UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended March 31, 2004
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from ______, 19__ to ______, 19__
Commission File Number: 0-17204
INFINITY, INC.
- --------------------------------------------------------------------------------
(Exact Name of Issuer as Specified in its Charter)
Colorado 84-1070066
- -------------------------------- ------------------------------------
(State or Other Jurisdiction of (IRS Employer Identification Number)
Incorporation or Organization)
211 West 14th Street
Chanute, Kansas 66720
- --------------------------------------------------------------------------------
Address of Principal Executive Offices, Including Zip Code
(620) 431-6200
- --------------------------------------------------------------------------------
(Issuer's Telephone Number, Including Area Code)
N/A
- --------------------------------------------------------------------------------
(Former Name, Former Address, and Former Fiscal Year,
if Changed Since Last Report)
Check whether the Registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
X Yes No
--- ---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
--- ---
There were 9,396,091 shares of the Registrant's Common Stock outstanding as of
May 14, 2004.
1
INFINITY, INC.
FORM 10-Q
INDEX
-----
Page
Part I Financial Information Number
- -------- --------------------- ------
Item 1. Financial Information:
Consolidated Balance Sheets . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Operations . . . . . . . . . . . . 4
Consolidated Statements of Comprehensive Loss . . . . . . . . 5
Consolidated Statement of Changes in Stockholders' Equity . . 6
Consolidated Statements of Cash Flows . . . . . . . . . . . . 7
Notes to Unaudited Consolidated Financial Statements . . . . . 9
Item 2. Management's Discussion and Analysis of Financial
Conditions and Results of Operations . . . . . . . . . . . . 13
Critical Accounting Policies . . . . . . . . . . . . . . . . . 23
Item 3. Quantitative and Qualitative Disclosures about Market Risk . . 24
Item 4. Controls and Procedures . . . . . . . . . . . . . . . . . . . 25
Part II: Other Information
-----------------
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . 25
Item 2. Changes in Securities and Use of Proceeds . . . . . . . . . . 25
Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . . . . 25
Item 4. Submission of Matters to a Vote of Security Holders . . . . . 25
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . 25
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . 25
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
2
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
------
March 31, 2004 Dec. 31, 2003
---------------- ---------------
Current assets (Unaudited)
Cash and cash equivalents $ 1,174,579 $ 727,134
Accounts receivable, less allowance for doubtful
accounts of $80,419 (2004) and $80,000 (2003) 1,998,636 1,766,642
Inventories 387,332 351,197
Prepaid expenses and other 319,389 222,625
Derivative asset --- 97,624
---------------- ---------------
Total current assets 3,879,936 3,165,222
Property and equipment, at cost, less accumulated
depreciation 9,876,089 10,169,159
Oil and gas properties, using full cost accounting net
of accumulated depreciation, depletion, amortization
and ceiling write-down
Subject to amortization 24,729,101 23,446,343
Not subject to amortization 13,594,051 12,815,834
Intangible assets, at cost, less accumulated amortization 2,932,399 3,952,989
Note receivable, less current portion 1,576,781 1,580,742
Other assets, net 380,925 135,989
---------------- ---------------
Total assets $ 56,969,282 $ 55,266,278
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Notes payable $ 367,034 $ ---
Current portion of long-term debt 2,049,540 1,762,777
Current portion of note payable - related party 1,750,000 ---
Accounts payable 2,226,818 2,645,277
Accrued expenses 1,607,501 966,769
---------------- ---------------
Total current liabilities 8,000,893 5,374,823
Long-term liabilities
Production taxes payable 317,744 229,889
Asset retirement obligations 544,296 520,638
Long-term debt, less current portion 8,536,829 9,252,872
8% subordinated convertible notes payable 2,663,000 2,793,000
7% subordinated convertible notes payable 11,184,000 11,184,000
Note payable - related party --- 3,000,000
---------------- ---------------
Total liabilities 31,246,762 32,355,222
---------------- ---------------
Stockholders' equity
Common stock, par value $.0001, authorized 300,000,000
shares, issued and outstanding 9,396,091 (2004) and
8,204,032 (2003) shares 940 820
Additional paid-in-capital 37,394,557 32,720,904
Accumulated other comprehensive income --- 97,624
Accumulated deficit (11,672,977) (9,908,292)
---------------- ---------------
Total stockholders' equity 25,722,520 22,911,056
---------------- ---------------
Total liabilities and stockholders' equity $ 56,969,282 $ 55,266,278
================ ===============
The consolidated balance sheet at December 31, 2003 has been derived from the
audited consolidated financial statements at that date.
See Notes to Unaudited Consolidated Financial Statements
3
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended March 31,
----------------------------
2004 2003
------------- -------------
Revenues
Oil and gas service operations $ 2,195,724 $ 1,867,307
Oil and gas sales 1,371,298 1,738,136
------------- -------------
Total revenues 3,567,022 3,605,443
Cost of revenues
Oil and gas service operations 1,420,552 1,204,947
Oil and gas production expenses 362,724 740,640
Oil and gas production taxes 155,974 209,683
------------- -------------
Total cost of revenue 1,939,250 2,155,270
------------- -------------
Gross profit 1,627,772 1,450,173
Operating expenses 1,262,076 1,102,233
Depreciation, depletion and amortization 1,047,140 535,456
------------- -------------
Operating loss (681,444) (187,516)
------------- -------------
Other (expense) income
Interest and other income 38,875 40,800
Amortization of loan costs (843,405) (186,194)
Interest expense and finance charges (278,736) (289,112)
Gain on sales of assets 25 ---
------------- -------------
Total other expense ( 1,083,241) ( 434,506)
------------- -------------
Net loss before income taxes (1,764,685) (622,022)
Income tax benefit --- ---
------------- -------------
Net loss $ (1,764,685) $ (622,022)
------------- -------------
Basic and diluted net loss per common share $ (0.19) $ (0.08)
------------- -------------
Weighted average basic and diluted shares outstanding 9,195,504 7,751,819
See Notes to Unaudited Consolidated Financial Statements
4
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(UNAUDITED)
Three Months Ended March 31
-----------------------------
2004 2003
-------------- -------------
Net loss $ (1,764,685) $ (622,022)
Other comprehensive loss:
Unrealized loss on forward sales
contract, net of tax benefit of
$75,426 for the three months ended
3/31/2003: --- (120,484)
Reclassifications, net of tax expense of
($57,559) for the three
months ended 3/31/2003: 97,624 91,944
-------------- -------------
Total other comprehensive income (loss) 97,624 (28,540)
-------------- -------------
Comprehensive loss $ (1,667,061) $ (650,562)
============== =============
See Notes to Unaudited Consolidated Financial Statements
5
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
Common Stock Additional Other Total
------------------ Paid-In Comprehensive Accumulated Stockholders'
Shares Amount Capital Income Deficit Equity
-------------------------------------------------------------------------------
Balance, December 31, 2003 8,204,032 $ 820 $32,720,904 $ 97,624 $ (9,908,292) $ 22,911,056
Issuance of common stock for
cash upon the exercise of options 40,000 4 59,996 - - 60,000
Conversion of 8% subordinated
convertible notes and accrued interest
into common stock 27,059 3 132,033 - - 132,036
Issuance of common stock for
cash at $4.00 per share, net of
$18,263 of deferred offering costs 1,000,000 100 3,981,637 - - 3,981,737
Issuance of common stock as partial payment
on related party debt, valued at $4.00
per share 125,000 13 499,987 - - 500,000
Change in other comprehensive income - - - (97,624) - (97,624)
Net loss for period - - - - (1,764,685) (1,764,685)
--------------------------------------------------------------------------------
Balance, March 31, 2004 9,396,091 $ 940 $37,394,557 $ - $(11,672,977) $ 25,722,520
================================================================================
See notes to Unaudited Consolidated Financial Statements
6
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended March 31,
----------------------------------
2004 2003
---------------- ----------------
Cash flows from operating activities
Net loss $ (1,764,685) $ (622,022)
Adjustments to reconcile net loss to net cash
provided by operating activities
Depreciation, depletion and amortization 1,047,140 535,456
Amortization of loan costs included in
interest expense 843,405 186,194
Gain on sale of assets (25) ---
(Increase) decrease in operating assets
Accounts receivable (231,994) (206,889)
Inventories (36,136) 74,226
Prepaid expenses (96,764) (26,315)
Increase (decrease) in operating liabilities
Accounts payable (248,928) 376,350
Accrued expenses 730,625 467,656
---------------- ----------------
Net cash provided by operating activities 242,638 784,656
---------------- ----------------
Cash flows from investing activities
Proceeds from sale of property and equipment 1,500 ---
Investment in oil and gas properties (2,508,639) (2,360,565)
Investment in other assets and intangibles (244,936) (145,352)
Purchase of property and equipment (107,038) (115,080)
Payments on note receivable 3,961 3,668
---------------- ----------------
Net cash used in investing activities (2,855,152) (2,617,329)
---------------- ----------------
Cash flows from financing activities
Proceeds from notes payable 275,000 1,000,000
Proceeds from borrowings on long-term debt 390,267 176,787
Proceeds from issuance of common stock 4,060,000 664,391
Deferred offering costs (18,263) ---
Repayment of long-term debt (1,647,045) (610,898)
---------------- ----------------
Net cash provided by financing activities 3,059,959 1,230,280
---------------- ----------------
Net increase (decrease) in cash and cash equivalents 447,445 (602,393)
Cash and cash equivalents, beginning of period 727,134 867,017
---------------- ----------------
Cash and cash equivalents, end of period $ 1,174,579 $ 264,624
================ ================
See Notes to Unaudited Consolidated Financial Statements
7
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended March 31,
----------------------------
2004 2003
------------ --------------
Supplemental cash flow disclosures:
Cash paid for interest, net of
amounts capitalized $ 35,397 $ 4,853
Non-cash transactions:
Amortization of loan costs included in oil and gas properties 175,570 684,466
Change in accumulated other comprehensive income,,
net of income taxes in 2003 97,624 28,540
Property and equipment acquired through
seller financed debt, net --- 967,975
Stock-based compensation for options issued with
bridge loans recorded as loan costs --- 750,000
Conversion of subordinated debt and accrued
interest to common stock 132,036 1,646,472
Non-cash investment in retirement obligation on
long-lived assets 18,669 447,357
Issuance of common stock in partial satisfaction of
related party debt 500,000 ---
Conversion of accounts payable into a note payable 169,531 ---
See Notes to Unaudited Consolidated Financial Statements
8
INFINITY, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) Nature of Operations and Basis of Presentation
Infinity, Inc. ("Infinity") is a Colorado corporation organized 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 oilfield services
in eastern Kansas, northeastern Oklahoma and the Powder River Basin of Wyoming.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles in the
United States for interim financial information. Accordingly, certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles in the
United States have been condensed or omitted in this Form 10-Q pursuant to the
rules and regulations of the United States Securities and Exchange Commission
("SEC"). A summary of Infinity's significant accounting policies are
incorporated by reference to the annual report on Form 10-K at December 31, 2003
of Infinity and the subsequent amendments to the report. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Certain reclassifications
have been made to the prior period to conform to the classifications used in the
current period. These reclassifications did not have an impact on previously
reported results of operations. The results of operations for the three-month
period ended March 31, 2004 are not necessarily indicative of the results that
may be expected for the year ended December 31, 2004. The accompanying
consolidated financial statements should be read in conjunction with Infinity's
audited consolidated financial statements for the year ended December 31, 2003.
The consolidated financial statements include the accounts of Infinity and
its wholly owned subsidiaries. All intercompany accounts and transactions have
been eliminated in consolidation.
(2) Going Concern
Infinity's consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and liquidation of
liabilities in the ordinary course of business. During the three months ended
March 31, 2004, Infinity had a consolidated net loss of approximately $(1.8)
million, and a working capital deficit at March 31, 2004 of approximately $(4.1)
million.
A substantial portion of the increase in the working capital deficit was
the result of $1.8 million of long-term debt at December 31, 2003, which is due
in January 2005, becoming due within one year and therefore, reflected as
current debt. In addition, during the quarter ended March 31, 2004, Infinity
borrowed $0.3 million under notes due within one year.
Infinity also has contractual obligations of approximately $0.3 million
under the initial completion phase of a development contract for its Labarge
project and expects drilling obligations under the second phase of the contract
to total approximately $3.0 million through the first quarter of 2005. In
addition, management estimates cash requirements of $0.3 million for the Labarge
environmental impact study, $0.1 million for lease rental payments, $0.7 million
for interest on notes (net of notes issued in lieu of cash payments) and $2.0
million for general corporate usage. Thus, in total, Infinity has current
minimum cash requirements of approximately $10.5 million including the working
capital deficit at March 31, 2004.
9
Management believes it will be able to fund approximately $7.6 million of
its current minimum cash requirements through its operations during the
remainder of 2004 and the first quarter of 2005. However, the timing of the
receipt of funding from operations is not expected to match the timing of cash
requirements in such a way as to allow for Infinity to meet its obligations in a
timely manner. Thus management expects that Infinity will be required to fund
some of its obligations through other sources. In order to fund these
obligations in a timely manner, and any other capital expenditures, Infinity
will be required to pursue additional funding through potential conventional
bank financing, the forward sale of its oil and gas production, or through the
public or private equity or debt markets. The ability of Infinity to achieve
the required operating results to provide funding or obtain additional debt or
equity financing on terms acceptable to management, cannot be assured.
In April 2004, LaSalle Bank N.A. ("LaSalle") amended the existing credit
facility with Consolidated Oil Well Services, Inc. ("Consolidated") to
consolidate outstanding debt of approximately $1.0 million with the $1.3
million in debt incurred to complete the acquisition of Blue Star Acid Services,
Inc. ("Blue Star") (see Note 8). The amendment did not extend the term of the
loan, and therefore, the consolidated loan balance at April 20, 2004 of $2.3
million remains due December 31, 2004. However, management believes it will be
able to renegotiate the term of the loan in order to refinance the loan into
long-term debt and thus reduce the current cash needs. In addition, management
believes it has approximately $5.5 million of borrowing capacity on its oilfield
service assets which would allow management to not only extend the term, but
expand the borrowing capacity as well. Any expansion of the borrowing capacity
under a new long-term agreement would be used to retire other current
obligations or fund property development. The ability of Consolidated to obtain
additional funding or renegotiate the terms of the LaSalle facility cannot be
assured.
The amount that can be distributed to Infinity by its subsidiaries is
restricted by terms of certain loan agreements. The terms of the loan
agreements for the oil field services subsidiary allow for additional amounts to
be distributed with consent of the lender. Consolidated 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 Infinity to meet its general corporate needs,
however that cannot be assured.
Future reserve reductions or ceiling write-downs could hinder Infinity's
ability to obtain future financing on terms acceptable to management or could
result in reductions in the borrowing base on existing obligations, which could
result in accelerated payment of those obligations.
(3) Oil and Gas Properties
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, including salaries, benefits and other internal costs directly
attributable to these activities. Interest costs related to unproved properties
and properties under development, including the amortization of loan costs
associated with borrowings that were used to develop the properties, are also
capitalized to oil and gas properties.
10
From inception through March 31, 2004, Infinity has capitalized the
following financing costs related to properties not subject to amortization. As
these projects are developed, the costs are transferred to properties subject to
amortization:
Three Months
Ended Cumulative
March 31, 2004 to Date
--------------- -----------
Beneficial conversion feature related to the 8%
subordinated convertible notes $ --- $ 1,165,500
Capitalized interest 162,896 $ 2,223,826
Capitalized amortization of loan costs 175,570 $ 3,030,646
--------------- -----------
$ 338,466 $ 6,419,972
=============== ===========
If the net investment in oil and gas properties, as adjusted for asset
retirement obligations, exceeds an amount equal to the sum of (1) the
standardized measure of discounted future net cash flows from proved reserves,
adjusted for cash flow hedges, and (2) the lower of cost or fair market value of
properties in the process of development and unexplored acreage, the excess is
charged to expense as a ceiling write-down. The standardized measure is
calculated using a 10% discount rate and is based on un-escalated prices in
effect at quarter-end, or a subsequent effective measurement date if there are
significant changes in pricing, volumes and costs which would materially affect
the measurement, with effect given to the Infinity's gas sales contracts. At
March 31, 2004, Infinity would have recognized a $1.5 million ceiling write-down
based on a gas price of approximately $5.20 per thousand cubic feet ("Mcf") in
effect at that date. However, due to subsequent significant increases in gas
sales prices to approximately $6.06 per Mcf and taking into account subsequent
forward gas sales contracts at the May 7, 2004, Infinity was not required to
recognize a ceiling write-down in the quarter ended March 31, 2004. Included in
the ceiling write-down calculation at March 31, 2004 and at the subsequent May
7, 2004 measurement date, were reserves of $3.8 million and $4.9
million,respectively, for reserves related to the March, 2004 acquisition of an
additional 49% working interest in two existing wells and 960 acres of
undeveloped leaseholds adjacent to the Pipeline project. A decrease in gas
prices to a spot sales price of approximately $5.58 per Mcf or less, a
significant decrease in estimated gas production in future periods, or the
reclassification of development costs to properties subject to depletion without
an increase in associated reserves could result in a ceiling write-down during
future periods.
Depreciation and depletion of proved oil and gas properties is computed on
a 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 the 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. The costs of certain unevaluated
leasehold acreage and wells drilled are not being amortized. Costs not being
amortized are periodically assessed for possible impairments or reduction in
value. If a reduction in value has occurred, costs being amortized are
increased.
Normal dispositions of oil and gas properties are accounted for as
adjustments of capitalized costs, with no gain or loss recognized.
(4) Long-Term Debt
Effective June 13, 2001 Infinity, Inc. sold $6,475,000 in 8% Subordinated
Convertible Notes in a private placement. During the three months ended March
31, 2004, $130,000 of the notes and interest accrued on those notes were
converted into 27,059 shares of common stock, leaving an outstanding balance on
the notes of $2,663,000 at March 31, 2004.
11
Effective April 17, 2002 Infinity, Inc. sold $12,540,000 in 7% Subordinated
Convertible Notes in a private placement. Interest payments can be made in cash
or through the issuance of additional notes. Subsequent to March 31, 2004,
Infinity issued $391,000 in additional notes for the payment of accrued interest
due April 15, 2004, leaving an outstanding balance on the notes of $11,575,000
at April 15, 2004.
Effective November 25, 2002 Infinity issued $3,000,000 in unsecured notes
to a stockholder. These notes are secured with a first or second interest in
certain gas properties and accrue interest at 7% per annum. On January 15,
2004, Infinity issued 125,000 shares of common stock valued at $4.00 per share
and paid $750,000 in cash, as partial payment on the $3,000,000 bridge note.
The remaining note balance of $1,750,000 is due January 30, 2005.
There were no other significant changes to existing debt other than changes
related to the normal payment terms.
(5) Earnings per Share
Basic earnings per share were computed by dividing loss available to common
stockholders by the weighted average number of common shares outstanding for the
periods. At March 31, 2004 and 2003, potential common shares of 5,028,175 and
4,229,192, respectively, are anti-dilutive.
(6) Equity - Common Stock
Infinity received proceeds of $4,000,000 and incurred offering costs of
approximately $18,000 when it issued 1,000,000 share of common stock pursuant to
a stock purchase agreement dated January 14, 2004. The proceeds of this
offering, were used to repay $750,000 on the note to a related party discussed
in Note (4), to pay costs associated with the completion of six Pipeline wells
drilled in the fourth quarter of 2003, to acquire an additional interest in two
producing wells and 960 acres of undeveloped leases adjacent to the Pipeline
producing leases, to pay for well completion services not provided under the
Labarge development agreement with Schlumberger Technology, Ltd, and to pay for
other working capital needs.
(7) Equity - Stock Options
During the three months ended March 31, 2004, options to purchase 40,000
shares of common stock were exercised resulting in proceeds to Infinity of
$60,000. Options to purchase 10,000 shares were forfeited under a termination
clause in the Option Plans.
On April 16, 2004 the Board of Directors adopted the 2004 Stock Option
Plan. The 2004 Stock Option Plan, if approved by the stockholders at the annual
meeting, allows Infinity to grant incentive stock options and non-qualified
stock options to purchase up to 410,000 shares of common stock.
(8) Subsequent Events
Subsequent to March 31, 2004, Consolidated acquired substantially all of
the assets and liabilities of Blue Star Acid Services, Inc. ("Blue Star") for
$1.2 million in cash and paid debt of approximately $0.1 million secured by the
equipment acquired. Blue Star provides acid and cementing services in an area
that overlaps a substantial portion of the eastern Kansas service area of
Consolidated as well as central Kansas and north central Oklahoma. With the
acquisition, Consolidated expanded its service area, increased its cementing
capabilities through the acquisitions of the equipment which is designed to
provide service to deeper oil and gas wells, eliminated
12
possible future capital expenditures for additional equipment, and retained
experienced personnel. Agreements associated with the acquisition include a
three-year non-compete agreement by the previous principal owners of Blue Star
and the manager of the facility and a three-year employment contract with the
facility manager. The facility manager is also a former owner of Blue Star.
The acquisition was funded with $1.3 million of current debt through an
amendment of Consolidated's facility with LaSalle Bank. The operations of Blue
Star will be included in Infinity's consolidated statement of operations
effective April 20, 2004.
(9) Recent Accounting Pronouncements
In March 2004, the Financial Accounting Standards Board ("FASB") issued an
exposure draft entitled "Share-Based Payment, and Amendment of FASB Statements
No. 123 and 95." This proposed statement addresses the accounting for
share-based payment transactions in which an enterprise receives employee
services in exchanged for (a) equity instruments or the enterprise or (b)
liabilities that are based on the fair value of the enterprises equity
instruments or that may be settled by the issuance of such equity instruments.
The proposed statement would eliminate the ability to account for share-based
compensation transactions using APB Opinion No. 25, "Accounting for Stock Issued
to Employees", and generally would require instead that such transactions be
accounted for using a fair-value-based method. As proposed, this statement
would be effective for Infinity on January 1, 2005. Infinity is currently
unable to determine what effect this statement will have on its financial
position or results of operations.
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus
that mineral rights, as defined in EITF Issue No. 04-2, "Whether Mineral Rights
Are Tangible or Intangible Assets," are tangible assets and that they should be
removed as examples of intangible assets in SFAS No. 141, "Business
Combinations" and No. 142, "Goodwill and Other Intangible Assets". The FASB has
recently ratified this consensus and directed the FASB staff to amend SFAS Nos.
141 and 142 through the issuance of FASB Staff Position FAS Nos. 141-1 and
142-1. Historically, Infinity has included the costs of such mineral rights as
tangible assets, which is consistent with the EITF's consensus. As such, EITF
04-02 has not affected Infinity's consolidated financial statements.
ITEM 2.
-------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
-----------------------------------------------
FORWARD LOOKING STATEMENTS
--------------------------
This Form 10-Q contains forward-looking statements, within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act of
1934. We us words such as "anticipate," "believe," "estimate," "expect," "may,"
"plan," "project," "should" or similar expressions to identify forward-looking
statements. Forward-looking statements inherently involve risks and
uncertainties that could cause actual results to differ materially from the
forward-looking statements. Forward-looking statements in this Form 10-Q
include, among other things, statements regarding:
- Infinity's growth strategies;
- anticipated trends in Infinity's business and its future results of
operations;
- estimates of expenses and revenues;
- sources, timing and terms of additional or renegotiated financing;
13
- amount and timing of future capital expenditures;
- market conditions in the oil and gas industry;
- the level of anticipated production of oil and gas;
- potential acquisitions and dispositions, including timing, cost and
likelihood of successfully integrating acquisitions;
- the costs of complying with government regulation, including the likelihood
and timing of obtaining required government permits;
- exploration and development activity, including the number and timing of
new or recompleted wells, planned expenditures and anticipated production;
- demand for Infinity's oil field services;
- continued evaluation of the Labarge acreage under the Schlumberger
agreement;
- success or progress regarding negotiations for the development of
concessions in Nicaragua; and
- the impact of the adoption of new accounting standards.
These forward-looking statements are based largely on Infinity's
expectations and are subject to numerous risks and uncertainties which are
beyond the company's control. The forward-looking statements we discuss in this
report might not occur in light of these risks and uncertainties. Specific
examples of these risks and uncertainties include the volatility of oil and gas
prices, the likelihood of obtaining financing on acceptable terms and the
uncertainties surrounding the continued evaluation of the Labarge acreage.
These and many other risks and uncertainties are described in our Annual Report
on Form 10-K for the year ended December 31, 2003 under the heading "Risk
Factors." We undertake no obligation to update these forward-looking
statements.
Overview
Infinity is an independent energy company primarily engaged in the
operation, development, production, exploration and acquisition of North
American unconventional natural gas properties. Infinity, through its
wholly-owned subsidiary Infinity Oil and Gas of Wyoming, Inc.
("Infinity-Wyoming") currently has net production of approximately 3.3 MMcf and
80 barrels of oil per day from its Pipeline field on the Wamsutter Arch in the
Greater Green River Basin of south-central Wyoming ("Pipeline") and is
evaluating the results of completions or recompletions of three coal bed methane
gas wells on its Labarge property in the Big Piney area in the Greater Green
River Basin of southwestern Wyoming. Consolidated Oil Well Services, Inc.
("Consolidated"), a wholly-owned Kansas corporation, provides oil and gas field
services in eastern Kansas, northeastern Oklahoma and the Powder River Basin of
Wyoming.
Recent Developments
During the first quarter of 2004, Infinity-Wyoming completed six wells that
were drilled prior to December 31, 2003 on the Pipeline acreage. In addition to
the completion activity, Infinity-Wyoming assumed operations of two additional
wells in the field following the acquisition of additional working interest in
those wells in March. Management anticipates the addition of approximately 70
Mcf per day of gas production net to Infinity's interest from the two additional
wells. The acquisition also included six 160-acre undeveloped drilling
locations immediately adjacent to Infinity-Wyoming's existing producing
leasehold.
14
Infinity, under an agreement with Schlumberger Technology, Ltd
("Schlumberger") and Red Oak Capital Management, LLC ("Red Oak") has completed
or is completing or recompleting five of the ten wells drilled on the Labarge
acreage. Infinity and Schlumberger continue to evaluate the effectiveness of
the activity as measured by initial production results and technical data
derived from the work.
Infinity has been awarded concessions for the development of 24 blocks
consisting of approximately 1.4 million acres offshore Nicaragua and is
currently negotiating the final terms of the lease and development plans with
the government of Nicaragua.
On April 20, 2004, Consolidated acquired the assets and assumed certain
liabilities of Blue Star Acid Services, Inc. ("Blue Star"), an oilfield services
firm based in Eureka, KS. In the twelve-month period ended February 29, 2004,
Blue Star generated revenues in excess of $1.5 million (unaudited). The
acquisition was funded by restructuring of the borrowings under Consolidated's
existing credit facility and is expected to satisfy a portion of Consolidated's
anticipated 2004 equipment and personnel needs.
First Quarter 2004 Overview
Infinity reported a loss of approximately $(1.8) million, or $(0.19) per
diluted share, for the first quarter of 2004 compared to a loss of approximately
$(0.6) million or $(0.08) per diluted share in the first quarter of 2003. The
increase in the net loss for the period was mainly due to the following factors:
- Production of oil and gas decreased 37% which was partially offset by a 25%
increase in realized prices.
- Depletion of oil and gas assets increased by $0.5 million.
- Amortization of loan costs increased by approximately $0.6 million.
2004 Operational and Financial Objectives
Oilfield Services
- -----------------
Consolidated expects to realize an increase in its oilfield service revenue
during the remainder of 2004 due to a noted increase in the number of wells
being drilled by property owners in Consolidated's service areas during the
second quarter of 2004 and as a result of the Blue Star acquisition made in
April, 2004. Consolidated will continue to evaluate additional acquisitions in
order to:
- expand the services that are provided,
- expand the area that is serviced,
- gain market share by providing complimentary services to its existing
services, and
- gain market share by eliminating competition.
Revenues from oilfield services are expected to be between $13.5 million and
$16.0 million with income before taxes of approximately $2.0 to $2.5 million for
the remainder of 2004 and the first quarter of 2005. Consolidated could incur
capital expenditures, in addition to those incurred in the Blue Star
acquisition, of approximately $1.2 million related to equipment and facilities.
There are
15
no current commitments for these potential acquisitions and management believes
Consolidated would be able to finance them through additional vendor financing.
Oil and Gas Production
- ----------------------
Infinity-Wyoming plans to focus on the following strategic operational
objectives during the remainder of 2004 which includes the following contractual
obligations:
- completion of the Labarge environmental impact study and the Pipeline
environment assessment in order to facilitate future permitting on the
projects at an estimated cost of approximately $0.3 million.
- participate in the completion of two additional wells under the initial
well completion bundle and the drilling of up to five new wells under the
agreement with Schlumberger and Red Oak. The expected costs for the
completion activities is approximately $0.3 million and for the drilling
activity is approximately $3.0 million.
Contingent on obtaining funding, Infinity-Wyoming will focus on the following
strategic operational objectives during the remainder of 2004:
- optimize production from certain Pipeline wells through selective workovers
or additional completion and stimulation activity;
- increasing daily production, net to Infinity-Wyoming's interest by
approximately 1,300 Mcfe per day by drilling four additional operated wells
(a net of three to Infinity-Wyoming's interest) at an estimated cost of
$1.5 million on Pipeline proved, undeveloped locations;
- perform remediation, completion and exploration activities on the Sand Wash
and Piceance prospects in order to further evaluate the properties for
potential joint venture opportunities and development. Infinity-Wyoming
anticipates spending approximately $1.3 million on these activities.
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-Wyoming expects to generate approximately $4.0 million in
operating cash flow from oil and gas production operations during the
remainder of 2004 and the first quarter 2005;
- 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; and
- the success of the completion efforts on the existing Labarge wells. If
Schlumberger is not satisfied with, or successful in, its and
Infinity-Wyoming's efforts then it may elect not to risk its services and
Red Oak may be unwilling, or unable to secure financing for the further
development of the property. If this occurs, Infinity-Wyoming will be
required to fund all of the development activities.
Infinity, Inc. Activity
Infinity continues to negotiate the final development agreement with the
Instituto Nicaraguense de Energia ("INE") for the Perlas and Tyra blocks
offshore Nicaragua. Management believes that is should be able to complete the
negotiations sometime in the second or third quarter of 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
16
acquisition and re-processing of geophysical data. Infinity estimates the
performance bond will be between approximately $0.2 million and $0.8 million
depending on the final terms of the lease. Infinity also anticipates that it
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 an agreement have
not been reached and due diligence has not been completed, Infinity cannot
definitively determine what financial resources might be required to complete
the acquisition and exploration.
RESULTS OF OPERATIONS
Infinity incurred a net loss after taxes of $(1.8) million, or $(0.19) per
fully diluted share, in the quarter ended March 31, 2004 compared to a net loss
after taxes of $($0.6) million, or $(0.08) per fully diluted share in the
quarter ended March 31, 2003.
Infinity experienced a $0.2 million increase in gross profit to $1.6
million in the quarter ended March 31, 2004 from $1.4 million for the quarter
ended March 31, 2003. The increase in gross profit during the quarter ended
March 31, 2004 compared to the quarter ended March 31, 2003 was the result of a
$0.1 million, or 17% increase in gross profit from oilfield service operations
on $0.3 million of additional revenue and a $0.1 million, or 8% increase, in
gross profit from oil and gas production on approximately $0.4 million less
revenue.
For the period ended March 31, 2004, Infinity recognized $1.0 million in
depreciation, depletion and amortization expense compared to $0.5 million in the
period ended March 31, 2003. The $0.5 million, or 96% increase was the result
of a $0.5 million increase in depletion of oil and gas properties due to an
increase in depletable assets and a lower proved reserve base over which the oil
and gas properties are being depleted.
For the period ended March 31, 2004, Infinity recognized amortization of
loan costs as interest expense of approximately $0.8 million compared to
approximately $0.2 million for the period ended March 31, 2003. The increase in
amortization was the result of the acceleration of the amortization of loan
costs associated with the partial payment of the related outstanding notes.
Oilfield Services
- ------------------
Consolidated recorded sales of $2.2 million and cost of revenues of $1.4
million for the quarter ended March 31, 2004 compared to sales of $1.9 million
and cost of sales of $1.2 million for the comparable period ended March 31,
2003. The following table details the comparison of gross revenue in millions
of dollars, before discounts and intercompany eliminations (approximately
$11,000 at March 31, 2003), for the periods, based on the number and type of
core service jobs performed (due to rounding the sum of the individual amounts
presented may not equal the totals):
17
Oilfield Service Statistics
($ in millions, before discounts)
2004 2003 CHANGE
---------------- ---------------- ---------------
JOB TYPE JOBS REVENUE JOBS REVENUE JOBS REVENUE
Cementing 511 $ 1.0 291 $ 0.7 220 $ 0.3
Acidizing 191 $ 0.2 215 $ 0.2 (24) $ 0.0
Fracturing 138 $ 1.0 164 $ 1.0 (26) $ 0.0
Other $ 0.1 $ 0.1 $ 0.0
Discounts and eliminations $ (0.1) $ (0.1) $ 0.0
--------- --------- --------
$ 2.2 $ 1.9 $ 0.3
========= ========= ========
During the period ended March 31, 2004, revenue generated by acidizing and
fracturing operations was flat compared to the revenue generated from those
operations in the quarter ended March 31, 2003, even though the number of jobs
performed decreased by 11% and 16%, respectively. The increase in revenue per
job was the result of price increases. Management anticipates an increase in
acidizing and fracturing services during the second and third quarters of 2004
compared to the prior year due to the increase in the number of cement jobs
during the first quarter of 2004 compared to the prior-year period. With the
increase in the revenue per job, as indicated by the first quarter analysis, and
the expected increase in the number of acidizing and fracturing jobs anticipated
in future periods management anticipates its estimated cash flow from oilfield
services to be up substantially for the remainder of the year.
Oil and Gas Production
- ----------------------
During the quarter ended March 31, 2004, Infinity-Wyoming recorded
approximately $1.0 million in revenue on the sale of 203,947 Mcf of gas during
the period ended March 31, 2004 compared to $1.2 million in revenue on the sale
of 308,694 Mcf of natural gas during the period ended March 31, 2003.
Infinity-Wyoming also recorded approximately $0.3 million in revenue on the sale
of 9,236 barrels of oil compared to approximately $0.6 million in revenue on the
sale of 16,871 barrels of oil in the three month period ended March 31, 2003.
Infinity-Wyoming was in a period of development inactivity during much of the
latter part of 2003 and therefore, since there were no new wells coming online,
Infinity-Wyoming was unable to replace the natural decline in production on
previously completed wells. The decline in revenue during the period ended
March 31, 2004, due to the decline in production, was partially offset by an
increase in oil and gas prices. The prices that Infinity-Wyoming received for
its products increased by approximately 25% from $4.24 per thousand cubic foot
equivalent ("Mcfe") in the period ended March 31, 2003, to $5.28 per Mcfe for
the period ended March 31, 2004. Infinity-Wyoming decreased lease operating
expense from $0.7 million in the quarter ended March 31, 2003 to $0.4 million in
the quarter ended March 31, 2004 by reducing costs associated with well
workovers and the supervision associated with the workovers and production
testing resulting. Production taxes and transportation costs were also reduced
due to the lower volumes of gas produced and sold during the period.
18
The following table provides statistical information by field for
production volumes, revenue and production costs for the quarter ended March 31,
2004 and 2003 (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
Volumes in 000's: 2004 2003 2004 2003 2004 2003
- ----------------- -------- -------- ------ ------- -------- --------
Oil Sales Volumes (Bbls) 9.2 16.9 0.0 0.0 9.2 16.9
Gas Sales Volumes (Mcf) 200.1 305.0 3.3 3.7 203.4 308.7
Mcf Equivalent 256.2 406.2 3.3 3.7 259.4 409.9
Values in 000's:
- ----------------
Oil Revenue $ 327.6 $ 563.5 $ 0.0 $ 0.0 $ 327.6 $ 563.5
Gas Revenue $1,018.8 $1,165.2 $ 16.4 $ 10.0 $1,043.7 $1,174.6
Production Expense $ 104.4 $ 174.1 $113.0 $346.3 $ 215.3 $ 528.3
Production Taxes $ 154.2 $ 210.1 $ 1.8 $ 0.1 $ 156.0 $ 211.2
Transportation Expense $ 135.1 $ 213.1 $ 1.6 $ (2.5) $ 136.7 $ 210.6
Per Mcf Equivalent:
- -------------------
Revenue $ 5.26 $ 4.26 $ 4.97 $ 2.70 $ 5.28 $ 4.24
Production Expense $ 0.41 $ 0.43 $34.24 $93.59 $ 0.83 $ 1.29
Production Taxes $ 0.60 $ 0.52 $ 0.55 $ 0.32 $ 0.60 $ 0.52
Transportation Expense $ 0.53 $ 0.52 $ 0.48 $(0.69) $ 0.53 $ 0.51
Operating Expenses
- -------------------
During the period ended March 31, 2004, Infinity recognized approximately
$1.3 million in corporate operating expenses compared to approximately $1.1
million in the period ended March 31, 2003. The increase is mainly due to a
decrease in property development activities to which costs were allocated in
prior years, increased insurance costs, and professional costs associated with
regulatory compliance filings. Depreciation, depletion and amortization expense
increased to $1.0 million in the period ended March 31, 2004 compared to $0.5
million in the period ended March 31, 2003. The increase was due to increased
depletion taken on oil and gas properties subject to depletion due to higher
costs included in the depletable pool and a smaller reserve base over which to
amortize the costs.
Other Income and Expenses
- ----------------------------
During the period ended March 31, 2004, other income and expenses increased
to a $1.1 million net expense compared to a $0.4 million net expense for the
period ended March 31, 2003. The increase was due to increased amortization of
loan costs recognized in the period as amortization was accelerated on a portion
of the capitalized loan costs due to the partial repayment of the associated
note.
Net Loss
- ---------
Infinity recognized a net loss of $(1.8) million during the period ended
March 31, 2004 compared to a net loss of $(0.6) million in the period ended
March 31, 2003. The increase in the
19
loss was mainly due to a $0.2 million increase in operating expenses, a $0.5
million increase in depletion on oil and gas properties, and a $0.7 million
increase in amortization of loan costs.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2004, the Company had a working capital deficit of $(4.1)
million compared to a working capital deficit of $(2.2) million at December 31,
2003. The increase in the working capital deficit was primarily the result of
$1.8 million of long-term debt to a related party reflected as current at March
31, 2004, since it is due in the first quarter of 2005 and additional borrowings
on short-term notes that offset repayments of existing current debt.
During the quarter ended March 31, 2004, cash provided by operations was
$0.2 million compared to cash provided by operating activities during the
quarter ended March 31, 2003 of $0.8 million. During the period ended March 31,
2004, Infinity used $2.9 million of cash in investing activities consisting of
$2.5 million for oil and gas properties, $0.2 million for other assets and $0.1
million for property and equipment. This compares to Infinity investing $2.4
million in oil and gas properties, $0.1 million in other assets and $0.1 million
in property and equipment during the period ended March 31, 2003.
During the period ended March 31, 2004, Infinity-Wyoming borrowed $0.3
million with which to pay costs incurred in the development of its oil and gas
properties. This loan is payable in ten payments of $25,000, two of which have
already been made, plus interest at 6.75%. Infinity-Wyoming also converted
approximately $0.2 million in accounts payable to a note payable with the vendor
and will make monthly payments of approximately $13,500 plus interest for one
year. Infinity-Wyoming also has a $5.1 million balance on its line of credit
with U.S. Bank. The balance accrues interest on a monthly basis at 5.5%. The
balance of the note is due June 30, 2006.
As of March 31, 2004, Consolidated had borrowings of $0.5 million on a
revolving credit line, $0.7 million on a term loan and $0.3 million on a capital
expenditures line. Subsequent to March 31, 2004, Consolidated borrowed an
additional $1.3 million in order to purchase the assets of Blue Star. LaSalle
amended the existing term note and capital expenditures line and consolidated
these borrowings together with the new borrowings related to the Blue Star
acquisition, into a new note. Consolidated will make monthly payments of
$95,626 plus interest on the new note until December 31, 2004, at which time the
remaining principal and interest will be due. Management plans to, and
anticipates, that it will be able to renegotiate the term of this note which
will result in refinancing the debt to long-term debt.
Infinity owes $1.8 million on a note to a related party which is due
January 30, 2005, and accrues interest at 7%, with interest payments due
monthly.
Infinity 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 have current payments of
approximately $58,000 per month.
Infinity received proceeds of approximately $4.0 million, net of offering
costs, from a private placement of 1,000,000 shares of common stock in January
2004. In addition, Infinity received proceeds from the issuance of common
stock, upon the exercise of 40,000 options, of $0.1 million during the period
ended March 31, 2004.
The working capital deficit as of March 31, 2004 was $(4.1) million.
Infinity expects to spend approximately $3.7 million meeting its drilling and
completion, pipeline installation and environmental impact study obligations
during the next year and incur approximately $1.5 million in
20
additional interest on its outstanding notes. Infinity also expects to incur
approximately $2.0 million in corporate cash usage during the next year and has
incurred $1.3 million in costs with the acquisition of Blue Star.
Consolidated expects to generate approximately $3.6 million in operating
cash flow from the oilfield service business during the remainder of 2004 and
the first quarter of 2005. The cash flow from this business segment is expected
to be driven by an increase in fracturing and acidizing business in the Cherokee
Basin of southeast Kansas as customers move forward with development activities
on leases that will be expiring within the next year, an increase in cementing
activity in the Powder River Basin of Wyoming and an increase in oilfield
service operations in eastern Kansas and northeast Oklahoma driven by higher oil
and gas prices and the acquisition of Blue Star. Infinity-Wyoming is also
expected to generate approximately $4.0 million in operating cash flow from oil
and gas production operations during the remainder of 2004 and the first quarter
of 2005. Management anticipates production from the wells on the Pipeline
project to continue to produce approximately 3,300 Mcfe per day net to
Infinity's interest and has not assumed any production increases from other
exploration and production projects, including Labarge. In addition to the
expected production volumes, Infinity-Wyoming has a contract in place to sell
2,000 MMBtu per day at $4.40 through March, 2005 and at $4.15 through March
2006. Production expenses are expected to stay fairly steady during the period.
Consolidated anticipates obtaining additional proceeds from financing
activity associated with the oilfield service assets. Consolidated currently
has approximately $5.5 million in borrowing base capacity on these assets and
believes that it will be able to restructure its current facility secured by
those assets. The restructuring could potentially extend the payment terms of
approximately $3.8 million of current debt into future periods if Consolidated
is successful in restructuring the note to include a three-year payment term
assuming 6% interest. Management has historically refinanced its asset-based
credit facility on three year terms, which has generated proceeds that have been
utilized for capital additions or distributed to the parent for other capital
expenditures. Historically financing terms have restricted distributions from
Consolidated to the parent; however, management anticipates that new terms would
allow for additional funds to be distributed to the parent.
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 and the first quarter of 2005. The
estimates do not include the Nicaragua exploration contract 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 March 31, 2005
(In Millions)
Current deficit $4.1
Property development requirements 3.3
Interest on notes 1.5
Blue Star acquisition 1.3
Corporate cash usage 2.0
Labarge environmental impact study 0.3
Lease rental payments 0.1
----
Total requirements $12.6
-----
21
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
Refinancing of current debt with LaSalle 3.8
----
Total sources 12.2
-----
Expected minimum cash requirement deficit $ 0.4
=====
In order to fund Infinity's expected minimum cash requirement deficit of
$0.4 million, and any other potential development expenditures, Infinity will be
required to pursue funding through conventional bank financing, the forward sale
of its oil and gas production or through the public or private equity or debt
market. Any proceeds from these potential sources will first be applied to the
$0.4 million expected minimum cash requirement deficit discussed above. 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, to secure the necessary drilling and completion
services, and to fund the development. Obtaining permits and sufficient funding
to meet these additional capital expenditures cannot be assured.
In addition to its operating needs, Consolidated anticipates it will incur
capital expenditures of approximately $1.0 million over the next year related to
vehicle acquisitions and equipment fabrication and approximately $0.2 million of
facilities capital maintenance. Management believes that credit available to
Consolidated through local sources and vendors will be sufficient to meet
Consolidated's capital expenditure needs of approximately $1.2 million.
Infinity-Wyoming anticipates having capital expenditures, subject to
permitting requirements, beyond its development obligations under the agreement
with Schlumberger and Red Oak, as discussed above, of approximately $3.0
million. This is substantially less than potential expenditures identified in
previous reports and reflects management's current interpretation of additional
geological, geophysical and engineering data. The additional anticipated
expenditures in order of priority are as follows: (1) drill and complete four
wells (three net wells) in the Pipeline field at a cost of approximately $1.5
million; (2) remediate and complete two existing wells and drill and complete a
horizontal well targeting the fractured Niobrara formation in the Sand Wash
Basin at a cost of approximately $1.0 million; and (3) drill a wireline-cored
pilot test well for evaluation of the coals on the Piceance Basin acreage at a
cost of approximately $0.5 million. Infinity-Wyoming also anticipates incurring
additional costs of approximately $0.3 million for various land acquisitions to
fill in acreage within existing properties.
Infinity continues to negotiate the final development agreement with INE
for the Perlas and Tyra blocks offshore Nicaragua. Management believes that is
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 acquisition and re-processing of geophysical data. Infinity
estimates the performance bond will be between approximately $0.2 million and
$0.8 million depending on the final terms of the lease. Infinity also
anticipates that it 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
22
final terms of an agreement have not been reached and due diligence has not been
completed, Infinity cannot determine what financial resources might be required
to complete the acquisition and exploration.
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. 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.
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
23
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. At March
31, 2004, Infinity would have recognized a $1.5 million ceiling write-down based
on the gas price in effect at that date. However, due to subsequent significant
increases in gas sales prices and taking into account forward gas sales
contracts at May 7, 2004, Infinity-Wyoming was not required to recognize a
ceiling write-down in the quarter ended March 31, 2004. A decrease in gas
prices, a significant decrease in estimated gas production in future periods, or
the reclassification of development costs to properties subject to depletion
without a corresponding increase in associated reserves could result in a
ceiling write-down during future periods. 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 oilfield 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
Deferred tax assets and liabilities represent the future tax return
consequences of 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.
ITEM 3.
-------
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 monthly low of $4.84 per Mcf
to a monthly high of $5.18 per Mcf during the quarter ended March 31, 2004. Oil
price realizations ranged from a monthly low of $33.35 per barrel to a monthly
high of $35.99 per barrel during the period.
Infinity-Wyoming periodically enters into forward sales contracts 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. Beginning April 1, 2004, Infinity has a
forward sales contract in place for the sale of 2,000 MMBtu per day at a price
of $4.40 per MMBtu. The contract expires March 31, 2005 at which time it is
replaced by a one-year contract for the sale of 2,000 MMBtu per day at a fixed
price of $4.15 per MMBtu.
24
ITEM 4.
-------
CONTROLS AND PROCEDURES
-----------------------
The chief executive officer and the chief financial officer have conducted
an evaluation of the effectiveness of the design and operation of Infinity's
disclosure controls and procedures within 90 days of the filing date of this
quarterly report. Based upon the results of this evaluation, the chief
executive officer and the chief financial officer have concluded that the
disclosure controls and procedures are effective as of March 31, 2004. During
the quarter ended March 31, 2004, there were no changes in our internal controls
over financial reporting that materially affected, or are reasonably likely to
affect, our internal control over financial reporting. Infinity believes that
they maintain proper procedures for gathering, analyzing and disclosing all
information in a timely fashion that is required to be disclosed in its Exchange
Act reports. There have been no significant changes in Infinity's controls
subsequent to the evaluation date.
PART II - OTHER INFORMATION
---------------------------
ITEM 1. LEGAL PROCEEDINGS.
Not Applicable
ITEM 2. CHANGES IN SECURITIES
On January 16, 2004, Infinity completed a private placement of one million
shares of its common stock at an aggregate offering price of $4.0 million. In
connection with this private placement, Infinity relied on Section 4(2) of the
Securities Act of 1933. The placement was made to two purchasers both of whom
were accredited investors as defined in Regulation D.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.1 Amended Loan and Security Agreement between LaSalle Bank N.A. and
Consolidated Oil Well Services, Inc., term note and related
guarantees.
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes- Oxley Act
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes- Oxley Act
25
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. 1350 (Section 906 of the
Sarbanes-Oxley Act)
(b) Reports on Form 8-K:
The Company filed a Form 8-K dated January 16, 2004, to disclose under
Item 5 the completion of a private placement of its common stock and
to file under Item 7 certain exhibits related to the placement.
The Company filed a Form 8-K dated March 29, 2004, under Item 7 and
Item 12 to report fourth quarter and year-end 2003 financial results,
to report year-end proved reserves and to provide an update of
exploration and production operations.
26
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
INFINITY, INC.
Dated: May 17, 2004 By: /s/ Stanton E. Ross
-------------------------------------
Stanton E. Ross, President
Dated: May 17, 2004 By: /s/ Jon D. Klugh
-------------------------------------
Jon D. Klugh, Chief Financial Officer
27