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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2004
[ ] TRANSITION REPORT UNDER SECTION 13 OF 15(d) OF THE EXCHANGE
ACT
Commission file number 0-26321
GASCO ENERGY, INC.
(Exact name of registrant as specified in its charter)
Nevada 98-0204105
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
14 Inverness Drive East, Suite H-236, Englewood, Colorado 80112
(Address of principal executive offices)
(303) 483-0044
(Registrant's telephone number, including area code)
No Change
(Former name, former address and former fiscal year,
if changed since last report)
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 require to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12 b-2 of the Exchange Act). Yes [ ] No [X]
Number of Common shares outstanding as of November 10, 2004: 70,531,606
ITEM I - FINANCIAL INFORMATION
PART 1 - FINANCIAL STATEMENTS
GASCO ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2004 2003
ASSETS
CURRENT ASSETS
Cash and cash equivalents $13,763,821 $ 3,081,109
Restricted cash - 250,000
Prepaid expenses 399,921 555,786
Accounts receivable 424,874 499,363
----------- ---------
Total 14,588,616 4,386,258
----------- ---------
PROPERTY, PLANT AND EQUIPMENT, at cost
Oil and gas properties (full cost method)
Proved mineral interests 22,473,991 16,386,252
Unproved mineral interests 15,050,728 13,212,039
Furniture, fixtures and other 216,626 166,051
---------- ----------
Total 37,741,345 29,764,342
---------- ----------
Less accumulated depreciation, depletion and amortization (2,003,045) (1,232,634)
----------- -----------
Total 35,738,300 28,531,708
----------- ----------
OTHER ASSET
Deferred financing costs 113,283 141,213
----------- -----------
TOTAL ASSETS $ 50,440,199 $ 33,059,179
============ ============
The accompanying notes are an integral part of the
consolidated financial statements.
2
GASCO ENERGY, INC.
CONSOLIDATED BALANCE SHEETS (continued)
(Unaudited)
September 30, December 31,
2004 2003
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,003,645 $ 2,260,492
Advances from joint interest owners 971,272 -
Accrued expenses 25,104 933,520
---------- ---------
Total 2,000,021 3,194,012
---------- ---------
NONCURRENT LIABILITES
8% Convertible Debentures, net of unamortized discount $134,720 in
2004 and $159,722 in 2003 2,365,280 2,340,278
Asset retirement obligation 211,468 142,806
--------- ---------
Total 2,576,748 2,483,084
--------- ---------
STOCKHOLDERS' EQUITY
Series B Convertible Preferred stock - $.001 par value; 20,000 shares
authorized; 2,255 shares issued and outstanding with a liquidation
preference of $992,200 in 2004 and 11,734 shares issued and
outstanding with a liquidation preference of $5,162,960 in 2003 2 12
Common stock - $.0001 par value; 100,000,000 shares authorized;
66,438,641 shares issued and 66,364,941 outstanding in 2004;
45,675,936 shares issued and 45,602,236 shares outstanding in 2003 6,643 4,568
Additional paid in capital 73,771,240 52,979,325
Deferred compensation (686,921) (179,766)
Accumulated deficit (27,097,239) (25,291,761)
Less cost of treasury stock of 73,700 common shares (130,295) (130,295)
----------- -----------
Total 45,863,430 27,382,083
----------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 50,440,199 $ 33,059,179
============- ============
The accompanying notes are an integral part of the
consolidated financial statements.
3
GASCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
September 30,
--------------------------------------
2004 2003
REVENUES
Natural gas $ 757,073 $ 255,028
Oil 60,252 22,073
Interest 43,065 3,402
------- -------
Total 860,390 280,503
------- -------
OPERATING EXPENSES
General and administrative 869,982 684,480
Lease operating 179,241 104,084
Depletion, depreciation and amortization 283,522 124,948
Interest 68,056 1,200
--------- -------
Total 1,400,801 914,712
--------- -------
NET LOSS (540,411) (634,209)
Preferred stock dividends (23,754) (88,027)
---------- ---------
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS $ (564,165) $ (722,236)
=========== ===========
NET LOSS PER COMMON SHARE - BASIC AND DILUTED $ (0.01) $ (0.02)
========= =========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - BASIC AND DILUTED 65,835,129 40,388,800
========== ==========
The accompanying notes are an integral part of the
consolidated financial statements.
4
GASCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Nine Months Ended
September 30,
----------------------------------------
2004 2003
REVENUES
Natural gas $ 2,189,860 $ 885,866
Oil 156,138 49,612
Interest 91,470 9,128
--------- -------
Total 2,437,468 944,606
--------- -------
OPERATING EXPENSES
General and administrative 2,633,216 2,120,856
Lease operating 596,053 280,968
Depletion, depreciation and amortization 784,861 398,588
Interest 228,816 24,673
--------- ---------
Total 4,242,946 2,825,085
--------- ---------
LOSS BEFORE CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE (1,805,478) (1,880,479)
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE - (9,687)
----------- -----------
NET LOSS (1,805,478) (1,890,166)
Preferred stock dividends (136,640) (216,145)
------------ -----------
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS $ (1,942,118) $ (2,106,311)
============= =============
PER COMMON SHARE DATA - BASIC AND DILUTED:
Loss before cumulative effect of change in accounting principle $ (0.03) $ (0.05)
Cumulative effect of change in accounting principle - -
-------- ---------
NET LOSS PER COMMON SHARE - BASIC AND DILUTED $ (0.03) $ (0.05)
========= =========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - BASIC AND DILUTED 61,289,142 40,347,042
========== ==========
The accompanying notes are an integral part of the
consolidated financial statements.
5
>
GASCO ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
-----------------------------------
2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(1,805,478) $ (1,890,166)
Adjustment to reconcile net loss to net cash used in operating activities
Depreciation, depletion and impairment expense 770,411 388,532
Accretion of asset retirement obligation 14,450 10,056
Amortization of deferred compensation 241,002 66,661
Amortization of beneficial conversion feature 25,002 -
Amortization of deferred offering costs 27,930 -
Cumulative effect of change in accounting principle - 9,687
Changes in operating assets and liabilities:
Prepaid expenses 155,865 4,406
Accounts receivable 74,489 (86,759)
Accounts payable (1,287,740) 819,274
Advances from joint interest owners 971,272 -
Accrued expenses (908,416) (1,229,718)
----------- -----------
Net cash used in operating activities (1,721,213) (1,908,027)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from property sales 4,314,984 -
Cash paid for furniture, fixtures and other (50,575) (3,264)
Cash paid for acquisitions, development and exploration (12,187,200) (3,094,652)
------------ -----------
Net cash used in investing activities (7,922,791) (3,097,916)
------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of common stock 21,500,001 -
Proceeds from sale of preferred stock - 4,862,840
Cash designated as restricted - (250,000)
Cash undesignated as restricted 250,000 250,000
Cash paid for offering costs (1,429,659) (65,431)
Exercise of options to purchase common stock 33,336 -
Preferred dividends (26,962) (1,836)
Repayment of note payable - (1,400,000)
---------- -----------
Net cash provided by financing activities 20,326,716 3,395,573
---------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 10,682,712 (1,610,370)
CASH AND CASH EQUIVALENTS:
BEGINNING OF PERIOD 3,081,109 2,089,062
----------- ---------
END OF PERIOD $ 13,763,821 $ 478,692
============ =========
The accompanying notes are an integral part of the
consolidated financial statements.
6
>
GASCO ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NINE AND THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
NOTE 1 - ORGANIZATION
Gasco Energy, Inc. ("Gasco" or the "Company") is an independent energy company
engaged in the exploration, development, acquisition and production of crude oil
and natural gas reserves in the western United States.
The unaudited financial statements included herein were prepared from the
records of the Company in accordance with generally accepted accounting
principles in the United States applicable to interim financial statements and
reflect all adjustments which are, in the opinion of management, necessary to
provide a fair statement of the results of operations and financial position for
the interim periods. Such financial statements conform to the presentation
reflected in the Company's Form 10-K filed with the Securities and Exchange
Commission for the year ended December 31, 2003. The current interim period
reported herein should be read in conjunction with the Company's Form 10-K for
the year ended December 31, 2003.
The results of operations for the nine months ended September 30, 2004 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2004. All significant intercompany transactions have been
eliminated.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements include Gasco and its wholly
owned subsidiaries.
Restricted Cash
The restricted cash balance at December 31, 2003 represented a $250,000 escrow
agreement related to one of its drilling prospects. The funds held in escrow
were released during May 2004 upon completion of certain drilling obligations.
Asset Retirement Obligation
In June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations, " which required that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it was incurred if a
reasonable estimate of fair value could be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset.
The asset retirement liability will be allocated to operating expense by using a
systematic and rational method. The Company adopted this statement as of January
1, 2003 and recorded a net asset of $139,247, a related liability of $148,934
(using a 9% discount rate and a 2% inflation rate) and a cumulative effect of
change in accounting principle on prior years of $9,687. The information below
reconciles the value of the asset retirement obligation during the periods
indicated.
7
Nine Months Ended September 30,
2004 2003
Balance beginning of period $142,806 $ 148,934
Liabilities incurred 67,654 -
Liabilities settled (13,442) -
Revisions in estimated cash flows - -
Accretion expense 14,450 10,056
--------- --------
Balance end of period $ 211,468 $ 158,990
========== =========
Computation of Net Loss Per Share
Basic net loss per share is computed by dividing net loss attributable to the
common stockholders by the weighted average number of common shares outstanding
during the reporting period. The shares of restricted common stock granted to
certain officers, directors and employees of the Company are included in the
computation only after the shares become fully vested. Diluted net income per
common share includes the potential dilution that could occur upon exercise of
the options to acquire common stock computed using the treasury stock method
which assumes that the increase in the number of shares is reduced by the number
of shares which could have been repurchased by the Company with the proceeds
from the exercise of the options (which were assumed to have been made at the
average market price of the common shares during the reporting period). The
Series B Convertible Preferred Stock ("Preferred Stock") and the outstanding
common stock options have not been included in the computation of diluted net
loss per share during all periods because their inclusion would have been
anti-dilutive.
In March 2004, the FASB issued consensus on EITF 03-6, "Participating Securities
and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share,"
related to calculating earnings per share with respect to using the two-class
method for participating securities. This pronouncement is effective for all
periods after March 31, 2004, and requires prior periods to be restated. As the
Company has incurred net losses in the current and prior periods, and as the
Company's preferred stock does not have a contractual obligation to share in the
losses of the Company, the adoption of EITF 03-6 had no impact on the Company's
financial condition, or its results of operations.
Stock Based Compensation
The Company accounts for its stock-based compensation using Accounting
Principles Board Opinion No. 25 ("APB No. 25") and related interpretations.
Under APB 25, compensation expense is recognized for stock options with an
exercise price that is less than the market price on the grant date of the
option. For stock options with exercise prices at or above the market value of
the stock on the grant date, the Company adopted the disclosure-only provisions
of Statement of Financial Accounting Standards No. 123 "Accounting for
Stock-Based Compensation" ("SFAS 123") for the stock options granted to the
employees and directors of the Company. Accordingly, no compensation cost has
been recognized for these options. Had compensation expense for the options
granted been determined based on the fair value at the grant date for the
8
options, consistent with the provisions of SFAS 123, the Company's net loss and
net loss per share for the quarters and nine months ended September 30, 2004 and
2003 would have been increased to the pro forma amounts indicated below:
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Net loss attributable to common shareholders:
As reported $(564,165) $(722,236) $ (1,942,118) $ (2,106,311)
Add: Stock-based employee compensation
included in net loss (a) 122,838 13,828 194,936 13,828
Less: Stock based employee compensation
determined under the fair value based method 191,947 76,185 575,842 264,555
Pro forma $ (633,274) $(784,593) $ (2,323,024) $ (2,357,038)
Net loss per common share:
As reported $ (0.01) $ (0.02) $ (0.03) $ (0.05)
Pro forma (0.01) (0.02) (0.04) (0.06)
(a) Represents the compensation expense associated with the Company's restricted
stock awards.
The fair value of the common stock options granted during 2004 and 2003, for
disclosure purposes was estimated on the grant dates using the Black Scholes
Pricing Model and the following assumptions.
2004 2003
Expected dividend yield -- --
Expected price volatility 79 %-87% 82%
Risk-free interest rate 3.2%-3.7% 2.9%
Expected life of options 5 years 5 years
Use of Estimates
The preparation of the financial statements for the Company in conformity with
generally accepted accounting principles 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 financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
Recent Accounting Pronouncements
During March 2004, the Emerging Issues Task Force ("EITF") determined that
mineral rights as defined in EITF Issue No. 04-2, "Whether Mineral Rights are
Tangible or Intangible Assets," are tangible assets and should not be considered
intangible assets in Statement of Financial Accounting Standards No. 141
"Business Combinations" (SFAS 141) and Statement of Financial Accounting
Standards No. 142, "Goodwill and Intangible Assets" (SFAS 142). The Financial
9
Accounting Standards Board (FASB), in agreement with this determination, amended
SFAS Nos. 141 and 142 through the issuance of FASB Staff Position ("FSP) FSP
Nos. 141-1 and 142-1. In addition, the proposed FSP 142-b confirms that FAS 142
did not change the balance sheet classification or disclosures of mineral rights
of oil and gas producing entities. The Company has historically classified its
oil and gas leaseholds as tangible oil and gas properties which is consistent
with EITF 04-02, FSP Nos. 141-1 and 142-1 and therefore such pronouncements have
not impacted the Company's financial condition or results of operations.
NOTE 3 - STOCK ISSUANCES
On February 11, 2004 the Company completed the sale through a private placement
of 14,333,334 shares of its common stock to a group of accredited investors at a
price of $1.50 per share. Proceeds to the Company, net of fees and expenses were
approximately $20,070,000. The proceeds from this sale are being used for
general corporate purposes including the acquisition of oil and natural gas
assets and the development and exploitation of Gasco's Riverbend Project in the
Uinta Basin in Uintah County, Utah.
During the first nine months of 2004, certain holders of the Company's Series B
Convertible Preferred Stock ("Preferred Stock") converted 9,479 shares of
Preferred Stock into 5,958,226 shares of common stock.
On June 14, 2004, the Company's Board of Directors approved the issuance of
395,850 shares of common stock, under the Gasco Energy, Inc. Amended and
Restated 2003 Restricted Stock Plan ("Restricted Stock Plan"), to certain of the
Company's officers and employees. The restricted shares vest 20% on the first
anniversary, 20% on the second anniversary and 60% on the third anniversary of
the awards. The shares fully vest upon certain events, such as a change in
control of the Company, expiration of the individual's employment agreement and
termination by the Company of the individual's employment without cause. Any
unvested shares are forfeited upon termination of employment for any other
reason.
The compensation expense related to the restricted stock was measured on June
14, 2004 using the trading price of the Company's common stock, the date the
restricted shares were issued and is amortized over the three-year vesting
period. The shares of restricted stock are considered issued and outstanding at
the date of grant and are included in shares outstanding for the purposes of
computing diluted earnings per share. The Company had 735,850 unvested shares of
restricted stock outstanding as of September 30, 2004 and the compensation
expense related to these shares during the nine months ended September 30, 2004
was $194,936. There were 425,000 unvested shares of restricted stock outstanding
as of September 30, 2003 and the compensation expense related to these shares
was $13,828.
During the third quarter of 2004, upon vesting of a previous restricted stock
grant, an officer of Gasco returned 14,397 of his shares to the Company in
satisfaction of his personal tax liability that resulted from the vesting of the
restricted stock. The Company plans to cancel these shares during the fourth
quarter of 2004.
10
NOTE 4 - PROPERTY ACQUISITION
On March 9, 2004 the Company completed the acquisition of additional working
interests in six producing wells, 13,062 net acres and gathering system assets
located in the Uinta Basin in Utah for approximately $3,175,000. During May 2004
an unrelated third party exercised its right to purchase 25% of the acquired
properties at the acquisition price,which had the effect of reducing the
purchase price to approximately $2,400,000 and reducing the Company's interest
in the acquisition to 75%. The effective date of the acquisition was January 1,
2004; however, the net revenue from the producing wells during the period from
January 1, 2004 through March 9, 2004 was recorded as a reduction to the
purchase price.
The following unaudited pro forma consolidated results of operations are
presented as if the acquisition occurred on January 1, 2003.
For the Three Months Ended For the Nine Months
September 30, Ended September 30,
2004 2003 2004 2003
---- ---- ---- ----
Revenue $ 860,390 $522,407 $ 2,587,839 $1,760,318
Loss before cumulative effect of change
in accounting principle (540,411) (465,312) (1,736,281) (1,373,789)
Net Loss (540,411) (465,312) (1,436,281) (1,383,476)
Net Loss Attributable to Common
Stockholders (564,165) (553,339) (1,872,921) (1,599,621)
Net Loss per Common Share - Basic
and Diluted $(0.01) $ (0.01) $ (0.03) $ (0.04)
NOTE 5 - SERVICE PARTIES' AGREEMENT
On January 20, 2004 the Company entered into agreements, which were subsequently
amended during July 2004, with a group of industry providers (together, the
"Service Parties") to accelerate the development of Gasco's oil and gas
properties by drilling up to 50 wells in Gasco's Riverbend Project in Utah's
Uinta Basin.
Gasco has agreed that the Service Parties, which includes Schlumberger Oilfield
Services, will have the exclusive right to provide their services in the
development of the Riverbend acreage. The agreement provides for the group to
proceed initially with the first 10-well bundle, which approximates one year of
drilling with a single rig. If the group agrees, drilling may be accelerated
using additional rigs. Gasco's 2004 capital budget is approximately $13 million
for the drilling, completion and pipeline connection of wells in this area.
11
General Terms of the Amended Agreement:
o Contract Area consists of Gasco's leasehold position in portions of
Carbon, Duchesne and Uintah Counties, Utah.
o Gasco can continue to independently develop its acreage subject to
certain limitations and provisions of this agreement.
o Schlumberger will coordinate certain activities under Gasco's
direction as operator of record.
o Gasco has elected to fund approximately 30% of each of the wells
drilled under this agreement. Gasco's interest in the production
stream from a bundle, net of royalties, taxes and lease operating
expenses, is estimated to equal the proportion of the total well costs
that it funds.
o The Service Parties have undertaken to provide approximately 45% of
the costs of each project bundle.
To secure its obligations under the agreement, described above, the Company has
pledged its interests in each of the wells in each bundle.
Subsequent to September 30, 2004, the Service Parties agreed to proceed with the
second bundle of ten wells. The drilling of the second bundle will commence upon
completion of the first bundle, which is currently drilling its two final wells.
NOTE 6 - PROPERTY DISPOSITION
In connection with the Service Parties agreements, described in Note 5, the
Company completed a disposition of net profits interests between 18.75% and 25%
in the 8 wells that have been drilled in the Riverbend area in Utah during 2004
for total cash consideration of $4,314,984, net of adjustments and commissions.
The purpose of this transaction was to allow third party investors to become a
party to our service provider arrangements. The consideration paid to the
Company in this transaction represented the share of such investor's development
costs of the 8 wells. These investors have the opportunity to continue to
participate in the development program under the service provider arrangement by
funding 25% of future development costs.
The cash received by the Company consisted of $4,314,984, which represented the
purchase price for the transaction of $4,790,387 less adjustments of $327,227
for net revenue minus lease operating expense for the properties from June 2004
and $148,176, representing a commission to the purchasers' financial advisor,
which the Company agreed to pay.
The following unaudited pro forma consolidated results of operations are
presented as if the disposition occurred on January 1, 2003.
12
For the Three Months Ended For the Nine Months
September 30, Ended September 30,
2004 2003 2004 2003
---- ---- ---- ----
Revenue $ 751,898 $280,503 $ 1,985,220 $ 944,606
Loss before cumulative effect of change
in accounting principle (636,534) (634,209) (2,288,139) (1,880,479)
Net Loss (636,534) (634,209) (2,288,139) (1,890,166)
Net Loss Attributable to Common
Stockholders (660,288) (722,236) (2,424,779) (2,106,311)
Net Loss per Common Share - Basic
and Diluted $(0.01) $ (0.01) $ (0.04) $ (0.05)
NOTE 7 - STOCK OPTIONS
During the first nine months of 2004, the Company granted an additional
1,410,000 options to purchase shares of common stock to employees, directors and
consultants of the Company, at exercise prices ranging from $1.61 to $2.15 per
share. The options vest 16 2/3% at the end of each four-month period after the
issuance date and expire within ten years from the grant date.
The aggregate fair market value of the options granted to consultants of the
Company, determined using the Black Scholes Pricing Model, will be amortized and
charged to operations over the two year vesting period.
NOTE 8 - RELATED PARTY TRANSACTION
During May 2004, the Company's Board of Directors authorized the payment of
approximately $65,000 to the chairman of the Gasco Board of Directors as
reimbursement of legal fees paid by the chairman for legal services provided to
the Company in connection with a Gasco stock transaction during 2002.
NOTE 9 - STATEMENT OF CASH FLOWS
During the nine months ended September 30, 2004, the Company's non-cash
investing and financing activities consisted of the following transactions:
- Recognition of an asset retirement obligation for the plugging and
abandonment costs related to the Company's oil and gas properties
valued at $67,654.
- Reduction in the asset retirement obligation of $13,442 representing
the sale of 25% of the Company's interest in six producing wells as
further described in Note 4.
- Conversion of 9,479 shares of Preferred Stock into 5,958,226 shares of
common stock.
13
- Issuance of 41,959 shares of common stock in payment of the June 30,
2004 Preferred Stock dividend.
- Issuance of 395,850 shares of restricted common stock to certain of
the Company's employees.
During the nine months ended September 30, 2003, the Company's non-cash
investing and financing activities consisted of the following transactions:
- Recognition of an asset retirement obligation for the plugging and
abandonment costs related to the Company's oil and gas properties
valued at $148,934.
- Issuance of 287 shares of Preferred Stock in payment of the June 30,
2003 Preferred Stock dividend.
- Issuance of 425,000 shares of restricted common stock to certain of
the Company's officers and directors and the issuance of 100,000
shares of common stock as compensation to a former employee.
Cash paid for interest during the nine months ended September 30, 2004 and 2003
was $175,884 and $23,473, respectively.
NOTE 10 - LITIGATION
On June 9, 2003, Pannonian was named as a defendant in a lawsuit filed in the
United States District Court of Midland County, Texas. On July 15, 2003, Gasco
was also named as defendant in the same lawsuit. The plaintiffs, Burlington
Resources Oil & Gas Company LP by BROG GP Inc. its sole General Partner
("Burlington Resources") claimed that Pannonian and Gasco owed them
$1,007,894.14 in unpaid invoices. During March 2004, the Company repaid $900,723
of this liability and during July the Company made a final payment of $100,000
in settlement of this matter. Orders to dismiss both cases with prejudice were
filed on July 10, 2004.
NOTE 11 - SUBSEQUENT EVENTS
On October 11, 2004, the Board of Directors of Gasco, other than Mr. Erickson
and Mr. Bruner, approved a transaction pursuant to which Marc Bruner, the
chairman of Gasco's Board of Directors, and Mark Erickson, a director and
President and Chief Executive Officer of Gasco, will transfer to Gasco their
rights to receive certain overriding royalty interests in its properties in
exchange for the grant to each of them of options to purchase 100,000 shares of
Gasco common stock at the market price on the date of grant. Messrs. Bruner and
Erickson subsequently agreed to transfer such rights to Gasco for no options or
other consideration.
For each individual, these interests range between .06% and 0.6% of Gasco's
working interest in certain of its Utah and Wyoming properties. Gasco will also
agree to convey equivalent royalty interests to Mr. Bruner and Mr. Erickson, or
either of them, in the event that it sells any of the property subject to the
royalty interests, upon certain change of control events or upon the involuntary
14
termination of either individual. Mr. Bruner and Mr. Erickson acquired these
rights under a Trust Termination and Distribution Agreement, dated December 31,
2002, with respect to the Pannonian Employee Royalty Trust ("Royalty Trust").
The Royalty Trust had been established by Pannonian Energy, Inc. ("Pannonian")
prior to Pannonian becoming a wholly owned subsidiary of Gasco, to provide
additional compensation to the employees and founding directors of Pannonian,
which included Mr. Bruner and Mr. Erickson, in the form of oil and gas
interests. The terms of the Trust Termination and Distribution Agreement
("Termination Agreement") required Gasco to assign to the participants of the
Royalty Trust overriding royalty interests that arise out of the production of
oil and gas from certain properties as a result of future drilling. The
transaction has been reviewed and approved by Gasco's Audit Committee. Mr.
Erickson and Mr. Bruner have agreed in principle to the terms of this
transaction with the disinterested members of Gasco's Board of Directors. The
parties are currently finalizing the definitive agreements for this transaction
and expect to complete the transaction within the next two weeks.
On October 20, 2004 (the "Issue Date"), the Company closed the private placement
of $65 million in aggregate principal amount of its 5.50% Convertible Senior
Notes due 2011 (the "Notes") pursuant to an Indenture dated as of October 20,
2004 (the "Indenture"), between the Company and Wells Fargo Bank, National
Association, as trustee. The amount sold consisted of $45 million principal
amount originally offered plus the exercise by the initial purchasers of their
option to purchase an additional $20 million principal amount. The Notes were
sold only to qualified institutional buyers in reliance on Rule 144A under the
Securities Act of 1933.
The Notes are convertible into Company Common Stock, $.0001 par value per share
("Common Stock"), at any time prior to maturity at a conversion rate of 250
shares of Common Stock per $1,000 principal amount of Notes (equivalent to a
conversion price of $4.00 per share), which is subject to certain anti-dilution
adjustments.
Interest on the Notes accrues from October 20, 2004 or the most recent interest
payment date, and is payable in cash semi-annually in arrears on April 5th and
October 5th of each year, commencing on April 5, 2005. Interest is payable to
holders of record on March 15th and September 15th immediately preceding the
related interest payment dates, and will be computed on the basis of a 360-day
year consisting of twelve 30-day months.
The Company, at its option, may at any time on or after October 10, 2009, in
whole, and from time to time in part, redeem the Notes on not less than 20 nor
more than 60 days' prior notice mailed to the holders of the Notes, at a
redemption price equal to 100% of the principal amount of Notes to be redeemed
plus any accrued and unpaid interest to but not including the redemption date,
if the closing price of the Common Stock has exceeded 130% of the conversion
price for at least 20 trading days in any consecutive 30 trading-day period.
Upon a "change of control" (as defined in the Indenture), each holder of Notes
can require the Company to repurchase all of that holder's notes 45 days after
the Company gives notice of the change of control, at a repurchase price equal
to 100% of the principal amount of Notes to be repurchased plus accrued and
unpaid interest to, but not including, the repurchase date, plus a make-whole
premium under certain circumstances described in the Indenture.
15
Pursuant to a Collateral Pledge and Security Agreement dated October 20, 2004,
between the Company and Wells Fargo Bank, National Association, as Trustee and
Collateral Agent (the "Pledge Agreement"), the Company has pledged U. S.
government securities in an amount sufficient upon receipt of scheduled
principal and interest payments with respect to such securities to provide for
the payment of the first six scheduled interest payments on the Notes.
Approximately $10.3 million of the net proceeds from the offering of Notes was
used to acquire such U. S. government securities. The Notes are unsecured
(except as described above) and unsubordinated obligations of the Company and
rank on a parity (except as described above) in right of payment with all of the
Company's existing and future unsecured and unsubordinated indebtedness. The
Notes effectively rank junior to any future secured indebtedness and junior the
Company's subsidiaries' liabilities. The Indenture does not contain any
financial covenants or any restrictions on the payment of dividends, the
repurchase of the Company's securities or the incurrence of indebtedness.
Upon a continuing event of default, the trustee or the holders of 25% principal
amount of a series of Notes may declare the Notes immediately due and payable,
except that a default resulting from the Company's entry into a bankruptcy,
insolvency or reorganization will automatically cause all Notes under the
Indenture to become due and payable.
Immediately prior to and in connection with the closing of the offering of the
Notes, the holders of the Company's 8.00% Convertible Debentures converted the
entire $2.5 million principal amount thereof into 4,166,665 shares of Common
Stock. In connection with the conversion, the Company paid the holders $270,247,
representing 120% of the future interest payments under the Debentures through
November 15, 2005.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
Forward Looking Statements
Please refer to the section entitled "Cautionary Statement Regarding Forward
Looking Statements" at the end of this section for a discussion of factors which
could affect the outcome of forward looking statements used by the Company.
Overview
Gasco is a natural gas and petroleum exploitation, development and production
company engaged in locating and developing hydrocarbon prospects, primarily in
the Rocky Mountain region. The Company's mission is to enhance shareholder value
by using new technologies to generate and develop high-potential exploitation
prospects in this area. The Company's principal business is the acquisition of
leasehold interests in petroleum and natural gas rights, either directly or
indirectly, and the exploitation and development of properties subject to these
leases.
The Company's corporate strategy is to grow through drilling projects. The
Company has been focusing its drilling efforts in the Riverbend Project located
in the Uinta Basin of northeastern Utah. The higher oil and gas prices during
2003 and through the third quarter of 2004 due to factors such as reduced levels
of gas storage, colder temperatures in the northeastern part of the country and
decreased gas imports from Canada, have increased the profitability of the
Company's drilling projects in this area. The increased drilling activity
16
resulting from the higher oil and gas prices may also decrease the availability
of drilling rigs and experienced personnel.
Recent Developments
On January 20, 2004 the Company entered into agreements, which were subsequently
amended during July 2004, with a group of industry providers (together, the
"Service Parties") to accelerate the development of Gasco's oil and gas
properties by drilling up to 50 wells in Gasco's Riverbend Project in Utah's
Uinta Basin.
Gasco has agreed that the Service Parties, which includes Schlumberger Oilfield
Services, will have the exclusive right to provide their services in the
development of the Riverbend acreage. The agreement provides for the group to
initially proceed with the first 10-well bundle, which approximates one year of
drilling with a single rig. If the group agrees, drilling may be accelerated
using additional rigs. Gasco's 2004 capital budget is approximately $13 million
for the drilling, completion and pipeline connection of wells in this area.
General Terms of the Agreement:
o Contract Area consists of Gasco's leasehold position in portions of
Carbon, Duchesne and Uintah Counties, Utah.
o Gasco can continue to independently develop its acreage subject to
certain limitations and provisions of this agreement.
o Schlumberger will coordinate certain activities under Gasco's
direction as operator of record.
o Gasco has elected to fund approximately 30% of each of the wells
drilled under this agreement. Gasco's interest in the production
stream from a bundle, net of royalties, taxes and lease operating
expenses, is estimated to equal the proportion of the total well costs
that it funds.
o The Service Parties have undertaken to provide approximately 45% of
the costs of each project bundle.
To secure its obligations under the agreement, described above, the Company has
pledged its interests in each of the wells in each bundle.
Subsequent to September 30, 2004, the Service Parties agreed to proceed with the
second bundle of ten wells. The drilling of the second bundle will commence upon
completion of the first bundle, which is currently drilling its two final wells.
During the first nine months of 2004, the Company drilled eight gross wells and
spudded two additional wells in the Riverbend area, which are part of the 10
well bundle contemplated by the agreements with the Service Parties, as
described above. Five of these wells began producing during the third quarter
and the remaining three wells began producing during October and November. The
Company increased its drilling activities in this area by adding a second
drilling rig in late April 2004 and anticipates drilling a total of 12 gross
wells during 2004. The Company has also successfully recompleted four additional
wells in this area and has identified three additional recompletion projects for
the remainder of 2004.
17
During July 2004, the Company began construction on a ten-mile pipeline as part
of a gathering system in the Riverbend area to create additional pipeline
capacity for the Company's drilling projects in this area. This pipeline was
completed in early November and currently gathers 100% of the Company's gas
across the Riverbend Project. The estimated cost of this project is
approximately $1,200,000.
On February 11, 2004, the Company completed the sale through a private placement
of 14,333,334 shares of its common stock to a group of accredited investors at a
price of $1.50 per share. Proceeds to the Company, net of fees and expenses were
approximately $20,070,000. The proceeds from this sale are being used for
general corporate purposes including the acquisition of oil and natural gas
assets and the development and exploitation of Gasco's Riverbend Project in the
Uinta Basin in Uintah County, Utah.
On March 9, 2004, the Company completed the acquisition of additional working
interests in six producing wells, 13,062 net acres and gathering system assets
located in the Uinta Basin in Utah for approximately $3,175,000. During May 2004
an unrelated third party exercised its right to purchase 25% of the acquired
properties at the acquisition price,which had the effect of reducing the
purchase price to approximately $2,400,000 and reducing the Company's interest
in the acquisition to 75%. The effective date of the acquisition was January 1,
2004 however; the net revenue from the producing wells during the period from
January 1, 2004 through March 9, 2004 was recorded as a reduction to the
purchase price.
In connection with the Service Parties agreements, described above, the Company
completed a disposition of net profits interests between 18.75% and 25% in the 8
wells that have been drilled in the Riverbend area in Utah during 2004 for total
cash consideration of $4,314,984, net of adjustments and commissions. The
purpose of this transaction was to allow third party investors to become a party
to our service provider arrangements. The consideration paid to the Company in
this transaction represented the share of such investor's development costs of
the 8 wells. These investors have the opportunity to continue to participate in
the development program under the service provider arrangement by funding 25% of
future development costs.
During the third quarter of 2004, the Company's Audit Committee, certain members
of management and Deloitte & Touche LLP ("Deloitte"), the Company's prior
independent registered public accounting firm, engaged in several discussions
regarding whether Deloitte would continue to provide audit services to us. These
discussions focused partly on Deloitte's increased staffing requirements for us
and many of Deloitte's other clients, due in part to additional requirements of
Rule 404 under the Securities Exchange Act of 1934 and other rules promulgated
under the Sarbanes-Oxley Act. Deloitte indicated that it had to make a choice in
the deployment of its resources. On September 8, 2004, Deloitte resigned as the
Company's independent registered public accounting firm. On September 14, 2004,
our Audit Committee engaged Hein & Associates LLP to serve as the Company's
independent public accountants for the fiscal year 2004. The Audit Committee has
decided to continue to retain Deloitte to advise the Company with respect to tax
matters.
18
On October 11, 2004, the Board of Directors of Gasco, other than Mr. Erickson
and Mr. Bruner, approved a transaction pursuant to which Marc Bruner, the
chairman of Gasco's Board of Directors, and Mark Erickson, a director and
President and Chief Executive Officer of Gasco, will transfer to Gasco their
rights to receive certain overriding royalty interests in its properties in
exchange for the grant to each of them of options to purchase 100,000 shares of
Gasco common stock at the market price on the date of grant. Messrs. Bruner and
Erickson subsequently agreed to transfer such rights to Gasco for no options or
other consideration.
For each individual, these interests range between .06% and 0.6% of Gasco's
working interest in certain of its Utah and Wyoming properties. Gasco will also
agree to convey equivalent royalty interests to Mr. Bruner and Mr. Erickson, or
either of them, in the event that it sells any of the property subject to the
royalty interests, upon certain change of control events or upon the involuntary
termination of either individual. Mr. Bruner and Mr. Erickson acquired these
rights under a Trust Termination and Distribution Agreement, dated December 31,
2002, with respect to the Pannonian Employee Royalty Trust ("Royalty Trust").
The Royalty Trust had been established by Pannonian Energy, Inc. ("Pannonian")
prior to Pannonian becoming a wholly owned subsidiary of Gasco, to provide
additional compensation to the employees and founding directors of Pannonian,
which included Mr. Bruner and Mr. Erickson, in the form of oil and gas
interests. The terms of the Trust Termination and Distribution Agreement
("Termination Agreement") required Gasco to assign to the participants of the
Royalty Trust overriding royalty interests that arise out of the production of
oil and gas from certain properties as a result of future drilling. The
transaction has been reviewed and approved by Gasco's Audit Committee. Mr.
Erickson and Mr. Bruner have agreed in principle to the terms of this
transaction with the disinterested members of Gasco's Board of Directors. The
parties are currently finalizing the definitive agreements for this transaction
and expect to complete the transaction within the next two weeks.
On October 20, 2004, the Company closed its previously announced private
offering of $65 million 5.50% Convertible Senior Notes due 2011. The notes were
issued at par. The principal amount of the notes reflects the exercise of the
option by the initial purchasers to purchase up to an additional $20 million of
the notes. Net proceeds from the private offering will be used to fund capital
expenditures to develop oil and gas properties, working capital and general
corporate purposes, which may include future acquisitions of interests in oil
and gas properties.
The notes are convertible into Gasco common stock at a conversion rate of 250
shares of common stock per $1,000 principal amount of notes (equivalent to a
conversion price of $4.00 per share), which is subject to certain adjustments.
The Company will have a call option, pursuant to which it may redeem the
securities, in part or in whole, on or after October 10, 2009, at 100% of the
principal amount if the closing price of the common stock exceeds 130% of the
conversion price, in accordance with conditions specified in the offering
memorandum.
The notes were sold only in the United States to qualified institutional buyers
in transactions exempt from the registration requirements of the Securities Act
of 1933, as amended. Neither the notes nor the shares of the Company's common
stock into which they are convertible have been registered under the Securities
Act of 1933, as amended, or any state securities laws, and they may not be
offered or sold in the United States absent registration or an applicable
19
exemption from registration requirements. The notes are eligible for trading in
accordance with Rule 144A under the Securities Act of 1933.
Immediately prior to and in connection with the closing of the offering of the
Notes, the holders of the Company's 8.00% Convertible Debentures converted the
entire $2.5 million principal amount thereof into 4,166,665 shares of Common
Stock. In connection with the conversion, the Company paid the holders $270,247,
representing 120% of the future interest payments under the Debentures through
November 15, 2005.
The Company has re-entered one of its wells in the Muddy Creek Project in the
Greater Green River Basin Area in Wyoming. The well is currently producing and
the Company has scheduled a multi-stage fracture stimulation program for this
well during December. The Company is also considering several options for its
properties in this area such as the farm-out or sale of some of its acreage and
other similar type transactions.
Oil and Gas Production Summary
The following table presents the Company's production and price information
during the three and nine months ended September 30, 2004 and 2003. The Mcfe
calculations assume a conversion of 6 Mcfs for each Bbl of oil.
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2004 2003 2004 2003
---------- ------- -------- --------
Natural gas production (Mcf) 129,605 59,028 379,107 199,645
Average sales price per Mcf $5.84 $4.30 $5.78 $ 4.44
Oil production (Bbl) 1,427 802 4,212 1,750
Average sales price per Bbl $42.22 $27.52 $37.07 $ 28.35
Production (Mcfe) 138,167 63,840 404,379 210,145
During the three and nine months ended September 30, 2004, the Company's oil and
gas production increased by approximately 116% and 92%, respectively primarily
due to the Company's drilling projects, completions, recompletions and the
compressor installation that took place during 2003 as well as the Company's
acquisition of additional interests in six wells in the Riverbend area as
discussed above.
During 2004 Gasco's 2004 capital budget is approximately $13 million for the
drilling, completion and pipeline connection of wells in the Riverbend Project.
The Company contracted a second rig, which began drilling during April 2004. The
Company anticipates drilling 12 gross wells during its 2004 drilling program
using both of these rigs. The Company anticipates an overall increase in its
compensation expense because it will have to hire additional personnel to manage
the workload associated with its operational plan for 2004 and 2005. Management
20
believes it has sufficient capital for the remainder of its 2004 operational
budget. As a result of the Company's fund raising efforts during October,
management has decided to search for a third drilling rig for its Utah
operations.
Liquidity and Capital Resources
The following table summarizes the Company's sources and uses of cash for each
of the nine months ended September 30, 2004 and 2003.
For the Nine Months
Ended September 30,
------------------------------------
2004 2003
---- ----
Net cash used in operations $ (1,721,213) $ (1,908,027)
Net cash used in investing activities (7,922,791) (3,097,916)
Net cash provided by financing activities 20,326,716 3,395,573
Net increase (decrease) in cash 10,682,712 (1,610,370)
Cash used in operations during 2004 and 2003 is primarily comprised of the
Company's general and administrative expenses partially offset by gas revenue
from the Company's producing wells. The decrease in cash used in operations
during 2004 is primarily the result of the fluctuations in the Company's
operating assets and liabilities due to the Company's increased drilling and
completion activity partially offset by higher cash flow from operations due to
increased revenue resulting from the increase in production discussed above. See
further discussion under Results of Operations.
The Company's investing activities during 2004 and 2003 related primarily to the
Company's development and exploration activities. These activities consisted of
the Company's drilling projects in the Riverbend area, the construction of a
ten-mile pipeline in this area and the costs associated with the Company's
acreage in Wyoming and Utah. The investing activities during 2004 included the
Company's property acquisition and the Company's disposition of a net profits
interest in eight of its wells, both of which are described above.
Historically, the Company has relied on the sale of equity, farm-outs and other
similar types of transactions to fund working capital, the acquisition of its
prospects and its drilling and development activities. The financing activity
during 2003 consisted primarily of the sale of Series B Preferred Stock
partially offset by the repayment of a $1,400,000 note payable. The financing
activity during the first nine months of 2004 consisted primarily of the sale of
14,333,334 shares of common stock as further described above. The Company
anticipates funding its working capital and budgeted capital expenditures for
the remainder of 2004 and for 2005 with the proceeds of its October debt
financing and from operating cash flows. The Company may also raise additional
funds through the sale of debt or equity securities, farm-outs or other similar
transactions to fund part of its 2005 budget.
Capital Budget
On January 16, 2004 the Company entered into agreements, which were subsequently
amended during July 2004, with a group of industry providers (together, the
"Service Parties") to accelerate the development of Gasco's oil and gas
properties by drilling up to 50 wells in Gasco's Riverbend Project in Utah's
21
Uinta Basin. Gasco has agreed that the Service Parties will have the exclusive
right to provide their services in the development of the Riverbend acreage. The
agreement provides for the group to initially proceed with the first 10-well
bundle, which approximates one year of drilling with a single rig. If the group
agrees, drilling may be accelerated using additional rigs. Gasco's 2004 capital
budget is approximately $13 million for the drilling, completion and pipeline
connection of wells in this area. The Company spent approximately $5 million for
these purposes during the first six months of 2004. Gasco has elected to fund
approximately 30% of the cost of each of the wells drilled under this agreement.
Gasco's interest in the production stream from a bundle, net of royalties, taxes
and lease operating expenses is estimated to equal the proportion of the total
well costs that it funds.
To secure its obligations under the agreement described above, the Company has
pledged its interests in each of the wells in each bundle.
Subsequent to September 30, 2004, the Service Parties agreed to proceed with the
second bundle of ten wells. The drilling of the second bundle will commence upon
completion of the first bundle, which is currently drilling its two final wells.
On February 11, 2004 the Company completed the sale through a private placement
of 14,333,334 shares of its common stock to a group of accredited investors at a
price of $1.50 per share. Proceeds to the Company, net of fees and estimated
expenses were approximately $20,070,000. The proceeds from this sale are being
used for general corporate purposes including the development and exploitation
of Gasco's Riverbend Project in the Uinta Basin in Uintah County, Utah.
The Company's use of the funds from this transaction and its cash on hand
include the following projects:
- The March 9, 2004 acquisition of additional interests in six producing
wells, 13,062 net acres and certain other assets located in the Uinta
Basin in Utah for approximately $2,400,000 as adjusted for the
exercise of the right of a third party to purchase 25% of such
interests at the acquisition cost during May 2004.
- The Company's planned expenditures of approximately $12,425,000 for
the drilling, completion and pipeline connection of wells in this
area.
- The completion of a gathering system within the Riverbend Area at an
estimated cost of approximately $1,200,000.
Management believes it has sufficient capital for the remainder of its 2004
operational budget. As a result of the Company's fund raising efforts during
October, management has decided to search for a third drilling rig for its Utah
operations.
Schedule of Contractual Obligations
The following table summarizes the Company's obligations and commitments to make
future payments under its note payable, operating leases, employment contracts
and consulting agreement for the periods specified as of September 30, 2004.
22
Payments due by Period
Contractual Obligations Total 1 year 2-3 years 4-5 years After 5 years
Convertible Debentures $2,500,000 $ - $ 525,000 $ 1,975,000 $ -
Interest on Convertible
Debentures 800,167 200,000 373,750 226,417 -
Operating Lease - office
Space 40,953 40,953 - - -
Employment Contracts 626,667 470,000 156,667 - -
Consulting Agreement 160,000 120,000 40,000 - -
-------- --------- ---------- ----------- --------
Total Contractual Cash
Obligations $4,127,787 $ 830,953 $1,095,417 $ 2,201,417 $ -
========== ========= ========== =========== =======
The Debentures in the table above were converted into 4,166,665 shares of common
stock during October 2004.
The Company has not included asset retirement obligations as discussed in Note 2
of the accompanying financial statements, as the Company cannot determine with
accuracy the timing of such payments.
Critical Accounting Policies and Estimates
The preparation of the Company's consolidated financial statements in conformity
with generally accepted accounting principles in the United States requires
management to make assumptions and estimates that affect the reported amounts of
assets, liabilities, revenues and expenses as well as the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. The
following is a summary of the significant accounting policies and related
estimates that affect the Company's financial disclosures.
Oil and Gas Reserves
Gasco follows the full cost method of accounting whereby all costs related to
the acquisition and development of oil and gas properties are capitalized into a
single cost center referred to as a full cost pool. Depletion of exploration and
development costs and depreciation of production equipment is computed using the
units of production method based upon estimated proved oil and gas reserves.
Under the full cost method of accounting, capitalized oil and gas property costs
less accumulated depletion and net of deferred income taxes may not exceed an
amount equal to the present value, discounted at 10%, of estimated future net
revenues from proved oil and gas reserves plus the cost, or estimated fair value
if lower, of unproved properties. Should capitalized costs exceed this ceiling,
an impairment is recognized.
Estimated reserve quantities and future net cash flows have the most significant
impact on the Company because these reserve estimates are used in providing a
measure of the Company's overall value. These estimates are also used in the
quarterly calculations of depletion, depreciation and impairment of the
Company's proved properties.
23
Estimating accumulations of gas and oil is complex and is not exact because of
the numerous uncertainties inherent in the process. The process relies on
interpretations of available geological, geophysical, engineering and production
data. The extent, quality and reliability of this technical data can vary. The
process also requires certain economic assumptions, some of which are mandated
by the Securities and Exchange Commission ("SEC"), such as gas and oil prices,
drilling and operating expenses, capital expenditures, taxes and availability of
funds. The accuracy of a reserve estimate is a function of the quality and
quantity of available data; the interpretation of that data; the accuracy of
various mandated economic assumptions; and the judgment of the persons preparing
the estimate.
The most accurate method of determining proved reserve estimates is based upon a
decline analysis method, which consists of extrapolating future reservoir
pressure and production from historical pressure decline and production data.
The accuracy of the decline analysis method generally increases with the length
of the production history. Since most of the Company's wells have been producing
less than two years, their production history is relatively short, so other
(generally less accurate) methods such as volumetric analysis and analogy to the
production history of wells of other operators in the same reservoir were used
in conjunction with the decline analysis method to determine the Company's
estimates of proved reserves. As the Company's wells are produced over time and
more data is available, the estimated proved reserves will be redetermined on an
annual basis and may be adjusted based on that data.
Actual future production, gas and oil prices, revenues, taxes, development
expenditures, operating expenses and quantities of recoverable gas and oil
reserves most likely will vary from the Company's estimates. Any significant
variance could materially affect the quantities and present value of the
Company's reserves. In addition, the Company may adjust estimates of proved
reserves to reflect production history, results of exploration and development
and prevailing gas and oil prices. The Company's reserves may also be
susceptible to drainage by operators on adjacent properties.
Revenue Recognition
The Company's revenue is derived from the sale of oil and gas production from
its producing wells. This revenue is recognized as income when the production is
produced and sold. The Company typically receives its payment for production
sold one to three months subsequent to the month the production is sold. For
this reason, the Company must estimate the revenue that has been earned but not
yet received by the Company as of the reporting date. The Company uses actual
production reports to estimate the quantities sold and the Questar Rocky
Mountain spot price less marketing and transportation adjustments to estimate
the price of the production. Variances between our estimates and the actual
amounts received are recorded in the month the payment is received.
Stock Based Compensation
The Company accounts for its stock-based compensation using the intrinsic value
recognition and measurement principles detailed in Accounting Principles Board's
Opinion No. 25 ("APB No. 25"). No stock-based compensation expense has been
24
reflected in the Company's financial statements for the options granted to its
employees as these options had exercise prices equal to or higher than the
market value of the underlying common stock on the date of grant. The Company
uses the Black-Scholes option valuation model to calculate the required
disclosures under SFAS 123. This model requires the Company to estimate a risk
free interest rate and the volatility of the Company's common stock price. The
use of a different estimate for any one of these components could have a
material impact on the amount of calculated compensation expense.
Results of Operations
The following table presents information regarding the production volumes,
average sales prices received and average production costs associated with the
Company's sales of natural gas for the periods indicated. The Mcfe calculations
assume a conversion of 6 Mcf for each Bbl of oil.
For the Nine
For the Three Months Months Ended
Ended September 30, September 30,
2004 2003 2004 2003
Natural gas production (Mcf) 129,605 59,028 379,107 199,645
Average sales price per Mcf $ 5.84 $ 4.30 $ 5.78 $4.44
Oil production (Bbl) 1,427 802 4,212 1,750
Average sales price per Bbl $ 42.22 $ 27.52 $ 37.07 $ 28.35
Production (Mcfe) 138,167 63,840 404,379 210,145
Expenses per Mcfe:
Lease operating $ 1.30 $ 1.63 $ 1.47 $ 1.34
Depletion and impairment $ 2.05 $ 1.96 $ 1.94 $ 1.90
The Third Quarter of 2004 compared to the Third Quarter of 2003
Oil and gas revenue increased $540,224 during the third quarter of 2004 compared
with the third quarter of 2003 due to an increase in gas production of 70,577
Mcf and an increase in oil production of 625 bbls during the third quarter of
2004 combined with an increase in the average gas and oil prices of $1.54 per
Mcf and $14.70 per bbl during the third quarter of 2004. The increase in
production is primarily due to the Company's drilling, completion and
recompletion activity during 2003 and 2004, the compressor installation during
February 2003 and the acquisition of additional working interests in six wells
in March 2004.
Interest income increased $39,663 from 2003 to 2004 primarily due to higher
average cash and cash equivalent balances during 2004 relating primarily to the
Company's stock offering during February 2004.
General and administrative expense increased by $185,502 during 2004 as compared
with 2003, primarily due to the Company's increased operational activity. The
increase in these expenses is comprised of approximately $55,000 in legal and
consulting fees associated with the Company's property and financing
transactions during the first nine months of 2004, $108,000 in stock based
compensation primarily related to the Company's restricted stock issuance and
25
the issuance of stock options to consultants, and approximately $22,000 in costs
related to increased shareholder communications relating to the Company's
expanded operational activity. The remaining increase in general and
administrative expenses is due to the fluctuation in numerous other expenses,
none of which are individually significant.
Lease operating expense increased by $75,157, during the third quarter of 2004,
primarily due to increased operating costs and production taxes relating to the
increased production discussed above.
Depletion, depreciation and amortization expense during 2004 is comprised of
$263,000 of depletion expense related to the Company's proved oil and gas
properties, $15,735 of depreciation expense related to the Company's furniture,
fixtures and other assets and $4,787 of accretion expense related the Company's
asset retirement obligation. The corresponding expense during 2003 consists of
$108,000 of depletion expense, $13,596 of depreciation expense and $3,352 of
accretion expense. The increase in depletion expense during 2004 as compared
with 2003 is due primarily to the increase in production resulting from the
Company's increased drilling and completion activity as well as the property
acquisition discussed above.
Interest expense during 2004 consists of $68,509 of interest expense related to
the Company's outstanding Debentures. The interest expense during 2003 consists
of the interest incurred on an outstanding note payable that was repaid during
February 2004.
The Nine Months Ended September 30, 2004 Compared to the Nine Months Ended
September 30, 2003
The comparisons for the nine months ended September 30, 2004 and the nine months
ended September 30, 2003 are consistent with those discussed in the third
quarter of 2004 compared to the third quarter of 2003 except as discussed below.
Interest expense during 2004 consists of $203,070 of interest expense related to
the Company's outstanding Debentures and $25,746 of interest expense related to
the Company's litigation settlement described in Note 10 of the accompanying
financial statements. The interest expense during 2003 represents the interest
incurred on the Company's outstanding note payable, which was repaid during
February 2003.
The cumulative effect of change in accounting principle during 2003 represents
the Company's recognition of an asset retirement obligation in connection with
the adoption of SFAS 143 on January 1, 2003.
Recent Accounting Pronouncements
During March 2004, the Emerging Issues Task Force ("EITF") determined that
mineral rights as defined in EITF Issue No. 04-2, "Whether Mineral Rights are
Tangible or Intangible Assets," are tangible assets and should not be considered
intangible assets in Statement of Financial Accounting Standards No. 141
"Business Combinations" (SFAS 141) and Statement of Financial Accounting
Standards No. 142, "Goodwill and Intangible Assets" (SFAS 142). The Financial
Accounting Standards Board (FASB), in agreement with this determination, amended
26
SFAS Nos. 141 and 142 through the issuance of FASB Staff Position ("FSP) FSP
Nos. 141-1 and 142-1. In addition, the proposed FSP 142-b confirms that FAS 142
did not change the balance sheet classification or disclosures of mineral rights
of oil and gas producing entities. The Company has historically classified its
oil and gas leaseholds as tangible oil and gas properties which is consistent
with EITF 04-02, FSP Nos. 141-1 and 142-1 and therefore such pronouncements have
not impacted the Company's financial condition or results of operations.
In March 2004, the FASB issued consensus on EITF 03-6, "Participating Securities
and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share,"
related to calculating earnings per share with respect to using the two-class
method for participating securities. This pronouncement is effective for all
periods after March 31, 2004, and requires prior periods to be restated. As, the
Company has incurred net losses in the current and prior periods, and as the
Company's preferred stock does not have a contractual obligation to share in the
losses of the Company, the adoption of EITF 03-6 had no impact on the Company's
financial condition, or its results of operations.
Cautionary Statement Regarding Forward-Looking Statements
In the interest of providing the stockholders with certain information regarding
the Company's future plans and operations, certain statements set forth in this
Form 10-Q relate to management's future plans and objectives. Such statements
are forward-looking statements within the meanings of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. All statements other than statements of historical
facts included in this report, including, without limitation, statements
regarding the Company's future financial position, business strategy, budgets,
projected costs and plans and objectives of management for future operations,
are forward-looking statements. In addition, forward-looking statements
generally can be identified by the use of forward-looking terminology such as
"may," "will," "expect," "intend," "project," "estimate," "anticipate,"
"believe," or "continue" or the negative thereof or similar terminology.
Although any forward-looking statements contained in this Form 10-Q or otherwise
expressed by or on behalf of the Company are, to the knowledge and in the
judgment of the officers and directors of the Company, believed to be
reasonable, there can be no assurances that any of these expectations will prove
correct or that any of the actions that are planned will be taken.
Forward-looking statements involve known and unknown risks and uncertainties
which may cause the Company's actual performance and financial results in future
periods to differ materially from any projection, estimate or forecasted result.
Important factors that could cause actual results to differ materially from the
Company expectations ("Cautionary Statements") include those discussed under the
caption "Risk Factors", in the Company's Form 10-K for the year ended December
31, 2003. All subsequent written and oral forward-looking statements
attributable to the Company, or persons acting on its behalf, are expressly
qualified in their entirety by the Cautionary Statements. The Company assumes no
duty to update or revise its forward-looking statements based on changes in
internal estimates or expectations or otherwise.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk relates to changes in the pricing applicable
to the sales of gas production in the Uinta Basin of northeastern Utah and the
27
Greater Green River Basin of west central Wyoming. This risk will become more
significant to the Company as more wells are drilled and begin producing in
these areas. Although the Company is not using derivatives at this time to
mitigate the risk of adverse changes in commodity prices, it may consider using
them in the future.
ITEM 4 - CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the Company has evaluated,
under the supervision and with the participation of the Company's management,
including the Company's Chief Executive Officer and Chief Financial Officer, the
effectiveness of the design and operation of the Company's disclosure controls
and procedures as defined in Exchange Act Rule 13a-15(e). Based upon that
evaluation, the Company's Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures are effective.
Disclosure controls and procedures are controls and procedures that are designed
to ensure that information required to be disclosed in Company reports filed or
submitted under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commission's
rules and forms.
There has been no change in the Company's internal control over financial
reporting identified in the above evaluation that occurred during the Company's
last fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
28
PART II OTHER INFORMATION
Item 1 - Legal Proceedings
See Note 10 to the accompanying financial statements.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3 - Defaults Upon Senior Securities
None.
Item 4 - Submission of Matters to a Vote of Security Holders
None.
Item 5 - Other Information
None.
Item 6 - Exhibits
Exhibit Number Exhibit
2.1 Purchase and Sale Agreement between ConocoPhillips and the
Company relating to the Riverbend Field, Uintah and Duchesne
Counties, Utah, Effective January 1, 2004 (incorporated by
reference to Exhibit 2.1 to the Company's Current Report on Form
8-K dated March 9, 2004, filed on March 15, 2004).
2.2 Net Profits Purchase Agreement between Gasco Production Company,
Red Oak Capital Management, LLC, MBG, LLC and MBGV Partition,
LLC, dated August 6, 2004 (incorporated by reference to Exhibit
2.1 of the Company's Current Report on Form 8-K filed September
7, 2004).
2.3 Purchase Supplement to Net Profits Purchase Agreement between
Gasco Production Company, Red Oak Capital Management, LLC, MBG,
LLC and MBGV Partition, LLC, dated August 20, 2004 (incorporated
by reference to Exhibit 2.2 of the Company's Current Report on
Form 8-K filed September 7, 2004.
29
3.1 Amended and Restated Articles of Incorporation (incorporated by
reference to Exhibit 3.1 to the Company's Form 8-K dated December
31, 1999, filed on January 21, 2000).
3.2 Certificate of Amendment to Articles of Incorporation
(incorporated by reference to Exhibit 3.1 to the Company's Form
8-K/A dated January 31, 2001, filed on February 16, 2001).
3.3 Amended and Restated Bylaws (incorporated by reference to Exhibit
3.4 to the Company's Form 10-Q for the quarter ended March 31,
2002, filed on May 15, 2002).
3.4 Certificate of Designation for Series B Preferred Stock
(incorporated by reference to Exhibit 3.5 to the Company's Form
S-1 Registration Statement, File No. 333-104592).
4.1 Form of Subscription and Registration Rights Agreement, dated as
of August 14, 2002 between the Company and certain investors
Purchasing Common Stock in August 2002. (Filed as Exhibit 10.21
to the Company's Form S-1 Registration Statement dated November
15, 2002, filed on November 15, 2002).
4.2 Form of Gasco Energy, Inc. 8.00% Convertible Debenture, dated
October 15, 2003 between each of The Frost National Bank,
Custodian FBO Renaissance US Growth & Investment Trust PLC Trust
No. W00740100, HSBC Global Custody Nominee (U.K.) Limited
Designation No. 896414 and The Frost National Bank, Custodian FBO
Renaissance Capital Growth & Income Fund III, Inc. Trust No.
W00740000 (incorporated by reference to Exhibit 4.6 to the
Company's Form 10-Q for the quarter ended September 30, 2003,
filed on November 10, 2003).
4.3 Deed of Trust and Security Agreement, dated October 15, 2003
between Pannonian and BFSUS Special Opportunities Trust PLC,
Renaissance Capital Growth & Income Fund III, Inc. and
Renaissance US Growth & Income Trust PLC (incorporated by
reference to Exhibit 4.7 to the Company's Form 10-Q for the
quarter ended September 30, 2003, filed on November 10, 2003).
4.4 Subsidiary Guaranty Agreement, dated October 15, 2003 between
Pannonian and Renn Capital Group, Inc (incorporated by reference
to Exhibit 4.8 to the Company's Form 10-Q for the quarter ended
September 30, 2003, filed on November 10, 2003).
4.5 Subsidiary Guaranty Agreement, dated October 15, 2003 between San
Joaquin Oil and Gas, Ltd. And Renn Capital Group, Inc
(incorporated by reference to Exhibit 4.9 to the Company's Form
10-Q for the quarter ended September 30, 2003, filed on November
10, 2003).
30
4.6 Form of Subscription and Registration Rights Agreement between
the Company and investors purchasing Common Stock in October 2003
(incorporated by reference to Exhibit 4.10 to the Company's Form
10-Q for the quarter ended September 30, 2003, filed on November
10, 2003).
4.7 Form of Subscription and Registration Rights Agreement between
the Company and investors purchasing Common Stock in February,
2004 (incorporated by reference to Exhibit 4.7 to the Company's
Form 10-K for the year ended December 31, 2003, filed on March
26, 2004.
4.8 Indenture dated as of October 20, 2004, between Gasco Energy,
Inc. and Wells Fargo Bank, National Association, as Trustee
(incorporated by reference to Exhibit 4.1 to the Company's
Current Report on Form 8-K filed on October 20, 2004).
4.9 Form of Global Note representing $65 million principal amount of
5.5% Convertible Senior Notes due 2011 (incorporated by reference
to Exhibit A to Exhibit 4.1 to the Company's Current Report on
Form 8-K filed on October 20, 2004).
*4.10Registration Rights Agreement dated October 20, 2004, among
Gasco Energy, Inc., J.P. Morgan Securities Inc. and First Albany
Capital Inc.
*31 Rule 13a-14(a)/15d-14(a) Certifications.
*32 Section 1350 Certifications
* Filed herewith.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
GASCO ENERGY, INC.
Date: November 12, 2004 By: /s/ W. King Grant
-----------------------------------------
W. King Grant, Executive Vice President
Principal Financial and Accounting Officer
32
INDEX TO EXHIBITS
Exhibit Number Exhibit
2.1 Purchase and Sale Agreement between ConocoPhillips and the
Company relating to the Riverbend Field, Uintah and Duchesne
Counties, Utah, Effective January 1, 2004 (incorporated by
reference to Exhibit 2.1 to the Company's Current Report on Form
8-K dated March 9, 2004, filed on March 15, 2004).
2.2 Net Profits Purchase Agreement between Gasco Production Company,
Red Oak Capital Management, LLC, MBG, LLC and MBGV Partition,
LLC, dated August 6, 2004 (incorporated by reference to Exhibit
2.1 of the Company's Current Report on Form 8-K filed September
7, 2004).
2.3 Purchase Supplement to Net Profits Purchase Agreement between
Gasco Production Company, Red Oak Capital Management, LLC, MBG,
LLC and MBGV Partition, LLC, dated August 20, 2004 (incorporated
by reference to Exhibit 2.2 of the Company's Current Report on
Form 8-K filed September 7, 2004.
3.1 Amended and Restated Articles of Incorporation (incorporated by
reference to Exhibit 3.1 to the Company's Form 8-K dated December
31, 1999, filed on January 21, 2000).
3.2 Certificate of Amendment to Articles of Incorporation
(incorporated by reference to Exhibit 3.1 to the Company's Form
8-K/A dated January 31, 2001, filed on February 16, 2001).
3.3 Amended and Restated Bylaws (incorporated by reference to Exhibit
3.4 to the Company's Form 10-Q for the quarter ended March 31,
2002, filed on May 15, 2002).
3.4 Certificate of Designation for Series B Preferred Stock
(incorporated by reference to Exhibit 3.5 to the Company's Form
S-1 Registration Statement, File No. 333-104592).
4.1 Form of Subscription and Registration Rights Agreement, dated as
of August 14, 2002 between the Company and certain investors
Purchasing Common Stock in August 2002. (Filed as Exhibit 10.21
to the Company's Form S-1 Registration Statement dated November
15, 2002, filed on November 15, 2002).
4.2 Form of Gasco Energy, Inc. 8.00% Convertible Debenture, dated
October 15, 2003 between each of The Frost National Bank,
Custodian FBO Renaissance US Growth & Investment Trust PLC Trust
No. W00740100, HSBC Global Custody Nominee (U.K.) Limited
Designation No. 896414 and The Frost National Bank, Custodian FBO
Renaissance Capital Growth & Income Fund III, Inc. Trust No.
W00740000 (incorporated by reference to Exhibit 4.6 to the
Company's Form 10-Q for the quarter ended September 30, 2003,
filed on November 10, 2003).
4.3 Deed of Trust and Security Agreement, dated October 15, 2003
between Pannonian and BFSUS Special Opportunities Trust PLC,
Renaissance Capital Growth & Income Fund III, Inc. and
Renaissance US Growth & Income Trust PLC (incorporated by
reference to Exhibit 4.7 to the Company's Form 10-Q for the
quarter ended September 30, 2003, filed on November 10, 2003).
4.4 Subsidiary Guaranty Agreement, dated October 15, 2003 between
Pannonian and Renn Capital Group, Inc (incorporated by reference
to Exhibit 4.8 to the Company's Form 10-Q for the quarter ended
September 30, 2003, filed on November 10, 2003).
4.5 Subsidiary Guaranty Agreement, dated October 15, 2003 between San
Joaquin Oil and Gas, Ltd. And Renn Capital Group, Inc
(incorporated by reference to Exhibit 4.9 to the Company's Form
10-Q for the quarter ended September 30, 2003, filed on November
10, 2003).
4.6 Form of Subscription and Registration Rights Agreement between
the Company and investors purchasing Common Stock in October 2003
(incorporated by reference to Exhibit 4.10 to the Company's Form
10-Q for the quarter ended September 30, 2003, filed on November
10, 2003).
4.7 Form of Subscription and Registration Rights Agreement between
the Company and investors purchasing Common Stock in February,
2004 (incorporated by reference to Exhibit 4.7 to the Company's
Form 10-K for the year ended December 31, 2003, filed on March
26, 2004.
4.8 Indenture dated as of October 20, 2004, between Gasco Energy,
Inc. and Wells Fargo Bank, National Association, as Trustee
(incorporated by reference to Exhibit 4.1 to the Company's
Current Report on Form 8-K filed on October 20, 2004).
4.9 Form of Global Note representing $65 million principal amount of
5.5% Convertible Senior Notes due 2011 (incorporated by reference
to Exhibit A to Exhibit 4.1 to the Company's Current Report on
Form 8-K filed on October 20, 2004).
*4.10Registration Rights Agreement dated October 20, 2004, among
Gasco Energy, Inc., J.P. Morgan Securities Inc. and First Albany
Capital Inc.
*31 Rule 13a-14(a)/15d-14(a) Certifications.
*32 Section 1350 Certifications
* Filed herewith.