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 June 30, 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.
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(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
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Address of Principal Executive Offices, Including Zip Code
(620) 431-6200
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(Issuer's Telephone Number, Including Area Code)
N/A
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(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
August 13, 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 Income (Loss)................. 6
Consolidated Statement of Changes in Stockholders' Equity.............. 7
Consolidated Statements of Cash Flows.................................. 8
Notes to Unaudited Consolidated Financial Statements................... 10
Item 2. Management's Discussion and Analysis of Financial
Conditions and Results of Operations.......................... 16
Critical Accounting Policies........................................... 27
Item 3. Quantitative and Qualitative Disclosures about Market Risk............. 28
Item 4. Controls and Procedures................................................ 29
Part II: Other Information
Item 1. Legal Proceedings...................................................... 29
Item 2. Changes in Securities and Use of Proceeds.............................. 29
Item 3. Defaults Upon Senior Securities........................................ 29
Item 4. Submission of Matters to a Vote of Security Holders.................... 29
Item 5. Other Information...................................................... 30
Item 6. Exhibits and Reports on Form 8-K....................................... 30
Signatures...................................................................... 31
Exhibits ....................................................................... 32
2
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
June 30, 2004 Dec. 31, 2003
------------ ------------
Current assets (unaudited)
Cash and cash equivalents $ 582,910 $ 727,134
Accounts receivable, less allowance for doubtful
accounts of $82,683 (2004) and $80,000 (2003) 2,625,440 1,766,642
Current portion of note receivable 1,589,054 16,311
Inventories 366,500 351,197
Prepaid expenses and other 273,012 206,314
Derivative asset -- 97,624
------------ ------------
Total current assets 5,436,916 3,165,222
Property and equipment, at cost, less accumulated depreciation 10,525,548 10,169,159
Oil and gas properties, using full cost accounting net
of accumulated depreciation, depletion, amortization
and ceiling write-down
Subject to amortization 28,140,346 23,446,343
Not subject to amortization 10,520,324 12,815,834
Intangible assets, at cost, less accumulated amortization 2,448,129 3,952,989
Note receivable, less current portion -- 1,580,742
Other assets, net 446,492 135,989
------------ ------------
Total assets $ 57,517,755 $ 55,266,278
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Notes payable $ 250,227 $ --
Note payable - related party 20,000 --
Current portion of long-term debt 1,189,289 1,762,777
Current portion of note payable - related party 1,750,000 --
Accounts payable 2,425,146 2,645,277
Accrued expenses 1,701,849 966,769
------------ ------------
Total current liabilities 7,336,511 5,374,823
Long-term liabilities
Production taxes payable 224,654 229,889
Asset retirement obligations 549,655 520,638
Long-term debt, less current portion 10,560,617 9,252,872
8% subordinated convertible notes payable 2,663,000 2,793,000
7% subordinated convertible notes payable 11,575,000 11,184,000
Note payable - related party -- 3,000,000
------------ ------------
Total liabilities 32,909,437 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 37,382,562 32,720,904
Accumulated other comprehensive income -- 97,624
Accumulated deficit (12,775,184) (9,908,292)
------------ ------------
Total stockholders' equity 24,608,318 22,911,056
------------ ------------
Total liabilities and stockholders' equity $ 57,517,755 $ 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 June 30,
2004 2003
----------- -----------
Revenues
Oil and gas service operations $ 3,343,906 $ 3,006,653
Oil and gas sales 1,701,554 1,995,954
----------- -----------
Total revenues 5,045,460 5,002,607
Cost of revenues
Oil and gas service operations 1,857,114 1,527,209
Oil and gas production expenses 474,861 552,640
Oil and gas production taxes 195,238 216,666
----------- -----------
Total cost of revenue 2,527,213 2,296,515
----------- -----------
Gross profit 2,518,247 2,706,092
Operating expenses 1,564,074 1,666,247
Depreciation, depletion and amortization 1,314,688 544,071
----------- -----------
Operating income (loss) (360,515) 495,774
----------- -----------
Other (expense) income
Interest and other income 38,157 37,976
Amortization of loan costs (430,692) (457,930)
Interest expense and finance charges (310,478) (296,318)
Loss on sales of assets (38,679) (3,694)
----------- -----------
Total other expense (741,692) (719,966)
----------- -----------
Net loss before income taxes (1,102,207) (224,192)
Income tax benefit -- --
----------- -----------
Net loss $(1,102,207) $ (224,192)
----------- -----------
Basic and diluted net loss per common share $ (0.12) $ (0.03)
----------- -----------
Weighted average basic
and diluted shares outstanding 9,396,091 8,061,396
See Notes to Unaudited Consolidated Financial Statements
4
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Six Months Ended June 30,
2004 2003
----------- -----------
Revenues
Oil and gas service operations $ 5,539,630 $ 4,873,960
Oil and gas sales 3,072,852 3,734,090
----------- -----------
Total revenues 8,612,482 8,608,050
Cost of revenues
Oil and gas service operations 3,277,666 2,732,156
Oil and gas production expenses 837,585 1,293,280
Oil and gas production taxes 351,212 426,349
----------- -----------
Total cost of revenue 4,466,463 4,451,785
----------- -----------
Gross profit 4,146,019 4,156,265
Operating expenses 2,826,150 2,768,480
Depreciation, depletion and amortization 2,361,828 1,079,527
----------- -----------
Operating income (loss) (1,041,959) 308,258
----------- -----------
Other (expense) income
Interest and other income 77,032 78,776
Amortization of loan costs (1,274,097) (644,124)
Interest expense and finance charges (589,214) (582,430)
Loss on sales of assets (38,654) (3,694)
----------- -----------
Total other expense (1,824,933) (1,154,472)
----------- -----------
Net loss before income taxes (2,866,892) (846,214)
Income tax benefit -- --
----------- -----------
Net loss $(2,866,892) $ (846,214)
----------- -----------
Basic and diluted net loss per common share $ (0.31) $ (0.11)
----------- -----------
Weighted average basic
and diluted shares outstanding 9,295,798 7,907,466
See Notes to Unaudited Consolidated Financial Statements
5
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
Three Months Six Months
Ended June 30 Ended June 30
-------------------------- --------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Net loss $(1,102,207) $ (224,192) $(2,866,892) $ (846,214)
Other comprehensive income:
Unrealized loss on forward sales
contract, net of deferred tax expense
of $75,426 for the three months ended
6/30/2003: -- 888,976 -- 768,492
Reclassifications, net of deferred
benefit of $57,559 for the three
months ended 6/30/2003: -- (91,944) 97,624 --
----------- ----------- ----------- -----------
Total other comprehensive income (loss) -- 797,032 97,624 768,492
----------- ----------- ----------- -----------
Comprehensive income (loss) $(1,102,207) $ 572,840 $(2,769,268) $ (77,722)
=========== =========== =========== ===========
See Notes to Unaudited Consolidated Financial Statements
6
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
$30,258 of deferred offering costs 1,000,000 100 3,969,642 -- -- 3,969,742
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 -- -- -- -- (2,866,892) (2,866,892)
------------ ------------ ------------ ------------ ------------ ------------
Balance, June 30, 2004 9,396,091 $ 940 $ 37,382,562 $ -- $(12,775,184) $ 24,608,318
============ ============ ============ ============ ============ ============
See notes to Unaudited Consolidated Financial Statements
7
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended June 30,
2004 2003
----------- -----------
Cash flows from operating activities
Net loss $(2,866,892) $ (846,214)
Adjustments to reconcile net loss to net cash
provided by operating activities
Depreciation, depletion and amortization 2,361,828 1,079,527
Amortization of loan costs included in
interest expense 1,274,097 644,124
Loss on sale of assets 38,654 3,694
(Increase) decrease in operating assets
Accounts receivable (858,798) (1,060,144)
Inventories (15,303) 17,192
Prepaid expenses (66,698) 104,718
Increase (decrease) in operating liabilities
Accounts payable (50,600) 281,662
Accrued expenses 1,052,698 578,561
----------- -----------
Net cash provided by operating activities 868,986 803,120
----------- -----------
Cash flows from investing activities
Proceeds from sale of property and equipment 159,479 42,911
Investment in oil and gas properties (3,670,809) (2,908,614)
Investment in other assets and intangibles (322,503) (335,001)
Purchase of property and equipment (1,177,139) (139,759)
Payments on note receivable 7,999 7,407
----------- -----------
Net cash used in investing activities (5,002,973) (3,333,056)
----------- -----------
Cash flows from financing activities
Proceeds from notes payable 295,000 2,263,381
Proceeds from borrowings on long-term debt 2,863,997 853,714
Proceeds from issuance of common stock 4,060,000 815,819
Equity issuance costs (30,258) --
Repayment of notes payable (194,304) --
Repayment of debt (3,004,672) (1,504,990)
----------- -----------
Net cash provided by financing activities 3,989,763 2,427,924
----------- -----------
Net decrease in cash and cash equivalents (144,224) (102,012)
Cash and cash equivalents, beginning of period 727,134 867,017
----------- -----------
Cash and cash equivalents, end of period $ 582,910 $ 765,005
=========== ===========
See Notes to Unaudited Consolidated Financial Statements
8
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended June 30,
2004 2003
-------- --------
Supplemental cash flow disclosures:
Cash paid for interest, net of
amounts capitalized $ 587,520 $ 572,832
Non-cash transactions:
Amortization of loan costs included in oil and gas properties 240,768 2,714,974
Change in accumulated other comprehensive income,
net of income taxes in 2003 97,624 768,492
Property and equipment acquired through
seller financed debt, net 195,115 967,975
Stock-based compensation for options issued with
bridge loans recorded as loan costs -- 4,543,329
Conversion of subordinated debt and accrued
interest to common stock 132,036 3,096,952
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 --
Issuance of 7% Convertible Subordinated Notes in
lieu of cash interest payment 391,000 --
See Notes to Unaudited Consolidated Financial Statements
9
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 is herein
incorporated by reference from 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
and six-month periods ended June 30, 2004 are not necessarily indicative of the
results that may be expected for the year ended December 31, 2004. The
accompanying unaudited 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 inter-company accounts and transactions have
been eliminated in consolidation.
Subsequent to June 30, 2004, Infinity, Inc. formed a new wholly owned
subsidiary, Infinity Oil and Gas of Texas, Inc. ("Infinity-Texas") to acquire
and develop oil and gas properties in Texas. This subsidiary is a Delaware
corporation with its headquarters located in Denver, Colorado.
(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 six months ended June
30, 2004, Infinity had a consolidated net loss of approximately $2.9 million,
and a working capital deficit at June 30, 2004 of approximately $1.9 million
compared to a working capital deficit of approximately $2.2 million at December
31, 2003.
Infinity also has capital expenditure obligations through the period
ending June 30, 2005 of:
o approximately $0.6 million under the initial completion phase of a
development contract for its Labarge project;
o approximately $0.3 million for the Labarge environmental impact
study and Pipeline environmental assessment and $0.1 million for
lease rental payments;
10
o approximately $0.3 million to complete two Pipeline wells drilled in
June and July in which Infinity-Wyoming owns a 50% working interest;
o approximately $1.5 million to acquire an interest in 28,400 (21,800
net) acres of oil and gas leases in the Fort Worth Basin of Texas.
This acquisition, which closed in July 2004, was funded with
proceeds from an amended loan agreement with LaSalle Bank, N. A.
(LaSalle Bank") as discussed below. The purchase agreement also
requires Infinity to drill four wells prior to July 14, 2005, which
management estimates will cost approximately $2.1 million, and
complete such wells prior to September 13, 2005.
o approximately $0.3 million for interest on notes (net of the
anticipated issuance of notes in lieu of cash payments), and;
approximately $2.0 million for general corporate usage;
o Approximately $2.2 million for the payment of long term debt in
July, 2004 When Consolidated refinanced its debt with LaSalle Bank.
Thus, in total, Infinity has current minimum cash requirements of
approximately $11.3 million including the working capital deficit at June 30,
2004.
Subsequent to June 30, 2004 the credit facility with LaSalle Bank was
amended to increase the size of the term loan note to $5.4 million, consolidate
approximately $0.9 million in additional outstanding debt, extend the term of
the facility until December 31, 2007, reduce restrictions on the distribution of
funds to Infinity, Inc and provide working capital to Infinity.
Consolidated borrowed approximately $5.4 million from LaSalle Bank under
the term loan note of which:
o approximately $3.0 million was utilized to pay existing debt,
including the existing term loan under the LaSalle Bank facility;
o approximately $1.5 million funded the acquisition of the oil and gas
leases in the Fort Worth Basin;
o approximately $0.7 million was used to pay outstanding payables,
and;
o approximately $0.2 million will be used for capital additions by
Consolidated.
The current portion of long-term debt at June 30, 2004 reflects $0.8
million of current debt under payment terms of the amendment for the $3.0
million of existing debt that was paid with the proceeds from the borrowings.
The credit facilities with LaSalle Bank and US Bank limit the amount of funds
that can be distributed to Infinity, Inc. These limitations could affect the
timing and amount of corporate expenditures.
Management believes it will be able to fund approximately $6.8 million of
its current minimum cash requirements from cash generated by its operations
during the remainder of 2004 and the first half of 2005. However, the timing of
the receipt of cash from operations is not expected to match the timing of cash
requirements so as to allow 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, and any
other capital expenditures, in a timely manner, Infinity will be required to
pursue additional funding through potential short-term borrowings, conventional
bank financing, the forward sale of its oil and gas production, the sale of
assets, 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.
11
At December 31, 2003, Infinity reduced proved reserves and recorded a $2.8
million ceiling write-down on its oil and gas properties. Future proved 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 credit facilities, which could result in
accelerated payment of those obligations.
(3) Acquisitions
Effective April 20, 2004, Consolidated acquired substantially all of the
assets and liabilities of Blue Star Acid Services, Inc. ("Blue Star"), a
provider of acid and cementing services in eastern and central Kansas and
north-central Oklahoma, for $1.2 million in cash and the assumption of $0.2
million in liabilities. The acquisition was funded with $1.3 million of current
debt through an amendment of Consolidated's facility with LaSalle Bank. The
following table summarizes the allocation of the purchase price based on the
estimated fair values of the assets acquired and the liabilities assumed at the
date of acquisition.
At April 20, 2004
Current assets $ 223,000
Property, plant and equipment 1,172,000
---------
Total assets acquired 1,395,000
Current liabilities (70,000)
Long-term debt (125,000)
---------
Total liabilities assumed (195,000)
---------
Net assets acquired $ 1,200,000
===========
The operations of Blue Star are included in Infinity's consolidated
statement of operations effective April 20, 2004. Consolidated has entered into
a month-to-month lease for Blue Star's former office and facilities with one of
the former owners of Blue Star who is currently an employee of Consolidated. The
Audit Committee of Infinity has approved this month-to-month lease agreement
with the related party. Consolidated is currently negotiating a long-term lease
on the facility which will require Audit Committee approval prior to execution.
(4) 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.
From inception through June 30, 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:
12
Six Months
Ended Cumulative
June 30, 2004 to Date
---------- ----------
Beneficial conversion feature related to the 8%
subordinated convertible notes -- $1,165,500
Capitalized interest 281,704 $2,342,634
Capitalized amortization of loan costs 240,768 $3,095,844
---------- ----------
522,472 $6,603,978
========== ==========
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
June 30, 2004, Infinity would have recognized a $1.0 million ceiling write-down
based on a gas price of approximately $5.63 per thousand cubic feet ("Mcf") and
an oil price of approximately $38.74 per barrel of oil ("Bbl") in effect at that
date. However, due to subsequent significant increases in gas and oil sales
prices to approximately $5.91 per Mcf and $44.52 per Bbl at the August 10, 2004
measurement date, Infinity was not required to recognize a ceiling write-down
during the six months ended June 30, 2004. A decrease in oil or gas prices, 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 proved reserves could result in a ceiling write-down
during future periods.
Depreciation and depletion of proved oil and gas properties is computed on
the units-of-production method based upon estimates of proved reserves with oil
and gas being converted to a common unit of measure based on 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.
(5) Note Payable - Related Party
The president and chief executive officer of Infinity loaned $20,000 to
Infinity for general corporate purposes on June 11, 2004. The note accrues
interest at six percent (6%) per annum and is due 90 days from inception. The
transaction was reviewed and approved by the Audit Committee.
(6) Long-Term Debt
Effective June 13, 2001, Infinity, Inc. sold $6,475,000 in 8% Subordinated
Convertible Notes in a private placement. During the six months ended June 30,
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 June 30, 2004.
13
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. 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 June 30,
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.
Subsequent to June 30, 2004, Consolidated borrowed $5.4 million under an
amended credit facility with LaSalle Bank. The amended facility requires monthly
payments of $113,493 plus interest through November 2007, with a final payment
of the remaining balance of the note due December 31, 2007. The new facility
accrues interest at the Prime Rate plus 1.25% per annum, (5.25% at August 1,
2004). Proceeds from the borrowing were used to pay existing long term debt, pay
outstanding trade payables, acquire oil and gas leases, and for other working
capital purposes. On August 13, 2004 LaSalle Bank waived a violation of the net
income covenant at June 30, 2004. The current portion of long-term debt at June
30, 2004 reflects $0.8 million of current debt under payment terms of the
amendment for the $3.0 million of existing debt that was paid with the proceeds
from the borrowings.
Effective August 12, 2004, Infinity-Wyoming entered into a First
Amendment of Credit Agreement with U.S. Bank National Association. The
amendment established the borrowing base at $5.3 million for the period from
August 12, 2004 through December 31, 2004. Infinity-Wyoming has elected to make
five monthly $40,000 principal payments beginning on August 31, 2004, to satisfy
the borrowing base deficiency. Should the next scheduled semi-annual borrowing
base redetermination not occur as scheduled on December 31, 2004, variable
monthly amortization of the loan would commence on January 31, 2005, and all
remaining amounts outstanding would be due on June 30, 2006. Management is of
the opinion that the redetermination will occur as scheduled and that no loan
amortization will commence at that time. The amendment also waived a violation
of the working capital covenant at June 30, 2004.
There were no other significant changes to existing debt other than
changes caused by payments under normal payment terms.
(7) 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 June 30, 2004 and 2003, potential common shares of 2,750,800
and 2,919,450, respectively, are anti-dilutive.
(8) Equity - Common Stock
Infinity received proceeds of $4,000,000 and incurred offering costs of
approximately $30,000 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 stockholder discussed in Note (6),
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 by Schlumberger Technology, Ltd
("Schlumberger") under the Labarge development agreement with Schlumberger, and
to pay for other working capital needs.
(9) Equity - Stock Options
During the six months ended June 30, 2004, options to purchase 40,000
shares of common stock were exercised resulting in proceeds to Infinity of
$60,000. Options to purchase 84,000 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 which was approved by the Shareholders at the June 16, 2004 Annual Meeting
of Shareholders. The 2004 Stock Option Plan allows Infinity to grant incentive
stock options and non-qualified stock options to purchase up to 410,000 shares
of common stock at no less than the market price per share. Infinity granted
407,500 options on common shares at an option price of $4.26 per share during
the six months ended June 30, 2004. No incentive stock options were granted in
the period ended June 30, 2003. No compensation cost was recorded for the
options granted during The period. Had compensation costs for employee options
under Infinity's 2004 Stock Option Plan been determined based upon the fair
value at the grant date for awards under the plan consistent with the
methodology prescribed under Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation", Infinity's net loss and earnings
per share would have been as follows:
14
For the Six Months
Ended June 30,
2004
-----------
Net loss as reported $(2,866,892)
Deduct: Total stock-based employee compensation
expense, determined under fair value based method
for all awards, net of tax (1,527,892)
-----------
Pro forma net income $(4,394,874)
===========
Basic and diluted loss per share as reported $ (0.31)
Basic and diluted loss per share - pro forma $ (0.47)
For options granted during the six months ended June 30, 2004, the
estimated fair value of the options granted utilizing the Black-Scholes pricing
model under Infinity's plan was based on a weighted average risk-free interest
rate of 1.5%, and expected option life of 5 years, expected volatility of
approximately 147% and no expected dividends.
(10) 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 enterprise's 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.
15
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 use 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:
o Infinity's growth strategies;
o anticipated trends in Infinity's business and its future results of
operations;
o estimates of expenses and revenues;
o sources, timing and terms of additional or renegotiated financing;
o amount and timing of future capital expenditures;
o market conditions in the oil and gas industry;
o the level of anticipated production of oil and gas;
o potential acquisitions and dispositions, including timing, cost and
likelihood of successfully integrating acquisitions;
o the costs of complying with government regulation, including the
likelihood and timing of obtaining required government permits;
o exploration and development activity, including the number and timing of
new or recompleted wells, planned expenditures and anticipated production;
o demand for Infinity's oil field services;
o continued evaluation of the Labarge acreage under the Schlumberger
agreement;
o success or progress regarding negotiations for the development of
concessions in Nicaragua; and
o 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 that are beyond
Infinity'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.
16
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 & Gas of Wyoming, Inc. ("Infinity-Wyoming")
currently has net production of approximately 3.0 million cubic feet ("MMcf") of
natural gas per day 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 six months of 2004, Infinity-Wyoming completed six wells
on Pipeline acreage that were drilled prior to December 31, 2003. In addition to
the completion activity, Infinity-Wyoming assumed operations of two additional
wells in the field following an acquisition of additional working interest in
those wells in March 2004. The acquisition of the additional interest resulted
in the addition of approximately 70 Mcf per day of gas production net to
Infinity's interest from the two new wells. The acquisition also included six
160-acre undeveloped drilling locations immediately adjacent to
Infinity-Wyoming's existing producing leasehold. Infinity-Wyoming has drilled
wells at two of these locations and expects to complete the two wells prior to
the end of the third quarter of 2004 at an estimated total cost of $300,000, net
to our 50% working interest.
Infinity-Wyoming, under an agreement with Schlumberger Technology, Ltd
("Schlumberger") and Red Oak Capital Management, LLC ("Red Oak") has completed
one well and re-completed two additional wells of the ten wells drilled on the
Labarge acreage. Infinity-Wyoming expects to complete or re-complete two
additional wells under the agreement during the balance of 2004. Infinity and
Schlumberger continue to evaluate the effectiveness of the activity as measured
by initial production results and technical data derived from the work. Upon
determination of optimal completion technologies, Infinity-Wyoming anticipates
that it and Schlumberger will be positioned to drill up to ten new wells at
Labarge during the second half of 2005.
Infinity, which has been awarded concessions for the development of 24
blocks consisting of approximately 1.4 million acres offshore Nicaragua, is
currently negotiating the final terms of the lease and development plans with
the government of Nicaragua. Management believes that it will complete the
exploration and production agreement during the third quarter of 2004.
On April 20, 2004, Consolidated acquired the assets and assumed certain
liabilities of Blue Star, an oilfield services firm based in Eureka, Kansas. 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
the borrowings under Consolidated's existing credit facility and is expected to
satisfy a portion of Consolidated's anticipated 2004 equipment and personnel
needs. Blue Star provided acid and cementing services in an area that overlapped
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
acquisition of equipment which is designed to provide service to deeper oil and
gas wells, eliminated 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.
17
On July 9, 2004, Consolidated amended the terms of the loan agreement with
LaSalle Bank to increase the borrowing base. As a result Infinity borrowed an
additional $5.4 million under the term loan. Proceeds from the loan were used to
pay approximately $3.0 million of existing long-term debt, fund the July 2004
acquisition of the Barnett Shale acreage in the Fort Worth Basin of Texas, pay
existing trade payables and for other working capital and capital expenditures
needs. The amended loan has monthly payments of $113,493 plus interest through
November 2007, with a final payment due December 31, 2007. The loan bears
interest at the Prime Rate plus 1.25% (5.25% at August 1, 2004). The current
portion of long-term debt at June 30, 2004 reflects $0.8 million of current debt
under payment terms of the amendment for the $3.0 million of existing debt that
was paid with the proceeds from the borrowings.
On July 16, 2004, Infinity-Texas, Inc. ("Infinity-Texas"), a newly
incorporated, wholly owned subsidiary of Infinity, Inc. acquired approximately
28,400 (21,800 net) acres of leasehold in the Barnett Shale area of the Fort
Worth Basin of north central Texas for approximately $1.5 million. The
acquisition was financed under the amendment to the LaSalle Bank agreement
discussed above. The purchase agreement also requires Infinity to drill four
wells prior to July 14, 2005, which management estimates will cost approximately
$2.0 million, and complete such wells prior to September 13, 2005 or relinquish
the acreage to the seller.
Second Quarter 2004 Overview
Infinity reported a loss of approximately $(1.1) million, or $(0.12) per
diluted share, for the second quarter of 2004 compared to a loss of
approximately $(0.2) million or $(0.03) per diluted share in the second quarter
of 2003. The increase in the net loss for the period was mainly due to the
following factors:
o Production of oil and gas decreased 21% which was partially offset by an
11% increase in realized prices and a 13% decrease in production expenses.
o Depletion of oil and gas assets increased by $0.8 million due to an
increase in depletable costs and a decrease in the proved reserves over
which development costs are being depleted.
2004 Operational and Financial Objectives
Oilfield Services
Consolidated expects to realize an increase in its oilfield service
revenue during the remainder of 2004. This anticipated increase is due to an
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:
o expand the services currently provided,
o expand the area currently serviced,
o gain market share by providing complementary services to its existing
services, and
o gain market share through mergers and acquisitions.
18
Revenues from oilfield services are expected to be between $13.5 million and
$15.0 million for the remainder of 2004 and the first half of 2005. Consolidated
could incur capital expenditures, in addition to those incurred in the Blue Star
acquisition of approximately $0.4 million related to equipment and facilities.
There are no current commitments for these potential capital expenditures
acquisitions and management believes Consolidated would be able to finance them
through additional vendor financing or cash generated by operations.
Oil and Gas Production
Infinity-Wyoming
Infinity-Wyoming plans to focus on the following strategic operational
objectives during the remainder of 2004. These objectives include the following
contractual obligations:
o 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;
o evaluate and maintain strategic oil and gas leases through appropriate
lease rental payments at an estimated cost of $0.1 million; and
o participate in the completion of two additional wells in the initial well
completion bundle under the agreement with Schlumberger and Red Oak. The
expected cost for the completion activities is approximately $0.6 million.
Contingent on obtaining the required regulatory permits and funding on
terms acceptable to Infinity-Wyoming, it will focus on the following strategic
operational objectives during the remainder of 2004:
o optimize production from certain Pipeline wells through selective
workovers or additional completion and stimulation activity;
o increasing daily production, net to Infinity-Wyoming's interest by
approximately 1.3 MMcfe per day by drilling three additional operated
wells and completing two recently drilled wells (a net of four to
Infinity-Wyoming's interest) at an estimated cost of $1.9 million on
Pipeline proved undeveloped locations;
o drill and complete one well targeting the Frontier formation at a Labarge
location at an estimated cost of $0.8 million;
o drill and complete one horizontal fractured Niobrara well at its proved
undeveloped location in the Sand Wash Basin of Colorado at an estimated
cost of $1.2 million;
o 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 $0.5 million on these
activities.
Infinity-Texas
Depending on the successful completion of the initial well required under
its lease agreement in the Fort Worth Basin and contingent on funding
availability, Infinity-Texas anticipates the drilling of four horizontal wells
in the Fort Worth Basin of north central Texas during the fourth quarter of 2004
and the completion of such wells during the first half of 2005 at an estimated
cost of $4.5 million. Management also anticipates costs of approximately $0.5
for the acquisition of additional leases in the field and $0.6 million for the
installation of compression facilities and access to pipeline facilities.
19
The ability of Infinity-Texas to complete these activities is dependent on the
availability of the capital resources required to fund the activity.
Infinity, Inc. Activity
Infinity continues to negotiate the final exploration and production
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 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 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.
RESULTS OF OPERATIONS
Three Months Ended June 30
Infinity incurred a net loss after taxes of $1.1 million, or $0.12 per
fully diluted share, in the quarter ended June 30, 2004 compared to a net loss
after taxes of $0.2 million, or $0.03 per fully diluted share in the quarter
ended June 30, 2003.
Infinity experienced a $0.2 million decrease in gross profit to $2.5
million in the quarter ended June 30, 2004 from $2.7 million for the quarter
ended June 30, 2003. The decrease in gross profit during the quarter ended June
30, 2004 compared to the quarter ended June 30, 2003 was the result of a $0.2
million, or 16%, decrease in gross profit from oil and gas production operations
on a decrease in revenue of $0.3 million. A $0.3 million, or 11%, increase in
oil field service revenue was offset by a $0.3 million or 21% increase in costs
to provide the services due to higher labor, fuel and materials costs.
For the three months ended June 30, 2004, Infinity recognized $1.3 million
in depreciation, depletion and amortization expense compared to $0.5 million in
the three months ended June 30, 2003. The $0.8 million increase was the result
of a $0.7 million increase in depletion of oil and gas properties due to an
increase in depletable assets as additional wells were brought online and a
lower proved reserve base over which the oil and gas properties are being
depleted.
Oilfield Services
Consolidated recorded sales of $3.3 million and cost of revenues of $1.9
million for the quarter ended June 30, 2004 compared to sales of $3.0 million
and cost of revenues of $1.5 million for the comparable period ended June 30,
2003. Revenue from the Eureka, Kansas facility (Blue Star) contributed
approximately $0.4 in revenue and approximately $0.2 million in cost of sales to
the quarterly results. The following table details the comparison of gross
revenue in millions of dollars, before discounts, for the periods indicated,
based on the number and type of core service jobs performed (due to rounding the
sum of the individual amounts presented may not equal the totals):
20
Oilfield Service Statistics
($ in millions, before discounts)
Three Months ended June 30,
-----------------------------------------------------
2004 2003 CHANGE
------------------------- ------------------------ -----------------------
JOB TYPE JOBS REVENUE JOBS REVENUE JOBS REVENUE
Cementing 945 $2.1 514 $1.1 431 $1.0
Acidizing 267 $0.3 354 $0.4 (87) $(0.1)
Fracturing 165 $1.2 286 $1.7 (121) $(0.5)
Discounts
and eliminations $(0.3) $(0.2) $(0.1)
----- ----- -----
$3.3 $3.0 $0.3
===== ===== =====
Continued wetter than normal conditions in eastern Kansas, delays in
completing wells by operators, and increased competition in fracturing services
resulted in a significant reduction in the number of acidizing and fracturing
jobs completed during the quarter ended June 30, 2004 compared to the quarter
ended June 30, 2003. The 42% decrease in the number of fracturing jobs completed
was partially offset by a 22% increase in the revenue generated per job from
approximately $6,000 per job in the quarter ended June 30, 2003 to approximately
$7,300 per job in the 2004 period. Management anticipates an increase in
acidizing and fracturing services during the second half of 2004 compared to the
prior year due to the increase in the number of cement jobs during the first
half 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
increase substantially for the remainder of the year.
Oil and Gas Production
During the quarter ended June 30, 2004, Infinity-Wyoming recorded
approximately $1.4 million in revenue on the sale of approximately 266.7 MMcf of
gas compared to $1.5 million in revenue on the sale of 315.7 MMcf of natural gas
during the period ended June 30, 2003. Infinity-Wyoming also recorded
approximately $0.3 million in revenue on the sale of 8,203 barrels of oil
compared to approximately $0.5 million in revenue on the sale of 16,056 barrels
of oil in the three month period ended June 30, 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 at that time and into
early 2004, Infinity-Wyoming was unable to replace the natural decline in
production on previously completed wells. The decline in revenue during the
period ended June 30, 2004, due to the natural 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 11% from
approximately $4.86 per thousand cubic foot gas equivalent ("Mcfe") in the
period ended June 30, 2003, to $5.39 per Mcfe for the period ended June 30,
2004. Infinity-Wyoming decreased lease operating expense from $0.5 million in
the quarter ended June 30, 2003 to $0.4 million in the quarter ended June 30,
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.
The following table provides statistical information by field for
production volumes, revenue and production costs for the quarter ended June 30,
2004 and 2003 (due to rounding and other operating expenses the sum of the
individual amounts presented may not equal the totals):
21
Infinity-Wyoming
Production Statistics
Pipeline Labarge Total
Volumes in 000s: 2004 2003 2004 2003 2004 2003
- ---------------- ---- ---- ---- ---- ---- ----
Oil Sales Volumes (Bbls) 8.2 15.9 0.0 0.2 8.2 16.1
Gas Sales Volumes (Mcf) 258.7 308.4 8.0 8.3 266.7 316.7
Gas Equivalent (Mcfe) 307.7 403.8 8.0 9.5 315.7 413.3
Values in 000s:
Oil Revenue $315.8 $452.1 $0.0 $3.2 $315.8 $455.3
Gas Revenue $1,340.2 $1,490.5 $45.6 $50.1 $1,385.8 $1,540.6
Production Expense $178.0 $100.8 $111.8 $214.6 $286.4 $315.4
Production Taxes $190.4 $209.1 $4.8 $6.0 $195.2 $215.1
Transportation Expense $183.3 $232.1 $5.1 $6.6 $188.4 $238.7
Per Mcfe:
Revenue $5.35 $4.81 $5.70 $5.73 $5.39 $4.86
Production Expense $0.68 $0.25 $15.08 $23.08 $0.91 $0.76
Production Taxes $0.61 $0.52 $0.60 $0.64 $0.62 $0.52
Transportation Expense $0.59 $0.57 $0.64 $0.71 $0.60 $0.57
Operating Expenses
During the period ended June 30, 2004, Infinity recognized approximately
$1.6 million in corporate operating expenses compared to approximately $1.7
million in the period ended June 30, 2003. The decrease was mainly due to a $0.3
million decrease in costs associated with the failed merger transaction in 2003
that was partially offset by $0.1 million increase in legal and accounting
fees in 2004 associated with additional regulatory filings and compliance.
Depreciation, depletion and amortization expense increased to $1.3 million in
the period ended June 30, 2004 compared to $0.5 million in the period ended June
30, 2003. The increase was the result of an 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.
Other Income and Expenses
During the three-month period ended June 30, 2004, other income and
expenses was unchanged from the prior year period with total other expense of
approximately $0.7 million.
Net Loss
Infinity recognized a net loss of $1.1 million during the period ended
June 30, 2004 compared to a net loss of $0.2 million in the period ended June
30, 2003. The increase in the loss was mainly due to a $0.7 million increase in
depletion on oil and gas properties and a $0.2 million decrease in gross profit
on a $0.3 million decrease in oil and gas sales.
Six Months Ended June 30
Infinity incurred a net loss after taxes of $2.9 million, or $0.31 per
fully diluted share, in the six months ended June 30, 2004 compared to a net
loss after taxes of $$0.8 million, or $0.11 per fully diluted share in the six
month period ended June 30, 2003.
Gross profit for the six-month period ended June 30, 2004 was unchanged at
$4.5 million compared to the 2003 period. Increases in oil field service revenue
and expense discussed in Oilfield Services below were offset by decreases in oil
and gas production revenues and expenses as discussed in Oil and Gas Production
below.
22
For the period ended June 30, 2004, Infinity recognized $2.4 million in
depreciation, depletion and amortization expense compared to $1.1 million in the
period ended June 30, 2003. The $1.3 million increase was the result of an
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.
Oilfield Services
Consolidated recorded sales of $5.5 million and cost of revenues of $3.3
million for the six months ended June 30, 2004 compared to sales of $4.9 million
and cost of sales of $2.7 million for the comparable period ended June 30, 2003.
Approximately $0.4 million of the increased revenue and approximately $0.2
million of the cost of sales was generated in the second quarter by the newly
acquired Eureka, Kansas facility, formerly Blue Star Acid Services, Inc. The
following table details the comparison of gross revenue in millions of dollars,
before discounts, for the periods, based on the number and type of core service
jobs performed (due to rounding the sum of the individual amounts presented may
not equal the totals):
Oilfield Service Statistics
($ in millions, before discounts)
2004 2003 CHANGE
------------------------- ------------------------ -----------------------
JOB TYPE JOBS REVENUE JOBS REVENUE JOBS REVENUE
Cementing 1,456 $3.1 805 $1.7 651 $1.4
Acidizing 458 $0.5 569 $0.6 (111) $(0.1)
Fracturing 303 $2.2 450 $2.7 (147) $(0.5)
Other -- $0.1 -- $0.1 -- --
Discounts
and eliminations $(0.3) $(0.2) $(0.1)
------ ----- -----
$5.6 $4.9 $0.7
==== ==== =====
Continued wetter than normal conditions in eastern Kansas, delays in
completing wells by operators, and increased competition in fracturing services
resulted in a significant reduction in the number of acidizing and fracturing
jobs completed during the six months ended June 30, 2004 compared to the six
months ended June 30, 2003. The 33% decrease in the number of fracturing jobs
completed was partially offset by a 23% increase in the revenue generated per
job from approximately $6,100 per job in the six months ended June 30, 2003 to
approximately $7,500 per job in the 2004 period. Management anticipates an
increase in acidizing and fracturing services during the second half of 2004
compared to the prior year due to the increase in the number of cement jobs
during the first half 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 increase substantially for the remainder of the year.
Oil and Gas Production
During the six months ended June 30, 2004, Infinity-Wyoming recorded
approximately $2.4 million in revenue on the sale of 470.1 MMcf of gas compared
to $2.7 million in revenue on the sale of 625.5 MMcf of natural gas during the
period ended June 30, 2003. Infinity-Wyoming also recorded approximately $0.6
million in revenue on the sale of 17,526 barrels of oil compared to
approximately $1.0 million in revenue on the sale of 32,824 barrels of oil in
the six month period ended June 30, 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 at that time and into early 2004,
Infinity-Wyoming was unable to replace the natural decline in production on
previously completed wells. The decline in revenue during the period ended June
30, 2004, due to the natural 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 18% from approximately $4.51 per Mcfe in
the period ended June 30, 2003, to $5.34 per Mcfe for the period ended June 30,
2004. Infinity-Wyoming decreased lease operating expense from $0.9 million in
the six month period ended June 30, 2003 to $0.6 million in the six months ended
June 30, 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 by approximately
$0.2 million due to the lower volumes of gas produced and sold during the
period.
23
The following table provides statistical information by field for
production volumes, revenue and production costs for the six months ended June
30, 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 000s: 2004 2003 2004 2003 2004 2003
- ---------------- ---- ---- ---- ---- ---- ----
Oil Sales Volumes (Bbls) 17.5 32.8 0.0 0.2 17.5 33.0
Gas Sales Volumes (Mcf) 459.0 614.8 11.1 10.7 470.1 625.5
Gas Equivalent (Mcfe) 564.1 811.9 11.1 11.3 575.1 823.2
Values in 000s:
Oil Revenue $643.4 $1,015.6 $0.0 $2.7 $643.4 $1,018.3
Gas Revenue $2,367.4 $2,655.7 $62.1 $60.1 $2,429.5 $2,715.8
Production Expense $343.9 $275.0 $247.1 $568.7 $512.5 $843.7
Production Taxes $344.6 $419.2 $6.6 $7.1 $351.2 $426.3
Transportation Expense $318.4 $445.3 $6.7 $4.0 $325.1 $449.3
Per Mcfe:
Revenue $5.34 $4.52 $5.59 $5.56 $5.34 $4.51
Production Expense $0.61 $0.34 $22.26 $50.33 $0.89 $1.02
Production Taxes $0.61 $0.52 $0.59 $0.63 $0.61 $0.52
Transportation Expense $0.56 $0.55 $0.60 $0.35 $0.57 $0.55
Operating Expenses
During the period ended June 30, 2004, Infinity recognized approximately
$2.8 million in corporate operating expenses compared to approximately $2.8
million in the period ended June 30, 2003. An increase in legal, accounting and
engineering fees of approximately $0.3 million related to regulatory filings and
registrations in 2004 was offset by a $0.3 million decrease in costs associated
with the failed merger activity in 2003. Depreciation, depletion and
amortization expense increased to $2.4 million in the period ended June 30, 2004
compared to $1.1 million in the period ended June 30, 2003. The increase was the
result of an 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.
24
Other Income and Expenses
Other income and expenses increased by $0.6 million due to an increase in
the amount of amortization of loan costs recognized as interest expense during
the period ended June 30, 2004 compared to the 2003 period as amortization of
unamortized loan costs associated with debt being retired was accelerated when
the debt was retired.
Net Loss
Infinity recognized a net loss of $2.9 million during the period ended
June 30, 2004 compared to a net loss of $0.8 million in the period ended June
30, 2003. The increase in the loss was mainly due to a $0.7 million increase in
amortization of loan costs recognized as interest expense and a $1.3 million
increase in depletion of oil and gas properties.
LIQUIDITY AND CAPITAL RESOURCES
Cash and Capital Expenditures
Infinity had $0.6 million in cash and cash equivalents at June 30, 2004, a
decrease from $0.7 million at December 31, 2003. During the six months ended
June 30, 2004, Infinity generated approximately $4.0 million from the private
placement of one million shares of common stock, $0.1 million from the issuance
of 40,000 shares of common stock upon the exercise of stock options, $3.2
million in additional borrowings, and $0.9 million from operating activities.
Infinity used approximately $5.0 million in investing activities in the
six-month period ending June 30, 2004 as follows:
o Approximately $1.2 million was used for the purchase of oil field
service equipment;
o Approximately $0.5 million to acquire additional interest in two
producing wells and leases on 960 additional acres adjacent to the
Pipeline project;
o Approximately $1.4 completing six wells drilled in 2003 on the
Pipeline project and drilling one additional well on the project (a
second additional well was drilled after June 30, 2004);
o Approximately $1.4 million on the completion of one well and the
recompletion of two producing wells and one disposal well at
Labarge;
o Approximately $0.4 million in remediation and completion activities
on two existing wells in the Sand Wash Basin; and
o Approximately $0.3 million was used as a down payment and for due
diligence on the Barnett Shale acquisition which was included in the
other assets at June 30, 2004.
Subsequent to June 30, 2004 Consolidated amended the terms of the loan agreement
with Lasalle Bank to increase the borrowing. As a result Infinity borrowed an
additional $5.4 million under the term loan. Proceeds from the loan were used to
pay approximately $3.0 million of existing term loan debt, fund the July 2004
acquisition of the Barnett Shale leasehold in the Fort Worth Basin of north
central Texas, pay existing trade payables and for other working capital and
capital expenditures needs. The amended term loan has monthly payments of
$113,493 plus interest through November 2007 with a final payment due December
31, 2007. The loan bears interest at the Prime Rate plus 1.25% (5.25% as of
August 1, 2004). The current portion of long-term debt at June 30, 2004 reflects
$0.8 million of current debt under payment terms of the amendment for the $3.0
million of existing debt that was paid with the proceeds from the borrowings.
25
Cash Requirements
The table below reflects management's estimates of expected cash
requirements for the remainder of 2004 and the first half of 2005, based on
management's current strategic operational objectives:
For the twelve months ending June 30, 2005
(In Millions)
Current deficit $ 1.9
Corporate cash usage 2.0
Interest on notes 0.3
Consolidated equipment additions 0.4
Infinity-Wyoming capital expenditures 5.4
Infinity-Texas capital expenditures* 7.1
Nicaragua performance bonds and contract negotiation 0.9
------
Expected cash requirements under current strategic operational plans $ 18.0
======
* Approximately $1.5 million was funded by proceeds from the LaSalle Bank
financing in July, 2004
These amounts assume that $0.8 million of interest for the twelve month
period on the 7% Subordinated Convertible Notes is satisfied with the issuance
of additional notes.
Sources of Cash
The table below reflects Infinity's expected sources of cash for the
remainder of 2004 and the first half of 2005:
For the twelve months ending June 30, 2005
(In Millions)
Consolidated operating cash flow $ 3.0
Infinity-Wyoming operating cash flow 3.8
LaSalle Bank financing additional funds 3.2
-------
Total Sources $ 10.0
=======
Consolidated expects to generate approximately $3.0 million in operating
cash flow from the oilfield service business during the remainder of 2004 and
the first half 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 $3.8 million in operating cash flow from oil
and gas production operations during the remainder of 2004 and the first half of
2005. Management anticipates production from the wells on the Pipeline project
to continue to produce approximately 3.4 MMcfe to 3.5 MMcfe 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.
26
In order to fund Infinity's expected cash deficit under the current
strategic operational plan of $8.0 million, and any other potential development
expenditures, Infinity will be required to pursue external financing through
short term loans, conventional bank financing, the forward sale of its oil and
gas production, through the public or private equity or debt markets, joint
ventures or joint interest partners, or through asset sales. Together with cash
flow, any proceeds received from any of these sources will first be utilized to
ensure Infinity's minimum contractual obligations are met. The amount of
progress that Infinity-Wyoming and Infinity-Texas will be able to make on the
additional development of their properties under the current strategic
operational plan will be dependent upon their 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.
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.
Proved 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 proved 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 proved 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 proved 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 proved 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 proved 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 proved reserves associated with the assets with the
amortization being expensed as depletion in the period that the proved reserves
are produced. This depletion expense is calculated by dividing the period's
production volumes by the estimated volume of proved 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.
27
If the net investment in oil and gas properties less asset retirement
obligations, exceeds an amount equal to the sum of (1) the standardized measure
of discounted future net cash flows from proved reserves including the effect of
cash flow hedges, and (2) the lower of cost or fair market value of properties
in process of development and unexplored acreage, the excess is charged to
expense as additional depletion. Infinity is required to review the carrying
value of its oil and gas properties each quarter under the full cost accounting
rules of the Securities and Exchange Commission. Under these rules, capitalized
costs of proved oil and gas properties, less asset retirement obligations, may
not exceed the present value of estimated future net revenues from proved
reserves, discounted at 10%. Application of the ceiling test generally requires
pricing future revenue at the un-escalated prices in effect as of the last day
of the quarter, including the effects of cash flow hedges, and requires a
write-down for accounting purposes if the ceiling is exceeded. Unproved oil and
gas properties are not amortized, but are assessed for impairment either
individually or on an aggregated basis using a comparison of the carrying values
of the unproved properties to net future cash flows. Infinity recognized a
ceiling write down of $2,975,000 during 2003. At June 30, 2004, Infinity would
have recognized a $1.0 million ceiling write-down based on the gas price in
effect at that date. However, due to subsequent significant increases in gas
sales prices August 10, 2004, Infinity-Wyoming was not required to recognize a
ceiling write-down in the quarter ended June 30, 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 proved 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 low of $4.50 per Mcf to a high of
$6.37 per Mcf during the six months ended June 30, 2004. Oil price realizations
ranged from a low of $34.10 per barrel to a high of $40.08 per barrel during
the period.
28
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. 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.
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 June 30, 2004. During the six months
ended June 30, 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 it
maintains 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
None
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
Three issues were presented to Shareholders of the Infinity, Inc. for
consideration at the Annual Shareholders Meeting that was held June 17, 2004 at
Infinity's headquarters in Chanute, Kansas. These issues, all of which were
approved at the annual Shareholders meeting, were:
(a) The election of four Directors of the Company to serve until the
next annual Meeting of Shareholders and until their successors have
been duly elected and qualified;
(b) The approval of the Company's 2004 Stock Option Plan;
(c) The ratification of the appointment of Ehrhardt Keefe Steiner &
Hottman P. C., as Infinity's independent auditors;
The following sets forth the votes cast for, against or withheld, as
well as the number of abstentions and any broker non-votes, as to each
of the matters presented at the meeting:
29
Election of Directors:
Nominee For Withheld
----------------------------- ----------------------- ------------------------
Robert O. Lorenz 7,004,867 470,923
Leroy C. Richie 7,024,467 451,323
Stanton E. Ross 6,979,556 496,234
O. Lee Tawes 7,015,824 459,966
Approval of 2004 Stock Option Plan:
For Against Abstain Broker Non Votes
----------------------- ---------------------- ---------------------- -----------------------
1,509,082 680,973 22,364 5,263,371
Appointment of Ehrhardt Keefe Steiner & Hottman:
For Against Abstain
----------------------- ---------------------- ----------------------
7,400,577 64,558 10,655
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
10.1 Fourth Amendment to Loan and Security Agreement dated May 28, 2004
between LaSalle Bank National Association and Consolidated Oil Well
Services, Inc.; Fifth Amendment to Loan and Security Agreement dated
July 9, 2004 between LaSalle Bank National Association and
Consolidated Oil Well Services, Inc.
10.2 First Amendment to Credit Agreement between Infinity Oil & Gas of
Wyoming and U.S. Bank National Association dated August 12, 2004.
10.3 Promissory Note dated June 11, 2004 of Infinity, Inc. in favor of
Stanton E. Ross.
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
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act)
30
(b) Reports on Form 8-K:
The Company furnished a report on Form 8-K on May 17, 2004 pursuant to
Items 7 and 12 to report financial results for the first quarter of
2004.
31
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: August 16, 2004 By: /s/ Stanton E. Ross
-------------------------------------
Stanton E. Ross, President
Dated: August 16, 2004 By: /s/ Jon D. Klugh
-------------------------------------
Jon D. Klugh, Chief Financial Officer
32
EXHIBIT INDEX
10.1 Fourth Amendment to Loan and Security Agreement dated May 28, 2004
between LaSalle Bank National Association and Consolidated Oil Well
Services, Inc.; Fifth Amendment to Loan and Security Agreement dated
July 9, 2004 between LaSalle Bank National Association and
Consolidated Oil Well Services, Inc.
10.2 First Amendment to Credit Agreement between Infinity Oil & Gas of
Wyoming and U.S. Bank National Association dated August 12, 2004.
10.3 Promissory Note dated June 11, 2004 of Infinity, Inc. in favor of
Stanton E. Ross.
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
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act)
33