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 March 31, 2004.
[ ] Transition report under Section 13 or 15(d) of the Securities Exchange Act
of 1934 (No fee required) for the transition period from ____________________ to
___________________.
Commission file number: 0-32455
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FAR EAST ENERGY CORPORATION
---------------------------
(Exact Name of Registrant as Specified in Its Charter)
Nevada 88-0459590
------ ----------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
400 N. Sam Houston Parkway East, Suite 205, Houston, Texas 77060
----------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(713) 586-1900
---------------
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
The number of shares outstanding of Registrant's common stock, par value
$0.001, as of May 5, 2004 was 59,180,035.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION...............................................3
Item 1. Financial Statements.........................................3
Item 2. Management's Discussion And Analysis of Financial Condition
and Plan of Operation ...................................... 4
Item 3. Quantitative and Qualitative Disclosures About Market Risk..12
Item 4. Controls and Procedures.....................................12
PART II - OTHER INFORMATION.................................................12
Item 1. Legal Proceedings...........................................12
Item 2. Changes in Securities and Use of Proceeds...................13
Item 5. Other Information...........................................13
Item 6. Exhibits and Reports on Form 8-K............................14
INDEX TO EXHIBITS...........................................................15
2
PART I - FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
3
FAR EAST ENERGY CORPORATION AND SUBSIDIARIES
(formerly EZfoodstop.com)
(A Development Stage Company)
Consolidated Balance Sheet
March 31, December 31,
2004 2003
(unaudited) (audited)
----------- ------------
ASSETS
Current:
Cash and cash equivalents $1,256,000 $2,326,000
Prepaids and other current assets 184,000 4,000
----------- ------------
Total current assets 1,440,000 2,330,000
----------- ------------
Property and equipment, net 3,622,000 3,026,000
Intangible asset 194,000 217,000
----------- ------------
$5,256,000 $5,573,000
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $1,220,000 $ 664,000
Other liabilities 1,000 106,000
Outstanding stock options 1,137,000 930,000
Note payable -- 100,000
----------- ------------
Total current liabilities 2,358,000 1,800,000
----------- ------------
Commitments and contingencies -- --
Stockholders' equity:
Common stock, $0.001 par value, 500,000,000
shares authorized, 56,807,210 and 56,071,461
issued and outstanding at March 31, 2004 and
December 31, 2003 respectively 57,000 57,000
Additional paid in capital 9,988,000 9,595,000
Deficit accumulated during the development stage (7,145,00) (5,877,00)
Accumulated other comprehensive loss (2,000) (2,000)
----------- ------------
Total stockholders' equity 2,898,000 3,773,000
----------- ------------
$5,256,000 $5,573,000
=========== ============
See accompanying notes to consolidated financial statements.
F-1
FAR EAST ENERGY CORPORATION AND SUBSIDIARIES
(formerly EZfoodstop.com)
(A Development Stage Company)
Consolidated Statement of Operations
For the Three Months Ended March 31, 2004 and 2003
(unaudited)
Cumulative
During
Development
Stage 2004 2003
------------ ---------- --------------
Revenues:
Interest income $ 20,000 $ 1,000 $ --
Foreign currency exchange (loss) gain (1,000) -- --
------------ ---------- --------------
Total revenues 19,000 1,000 --
Expenses:
Geologic and engineering services 662,000 103,000 72,000
Other consulting and professional services 614,000 83,000 87,000
Compensation 1,626,000 201,000 242,000
Stock compensation 1,137,000 207,000 --
Travel 993,000 84,000 92,000
Legal and accounting 690,000 208,000 68,000
Mineral lease rent 79,000 19,000 --
Loss on investment in joint venture 22,000 -- 22,000
Amortization of contract rights 81,000 23,000 15,000
General and administrative 1,260,000 341,000 74,000
------------ ----------- ------------
Total expenses 7,164,000 1,269,000 672,000
------------ ----------- ------------
Loss before income taxes (7,145,000) (1,268,000) (672,000)
Income taxes -- -- --
------------ ----------- ------------
Net loss (7,145,000) (1,268,000) (672,000)
Deficit-beginning of period -- (5,877,000) (2,156,000)
------------ ----------- ------------
Accumulated deficit-end of period $(7,145,000) $(7,145,000) $(2,828,000)
============ ============ ============
Earnings per share-Basic $ (0.02) $ (0.02)
=========== ============
Earnings per share-Diluted $ (0.02) $ (0.02)
=========== ============
See accompanying notes to consolidated financial statements.
F-2
FAR EAST ENERGY CORPORATION AND SUBSIDIARIES
(formerly Ezfoodstop.com)
(A Development Stage Company)
Consolidated Statement of Cash Flows
For the Three Months Ended March 31, 2004 and 2003
(unaudited)
Cumulative
During
Development
Stage 2004 2003
----------- ---------- ------------
Cash flows from operating activities:
Net loss $(7,145,00) $(1,268,000) $(672,000)
Adjustments to reconcile net loss to cash
used in operations:
Depreciation and amortization 113,000 29,000 20,000
Stock option compensation 1,151,000 221,000 --
Loss on investment in joint venture 22,000 -- --
Increase in prepaid expense (184,000) (180,000) --
Increase in accounts payable 1,220,000 556,000 302,000
Increase in other liabilities 1,000 (105,000) --
----------- ------------ ----------
Net cash used in operations (4,822,000) (747,000) (350,000)
----------- ------------ ----------
Cash flows from investing activities:
Net acquisitions of intangibles (275,000) -- (150,000)
Loss on investment in joint venture (22,000) -- 14,000
Investments in unproved oil and gas
properties (2,275,000) (600,000) --
Investments in property and equipment (148,000) (2,000) --
----------- ------------ ----------
Net cash used in investing activities (2,720,000) (602,000) (136,000)
----------- ------------ ----------
Cash flows from financing activities:
Net proceeds from the issuance of notes
payable 300,000 -- --
Proceeds from the sale of common stock 8,208,000 20,000 135,000
Decrease in long term liabilities -- -- (250,000)
Proceeds from the exercise of warrants 292,000 259,000 --
----------- ------------ ----------
Net cash provided from (used in) financing
activities 8,800,000 279,000 (115,000)
----------- ------------ ----------
Effect of exchange rate changes on cash (2,000) -- --
----------- ------------ ----------
Increase (decrease) in cash and cash
equivalents 1,256,000 (1,070,000) (601,000)
Cash and cash equivalents - beginning
of period -- 2,326,000 1,008,000
----------- ------------ ----------
1,256,000 1,256,000 407,000
=========== ============ ==========
See accompanying notes to consolidated financial statements.
F-3
FAR EAST ENERGY CORPORATION AND SUBSIDIARIES
(formerly Ezfoodstop.com)
(A Development Stage Company)
Notes to Consolidated Financial Statements
For the Three Month Period Ended March 31, 2004 (unaudited)
1. The Corporation and its Business
The financial statements include the accounts of Far East Energy
Corporation and its wholly owned subsidiaries (Far East or the Company), Newark
Valley Oil & Gas, Inc. (Newark), Yunnan Huayi Eco-Tech Consulting Co. Ltd. (Eco
Tech), and its Chinese joint venture entity, Guihzou Far East Panjiang Chemical
Co. Ltd. (GFEPC). Far East is organized under the laws of the State of Nevada.
Newark is organized under the laws of the State of Nevada. Eco Tech is a
Chinese company. GFEPC is a Chinese joint venture. All significant intercompany
balances and transactions have been eliminated in consolidation.
The Company was incorporated as Egoonline.com in the State of Nevada,
United States of America on February 4, 2000 under the Nevada Revised Statutes,
Chapter 78, Private Companies, and changed its name to EZFoodstop.com on April
26, 2000. EZFoodstop.com changed its name to Far East Energy Corporation on
January 10, 2002.
The Company is in its development stage and to date its activities have
been limited to initial organization, capital formation, acquisition of assets
(assets being defined as mineral leases and/or production sharing contracts
giving the Company the right to explore for, develop, produce and sell oil and
gas or coalbed methane (CBM)), CBM well drill planning, gas well drilling
program planning and drilling its first three exploratory wells in the fourth
quarter of 2003 and the first quarter of 2004. Its current activities are
principally focused on developing its coal bed methane projects located in the
Shanxi and Yunnan Provinces of China.
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles, which contemplates
continuation of the Company as a going concern. The Company has been in the
development stage since its formation on February 4, 2000. The Company has
incurred net losses since its inception and has not established a source of
revenue. In view of these matters, realization of a major portion of the assets
in the accompanying consolidated balance sheet is dependent upon continued
operations of the Company, which in turn is dependent upon the Company's ability
to meet its financing requirements, and the success of its future operations.
Management believes that its current operations and funding plans provide the
opportunity for the Company to continue as a going concern. However, these
factors raise substantial doubt about the Company's ability to continue as a
going concern. The accompanying consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
2. Basis of Presentation
The accompanying consolidated financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission
(SEC). Certain information and footnote disclosure normally included in annual
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to those rules and
regulations. The accompanying financial statements should be read in conjunction
with Far East's annual financial statements and notes thereto included in Far
East's Form 10-KSB.
In the opinion of management, the consolidated financial statements
reflect all adjustments (consisting of only normal and recurring adjustments)
necessary to present fairly the financial position, results of operations and
cash flows for those periods presented. Operating results for the three months
ended March 31, 2004 are not necessarily indicative of the results that may be
expected for the year ended December 31, 2004.
F-4
3. Going Concern
The Company's financial statements are prepared using generally accepted
accounting principles applicable to a going concern, which contemplates the
realization of assets and the liquidation of liabilities in the normal course of
business. The Company currently has no source of revenue.
Management intends to continue financing efforts to support the current
and proposed business operations in China and Montana. The ability of the
Company to continue as a going concern is dependent upon its ability to raise
substantial funds for use in development activities and upon the success of the
Company's planned exploration and development activities. There can be no
guarantee of future fundraising success. The success of exploratory drilling is
uncertain.
However, management believes that the Company will continue to be
successful in raising the funds necessary to explore for gas and, assuming
success in those exploratory efforts, to raise the funds necessary for
production and development.
Management believes that the Company will be able to raise funds
sufficient to assure satisfaction of its operating capital needs/plans and
financial obligations through December 31, 2005. These funds are anticipated to
be raised through private offerings to accredited investors through the third
quarter of 2004. If management is not successful in raising the required monies
for operations thereafter, the Company may not be able to continue as a going
concern.
Because the Company has acquired an undeveloped natural resource that will
require substantial exploration and development, management does not expect to
generate meaningful revenues until at least 2005. Expenses for the second half
of 2004 will have to be financed through cash flow, which may not yet be
available if production and sales of coalbed methane gas are not significant, or
through future financings of equity and/or debt.
4. Property and Equipment
Property and equipment includes the following:
March 31, December 31,
2004 2003
Unproven oil and gas properties $ 3,506,000 $ 2,906,000
Furniture and equipment 148,000 146,000
------------ -------------
3,654,000 3,052,000
Accumulated depreciation (32,000) (26,000)
------------ -------------
$ 3,622,000 $ 3,026,000
============ =============
Depreciation expense for the three months ended March 31, 2004, and 2003,
was approximately $6,000 and $5,000, respectively.
5. Intangible Asset
Intangible assets consist of mineral exploration rights acquired during
2002 pursuant to a Production Sharing Contract with the China United Coal Bed
Methane Corporation (CUCBM) and are being amortized over three years.
Assigned costs and accumulated amortization at March 31, 2004 and December
31, 2003 were as follows:
F-5
March 31, December 31,
2004 2003
------------------------
Gross amounts $ 275,000 $ 275,000
Less accumulated amortization 81,000 58,000
----------- ------------
$ 194,000 $ 217,000
=========== ============
Amortization expense for the three months ended March 31, 2004 and 2003
amounted to approximately $23,000 and $15,000, respectively. Estimated
amortization expense for the next three years is $68,000, $91,000 and $35,000.
On January 25, 2002, the Company entered into a Production Sharing
Contract with the China United Coal Bed Methane Corporation (CUCBM), which has
exclusive legal authority over all coal bed methane gas in the People's Republic
of China (PRC). Pursuant to the Production Sharing Contract, the Company
received the authority from CUCBM to jointly explore, develop, produce and sell
coal bed methane gas in and from a total area of 1,072 unevaluated square
kilometers in the Enhong and Laochang areas of Yunnan Province, PRC. The
Production Sharing Contract was subject to formal ratification by PRC's Ministry
of Foreign Trade and Economic Cooperation (MOFTEC). On December 31, 2002, MOFTEC
ratified this Production Sharing Contract. The contract required the Company to
pay $150,000 to CUCBM upon ratification and an annual payment of $100,000 on the
anniversary date for two subsequent years.
The Company has the right to earn a minimum of 60% interest in the joint
venture, with CUCBM retaining the remaining 40%. In the event CUCBM elects to
participate at a level less than 40%, their interest will be reduced
proportionately, increasing the Company's participating interest.
As a result of MOFTEC's ratification and approval of the Production
Sharing Contract concerning the Enhong and Laochang areas, the Company has
commenced its exploration program, which initially involves the drilling of five
(5) exploratory wells, three (3) of which have been completed, and eight (8)
pilot development wells.
The Company has another Production Sharing Contract of the same date with
CUCBM in the Zhaotong area of Yunnan Province, which has not yet been ratified.
6. Notes Payable
On July 23, 2003, the Company signed a Loan Agreement with Clarion Finanz
AG. The principle amount of the loan was $200,000. Maturity was on demand, at
the option of the lender, repayable in cash with accrued interest. Interest on
the loan was five (5) percent per year. The loan had a Conversion Privilege, at
the exclusive option of the lender. The loan balance was convertible into the
Company's stock at $0.65 per share of common stock and one full warrant for one
common share exercisable at $1.00. Interest payments were to be made yearly at
the annual maturity date, unless repaid earlier in full. The lender exercised
the conversion feature on October 6, 2003 with regard to $100,000 of the
outstanding balance of the loan. The lender received 153,846 restricted shares
of common stock at $0.65 per share and one full warrant exercisable at $1.00.
The stock is restricted for two years from the date of conversion. The lender
exercised the conversion feature on February 20, 2004 with regard to the
remaining $100,000 of the outstanding balance of the loan. The lender received
153,846 restricted shares of common stock at $0.65 per share and one full
warrant exercisable at $1.00. The stock is restricted for two years from the
date of conversion. The lender also converted the warrants exercisable on
February 20, 2004 into 307,692 restricted shares of common stock.
7. Commitments and Contingencies
The Company is periodically involved in legal actions arising from normal
business activities. Management believes that these actions are without merit or
that the ultimate liability, if any, resulting from them will not materially
F-6
affect the financial position or results of operations of the Company. The
Company does not anticipate any material losses as a result of commitments and
contingent liabilities.
Rent expense for the three months ended March 31, 2004 was approximately
$5,000. There are no noncancelable leases with remaining terms in excess of one
year.
CUCBM Minimum Exploration Work Commitment Agreement
In conjunction with the Production Sharing Agreements, the Company entered
into a Minimum Exploration Work Commitment agreement with CUCBM that requires
the Company to drill five (5) exploratory wells on the Enhong and Laochang
fields. The Company will also be required to drill two (2) exploratory wells on
the Zhaotong field upon ratification of that Production Sharing Contract. When
the Company completes the exploratory wells (Phase I of the Minimum Exploration
Work Commitment Agreement) management may elect to begin Phase Two wherein the
Company will be required to drill eight (8) pilot development wells on the
Enhong and Laochang fields and four (4) pilot development wells on the Zhaotong
field if that Production Sharing Contract is ratified. The Company had drilled
three exploratory wells as of May 7, 2004.
Conoco Phillips Memorandum of Understanding
On March 19, 2003, the Company entered into a Memorandum of Understanding
("MOU") with a Conoco Phillips subsidiary, Phillips China Inc. (Phillips), which
sets forth the terms and conditions of an agreement for the Company to acquire a
net undivided forty percent (40%) from Phillips' seventy percent (70%) interest
in both the Shouyang PSC (near Taiyuan City) and the Qinnan PSC (near Jincheng
and Qinshui). On July 17, 2003, Far East and Phillips signed two Farmout
Agreements on the Qinnan and Shouyang CBM blocks in Shanxi Province, P.R.C. and
also signed an Assignment Agreement on the two blocks. These agreements
formalized the Company's acquisition of an undivided forty percent (40%) working
interest from Phillips' (70%) interest. The breakdown is Far East forty percent
(40%), Phillips thirty percent (30%) and CUCBM thirty percent (30%). The
Assignment Agreement and appropriate amendments to the PSCs substituting the
Company for Phillips China as the principal party and operator was approved by
CUCBM on March 15, 2004 and final ratification was granted by PRC's Ministry of
Commerce on March 22, 2004.
The Farmout Agreements obligate Far East to fracture stimulate and
production test three exploration wells that were drilled by Phillips with Far
East paying 100% of the cost for these tests. Upon the satisfactory completion
of the testing, Far East shall have the option to give notice to extend into the
second phase of exploration by drilling three (3) additional wells. The Company
will be responsible for 100% of the costs of the second phase of exploration and
the drilling of three (3) wells. Upon Far East successfully completing the
second phase, Phillips will have the option to elect to either retain its net
undivided thirty percent (30%) participating interest, or take a five percent
(5%) overriding royalty interest ("ORRI") on the contractor's overall
Participating Interest share under the PSCs. The ORRI will be capped at five
percent (5%) of the current contractor's seventy percent (70%) Participating
Interest, or a three and a half percent (3.5%) ORRI on a one hundred percent
(100%) Participating Interest basis. Under the terms of the Farmout Agreement,
the Company has until May 14, 2004 to post a $1,000,000 surety bond to act as a
work performance guarantee covering all aspects of the evaluation and work
program to test the three existing wells, which the Company is attempting to
obtain now. In the first nine months of 2004, approximately $1.8 million is
expected to be utilized to fracture and test the gas flows from the three (3)
wells drilled by ConocoPhillips, cover costs related to CUCBM Joint Management
Committee salary fees, training fees, exploration fees and assistance fees as
outlined in the Production Sharing Contract, and to pay ConocoPhillips $76,052
for CBM equipment and materials associated with the project.
Threatened legal actions
The Company has received notification that a Director of the Company is
contemplating initiating legal action against the Company for non-payment of
certain expenses, compensation claims and claims of being owed a note payable.
F-7
Management does not believe the compensation and note payable claims are valid.
The expenses claimed and unpaid are approximately $42,000 at March 31, 2004 and
are recorded in the accompanying consolidated financial statements.
U.S. Securities and Exchange Commission Trading Investigation
In December 2003, we learned that the Company is the subject of an
investigation by the U.S. Securities and Exchange Commission. We understand that
the Commission is investigating whether anyone has issued false or misleading
statements in an attempt to manipulate the price of our common stock, whether
anyone has profited from selling stock at artificially high prices due to the
manipulative statements, and whether any individual or group has failed to file
ownership reports with the Commission as required for 10% or more stockholders
under Section 16 of the Securities Exchange Act of 1934 or failed to file
ownership reports with the Commission as required for 5% or more stockholders
under Section 13 of the Securities Exchange Act of 1934. Management does not
know of any acquisitions in excess of 5% of its outstanding shares, except for
those described in previous 13D filings with the SEC. We have supplied
information to the Commission in response to their information requests and
intend to cooperate with their investigation. We do not know what the outcome of
their investigation may be.
The Exchange Act and SEC rules require that a person or group of persons
who acquire more than 5% of a class of equity securities that are registered
under the Exchange Act must report their holdings in a Schedule 13D filing with
the SEC within 10 days after they become 5% shareholders, and must thereafter
report changes in their ownership of the securities. In addition, Section 16(a)
of the Exchange Act generally requires that owners of more than 10% of a class
of stock that is registered under the Exchange Act, must report changes in their
holdings within 48 hours of an acquisition or disposition of the securities.
If a person or group owns a large block of stock of a publicly traded
company, particularly if that stock is not subject to restrictions on its
purchase and sale on the open market, there is a risk that the person or group
could sufficiently control the market for the stock to drive the stock's trading
price stock up or down, and thereby the undisclosed control group could reap
trading profits at the expense of other public investors. In addition, Schedule
13D requires owners of a control group of stock to disclose their intentions
with respect to management or control of the company. Far East is making this
announcement to alert the public that an undisclosed control group might exist.
Employment Agreement
On October 13, 2003, the Company entered into a five-year employment
agreement with Michael R. McElwrath, which was approved by the Board of
Directors. Under the terms of the agreement, Mr. McElwrath's annual base salary
shall be no less than $225,000. Mr. McElwrath is also eligible to receive
performance bonuses semi-annually in the amount of not less than $20,000 subject
to determination of specific performance criteria. Mr. McElwrath received a
$56,250 signing bonus and is entitled to participate in all Company benefit
plans that are offered. In addition, Mr. McElwrath received 1,200,000 stock
options that vest over four years, 240,000 of which vest upon the effective date
of this employment agreement. The stock options have an exercise price of $0.65,
which was $0.65 below fair market value on the effective date of the contract.
Accordingly, additional compensation cost of $39,000 has been recognized in the
accompanying consolidated financial statements for the period ended March 31,
2004. The employment agreement provides for a separation or severance payment of
$100,000 if terminated by the company without cause as defined by the agreement.
Either party may provide thirty- day written notice to terminate this contract.
Should the Company terminate this agreement without cause, Mr. McElwrath is
entitled to any shares, which have not yet vested but are scheduled to vest
within thirty days of the written notice of termination.
F-8
8. Stockholders' Equity
Common Stock
In February 2004, we entered into an investor relations and consultant
contract whereby the consultant will receive each month $2,500 in cash and 3,000
shares of our common stock. As of March 31, 2004, we had 6,000 shares issuable
to the consultant for services rendered.
Private Placement Offering of Common Stock
During the quarter ended March 31, 2004, we initiated a private placement
sale of investment units. As of March 31, 2004, we had sold one unit. Each
investment unit consists of 10,000 shares of common stock and a warrant to
purchase 10,000 shares of common stock at $2.50 per share, over the next two
years. The Warrants may be exercised immediately after issuance until the
earlier of (i) two (2) years from the date of the Warrant Agreement, or (ii) the
date upon which the Warrants are redeemed by the Company (which may occur at
$0.01 per share in the event the Company provides at least forty days prior
written notice, the average closing price of the common stock for the fifteen
days prior to such written notice exceeds $3.50, and the Company limits its
redemption to 25% of the Warrant holder's total purchasable shares per month).
Proceeds of approximately $20,000 were received. This private placement is being
made pursuant to exemptions from registration under Regulation S of the
Securities Act of 1933 and requires the purchaser hold the stock for one year
from the date of purchase.
Exercise of Warrants To Purchase Common Stock
During the first quarter of 2004, the Company initiated redemption of 25%
of warrants issued in the offering that closed October 7, 2003 pursuant to the
warrant agreement. Warrant holders had to exercise these warrants by April 10,
2004 when these warrants terminate. During the first quarter of 2004, certain
shareholders exercised 258,211 warrants at an exercise price of $1.00 for
258,211 shares of common stock.
On July 23, 2003, the Company signed a Loan Agreement with Clarion Finanz
AG. The principle amount of the loan is $200,000. The loan had a Conversion
Privilege, at the exclusive option of the lender. The loan balance was
convertible into the Company's stock at $0.65 per share of common stock and one
full warrant for one common share exercisable at $1.00. The lender exercised the
conversion feature on October 6, 2003 with regard to $100,000 of the outstanding
balance of the loan. The lender exercised the conversion feature on February 20,
2004 with regard to $100,000 of the outstanding balance of the loan. The lender
received 153,846 restricted shares of common stock at $0.65 per share and one
full warrant exercisable at $1.00. The stock is restricted for two years from
the date of conversion. The lender also converted the warrants exercisable on
February 20, 2004 into 307,692 restricted shares of common stock.
Authorized
On March 4, 2003, a Special Meeting of our shareholders approved an
amendment to our articles of incorporation to increase the number of shares of
Common Stock authorized for issuance from 100,000,000 to 500,000,000 at par
value of $0.001. The shareholders also approved an amendment to our articles of
incorporation to authorize a class of 500,000,000 shares of preferred stock, par
value $0.001.
Stock Options
The Company applies APB Opinion 25, "Accounting for Stock Issued to
Employees," and related interpretations in accounting for its stock option plan
and has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS
No. 123) as amended by Statement of Financial Accounting Standards "Accounting
for Stock- Based Compensation--Transition and Disclosure--an amendment of FASB
Statement No. 123" (SFAS No.148).
F-9
Had compensation cost for these plans been determined consistent with the
provisions of SFAS No. 123, the Company's stock-based compensation expense, net
loss and loss per share would have been adjusted to the following pro forma
amounts:
March 31, March 31,
2004 2003
-------------------
Net loss:
As reported $(1,268,000) $(672,000)
Deducts: Total stock-based
employee compensation expense determined
under intrinsic value method for all
awards, net of tax (859,000) (252,000)
----------- -------------
Pro forma net loss $(2,127,000) $(924,000)
=========== =============
Basic loss per share:
As reported $0.02 $0.02
Pro forma $0.04 $0.02
Diluted loss per share:
As reported $0.02 $0.02
Pro forma $0.03 $0.02
The Company estimated the fair value of each stock award at the grant date
by using the Black-Scholes option-pricing model with the following
weighted-average assumptions: dividend yield at 0%; expected volatility of
approximately 30%; risk-free interest rate of 0.9% to 1.4% and expected lives of
five to ten years for the options.
9. Subsequent Events
Subsequent to the quarter ended March 31, 2004, and as of May 7, 2004, we
have raised approximately $2.04 million in an equity offering involving the sale
of 102 investment units, each of which consist of 10,000 shares of our common
stock and a warrant to purchase 10,000 shares of our common stock at $2.50.
Additionally, subsequent to March 31, 2004, and as of May 7, 2004, we
received approximately $2,388,826 upon the exercise of 2,388,826 warrants to
purchase 2,388,826 shares of our common stock. These warrants were issued as
part of our October 7, 2003 offering.
F-10
Item 2. Management's Discussion And Analysis of Financial Condition and Plan
of Operation
As used herein, the terms "Company", "we", "our" or "us" refer to Far East
Energy Corporation, a Nevada corporation, and its subsidiaries and predecessors,
unless the context indicates otherwise. Our United States office is located in
Houston, Texas, and we have offices in Beijing and in Kunming, Yunnan Province
of the People's Republic of China ("PRC").
Forward-looking Information
This information statement contains forward-looking statements. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. These statements relate to
future events or to our future financial performance. In some cases, you can
identify forward-looking statements by terminology such as "may," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential" or "continue" or the negative of such terms or other comparable
terminology. These statements are only predictions. Actual events or results may
differ materially. There are a number of factors that could cause our actual
results to differ materially from those indicated by such forward-looking
statements.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance, or achievements. Moreover, we do not assume
responsibility for the accuracy and completeness of such forward-looking
statements. We are under no duty to update any of the forward-looking statements
after the date of this information statement to conform such statements to
actual results. The foregoing management's discussion and analysis should be
read in conjunction with our financial statements and the notes herein.
2004 Plan of Operation
Yunnan Province, China
We spudded our first well on the Enhong-Laochang coalbed methane block in
Yunnan Province on October 26, 2003. The FCY-LC01 reached total depth of 825
meters (2,722 feet) on November 30, 2003. A total of 15 mineable coal seams were
penetrated during the drilling of the well, with a total thickness of 29.40
meters (97 feet), which we consider to be excellent. The coring of the coal
samples showed a recovery rate of 94.8%. In addition, the drilling revealed four
targeted major coal seams with a total thickness of 16.30 meters (54 feet), all
within an interval of about 110 meters (363 feet), which we believe are
favorable for fracturing and production of CBM. Testing of 18 desorption samples
from the well resulted in gas content estimates of approximately 650 cubic feet
per ton of coal.
On February 18, 2004, we concluded drilling our second well ("the
FCY-EH02") in the Enhong-Laochang Block and began conducting desorption
testing. Total depth of this second well reached 420 meters (1,344 feet),
penetrating 15 coal seams with a thickness of 16.7 meters (53.4 feet). The total
thickness of the coal seams targeted for potential production was 6.6 meters
with a recovery rate of 70%. Estimated gas content, based on preliminary
desorption results is approximately 10 cubic meters per ton of coal, or about
350 cubic feet per ton of coal.
On April 7, 2004, we concluded drilling our third well ("the FCY-EH01") in
the Enhong Block in Yunnan Province near Shang Sheshui Village and began
conducting desorption testing. Total depth of this third well reached 435 meters
(1,436 feet), penetrating 42 coal seams with a thickness of 42.8 meters (141
feet). The total thickness of the four coal seams targeted for potential
production was 17.2 meters (57 feet). Estimated gas content, based on
preliminary desorption results, is approximately 8-10 cubic meters per ton of
4
coal, or approximately 280-350 cubic feet per ton of coal.
Despite the strong results from these first wells we still cannot provide
assurances that commercial viability will be achieved. Profitable production
from these wells is subject to the following risks, among others:
- Three CBM wells cannot produce enough gas to achieve commercially
viability. We must complete several more CBM wells in near
proximity to each other in order to make it feasible to begin
production from any of them.
- No gas pipeline, LNG plant, or other offtake candidate currently
exists to take gas from these wells, and it is not likely that any
such facilities will be built until favorable results are obtained
from several more wells.
- Actual production may vary materially from preliminary test results.
Actual production from the well may be at recovery rates and gas
quality materially worse than our first indications.
We are evaluating whether to use horizontal drilling techniques or
continue to evaluate the Enhong-Laochang project with vertical wells. Under our
current PSC, we are required to drill two additional wells to satisfy
requirements of Phase I. If horizontal drilling techniques can be employed, we
believe that possibly only one horizontal well will be needed to satisfy the
requirements and are discussing the issue with CUCBM. Once a decision is
determined to drill vertical or horizontal wells, then drilling operations may
commence in November or December 2004, provided weather will permit the rig
movement to the location. We expect to spend a total of $1.3 million in the
first nine months of 2004 in the Enhong-Laochang project. We expect to fund
these activities with our existing capital, the exercise of warrants issued to
investors in our October 7, 2003 offering, and funds to be raised from the
offering being conducted outside the US in the first half of 2004.
Shanxi Province, China
We have entered into farmout agreements and an assignment agreement with
Phillips China, Inc., a subsidiary of Conoco Phillips, Inc., in which we agreed
to acquire a net undivided 40% of Phillips China's 70% interest in two
production sharing contracts in Shanxi Province. As currently structured, we
have a 40% interest in the projects, Phillips China has a 30% interest and CUCBM
has a 30% interest. The Assignment Agreement and appropriate amendments to the
PSCs substituting Far East Energy for Phillips China as the principal party and
operator was approved by CUCBM on March 15, 2004 and final ratification was
granted by the PRC's Ministry of Commerce on March 22, 2004.
The agreements obligate us, at our expense, to fracture stimulate and
production test three exploration wells that were drilled by Phillips China. We
anticipate the cost of these efforts to be $300,000 per well. We expect to begin
fracing and testing no later than late summer of 2004. If testing proves
satisfactory, we have the option to give notice to extend into the second phase
of exploration by drilling three (3) additional wells, also at our expense. If
we successfully complete the second phase, Phillips China will have the option
to elect to either retain its net undivided thirty percent (30%) participating
interest, or take an overriding royalty interest which will be capped at 3.5% of
the total Participating Interest.
In the first nine months of 2004, we expect to spend approximately
$1,800,000 to perform the required tests, cover costs related to CUCBM salary
fees, training fees, exploration fees and assistance fees required by the
production sharing contracts for these projects, and to pay ConocoPhillips
$76,052 for CBM equipment and materials associated with the project.
5
Our agreements with ConocoPhillips state that we have until May 14, 2004
to post a $1,000,000 bank guarantee or surety bond to guarantee performance of
the evaluation and work program to test the three existing wells. We estimate
that securing this surety bond will cost between $150,000-250,000, although we
may elect or have to place $1 million into escrow to satisfy this bond. An
additional $900,000 bond will be required if we enter the second drilling phase.
The cost of the additional bond is expected to be similar to the first bond. We
have the option to escrow the full amount of each required guarantee in lieu of
a bond. Required funding for these activities is expected to come from a
combination of existing capital, the exercise of warrants issued to investors in
our recently completed offering, and funds to be raised outside the US.
China Pipeline Access
In the Qinnan Block of our Shanxi Province project, the West-East pipeline
has the capacity of 1,000 MMcfpd. The Shanjing II pipeline is a 40" line which
would also have a 1,000 MMcfpd capacity and will run just north of our Shouyang
Block, in Shanxi Province. In the Qinnan and Shouyang areas we estimate that we
will eventually expend approximately $63 million for two short connecting
pipelines with 850 MMcfpd of capacity to the Shanjing II and West-East pipelines
(about 30 miles in total for the two connecting pipelines).
In the Yunnan area we have estimated a cost of $28 million for a 30-mile
pipeline with a capacity of 350 MMcfpd. At the present time there are no
pipelines to move gas for any great distance in the Yunnan Province, and gas
will have to be sold to the local communities.
Gas sales in these China blocks can also be achieved through development
of LNG. A 100-ton per day LNG plant will cost about $10 million to develop and
take about 2 years for construction. A 1000-ton per day LNG plant would cost
about $75 million with construction time close to 2 years. These costs may be
carried by an LNG company that would build the plants for the gas. It is very
possible that first gas sales from our China property will be through the
development of LNG plants close to our property.
Eastern Montana
Through our wholly owned subsidiary Newark Valley Oil & Gas, Inc., we are
developing plans for an exploratory drilling program on our Montana leases,
which we hope will demonstrate the existence of gas in commercial quantities.
However, our first priority is to complete our exploration obligations in China
because our properties in China clearly represent our greatest opportunity for
strong return on investment. We expect to expend approximately $250,000 in the
first half of 2004 to pay lease rentals in Montana and to conduct the necessary
evaluations and planning for a drilling program. These funds will come from
existing capital and/or the exercise of warrants issued in a financing concluded
in October 2003. The projected drilling program for China (Yunnan and Shanxi)
outlined above is anticipated to be financed through funding generated through a
current offering being made outside the US, plus cash-on-hand and the exercise
of warrants issued to investors in the financing concluded in October 2003.
If funds are not available for our Montana property, we will pursue a
farmout agreement with outside third parties. However, should funds be available
for our Montana project, we would expend between $1.5 and $2 million to drill
ten shallow wells as well as stimulate and construct a gathering system.
Assuming good results for the first ten well program, we may then proceed to
drill an additional 20 to 30 wells in 2005 to evaluate the potential of
constructing a pipeline to gain greater access to gas markets on the Northern
Border Pipeline. The cost of constructing a pipeline is estimated at $5 to $6
million. Continued development of this property could accelerate once a pipeline
is constructed and reach a pace of 50 to 75 wells per year for a period of four
to five years, at a cost of $8.5 to $12.7 million per year.
6
Montana Pipeline Access
We can get into the Bitter Creek Gathering System which has a capacity of
about 2,000 Mcfpd at the present time. If development were to continue and
Bitter Creek was unable to move all the available FEEC gas it is possible to lay
a 8" to 10" line to Northern Border Pipeline which is approx 25 to 30 miles
north of our acreage at a cost of approximately $4 to $6 million.
Results of Operation and Analysis of Financial Condition
The following discussion should be read in conjunction with the audited
financial statements and notes thereto included in our annual report on Form
10-KSB for the fiscal year ended December 31, 2003; and should further be read
in conjunction with the financial statements included in this report.
Comparisons made between reporting periods herein are for the quarter ended
March 31, 2004 as compared to the quarter ended March 31, 2003.
We had no operating revenue for the three months ended March 31, 2004 and
no revenue for the same period in 2003. The Company's total expenses for the
three months ended March 31, 2004 increased by 89% to $1,269,000 as compared to
$672,000 for the same period in 2003. The expenses we incurred in 2004 as
compared to 2003 are set forth in the table below.
- --------------------------------------------------------------------------------
Percentage Increase
Expenses* 2004 2003 (+) or decrease (-)
- --------------------------------------------------------------------------------
Geologic & Engineering Services $103,000 $72,000 (+) 43%
Other Consulting & Professional Services 83,000 87,000 (-) 5%
Compensation 201,000 242,000 (-) 17%
Travel 84,000 92,000 (-) 9%
Stock Option Compensation 207,000 - (+) 100%
Legal & Accounting 208,000 68,000 (+) 206%
Mineral lease rent 19,000 - (+) 100%
Loss on investment in joint venture - 22,000 (-) 100%
Amortization of Contract Rights 23,000 15,000 (+) 53%
General & Administrative 341,000 74,000 (+) 361%
Total $1,269,000 $672,000 (+) 89%
- --------------------------------------------------------------------------------
* Note that these expenses may not represent all actual expenditures in the
above categories as a result of our ability to capitalize certain expenditures.
Geologic and engineering services increased by approximately $31,000 or
43% from $72,000 during the three months ended March 31, 2003 to $103,000 during
the three months ended March 31, 2004. We spudded our first three exploratory
wells in the last quarter of 2003 and the first quarter of 2004 and capitalized
related drilling and geologic and engineering expenses of approximately
$606,000.
Compensation decreased by approximately $41,000 or 17% due to streamlining
management responsibilities.
Travel costs decreased approximately $8,000 or 9% from $92,000 during the
three months ended March 31, 2003 to $84,000 during the three months ended March
31, 2004. This decrease was due to less travel abroad.
7
Legal and accounting expenses increased approximately $140,000 or 206%
from $68,000 during the three months ended March 31, 2003 to $208,000 during the
three months ended March 31, 2004. The primary reasons for this increased
expense were our response to the SEC's investigation regarding ownership of the
Company's stock and costs related to our various current and previous financing
activities.
General and administrative expense increased approximately $267,000 or
361% from $74,000 during the three months ended March 31, 2003 to $341,000
during the three months ended March 31, 2004. Included in this increase are
overhead expenditures from expanded operating activities in China including
professional fees for CUCBM and contract labor.
These increased expenses resulted in our operating loss increasing to
$1,269,000 for the three months ended March 31, 2004, as compared to $672,000
for the same period of 2003. As is the case with our increased expenses, our
increased operating loss is also attributable to our increased efforts to
explore, develop, extract and sell coalbed methane gas in China, as well as our
financing efforts.
Liquidity and Capital Resources
As of March 31, 2004, our cash and cash equivalents were $1,256,000, as
compared to $2,326,000 as of December 31, 2003. The decrease is due to the
expenditures made in our planning for and the initiation of exploration and
development of oil and gas properties, as well as for the reasons set forth
above for our increased expenses.
Cash used in operating activities for the quarter ended March 31, 2004 was
$747,000 as compared to cash used in operating activities for the same period of
2003 of $350,000. This change is mainly attributable to our net loss partially
offset by an increase in accounts payable.
Cash used in investing activity increased to $602,000 for the quarter
ended March 31, 2004, as compared to $136,000 for the same period in 2003. This
increase is primarily attributable to our investment in unproved oil and gas
properties.
Cash provided by financing activities was $279,000 for the quarter ended
March 31, 2004, compared to cash used in financing activities of $115,000 for
2003. The increase in cash provided by financing activities reflects proceeds
from the exercise of warrants in 2004, and our decrease in long term liabilities
in 2003.
We believe that we have sufficient cash to fund operating needs and
financial obligations through the end of the third quarter of 2004. We
anticipate incurring approximately $3 million in exploration and development
expenses in the first nine months of 2004. This figure could be as high as $4
million if we elect to post cash reserves in lieu of performance bonds as
required by the ConocoPhillips agreements in Shanxi (See, 2004 Plan of Operation
- - Shanxi Province, China).
If we complete phase 1 requirements for both of the projects in China in
2004, we estimate that will require exploration related expenditures of
approximately $2MM in the fourth quarter of 2004. Incremental funding will be
necessary to provide cash to complete phase 1 by year-end.
To develop our projects in China over the long term, we need to obtain
funding to satisfy very significant expenditures for exploration and development
of those projects, if they are successful. We anticipate obtaining such
significant funds by various methods, which might include the issuance of
8
equity securities, obtaining farm-out partners and the potential sale of
property interests among other alternatives.
As of May 7, 2004, we have raised approximately $2.06 million in an equity
offering involving the sale of 103 investment units, each of which consist of
10,000 shares of our common stock and a warrant to purchase 10,000 shares of our
common stock at $2.50. Additionally, we notified investors in our October 7,
2003 offering of our intention to redeem 25% of the warrants received. As of May
7, 2004, we received a total of approximately $2,679,729 upon the exercise of
2,679,729 warrants to purchase 2,679,729 shares of our common stock.
We intend to continue financing efforts to support our current and
proposed business operations in China and Montana. Our ability to continue as a
going concern is dependent upon our ability to raise additional, substantial
funds for use in our planned development activities, and upon the success of our
planned exploration and development activities. Since there can be no guarantee
of future fundraising success, and since the success of exploratory drilling can
never, by definition, be guaranteed, it must be stated that there is substantial
doubt about our ability to continue as a going concern. However, management
believes that we will continue to be successful in raising the funds necessary
to explore for gas and, assuming success in those exploratory efforts, to raise
the funds necessary for production and development. Management believes that, in
the near term, we will be able to raise funds sufficient to assure satisfaction
of its operating capital needs and financial obligations through December 31,
2004. These funds are anticipated to be raised through a combination of the
continued exercise of warrants issued to investors in conjunction with the
recently completed private offering and future equity and/or debt offerings.
We do not expect to receive significant revenues from operations in China
until at least late 2006. If we elect to pursue a drilling program in Montana in
the last half of 2004, we could generate revenues during 2005, although we have
not resolved to pursue drilling in Montana as of May 7, 2004. To generate
revenue in China prior to the point at which production reaches pipeline
quantities, we may elect to construct liquefied natural gas (LNG) facilities on
our properties. However, we believe an LNG company may decide to construct such
facilities at their own cost. This would allow gas to be produced and sold in
the period before we achieve production in sufficient quantities to justify
constructing short connecting pipelines to the Shangjing II and West-East
pipelines in the Shanxi Province, or before a pipeline or other offtake facility
is operational in the Yunnan Province. A 100 ton/day LNG facility, which would
absorb approximately 5 million cubic feet of gas per day, would cost $10-15
million to construct. A 1000 LNG ton/day facility capable of absorbing 50
million cubic feet of gas per day would cost approximately $75 million. Again,
while we may opt to construct LNG facilities, it is quite possible that an LNG
concern may decide to construct such facilities near our properties at their own
cost. We may construct pipelines to move gas from our fields to either
municipalities or other pipelines. We estimate the cost to construct a pipeline
in the Enhong and Laochang areas to be approximately $28 million. Our farmout
agreement from ConocoPhillips provides us with rights to two separate blocks;
the Shouyang block, approximately 40 km south of the Shangjing II Pipeline to
Beijing, and the Qinnan block, approximately 10 km north of the West-East
Pipeline to Shanghai. We estimate the cost to construct pipeline connections
from the Shouyang and Qinnan blocks to the Shangjing II and West-East Pipelines,
respectively, to be approximately $63 million. We are delaying any decisions
regarding the construction of LNG facilities or pipelines until such time as
significant gas volumes are achieved. We believe this delay may allow us to
avoid construction costs to the extent other entities (attracted by our gas),
have constructed, are constructing or are planning to construct, such
facilities.
9
Critical Accounting Policies
Management's discussion and analysis of our financial condition and
results of operations are based on our consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States (GAAP). GAAP represents a comprehensive set of accounting
and disclosure rules and requirements, the application of which requires
management judgments and estimates including, in certain circumstances, choices
between acceptable GAAP alternatives. The preparation of these consolidated
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities, if any, at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. We base our estimates on historical experience and various
other assumptions that are believed to be reasonable under the circumstances.
Actual results could differ from these estimates under different assumptions or
conditions. Note 1 to our consolidated financial statements included in our Form
10-KSB for the year ended December 31, 2003, contains a comprehensive summary of
our significant accounting policies. The following is a discussion of our most
critical accounting policies, judgments and uncertainties that are inherent in
our application of GAAP:
Accounting for Oil and Gas Properties. Under the successful efforts method
of accounting, we capitalize all costs related to property acquisitions and
successful exploratory wells, all development costs and the costs of support
equipment and facilities. Certain costs of exploratory wells are capitalized
pending determination that proved reserves have been found. Such determination
is dependent upon the results of planned additional wells and the cost of
required capital expenditures to produce the reserves found. All costs related
to unsuccessful exploratory wells are expensed when such wells are determined to
be non-productive; other exploration costs, including geological and geophysical
costs, are expensed as incurred. We recognize gains or losses on the sale of
properties on a field basis.
The application of the successful efforts method of accounting requires
management's judgment to determine the proper designation of wells as either
developmental or exploratory, which will ultimately determine the proper
accounting treatment of the costs incurred. The results from a drilling
operation can take considerable time to analyze, and the determination that
commercial reserves have been discovered requires both judgment and application
of industry experience. Wells may be completed that are assumed to be productive
and actually deliver oil and gas in quantities insufficient to be economic,
which may result in the abandonment of the wells at a later date. Seismic costs
incurred to select development locations within a productive oil and gas field
are typically treated as development costs and capitalized. Judgment is required
to determine when the seismic programs are not within proved reserve areas and
therefore would be charged to expense as exploratory. The evaluation of oil and
gas leasehold acquisition costs requires management's judgment to estimate the
fair value of exploratory costs related to drilling activity in a given area.
Drilling activities in an area by other companies may also effectively condemn
leasehold positions.
The successful efforts method of accounting can have a significant impact
on the operational results reported when we enter a new exploratory area in
hopes of finding oil and gas reserves. Seismic costs can be substantial which
will result in additional exploration expenses when incurred. The initial
exploratory wells may be unsuccessful and the associated costs will then be
expensed as dry hole costs and any associated leasehold costs may be impaired.
Impairment of unproved oil and gas properties. Unproved leasehold costs
and exploratory drilling in progress are capitalized and are reviewed
periodically for impairment. Costs related to impaired prospects or unsuccessful
exploratory drilling are charged to expense. Our assessment of the results of
exploration activities, commodity price outlooks, planned future sales or
expiration of all or a portion of such leaseholds impacts the amount and timing
of impairment provisions. An impairment expense could result if oil and gas
prices decline in the future, as it may not be economic to develop some of these
unproved properties. As of March 31, 2004, we had total unproved oil and gas
property costs of approximately $3.5 million consisting of undeveloped
10
leasehold costs of $2.4 million in Montana and unevaluated exploratory drilling
costs of $1.1 million incurred in China, compared to $2.9 million consisting of
undeveloped leasehold costs of $2.4 million in Montana and unevaluated
exploratory drilling costs of $497,000 incurred in China as of December 31,
2003.
Estimates of future dismantlement, restoration, and abandonment costs. The
accounting for future development and abandonment costs changed on January 1,
2003, with the adoption of SFAS 143. SFAS No. 143 requires the fair value of a
liability for an asset retirement obligation to be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset. The accrual is based on estimates of these costs for
each of our properties based upon the type of production structure, reservoir
characteristics, depth of the reservoir, market demand for equipment, currently
available procedures and consultations with construction and engineering
consultants. Because these costs typically extend many years into the future,
estimating these future costs is difficult and requires management to make
estimates and judgments that are subject to future revisions based on numerous
factors, including changing technology, the political and regulatory environment
and, beginning in 2003, estimates as to the proper discount rate to use and
timing of abandonment. The Company has not acquired any assets that result in a
material future abandonment cost. Therefore, there is no provision in the
accompanying consolidated financial statements.
Income taxes. We provide deferred income taxes on transactions which are
recognized in different periods for financial and tax reporting purposes. We
also have deferred tax assets related to operating loss carryforwards. We
periodically assess the probability of recovery of recorded deferred tax assets
based on our assessment of future earnings outlooks by tax jurisdiction and
record valuation allowances when this assessment results in a determination that
recoverability is not likely. Such estimates and determinations are inherently
imprecise because many assumptions are utilized in the assessments that may
prove to be incorrect in the future. At March 31, 2004, and December 31, 2003,
we have recorded a valuation allowance for the full amount of net deferred tax
assets.
Assessments of functional currencies. Our Chinese operations use the
Chinese Yuan as their functional currency. Management determines the functional
currencies of our subsidiaries based on an assessment of the currency of the
economic environment in which a subsidiary primarily realizes and expends its
operating revenues, costs and expenses. The assessment of functional currencies
can have a significant impact on periodic results of operations and financial
position.
We have also adopted SFAS No. 52, Foreign Currency Translation, which
requires that the translation of the applicable foreign currency into U.S.
dollars be performed for balance sheet accounts using current exchange rates in
effect at the balance sheet date and for revenue and expense accounts using a
weighted average exchange rate during the period. The gains or losses resulting
from such translation are included in the consolidated statements of
stockholders' equity and comprehensive income.
We apply SFAS No. 128, Earnings Per Share, for the calculation of "Basic"
and "Diluted" earnings per share. Basic earnings per share includes no dilution
and is computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted
earnings per share reflects the potential dilution of securities that could
share in our earnings.
We also apply APB Opinion 25, Accounting for Stock Issued to Employees,
and related interpretations in accounting for our stock option plan and have
adopted the disclosure-only provisions of SFAS No. 123, as amended by SFAS No.
148, Accounting for Stock-Based Compensation. Compensation cost for stock
options granted has been recognized for certain options granted at an exercise
11
price below market value. Other options granted had an exercise price equal to
or greater than the market value of the underlying common stock on the day of
grant.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not engage in hedging activities and do not use commodity futures or
forward contracts in our cash management functions. We do not hedge our exposure
to currency rate changes. Instead, we are at risk for changes in currency
exchange rates between the United States and the People's Republic of China. In
general, we hold cash reserves in U.S. Dollars and transfer funds to China as
needed to operate our Chinese offices and conduct exploration operations. For
the near term, we do not expect to generate any operating income from activities
in China.
Because we frequently send money to China to fund operations, we are
exposed to foreign currency risk. If the value of U.S. dollars falls in relation
to the Chinese yuan, the cost to us of funding our Chinese operations would rise
because more dollars would be required to fund the same expenditures in yuan.
Conversely, if the value of U.S. dollars rises in relation to the Chinese yuan,
the change in exchange rates would decrease our dollar cost to fund operations
in China.
In recent years, the Chinese government has fixed the exchange rate
between U.S. dollars and Chinese yuan. Because the exchange rate has been fixed,
instead of variable, we have experienced no fluctuations in the value of goods
and services we purchase in China because of currency exchange. However, the
United States and other foreign governments have repeatedly sought to establish
a floating exchange rate between the Chinese yuan and other foreign currencies.
If, in the future, China accedes to requests to let its currency float against
the dollar, we must either adopt cash management strategies to hedge U.S.
dollars against the yuan or be subject to the exchange rate risks described
above.
ITEM 4 CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, we carried out an
evaluation under the supervision and with the participation of our management,
including our Chief Executive Officer and the Chief Financial Officer, of the
effectiveness of the design and operation of our disclosures controls and
procedures pursuant to Exchange Act Rule 13a-14.
Based upon the evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls are effective in timely alerting
them to material information relating to the company (including its consolidated
subsidiaries) required to be included in our periodic SEC filings. There have
been no significant changes in our internal controls or in other factors which
could significantly affect internal controls subsequent to the date we conducted
our evaluation.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Jawaharlal Gondi, one of our directors, has notified us that he intends to
file a claim against us for unpaid compensation and expenses and an unpaid
promissory note incurred during 2003. However, we have written to Mr. Gondi's
lawyer denying his claims for compensation in excess of what he has already been
paid and denying the note claim. We have acknowledged some of the expense claims
and paid them in part. At March 31, 2004, the unpaid expense claims amounted to
approximately $42,000, which amount we acknowledged and recorded as a liability
on our financial statements. As of the date of this report, we do not believe
any legal action has been filed against us regarding these claims.
12
Item 2 CHANGES IN SECURITIES AND USE OF PROCEEDS
In February 2004, we initiated the redemption of 25% of warrants issued in
our private placement offering that closed October 7, 2003. In the quarter ended
March 31, 2004, we issued to ten persons an aggregate of 258,211 shares of
common stock upon the exercise of warrants granted in the offering upon our
receipt of an aggregate exercise price of $258,211. All of these warrant holders
purchased these securities in our October 7, 2003 offering. Since March 31,
2004, and as of May 7, 2004, we have received $2,388,826 upon the exercise of an
additional 2,388,826 warrants. All of the shares were issued pursuant to
exemptions from registration under Sections 3(b) and 4(2) of the Securities Act
of 1933. No commission was paid on the exercise of these warrants.
During the quarter ended March 31, 2004, we initiated a private placement
sale of investment units. As of March 31, 2004, we had sold one unit. Each
investment unit consists of 10,000 shares of common stock and a warrant to
purchase 10,000 shares of common stock at $2.50 per share, over the next two
years. The Warrants may be exercised immediately after issuance until the
earlier of (i) two (2) years from the date of the Warrant Agreement, or (ii) the
date upon which we redeem the Warrants (which may occur at $0.01 per share in
the event we provide at least forty days prior written notice, the average
closing price of our common stock for the fifteen days prior to such written
notice exceeds $3.50, and we limit our redemption to 25% of the Warrant holder's
total purchasable shares per month). Proceeds of approximately $20,000 were
received. A cash commission of 10% was paid, as was a 3% expense allowance and
also a 10% warrant commission. This private placement is being made pursuant to
exemptions from registration under Regulation S under the Securities Act of 1933
and requires the purchaser hold the stock for one year from the date of
purchase.
Subsequent to the first quarter ended March 31, 2004, we continued our
Regulation S offering of investment units discussed above, with the units
consisting of the same terms as discussed in the preceding paragraph. Since
March 31, 2004 and as of May 7, 2004, we sold 102 investment units in exchange
for total proceeds of $2.04 million. A cash commission of 10% is being paid on
funds raised in this offering, as is a 3% expense allowance and also a 10%
warrant commission. These securities were sold to persons not resident in the
U.S. in reliance upon Regulation S under the Securities Act of 1933, as amended.
Item 5. OTHER INFORMATION
U.S. Securities and Exchange Commission Trading Investigation
In December 2003, we learned that the Company is the subject of an
investigation by the U.S. Securities and Exchange Commission. We understand that
the Commission is investigating whether anyone has issued false or misleading
statements in an attempt to manipulate the price of our common stock, whether
anyone has profited from selling stock at artificially high prices due to the
manipulative statements, and whether any individual or group has failed to file
ownership reports with the Commission as required for 10% or more stockholders
under Section 16 of the Securities Exchange Act of 1934 or failed to file
ownership reports with the Commission as required for 5% or more stockholders
under Section 13 of the Securities Exchange Act of 1934. Management does not
know of any acquisitions in excess of 5% of its outstanding shares, except for
those described in previous 13D filings with the SEC. We have supplied
information to the Commission in response to their information requests and
intend to cooperate with their investigation. We do not know what the outcome of
their investigation may be.
The Exchange Act and SEC rules require that a person or group of persons
who acquire more than 5% of a class of equity securities that are registered
under the Exchange Act must report their holdings in a Schedule 13D filing with
the SEC within 10 days after they become 5% shareholders, and must thereafter
13
report changes in their ownership of the securities. In addition, Section 16(a)
of the Exchange Act generally requires that owners of more than 10% of a class
of stock that is registered under the Exchange Act, must report changes in their
holdings within 48 hours of an acquisition or disposition of the securities.
If a person or group owns a large block of stock of a publicly traded
company, particularly if that stock is not subject to restrictions on its
purchase and sale on the open market, there is a risk that the person or group
could sufficiently control the market for the stock to drive the stock's trading
price stock up or down, and thereby the undisclosed control group could reap
trading profits at the expense of other public investors. In addition, Schedule
13D requires owners of a control group of stock to disclose their intentions
with respect to management or control of the company. Far East is making this
announcement to alert the public that an undisclosed control group might exist.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. Exhibits required to be attached by Item 601 of Regulation
S-B are listed in the Index to Exhibits beginning on page 15 of this Form
10-Q, which is incorporated herein by reference.
(b) Reports on Form 8-K. No reports were filed on Form 8-K during the
first quarter of 2004.
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 this 10th day of May, 2004.
Far East Energy Corporation
/s/ Michael R. McElwrath
----------------------------
Michael R. McElwrath
Chief Executive Officer, President and
Chairman of the Board (Principal Executive Officer)
/s/ Mark Schaftlein
-----------------------------
Mark Schaftlein
Chief Financial Officer (Principal Financial Officer)
14
INDEX TO EXHIBITS
Exhibits marked with an asterisk have been filed previously with the Commission
and are incorporated herein by reference.
EXHIBIT NO. PAGE NO. DESCRIPTION
3(i) * Articles of Incorporation (Incorporated by
reference from the Company's Form 10-SB, file number
000- 32455, filed on March 16, 2001.)
3(ii) * Bylaws (Incorporated by reference from the Company's
Form 10-SB, file number 000-32455, filed on March
16, 2001.)
10(i) + Memo of Understanding with Phillips China Inc.
10(ii) + Farmout Agreement-Qinnan (Phillips China)
10(iii) + Farmout Agreement-Shouyang (Phillips China)
10(iv) + Assignment Agreements on the Qinnan CMB blocks
(Phillips China)
10(v) + Assignment Agreements on the Shouyang CMB blocks
(Phillips China)
31(i) 16 302 Certification of Chief Executive Officer
31(ii) 17 302 Certification of Chief Financial Officer
32(i) 18 906 Certification of Chief Executive Officer
32(ii) 19 906 Certification of Chief Financial Officer
* Previously filed and incorporated herein by reference from the Company's Form
10-SB, file number 000-32455, filed on March 16, 2001. + Previously filed and
incorporated herein by reference from the Company's Form 10-QSB for the quarter
ended June 30, 2003.
15
EXHIBIT 31(i)
CERTIFICATION
I, Michael R. McElwrath, Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Far East Energy
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The small business issuer's other certifying officer(s) and I are responsible
for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d- 15(e)) for the registrant and have:
(a) designed such disclosure controls and procedures or caused such
disclosure controls and procedures to be designed under my supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to myself by others within those
entities, particularly during the period in which this report is being
prepared;
(b) designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under my
supervision, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principles;
(c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report my conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
(d) disclosed in this report any change in the registrant's internal
controls over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in the
case of an annual report) that has materially affected, or is reasonably
likely to materially effect, the registrant's internal controls over
financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing equivalent functions);
(a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonable likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
Date: May 10, 2004
/s/ Michael R. McElwrath
- ------------------------
Michael R. McElwrath
Chief Executive Officer
16
EXHIBIT 31(ii)
CERTIFICATION
I, Mark Schaftlein, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Far East Energy
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) designed such disclosure controls and procedures or caused such
disclosure controls and procedures to be designed under my supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to myself by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
(b) designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under my
supervision, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principles;
(c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report my conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
(d) disclosed in this report any change in the registrant's internal
controls over financial reporting that occurred during the registrant's
most recent quarter (the registrant's fourth fiscal quarter in the case of
an annual report) that has materially affected, or is reasonably likely to
materially effect, the small business issuer's internal controls over
financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing equivalent functions);
(a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonable likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
Date: May 10, 2004
/s/ Mark Schaftlein
- -----------------------
Mark Schaftlein
Chief Financial Officer
17
EXHIBIT 32(i)
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report on Form 10-Q of Far East Energy
Corporation (the "Company") for the period ended March 31, 2004 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), the
undersigned, Michael R. McElwrath, the Chief Executive Officer of the Company,
hereby certifies, pursuant to 18 U.S.C. section 1350, that:
(1) the Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Date: May 10, 2004
/s/ Michael R. McElwrath
- ------------------------
Michael R. McElwrath
Chief Executive Officer
18
EXHIBIT 32(ii)
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report on Form 10-Q of Far East Energy
Corporation (the "Company") for the period ended March 31, 2004 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), the
undersigned, Mark Schaftlein, Chief Financial Officer of the Company, hereby
certifies, pursuant to 18 U.S.C. section 1350, that:
(1) the Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Date: May 10, 2004
/s/ Mark Schaftlein
- ------------------------
Mark Schaftlein
Chief Financial Officer
19