22, 2007. 11,184,000 12,540,000
25,000,000 development credit facility
with a bank, $5,500,000 borrowing base
at December 31, 2003 to be redetermined
on a semi-annual basis on April 1 and
October 1; accrued interest at the prime
rate plus 1% (totaling 5% at December
31, 2003) is due on a monthly basis with
principal and unpaid interest due June 30,
2006; collateralized by all of the
Company's interest in its Pipeline and
Labarge properties. 5,500,000 -
Bridge loan with related party; interest at 7%
due and payable on January 30, 2005;
collateralized with a second mortgage on
the Company's Pipeline and Sand Wash oil
and gas properties. Subsequent to December
31, 2003, $1,250,000 of this loan was repaid. 3,000,000 3,000,000
Note payable to seller (for a 50% interest in
an airplane), with interest at 7% due on a
quarterly basis. The Company is required
to make annual principal payments equal
to 5% of the current outstanding principal
until paid in full. The seller can call the
note if the bank calls its note for the
original purchase of the airplane. The
note is collateralized by the Company's 50%
interest in the airplane with a net book value
of approximately $2,300,000. 2,326,201 -
2,000,000 revolving credit note with interest
at prime plus 1.0% (totaling 5% at December
31, 2003); due in December 2004. The note
is cross-collateralized by substantially all the
assets of the oil and gas service subsidiary. 96,367 6,506
F-24
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
December 31,
-------------------------
2003 2002
------------ -----------
2,900,000 term loan with interest at prime
plus 1.0% (totaling 5% at December 31, 2003),
due in monthly installments of $80,626 plus
interest, through December 2004. The note is
cross-collateralized by substantially all the
assets of the oil and gas service subsidiary. 905,138 1,960,651
1,000,000 term loan with interest at prime
plus 1.0% (totaling 5% at December 31, 2003),
due in monthly installments of $15,626 plus
interest, through December 2004. The note
is cross-collateralized by substantially all
the assets of the oil and gas service subsidiary. 390,000 570,000
Various fixed rate notes collateralized by
vehicles and equipment with interest rates
ranging from 6.0% to 9.5%; payable in
monthly installments of principal and interest
totaling $19,203, with payments due
between June 2002 and July 2008. 1,053,022 1,228,519
Note payable to a bank with interest at Wall
Street Prime plus .25% (totaling 4.25% at
December 31, 2003); payable in monthly
installments of $5,635 including interest
through November 2006; collateralized by
real property. 185,383 249,081
Note payable to a bank with interest at 9.25%,
payable in monthly installments of $4,883
including interest through December 2011;
collateralized by real estate. 330,228 335,035
Capital leases, with monthly installments
totaling $5,064, including interest and expiring
through November 2006. 204,310 245,197
Note payable to a bank with interest at 6.25%,
due in monthly principal installments
at $25,000 plus interest through January 2004.
The note was paid in full subsequent to
December 31, 2003. 25,000 -
Note payable to seller (for a 50% interest in
an airplane). The interest in the plane was
forfeited as full satisfaction for the note
in 2003. - 1,489,125
Notes payable to sellers of oil and gas
properties paid in full in 2003. - 607,236
------------ ------------
Total long-term obligations 27,992,649 26,474,351
Less current portion (1,762,777) (2,227,195)
------------ ------------
$26,229,872 $24,247,156
============ ============
____________________
(1) Taking into effect the change in conversion price subsequent to December
31, 2003
F-25
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Maturities of long-term obligations are as follows:
Long-Term Debt
Years Ending and Convertible
December 31, Notes Capital Leases Total
- ------------------------ ----------------- ---------------- ------------
2004 $ 1,714,902 $ 60,776 $ 1,775,678
2005 3,731,019 60,776 3,791,795
2006 8,786,228 110,000 8,896,228
2007 11,478,561 - 11,478,561
2008 156,433 - 156,433
Thereafter 1,921,196 - 1,921,196
Less amount
representing interest - (27,242) (27,242)
----------------- ---------------- ------------
Total principal 27,788,339 204,310 27,992,649
Less current portion (1,714,901) (47,876) (1,762,777)
----------------- ---------------- ------------
$ 26,073,438 $ 156,434 $26,229,872
================= ================ ============
Included in equipment in the accompanying consolidated balance sheet as of
December 31, 2003 and 2002, are assets held under capital leases in the amount
of approximately $297,000 net of accumulated amortization of approximately
$70,000 and $41,000, respectively.
Convertible Subordinated Notes
- --------------------------------
8% Convertible Subordinated Notes
Effective June 13, 2001, the Company sold $6,475,000 in 8% Subordinated
Convertible Notes in a private placement in which C.E. Unterberg, Towbin acted
as the placement agent. Interest on the notes accrues at a rate of 8% per annum
and is payable in arrears on each December 15 and June 15 commencing December
15, 2001. The notes were originally convertible to one share of common stock at
$5 per share and mature on June 13, 2006.
The notes are subordinated to substantially all the Company's other existing or
future notes payable, capital leases, debentures, bonds or other such
securities. In addition, the Company can redeem, at its option, all or a portion
of the notes as follows:
Redemption Price
Percentage of
Year Principal
------------------- -------------
2004 103.2%
2005 and thereafter 101.6%
If at any time the Company's stock price exceeds 300% of the conversion price
for 20 consecutive days, the Company can redeem, at its option, all or a portion
of the notes for the principal balance and accrued interest outstanding. If
there is a change in control of the Company, the Company must redeem the notes
at the rates noted above.
F-26
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company incurred costs of $501,906 associated with the placement, which has
been capitalized as loan costs and is being amortized using the effective
interest method. The Company also issued warrants to purchase 220,000 shares of
common stock at $5.99. The Company capitalized additional loan costs of $924,717
related to the fair value of the warrants as determined using the Black-Scholes
pricing model assuming a five year life, weighted average risk-free interest
rate of 8%, expected volatility of 80.66% and no expected dividend yield.
Proceeds from the offering were used in the development of the Company's oil and
gas properties.
As the conversion feature of the convertible notes was below the market value of
the stock on the date of issue, the Company recorded a discount of $1,165,500
related to the intrinsic value of the beneficial conversion feature. The notes
are immediately convertible and therefore, the discount was immediately
amortized.
The Company capitalized the amortization of the beneficial conversion feature
into oil and gas properties not subject to amortization as the debt was issued
in order to continue exploration and development of projects that were not
currently subject to amortization, and was not used for general operating
purposes.
During 2003 and 2002, the holders of $1,450,000 and $2,232,000 of 8%
subordinated convertible notes converted the debt and accrued interest into
295,689 and 454,974 shares of the Company's common stock, respectively.
Subsequent to December 31, 2003, the holders of $130,000 of 8% subordinated
convertible notes converted the debt into 27,059 shares of the Company's common
stock.
Subsequent to December 31, 2003, the Company issued 1,000,000 shares of common
stock at $4.00 per share in a private placement (See Note 18). The loan
indenture contains anti-dilution provisions that require the Company to adjust
the conversion price of the notes if stock is sold at a price less than the
conversion price. Therefore, the conversion price was adjusted to $4.88 per
share. In connection with the adjustment of the conversion price, the Company
recorded an approximately $54,000 charge related to the additional shares
issuable at the new conversion price.
7% Convertible Subordinated Notes
Effective April 22, 2002, the Company sold $12,540,000 in 7% Subordinated
Convertible Notes in a private placement in which C.E. Unterberg, Towbin acted
as the placement agent. A director of the Company is also an officer with C.E.
Unterberg, Towbin. In addition, to the extent a holder of the Company's 8%
Subordinated Convertible Notes converted any of their notes and the accrued
interest to stock, and purchased 7% Subordinated Convertible Notes, these
parties would be related parties. Interest on the 7% subordinated notes accrues
at a rate of 7% per annum and is payable in arrears on each April 15 and October
15. The Company can elect to pay the accrued interest in cash or in the form of
additional notes issued in increments of $1,000 with residual interest due in
cash. In December 2003, the Company issued $379,000 in new notes as payment for
interest due at that time. The Company expects it will issue additional notes in
April and October 2004 as payment for interest then due. The notes were
originally convertible to one share of common stock at $8.625 per share and
mature on April 22, 2007.
F-27
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The notes are subordinated to substantially all the Company's other existing or
future notes payable, capital leases, debentures, bonds or other such
securities. In addition, after April 22, 2004, the Company can redeem, at its
option, all or a portion of the notes as follows:
Redemption Price
Percentage of
Year Principal
------------------- -------------
2004 104.2%
2005 102.8%
2006 and thereafter 101.4%
Currently if the Company's stock price exceeds 300% of the conversion price for
20 consecutive days, the Company can redeem, at its option, all or a portion of
the notes for the principal balance and accrued interest outstanding. If there
is a change in control of the Company, the Company must redeem the notes at the
rates noted above if after April 22, 2004 or 101% of principal plus accrued
interest if before April 22, 2004.
The Company incurred costs of $865,505 associated with the issuance of the 7%
convertible notes, which have been capitalized as loan costs and are being
amortized using the effective interest method. The Company also issued warrants
to purchase 200,000 shares of common stock at $9.058. The Company capitalized
additional loan costs of $1,386,044 related to the fair value of the warrants as
determined using the Black-Scholes pricing model assuming a five year life,
weighed average risk-free interest rate of 7%, expected volatility of 98.30% and
no expected dividend yield. A portion of the proceeds from the offering was used
in the development of the Company's oil and gas properties. As the conversion
feature of the 7% convertible notes was above the market value of the stock on
the date of issue, the Company did not record a beneficial conversion feature.
During 2003, the holders of $1,735,000 of the 7% subordinated convertible notes
converted the debt and accrued interest into 203,712 shares of the Company's
common stock.
Subsequent to December 31, 2003, the Company issued 1,000,000 shares of common
stock at $4.00 per share in a private placement (See Note 18). The loan
indenture for the 7% notes contains anti-dilution provisions that require the
Company to adjust the conversion price of the notes if stock is sold at a price
less than the conversion price. Therefore, the conversion price was adjusted to
$8.067 per share. In connection with the adjustment of the conversion price, the
Company recorded an approximately $354,000 charge related to the additional
shares issuable at the new conversion price.
$25,000,000 Development Credit Facility
- ------------------------------------------
In September 2003, the Company established a Secured Revolving Borrowing Base
Credit Facility ("Facility") with a bank. The Facility provides for funding of
up to $25,000,000 with an initial borrowing base for the facility at $5,500,000.
Borrowing base determinations are based on the volume of oil and gas production
expected, the term and price of hedging contracts in place, and the costs
associated with producing the oil and gas and associated general and
administrative expense. The Facility is subject to semi-annual borrowing base
determinations based on the same criteria as the original determination. The
Company and the bank each have the option to request one additional
F-28
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
re-determination during each calendar year. The bank has the sole discretion
regarding any increase in the borrowing base if the semi-annual determination
indicates that there is additional borrowing base available. Interest on the
Facility accrues and is payable monthly at prime rate plus 1.0% (totaling 5.0%
at December 31, 2003). The Company incurred $110,000 in loan costs and
approximately $57,000 in legal costs to establish the Facility. These costs were
capitalized as loan costs and will be amortized using the effective interest
method.
The initial proceeds were used to pay initial loan costs, repay $3,850,000 of
new bridge loans obtained during 2003, for development of oil and gas properties
and for working capital. The loan is subject to various restrictive and
financial covenants. At December 31, 2003 the Company was in violation of the
working capital covenant.
Subsequent to December 31, 2003, the Company was granted a waiver of the
violation as of December 31, 2003, and through April 30, 2004, when management
believes it will be in, and stay in compliance for the remainder of 2004. This
Facility limits the amount of cash distribution from Infinity Oil and Gas of
Wyoming, Inc. ("Infinity-Wyoming") to Infinity, Inc. to the pro-rata share of
tax expense generated by the net taxable income of Infinity-Wyoming and
additional cash distributions of $300,000 per fiscal year.
Bridge Loan and Related Agreements - Related Party
- --------------------------------------------------
On November 25, 2002, the Company obtained a $3,000,000 one year bridge loan
from a related party with an annual interest rate at Wall Street prime plus 1.0%
in order to pay outstanding payables associated with the development of its oil
and gas properties. In March 2003, the note was extended to January 2004. In
May 2003, the note was amended to extend the maturity to January 30, 2005 and to
place requirements for accelerated payment should the Company raise in excess of
$3,500,000 in debt or equity financing. In June 2003, the loan agreement was
amended to waive a portion of the accelerated payment requirements and to
increase the interest rate to 7%. The note holder was also granted a first
priority security interest in the Company's Sand Wash property and a
subordinated security interest in the Pipeline property. The Company also
entered into a consulting agreement with the related party in June 2003 under
which the related party would facilitate a $3,850,000 bridge loan that was
obtained and paid off in 2003 and other future financings, if any.
The table below sets forth information about options that were granted in
conjunction with these transactions. All of the options issued were valued using
the Black-Scholes pricing model assuming a five year life, weighted average risk
free interest rate of 1.5%, expected volatility rates between 125% and 132% and
no expected dividend yield. The option value was capitalized as loan costs and
is being amortized using the effective interest method. The amortization is
treated as interest in the Company's consolidated statement of operations with a
portion capitalized to the non-producing properties developed with the proceeds
of the loan.
F-29
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of the options granted in connection with the loan
and related agreements:
Date of Options Option Loan
Grant Granted Price Costs
----------------- ------- ------- ----------
November 25, 2002 320,000 $ 8.75 $2,281,718
May 23, 2003 150,000 8.75 730,130
June 18, 2003 125,000 8.75 642,841
June 26, 2003 225,000 8.75 1,120,358
------- ----------
820,000 $4,775,047
======= ==========
Subsequent to December 31, 2003, the Company repaid $1,250,000 of the loan
balance outstanding with $750,000 in cash and the issuance of 125,000 shares of
common stock valued at $4.00 per share (See Note 19).
Revolving Credit and Term Loans
- -----------------------------------
In January 2002, the Company refinanced a portion of its long-term debt. The
Company entered into a financing agreement with a bank whereby the Company
executed the following:
- A $2,000,000 revolving credit note cross-collateralized by
substantially all the Company's assets except oil and gas properties;
with interest at prime plus 1.0%. The note is due December 31, 2004.
- An approximately $2,900,000 term note with interest at prime plus
1.0%, due in monthly installments of $80,626 plus interest, through
December 2004. The note is cross-collateralized by substantially all
the assets of the Company except oil and gas properties.
- A $1,000,000 capital expenditure line with interest at prime plus
1.0%, due in monthly installments of $15,626 plus interest through
December 31, 2004 when unpaid principal and interest are due. The note
is cross-collateralized by substantially all the assets of the Company
except oil and gas properties. The Company borrowed $720,000 under the
line.
The notes require the Company to comply with certain financial and restricted
covenants and are guaranteed by an officer of the Company up to $1,000,000.
This facility limits the amount of distributions that can be made, other than
through the normal course of business, to Infinity, Inc. and affiliated
companies to $250,000 per fiscal year without the prior consent of the lender.
2003 Debt Paid in Full
- --------------------------
In 2003, the Company issued 201,000 five year options and 462,500 five year
warrants to purchase common stock at $8.75 per share and granted a 4%
over-riding royalty in certain producing properties when it obtained three
bridge loans totaling $5,900,000 with interest rates ranging from 2% per month
to 12% per year. The Company capitalized loan costs of $3,297,390 for the
options and warrants and $1,250,000 based on the estimated fair value for the 4%
over-riding royalty conveyed. The Company used the Black-Scholes pricing model
assuming a five year life, weighted average risk-free interest rates of 1.5% to
4%, expected volatility between 126.11 % and 131.96 % and no expected
F-30
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
dividend yield to calculate the fair value of the options and warrants at the
date of grant. The Company repaid all of the loans during 2003 and all of the
loan costs were fully amortized during the year.
2002 Debt Paid in Full
- --------------------------
In March 2002, the Company issued five-year options to purchase 250,000 shares
of common stock at $7.34 per share when it obtained a $2,000,000, bridge loan
from a related party, with an annual interest rate of 8%, in order to pay
outstanding payables associated with the development of its oil and gas
properties. The Company capitalized loan costs of $1,347,728 related to the
fair value of the options as determined using the Black-Scholes pricing model
assuming a five year life, weighted average risk-free interest rate of 8%,
expected volatility of 89.55% and no expected dividend yield. The loans were
repaid in full in April 2002 with proceeds from the sale of the 7% subordinated
convertible notes.
Note 10 - Stockholder's Equity
- ------------------------------
Stock Split
- ------------
In May 2002, the Company effected a 2:1 stock split effective May 13, 2002. All
shares and per share amounts have been restated to give effect to the stock
split.
Warrants and Options to Non-Employees
- -----------------------------------------
The Company, in conjunction with a public stock offering in September 1988,
issued Class A and Class B warrants to purchase 425,918 shares of common stock.
The 223,496 Class A warrants have expired. During 2002, 163,264 shares of common
stock were issued upon the exercise of Class B warrants for proceeds of
$977,911. The remaining 39,158 Class B warrants expired in June 2002.
During 2001, in connection with the sale of $6,475,000 8% subordinated
convertible notes, the Company granted 220,000 warrants to purchase the
Company's common stock at $5.99 per share. The warrants expire in June 2006
(See Note 9).
During 2002, in connection with the sale of $12,540,000, 7% subordinated
convertible notes, the Company granted 200,000 warrants to purchase the
Company's common stock at $9.058 per share. The warrants expire in April 2007
(See Note 9).
In connection with obtaining $5,000,000 of bridge loans in March and November
2002, the Company granted 570,000, five year options to purchase the Company's
common stock at $7.34 (250,000 of the options) or $8.75 (320,000 of the options)
per share (See Note 9).
During 2003, in connection with the issuance of $1,000,000 of bridge notes,
which were paid in full in 2003, the Company granted 212,500 warrants to
purchase the Company's common stock at $8.75 per share. The warrants expire in
April 2008 (See Note 9).
During 2003, in connection with the issuance of $3,850,000 in bridge notes which
were paid in full in 2003, the Company granted 250,000 warrants to purchase the
Company's common stock at $8.75 per share. Subsequent to December 31, 2003, the
Company issued 1,000,000 shares of common stock at $4.00 per share in a private
placement. (See Note 18). The warrant agreement contains anti-dilution
provisions that require the Company to adjust the exercise price and change the
number of warrants outstanding if the Company sells stock at less than the
exercise price. Therefore, in January the warrants
F-31
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
were increased by 17,500 warrants to 267,500 warrants with an exercise price of
$8.18 per share. The warrants expire July 2, 2008 (See Note 9).
In connection with obtaining $1,050,000 of bridge loans in January and April of
2003 (which were paid in full during 2003), the amendments of an existing
$3,000,000 loan agreement, and a consulting contract to assist with the
facilitation of a $3,850,000 loan agreement, the Company granted options to
purchase the Company's common shares at $8.75 per share (See Note 9).
A summary of warrant and option activity with non-employees is as follows:
Warrant/Option Price Weighted Average
Number of Shares Per Share Price Per Share
----------------- -------------------- -----------------
Outstanding, March 31, 2001 269,922 $ 1.75 - $6.00 $ 5.16
Granted 220,000 5.99 5.99
Canceled or forfeited (25,000) 1.75 1.75
Exercised (2,500) 2.63 2.63
----------------- -------------------- -----------------
Outstanding, December 31, 2001 462,422 3.22 - 6.00 5.75
Granted 770,000 7.34 - 9.06 8.37
Canceled or forfeited (39,158) 6.00 6.00
Exercised (163,264) 6.00 6.00
----------------- -------------------- -----------------
Outstanding, December 31, 2002 1,030,000 3.22 - 9.06 7.66
Granted 1,163,500 8.75 8.75
Exercised (83,350) 7.34 7.34
----------------- -------------------- -----------------
Outstanding, December 31, 2003 2,110,150 $ 3.22 - $9.06 $ 8.27
================= ==================== =================
Number Weighted Number
Outstanding at Average Weighted Exercisable at Weighted
Range of Exercise December 31, Remaining Average December 31, Average
Prices 2003 Contractual Life Exercise Price 2003 Exercise Price
- ------------------ -------------- ---------------- --------------- -------------- --------------
$3.22 40,000 2 years $ 3.22 40,000 $ 3.22
$5.99 220,000 3 years $ 5.99 220,000 $ 5.99
$7.34 - 9.06 686,650 4 years $ 9.06 686,650 $ 8.50
$8.75 1,163,500 5 years $ 8.75 1,163,000 $ 8.75
-------------- --------------
2,110,150 2,110,150
============== ==============
The following is the weighted average fair value of warrants and options granted
to non-employees:
Period Ending December 31, Weighted Average Fair Value
-------------------------- ---------------------------
2001 (nine months) $ 9.50
2002 $ 6.51
2003 $ 4.98
F-32
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Options Under Employee Option Plans
- ---------------------------------------
The Company has adopted stock option plans containing both incentive and
non-statutory stock options. All options allow for the purchase of common stock
at prices not less than the fair market value of such stock at the date of
grant. If the optionee owns more than 10% of the total combined voting power of
all classes of the Company's stock, the exercise price can not be less than 110%
of the fair market value of such stock at the date of grant.
Options granted under the plans become exercisable immediately or as directed by
the Board of Directors and generally expire five or ten years after the date of
grant, unless the employee owns more than 10% of the total combined voting power
of all classes of the Company's stock, in which case they must be exercised
within five years of the date of grant. Pursuant to the plans, an aggregate of
1,928,047 options were available for grant. The Company granted 10,000, 345,000,
and 330,000 options to employees under the Plans during the years ended December
31, 2003 and 2002, and the nine months ended December 31, 2001, respectively. At
December 31, 2003, there were 95,720 shares remaining available under the plans.
A summary of stock option activity is as follows:
Option Price Weighted Average
Number of Shares Per Share Price Per Share
----------------- -------------- -----------------
Outstanding, March 31, 2001 789,750 $1.50 - $5.25 $ 2.48
Granted 330,000 5.00 5.00
Canceled or forfeited (7,300) 3.82 3.82
Exercised (62,850) 1.50 - 5.25 1.93
----------------- --------------- -----------------
Outstanding, December 31, 2001 1,049,600 1.50 - 5.00 3.30
Granted 345,000 7.00 - 8.70 8.70
Canceled or forfeited (6,200) 3.00 - 5.00 3.59
Exercised (247,500) 1.50 - 5.00 1.93
----------------- --------------- -----------------
Outstanding, December 31, 2002 1,140,900 1.50 - 8.70 5.23
Granted 10,000 8.75 8.75
Canceled or forfeited (61,781) 3.82 - 8.70 7.28
Exercised (62,819) 1.50 - 5.00 3.38
----------------- --------------- -----------------
Outstanding, December 31, 2003 1,026,300 $1.50 - $8.75 $ 5.25
================= =============== =================
F-33
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercisable at Average
Range of at December Contractual Exercise December 31, Exercise
Exercise Prices 31, 2003 Life Price 2003 Price
---------------- ----------- ----------- --------- -------------- ---------
$ 1.50 62,000 1 year $ 1.50 62,000 $ 1.50
$ 1.50 119,500 2 years $ 1.50 119,000 $ 1.50
$ 3.00-3.82 219,800 2 years $ 3.80 219,800 $ 3.80
$ 5.00 304,000 3 years $ 5.00 304,000 $ 5.00
$ 5.00 8,000 4 years $ 5.00 8,000 $ 5.00
$ 8.70 303,000 4 years $ 8.70 303,000 $ 8.70
$ 8.75 10,000 5 years $ 8.75 5,000 $ 8.75
----------- --------------
1,026,300 1,021,300
=========== ==============
The following is the weighted average fair value of options granted from stock
option plans:
Period Ending December 31, Weighted Average Fair Value
--------------------------- -----------------------------
2001 (nine months) $3.37
2002 $7.10
2003 $5.25
Subsequent to December 31, 2003, 40,000 options were exercised for proceeds of
approximately $60,000.
Options
- -------
The Company granted 177,500 options to employees outside its stock option plans
prior to March 31, 2001 with exercise prices ranging from $1.55 to $4.00 and a
weighted average price per share of $2.76. These options were exercised during
2002.
At December 31, 2003, the Company had no options to employees outside of the
stock option plans.
F-34
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 11- Income Taxes
- ------------------------
The provision for income taxes consists of the following:
For the Years Ended For the Nine
December 31, Months Ended
-------------------------- December 31,
2003 2002 2001
------------ ------------ -------------
Current income tax expense $ - $ - $ -
Deferred income tax (benefit) expense (4,003,321) (1,226,874) 1,590,056
Change in deferred tax asset valuation
allowance 4,003,321 82,846 -
------------ ------------ -------------
Total income tax (benefit) expense $ - $(1,144,028) $ 1,590,056
============ ============ =============
The effective income tax rate varies from the statutory federal income tax rate
as follows:
For the Year Ended For the Nine
December 31, Months Ended
---------------------- December 31,
2003 2002 2001
---------- ---------- -------------
Federal income tax rate (34)% (34)% 34%
State income tax rate (6) (6) 6
Other temporary and permanent
differences - 1 (1)
Change in valuation allowance 40 (3) -
---------- ---------- -------------
Effective tax rate 0% (42)% 39%
========== ========== =============
The significant temporary differences and carry forwards and their related
deferred tax asset (liability) and deferred tax asset valuation allowance
balances are as follows:
December 31,
--------------------------
2003 2002
------------ ------------
Deferred tax assets
Accruals and impairment $ 257,000 $ 252,000
Net operating loss carry-forward 9,551,000 4,601,000
Permanent differences 366,000 202,000
Other 118,000 18,000
------------ ------------
Gross deferred tax assets 10,292,000 5,073,000
------------ ------------
Deferred tax liabilities
Intangible drilling costs 4,190,000 3,191,000
Property and equipment 682,000 682,000
------------ ------------
Gross deferred tax liabilities 4,872,000 3,873,000
------------ ------------
Net deferred tax asset 5,420,000 1,200,000
Less valuation allowance (5,420,000) (1,200,000)
------------ ------------
Deferred tax asset $ - $ -
============ ============
F-35
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For income tax purposes, the Company has approximately $24,807,000 of net
operating loss carry-forwards expiring from 2015 through 2023.
During 2003 and 2002, the Company realized certain tax benefits related to stock
option plans in the amounts of $164,000 and $232,000, respectively. Such
benefits were recorded as a deferred tax asset as they increased the Company's
net operating losses and an increase in additional paid in capital. The
recognition of the valuation allowance offset the impact of this benefit.
The Company has provided for a valuation allowance of $5,420,000 due to the
uncertainty of realizing the tax benefits from its net operating loss
carry-forwards.
Note 12 - Commitments and Contingencies
- ---------------------------------------
Gas Gathering Contract
- ------------------------
In June 2001, the Company entered into a long-term gas gathering contract, which
expires in December 2008. This contract was amended April 4, 2003. Under the
amended contract, the Company will pay gas gathering fees per thousand cubic
feet ("MCF") delivered. The Company is obligated to pay a fee of $.40 per MCF
on the first 7,500,000 MCF and $.25 per MCF thereafter. Additionally, the
Company has an annual volume commitment for the first 3 years starting September
1, 2001. The Company's minimum volume for the first three years is (i) Year one
600,000 MCF, (ii) Year two 1,600,000 MCF, (iii) Year three 2,000,000 MCF, (iv)
Year four 1,800,000 MCF, and (v) Year five 1,500,000 MCF. If the Company
exceeds the minimum in any year, the excess reduces the following year's
commitment. If the Company does not meet the minimum in any year, the shortfall
is added to the following years and at the end of the three years, the Company
has to pay additional costs for the shortfall. Through December 31, 2003, the
Company had delivered approximately 2,060,000 MCF. While the Company has failed
to deliver the volumes required under the contract, the pipeline operator has
also not provided the compression and gathering capabilities it was required to
provide under the contract. Management has received a verbal commitment from
the operator that the volume commitments will be adjusted and management does
not believe there will be a contract shortfall under the renegotiated volumes
and therefore, anticipates no additional costs under the contract.
Financial Consulting Agreement
- --------------------------------
In July 2003 the Company entered into a eighteen month financial consulting
agreement with a related party. The Company issued options to purchase 125,000
shares of common stock that were valued at approximately $1,094,000 using the
Black-Scholes valuation model, as compensation for entering into the agreement.
(See Note 9) The related party helped facilitate the $3,850,000 bridge loan
that was obtained in July 2003.
Labarge Evaluation and Development Agreement
- ------------------------------------------------
In December 2003, the Company entered into an agreement with both Schlumberger
Technology Corporation and Red Oak Capital Management LLC to develop its Labarge
coal bed methane project. The agreement provides for the completion or
recompletion of five to ten of the Company's existing well bores, the
anticipated drilling of ten new wells in 2004, and the anticipated drilling of
twenty wells in each of the years 2005 through 2008.
F-36
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Based on the success of the initial completion program, and after each yearly
development phase, the project will be evaluated for continuation. Work on the
existing well bores began in January 2004 and is expected to be completed in the
second quarter of 2004.
Schlumberger has the exclusive right to provide completion services and supplies
for each development phase and Red Oak has the exclusive right to finance a
portion of the cost of wells drilled in the 2004, 2005 and 2006 drilling phases.
The Company will be required to finance approximately 50% of the drilling and
other costs for each phase.
Payment for the services provided by Schlumberger and Red Oak will be made from
net proceeds, after operating costs from the wells completed or re-completed in
each development phase. This method of payment for the services provided
results in a substantial portion of the net profits from the wells included in
each bundle being paid to Schlumberger and Red Oak until the obligation on each
bundle is satisfied. The agreement is secured by a pledge of the wells
completed or recompleted, and does not burden the ownership of or profits from
any other assets of the Company.
The Company has approximately $9,399,000 invested in unproved oil and gas
properties not subject to amortization on the Labarge project and expects to
incur approximately an additional $3,600,000 in costs during 2004 under the
agreement to evaluate and explore the property. At the conclusion of the 2004
evaluation and exploration activity, a significant portion of the investment in
unproved oil and gas properties will be reclassified to the full cost pool
subject to depletion and the ceiling test. If proved reserves are not found or
if reserves are not significant, the Company could be required to write-down a
portion of the full cost pool of oil and gas properties.
Regulations
- -----------
The Company's oil and gas operations are subject to various Federal, state and
local laws and regulations. The Company could incur significant expense to
comply with new or existing laws and non-compliance could have a material
adverse effect on the Company's operations.
Environmental
- -------------
The Company uses injection wells to dispose of water into underground rock
formations. If future wells produce water of lesser quality than allowed under
state laws or if water is produced at rates greater than can be injected, the
Company could incur additional costs to dispose of its water.
Note 13 - Retirement Plan
- -------------------------
The Company has a 401(k) plan covering substantially all of the employees of the
oil field services subsidiary. There were no Company contributions made to the
plan during the year ended December 31, 2003 and 2002 and the nine months ended
December 31, 2001. Effective January 1, 2004 the Company began matching, dollar
for dollar, employee contributions up to 4% of their gross pay. At the current
rate of participation, this benefit will cost the Company approximately $105,000
during 2004.
Note 14 - Industry Segments
- ---------------------------
The Company reports segment information in accordance with SFAS No 131, which
requires disclosure of information related to certain operating segments of the
Company.
The Company's operations have been classified into two industry segments: (i)
Oil Field Services; and (ii) Oil and Gas Production. The Oil Field Services
segment of the Company is directed at maintaining and enhancing production
obtained from oil and gas wells and currently has operations in Kansas,
Oklahoma, and Wyoming. The Oil and Gas Production segment of the Company has
acquired interests in undeveloped leaseholds in Wyoming, Colorado and Kansas of
which a portion have been developed into producing properties.
F-37
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Oil Field Oil & Gas Corporate and
Services Production Other Total
----------- ------------- --------------- ------------
Revenue
December 31, 2001 (nine months) $ 9,853,624 $ 1,759,095 $ - $11,612,719
December 31, 2002 8,570,631 2,367,713 - 10,938,344
December 31, 2003 11,634,457 6,589,281 - 18,223,738
Depreciation, amortization, depletion
and impairment (1)
December 31, 2001 (nine months) 842,694 136,649 631,518 1,610,861
December 31, 2002 1,485,495 273,936 223,155 1,782,586
December 31, 2003 1,420,952 1,561,247 92,048 6,049,247
Ceiling write-down
December 31, 2001 (nine months) - - - -
December 31, 2002 - - - -
December 31, 2003 - 2,975,000 - 2,975,000
Operating income (loss)
December 31, 2001 (nine months) 2,163,119 143,118 (841,432) 1,464,805
December 31, 2002 37,285 (299,079) (1,670,865) (1,932,659)
December 31, 2003 1,411,218 (1,629,866) (2,061,353) (2,280,001)
Total assets, net
December 31, 2002 9,967,770 35,566,847 7,595,652 53,130,269
December 31, 2003 9,069,144 40,220,115 5,977,019 55,266,278
Capital expenditures
December 31, 2001 (nine months) 2,524,719 7,982,573 7,710 10,515,002
December 31, 2002 1,561,357 14,695,044 865,505 17,121,906
December 31, 2003 459,820 6,175,325 197,567 6,832,712
____________________
(1) Excludes amortization of loan costs included in interest expense in the
accompanying consolidated statements of operations.
Note 15 - Significant Customers
- -------------------------------
During the nine months ended December 31, 2001, the Company had oil field
service sales to two unrelated third parties of approximately $2,640,000,
representing approximately 23% of net sales. During the year ended December 31,
2002, the Company had oil field service sales to one unrelated third party of
approximately $1,569,000, representing approximately 14% of net sales. In
addition, during 2002, the Company sold 89% of its oil and gas to three
unrelated companies. During the year ended December 31, 2003, the Company had
oil field service sales to one unrelated third party of approximately
$1,150,000, representing approximately 10% of net sales. In addition, during
2003, the Company sold approximately $6,453,000, or 98% of its oil and gas
revenue, to two unrelated customers. Receivables outstanding from the December
31, 2003 and 2002 significant customer sales were approximately $529,000 and
$586,000, respectively.
F-38
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 - Fair Value of Financial Instruments
- ---------------------------------------------
The carrying value of the Company's cash balance, accounts receivable, accounts
payable and accrued expenses represents the fair value of the accounts as of
December 31, 2003 and 2002. The fair value of the Company's long-term debt with
financial institutions and equipment financing companies approximates the
carrying value because (i) interest rates are variable or (ii) the debt
instruments were executed at rates comparable to current rates for similar
notes. The fair value of the Company's other long-term debt obligations cannot
be determined due to the nature of the transactions which created the debt, and
comparable market value information is not readily determinable without
incurring excessive costs. See Note 9 for the terms of the long-term debt
obligations.
Note 17 - Earnings Per Share
- ----------------------------
At December 31, 2003 and 2002, all potential Company shares of common stock are
anti-dilutive. At December 31, 2001, the following shows the amounts used in
computing earnings per share and the effects on income and the weighted average
number of shares of dilutive potential common stock:
Weighted Average
Income Common Shares Earnings Per
Numerator Denominator Share
------------ ---------------- -------------
Basic earnings per share (December 31, 2001)
Income available to common stockholders $2,540,395 6,501,104 $ .39
=============
Plus: Impact of assumed conversion of warrants and
options - 455,816
Impact of assumed conversion of 8%
subordinated convertible notes -* 9,002
---------- ----------------
Diluted earnings per share $2,540,395 6,965,922 $ .37
========== ================ =============
____________________
* Interest on 8% subordinated convertible notes was capitalized.
As of December 31, 2003, 2002 and 2001, the impact of 4,991,746, 4,473,413 and
344,090, respectively, of potential shares of common stock were not included
because their effect was anti-dilutive.
Note 18- Subsequent Events
- --------------------------
In January 2004, the Company issued 1,000,000 shares of common stock at $4.00
per share in a private placement. The Company used $750,000 of the proceeds from
the private placement, plus 125,000 shares of common stock valued at $4.00 per
share to pay down a portion of the $3,000,000 bridge loan (See Note 9).
In February 2004, the Company entered into a $250,000 note agreement with a
bank. The proceeds of the loan were used to pay outstanding payables. The note
bears interest at 6.25% and is due in 10 monthly installments of $25,000 plus
interest. In addition, the Company financed $169,532 of 2003 and 2004 payables
related to drilling wells at Pipeline, into a 1-year note payable. The note
bears interest at 6.5% and is due in monthly installments of $14,623, including
interest through February 2005.
During 2004, the Company entered into fixed price delivery contracts for 2,000
MMBTU per day from April 1, 2004 until March 31, 2006. The price for the period
April 1, 2004 until March 31, 2005 is $4.40 per MMBTU and the price for the
period April 1, 2005 until March 31, 2006 is $4.15 per MMBTU.
F-39
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Subsequent to obtaining the new contracts, the Company was required to obtain a
$300,000 letter-of-credit with a bank. The Company paid back $400,000 on the
$5,500,000 outstanding on its bank credit facility in order to allow for the
letter-of-credit under the current borrowing base.
In March, 2004 the Company acquired an additional working interest in two
partner operated wells and 960 gross acres of leasehold immediately offsetting
the Pipeline field. The purchase increased the Company's working interest in
the wells to 50% from an approximate 1.5% interest at December 31, 2003 and the
Company assumed operations on the properties.
Note 19 - Supplemental Oil and Gas Information (Unaudited)
- ----------------------------------------------------------
Proved Oil and Gas Reserves (Unaudited)
- --------------------------------------------
The following information was developed from reserve reports prepared by
independent reserve engineers:
Natural Gas Crude Oil
(MCF) (Barrels)
------------ ----------
Proved reserves as of March 31, 2001 9,144,761 444,573
Revisions of previous estimates 208,837 (277,120)
Production (128,998) (29,289)
------------ ----------
Proved reserves as of December 31, 2001 9,224,600 138,164
Sales or other deletions - (128,788)
Revisions of previous estimates (2,042,255) 85,277
Extension, discoveries and other additions 84,284,734 14,169
Production (676,879) (53,122)
------------ ----------
Proved reserves as of December 31, 2002 95,790,200 182,700
Revisions of previous estimates (90,374,776) 1,990
Extension, discoveries and other additions 3,175,927 66,102
Production (1,080,456) (57,684)
------------ ----------
Proved reserves as of December 31, 2003 7,510,895 193,138
============ ==========
The 2003 revision to the previous estimate of reserves is due primarily to the
following factors:
- operational issues at the existing Labarge wells;
- a lack of financial resources to rectify the operational issues on a
timely basis or to complete exploration on other wells; and
- geological studies that indicate the producing Pipeline wells were
producing from the sands rather than the coals thus leading the
Company to change the classification of Pipeline from a coal play to a
sand play.
Proved reserves are 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.
There are uncertainties inherent in estimating quantities of proved oil and gas
reserves, projecting future production rates, and timing of development
expenditures. Accordingly, reserve estimates are often different from the
quantities of oil and gas that are ultimately recovered.
All proved reserves are located in the United States.
F-40
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Proved Developed Oil and Gas Reserves
- ------------------------------------------
The following information sets forth the estimated quantities of proved
developed oil and gas reserves of the Company as of the end of each year.
--------------
Crude Oil and
Natural Gas Condensate
(MCF) (Barrels)
------------ --------------
Proved Developed Reserves
-------------------------
December 31, 2001 4,112,300 138,864
December 31, 2002 38,590,600 182,700
December 31, 2003 4,724,523 124,968
Costs Incurred in Oil and Gas Activities
- ----------------------------------------------
Costs incurred in connection with the Company's oil and gas acquisition,
exploration and development activities are shown below.
For the Nine
For the Years Ended Months Ended
December 31, December 31,
----------------------- -------------
2003 2002 2001
---------- ----------- -------------
Property acquisition costs
Proved $1,099,120 $ 72,383 $ 223,319
Unproved 661,224 2,279,587 1,291,126
---------- ----------- -------------
Total property acquisition costs 1,760,344 2,351,970 1,514,445
Development costs 3,167,700 786,095 721,760
Exploration costs 3,491,953 11,955,351 6,957,735
---------- ----------- -------------
Total costs $8,419,997 $15,093,416 $ 9,193,940
========== =========== =============
F-41
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Aggregate Capitalized Costs
- -----------------------------
Aggregate capitalized costs relating to the Company's oil and gas producing
activities, and related accumulated depreciation, depletion, amortization and
ceiling write-down are as follows:
For the Nine
For the Years Ended Months Ended
December 31, December 31,
------------ ------------ --------------
2003 2002 2001
------------ ------------ --------------
Proved oil and gas properties $28,194,858 $19,411,845 $ 5,009,661
Unproved oil and gas properties (1) 12,815,834 $13,176,850 12,404,906
------------ ------------ --------------
Total 41,010,692 32,588,645 17,414,567
Less accumulated depreciation,
depletion, amortization and
ceiling write-down (4,748,515) (304,418) (223,706)
------------ ------------ --------------
Net capitalized costs $36,262,177 $32,284,277 $ 17,190,861
============ ============ ==============
(1) 2003 includes approximately $885,000 in unproved oil and gas properties in
Nicaragua.
From inception through December 31, 2003, the Company has capitalized the
following financing costs related to properties not subject to amortization. As
these properties are developed, the costs are transferred to properties subject
to amortization:
December 31,
----------------------
2003 2002
---------- ----------
Beneficial conversion feature related to the
8% subordinated convertible notes $1,165,500 $1,165,500
Capitalized interest 2,246,019 1,863,783
Capitalized amortization of loan costs 4,885,586 2,170,612
---------- ----------
Total capitalized finance costs $8,297,105 $5,199,895
========== ==========
Oil and Gas Operations
- -------------------------
Aggregate results of operations in connection with the Company's oil producing
activities are shown below:
For the Years Ended For the Nine
-------------------------- Months Ended
December 31, December 31,
-------------------------- --------------
2003 2002 2001
------------ ------------ --------------
Revenue $ 6,589,281 $ 2,367,713 $ 1,759,095
Production costs and taxes 2,920,493 (1,820,692) (1,140,750)
Depreciation, depletion,
amortization and ceiling write-down (4,442,097) (196,627) (130,232)
------------ ------------ --------------
Results of operations from producing
activities (excluding corporate
overhead and interest costs) $ (773,309) $ 350,394 $ 488,113
============ ============ ==============
F-42
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil
- --------------------------------------------------------------------------------
and Gas Reserves (Unaudited)
- -------------------------------
The following information is based on the Company's best estimate of the
required data for the Standardized Measure of Discounted Future Net Cash Flows
as of December 31, 2003, 2002 and 2001 as required by SFAS No 69. The Statement
requires the use of a 10 percent discount rate. This information is not the
fair market value nor does it represent the expected present value of future
cash flows of the Company's proved oil and gas reserves.
As of December 31,
--------------------------------------------
2003 2002 2001
------------- -------------- -------------
Future cash inflows $ 51,591,800 $ 303,392,537 $ 27,499,212
Future production costs (16,204,800) (109,060,912) (11,493,932)
Future development costs (2,912,800) (16,424,600) (500,000)
Future income tax expense (2,765,267) (59,269,174) (5,969,531)
------------- -------------- -------------
Future net cash flows 29,708,938 118,637,851 9,535,749
10% annual discount for
estimated timing on cash flows (8,887,283) (63,585,181) (3,913,266)
------------- -------------- -------------
Standardized measure of
discounted future cash flows $ 20,821,655 $ 55,052,670 $ 5,622,483
============= ============== =============
Future cash inflows are computed by applying a year end weighted average spot
market gas price and oil price for the areas of production. The following table
shows the prices that have been used for each of the periods:
As of December 31,
------------------------
2003 2002 2001
------ ------ --------
Weighted average gas price per MCF $ 6.06 $ 3.11 $ 2.74
Weighted average oil price per barrel $31.34 $31.20 $ 16.71
A subsequent decline in prices received for oil and gas sales from those used to
compute cash inflows could result in a requirement that the Company recognize a
ceiling write-down to oil and gas properties in a future period.
Future production and development costs are computed by estimating the
expenditures to be incurred in developing and producing the Company's proved oil
and gas reserves at December 31, 2003, 2002 and 2001 assuming continuation of
existing economic conditions.
F-43
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following reconciles the change in the standardized measure of discounted
future net cash flow:
For the Nine
For the Years Ended Months Ended
December 31, December 31,
----------------------------- --------------
2003 2002 2001
-------------- ------------- --------------
Beginning of period $ 55,052,670 $ 5,622,483 $ 13,009,222
Extensions, discoveries and other
additions 9,004,500 77,054,495 -
Sales and transfers - (547,245) -
Net change in sales and transfer
prices, net of production costs 76,822,907 371,265 (7,315,638)
Revision of previous quantity
estimates (170,455,255) (1,590,027) (753,656)
Development costs incurred during
the period 976,462 786,095 -
Sales of oil and gas, net of
production costs and taxes (3,678,788) (547,021) (618,345)
Changes in future development costs 13,143,811 (252,092) -
Net change in income taxes 26,834,091 (25,423,023) -
Changes in production rates and
other 4,718,632 (1,337,938) -
Accretion of discount 8,392,625 915,698 1,300,900
-------------- ------------- --------------
End of period $ 20,821,655 $ 55,052,670 $ 5,622,483
============== ============= ==============
Future income tax expenses are computed by applying the appropriate period-end
statutory tax rates to the future pretax net cash flow relating to the Company's
proved oil and gas reserves, less the tax basis of the properties involved. The
future income tax expenses do not give effect to tax credits, allowances, or the
impact of general and administrative costs of ongoing operations relating to the
Company's proved oil and gas reserves.
F-44
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 20 - Quarterly Consolidated Financial Information (Unaudited)
- ------------------------------------------------------------------
The following table provides selected quarterly consolidated financial results
for the years ended December 31, 2003 and 2002:
Quarter
----------------------------------------------
First Second Third Fourth
---------- ---------- ---------- ----------
($ in thousands, except per share information)
2003
- ----
Total revenue $ 3,605 $ 5,003 $ 5,241 $ 4,375
Gross profit $ 1,450 $ 2,706 $ 2,764 $ 2,160
Net (loss) income $ (622) $ (224) $ (4,525) $ (4,554)
(Loss) earning per share $ (0.08) $ (0.03) $ (0.55) $ (0.57)
(Loss) earning per fully diluted share $ (0.08) $ (0.03) $ (0.55) $ (0.57)
2002
- ----
Total revenue (1) $ 2,126 $ 2,580 $ 2,817 $ 3,415
Gross profit (1) $ 808 $ 1,023 $ 1,163 $ 1,503
Net (loss) income $ (308) $ (415) $ (294) $ (540)
(Loss) earning per share $ (0.05) $ (0.06) $ (0.04) $ (0.07)
(Loss) earning per fully diluted share $ (0.05) $ (0.06) $ (0.04) $ (0.07)
========== ========== ========== ==========
- -------------------
(1) Includes the following reclassifications of other revenue and other costs
of revenue to interest and other income as reflected in the following
table:
Quarter
---------------------------------------------
First Second Third Fourth
--------- ---------- ---------- ----------
($ in thousands, except per share information)
Total 2002 revenue as previously reported $ 2,126 $ 2,583 $ 2,822 $ 3,420
Reclassifications $ - $ (3) $ (5) $ (5)
--------- ---------- ---------- -----------
Total 2002 revenue $ 2,126 $ 2,580 $ 2,817 $ 3,415
========= ========== ========== ===========
2002 Gross profits as previously reported $ 800 $ 1,016 $ 1,156 $ 1,504
Reclassifications $ 8 $ 7 $ 7 $ (1)
--------- ---------- ---------- -----------
2002 Gross profit $ 808 $ 1,023 $ 1,163 $ 1,503
========= ========== ========== ===========
F-45
INFINITY INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 21 - Schedule of Condensed Financial Information
- -----------------------------------------------------
The oil and gas production subsidiary of the Company that owns more than 25% of
the net assets of the Company is restricted from distributing more than $300,000
to the parent at December 31, 2003 under the $25,000,000 development credit
facility executed in September 2003. Accordingly, the condensed balance sheet,
statement of operations and cash flow statement for the parent are being
provided as of and for the period ended December 31, 2003. There were no
restrictions on the distribution of dividends to the parent by the subsidiary in
the prior two periods.
INFINITY, INC. CONDENSED BALANCE SHEET
December 31, 2003
ASSETS
Current assets
Cash and cash equivalents $ 22,019
Prepaid expenses and other 40,839
-------------
Total current assets $ 62,858
Property and equipment, at cost, less accumulated depreciation of $179,825 2,293,881
Oil and gas properties, not subject to amortization 884,790
Intangible assets, at cost less accumulated amortization of $9,716,459 3,534,449
Other assets 135,989
Cumulative investment in or advances to subsidiaries 29,009,328
-------------
Total assets $ 35,921,295
=============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Current portion of long-term debt $ 122,855
Accounts payable 371,867
Accrued expenses 240,187
-------------
Total current liabilities 734,909
Long-term liabilities
Long-term debt, less current portion 2,203,346
8% subordinated convertible notes payable 2,793,000
7% subordinated convertible notes payable 11,184,000
Note payable - related party 3,000,000
-------------
Total liabilities $ 19,915,255
-------------
Commitments and contingencies
Stockholders' equity
Common stock, par value $.0001, authorized 300,000.000
shares, issued and outstanding 8,204,032 820
Additional paid-in-capital 32,720,904
Accumulated deficit (16,715,684)
-------------
Total stockholders' equity $ 16,006,040
-------------
Total liabilities and stockholders' equity $ 35,921,295
=============
F-46
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFINITY, INC. CONDENSED STATEMENT OF OPERATIONS
Year ended December 31, 2003
Operating expenses $ 1,945,134
Depreciation, depletion and
Amortization 378,034
------------
2,323,168
------------
Operating loss (2,323,168)
Other (expense) income
Interest income 522
Amortization of loan costs (5,856,442)
Interest expense (868,718)
------------
Total other (expense) income (6,724,638)
------------
Loss before income taxes (9,047,806)
Income tax benefit -
------------
Net loss $(9,047,806)
============
Basic loss per share $ (1.12)
============
Diluted loss per share $ (1.12)
============
Weighted average basic shares
outstanding 8,047,688
============
Weighted average diluted shares
outstanding 8,047,688
============
F-47
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFINITY, INC. CONDENSED STATEMENT OF CASH FLOWS
Year ended December 31, 2003
Cash flows from operating activities
Net loss $(9,047,806)
------------
Adjustments to reconcile net loss to net cash used by operating activities
Depreciation, depletion and amortization 105,983
Amortization of loan costs included in interest expense 5,888,393
Change in assets and liabilities
Increase in prepaid expenses and other (16,980)
Increase in accounts payable 339,855
Increase in accrued expenses 425,238
------------
6,742,489
------------
Net cash used by operating activities (2,305,317)
------------
Cash flows from investing activities
Purchase of property, equipment, and intangibles (139,857)
Investment in oil and gas properties (177,664)
Increase in other assets (5,000)
Decrease in investment in and advances to subsidiaries 1,861,176
------------
Net cash provided by investing activities 1,538,655
------------
Cash flows from financing activities
Proceeds from borrowings on long-term debt 824,234
Principal payments on long-term debt (130,899)
------------
Net cash provided by financing activities 693,335
------------
Net decrease in cash and cash equivalents (73,327)
Cash and cash equivalents, beginning of period 95,346
------------
Cash and cash equivalents, end of period 22,019
============
F-48
INFINITY INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFINITY, INC. CONDENSED STATEMENT OF CASH FLOWS (CONTINUED)
Year ended December 31, 2003
Supplemental cash flow disclosures:
Cash paid for interest, net of amounts capitalized $ 578,248
=============
Non-cash transactions:
Property and equipment acquired through capital leases or seller financed debt $ 967,975
=============
Stock-based compensation for options and warrants granted in connection with
debt, recorded as loan costs $ 5,790,719
=============
Conversion of 8% subordinated convertible notes and accrued interest to
common stock $ 1,478,550
=============
Conversion of 7% subordinated convertible notes and accrued interest to
common stock $ 1,757,016
=============
Issuance of additional notes in lieu of cash interest payment or 7% subordinated
convertible notes $ 379,000
=============
Reclassify other assets to oil and gas properties not subject ot amortization $ 707,126
=============
The debt of the parent at December 31, 2003 consisted of the following:
8% subordinated convertible notes $ 2,793,000
7% subordinated convertible notes 11,184,000
Note payable to a related party 3,000,000
Note payable to seller (airplane) 2,326,201
-----------
Total Debt $19,303,201
===========
For additional information related to the terms of individual notes, see Note 9.
During the period ended December 31, 2003, subsidiaries of the parent
distributed approximately $1,861,000 to the parent. Distributions exceed the
amounts allowed under debt agreement during 2003 as prior to September 2003,
when the loan was executed, the subsidiary had no restrictions on cash
distributions to the parent. The proceeds from these distributions were used to
pay interest on outstanding debt and for working capital purposes.
The parent also provides a corporate guarantee on the revolving credit and term
notes held by oil well service subsidiary and the $25,000,000 development credit
facility obtained by the oil and gas production subsidiary.
F-49