Attached files
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 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 December 31, 2009
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _____________ to ___________________
Commission file number: 000-51425
Rancher Energy Corp.
--------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Nevada 98-0422451
---------- ----------
999 - 18th Street, Suite 3400
Denver, CO 80202
(Address of principal executive offices)
(303) 629-1125
(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 has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T (ss.232.405 of
this Chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files). Yes [ ] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] (Do not check if a smaller reporting company)
Small reporting company [X]
1
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [ ] No [X]
As of February 13, 2010, 119,316,723 shares of Rancher Energy Corp. common
stock, $.00001 par value, were outstanding.
2
Rancher Energy Corp.
Table of Contents
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Balance Sheets as of December 31, 2009 and March 31, 2009..................................4
Unaudited Statements of Operations for the Three and Nine Months ended
December 31, 2009 and 2008..........................................................................6
Unaudited Statement of Changes in Stockholders' Equity for the Nine Months ended
December 31, 2009...................................................................................8
Unaudited Statements of Cash Flows for the Nine Months ended
December 31, 2009 and 2008..........................................................................9
Notes to Financial Statements......................................................................10
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....................25
Item 3. Quantitative and Qualitative Disclosures About Market Risk...............................................35
Item 4. Controls and Procedures..................................................................................36
Item 4T. Controls and Procedures..................................................................................36
PART II - OTHER INFORMATION
Item 1. Legal Proceedings........................................................................................38
Item 1A. Risk Factors.............................................................................................38
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..............................................38
Item 3. Defaults Upon Senior Securities..........................................................................38
Item 4. Submission of Matters to a Vote of Security Holders......................................................38
Item 5. Other Information .......................................................................................38
Item 6. Exhibits.................................................................................................38
SIGNATURES........................................................................................................40
3
Part I. Financial Information.
Item 1. Financial Statements
Rancher Energy Corp.
Debtor in Possession
Balance Sheets
ASSETS
December 31,
2009 March 31, 2009
Unaudited Audited
Current assets:
Cash and cash equivalents $172,855 $917,160
Accounts receivable and prepaid expenses 783,514 584,139
Derivative receivable - 455,960
----------------- -------------------
Total current assets 956,369 1,957,259
----------------- -------------------
Oil and gas properties at cost (successful efforts method):
Unproved 53,077,682 53,328,147
Proved 19,374,998 20,631,487
Less: Accumulated depletion, depreciation, amortization and impairment (56,088,911) (41,840,978)
----------------- -------------------
Net oil and gas properties 16,363,769 32,118,656
----------------- -------------------
Other assets:
Furniture and equipment net of accumulated depreciation of $524,119 and $381,396,
respectively 619,348 770,354
Deferred finance costs - 387,414
Other assets 919,420 546,178
----------------- -------------------
Total other assets 1,538,768 1,703,946
----------------- -------------------
Total assets $18,858,906 $35,779,861
================= ===================
(Continued)
The accompanying notes are an integral part of these financial statements.
4
Rancher Energy Corp.
Debtor in Possession
Balance Sheets
(Continued)
LIABILITIES AND STOCKHOLDERS' EQUITY
December 31, 2009 March 31, 2009
----------------- --------------
Unaudited Audited
Current liabilities:
Accounts payable and accrued liabilities - post petition $930,569 $185,972
Asset retirement obligation 122,269 108,884
Note payable, net of unamortized discount of $-0- and $165,790, respectively 10,089,987 9,834,210
---------------------- ---------------------
Total current liabilities 11,142,825 10,129,066
Long-term liabilities:
Asset retirement obligation 1,277,891 1,171,796
---------------------- ---------------------
Total long-term liabilities 1,277,891 1,171,796
---------------------- ---------------------
Total liabilities not subject to compromise 12,420,716 11,300,862
Liabilities subject to compromise 1,282,836 630,836
---------------------- ---------------------
Total liabilities 13,703,552 11,931,698
1,194 1,191
Additional paid-in capital 92,949,532 92,582,001
Accumulated deficit (87,795,372) (68,735,029)
---------------------- ---------------------
Total stockholders' equity 5,155,354 23,848,163
---------------------- ---------------------
Total liabilities and stockholders' equity $18,858,906 $35,779,861
====================== =====================
The accompanying notes are an integral part of these financial statements.
5
Rancher Energy Corp.
Debtor In Possession
Statements of Operations
(Unaudited)
Three Months Ended December 31,
Revenues: 2009 2008
Oil & gas sales $970,502 $746,967
Derivative gains (losses) (6,809) 1,586,911
--------------------------- ---------------------------
963,693 2,333,878
--------------------------- ---------------------------
Operating expenses:
Production taxes 143,769 90,940
Lease operating expenses 411,150 831,559
Depreciation, depletion and amortization 299,184 350,847
Accretion expense 38,821 40,661
Impairment of unproved properties 13,525,642 32,500,000
Exploration expense 3,340 4,293
General and administrative 568,717 780,261
--------------------------- ---------------------------
Total operating expenses 14,990,623 34,598,561
--------------------------- ---------------------------
Loss from operations (14,026,930) (32,264,683)
--------------------------- ---------------------------
Other income (expense):
Amortization of deferred finance costs
and discount on note payable (239,106) (848,696)
Interest expense (460,165) (323,190)
Interest and other income 7 6,811
--------------------------- ---------------------------
Total other income (expense) (699,264) (1,165,075)
--------------------------- ---------------------------
Loss before reorganization items (14,726,194) (33,429,758)
--------------------------- ---------------------------
Reorganization Items
Professional and legal fees 158,727 -
--------------------------- ---------------------------
Net loss $(14,884,921) $(33,429,758)
=========================== ===========================
Basic and diluted net loss per share $(0.12) $(0.29)
=========================== ===========================
Basic and diluted weighted average shares outstanding 119,316,700 116,196,049
=========================== ===========================
The accompanying notes are an integral part of these financial statements
6
Rancher Energy Corp.
Debtor In Possession
Statements of Operations
(Unaudited)
Nine Months Ended December 31,
Revenues: 2009 2008
Oil & gas sales $2,498,376 $4,641,836
Derivative gains (losses) (357,582) 997,169
-------------------------- ----------------------------
2,140,794 5,639,005
-------------------------- ----------------------------
Operating expenses:
Production taxes 338,547 564,590
Lease operating expenses 1,088,163 2,004,422,
Depreciation, depletion and amortization 868,263 928,395
Accretion expense 119,480 117,771
Impairment of unproved properties 13,525,642 39,300,000
Exploration expense 15,172 13,896
General and administrative 2,066,226 2,788,415
-------------------------- ----------------------------
Total operating expenses 18,021,493 45,717,489
-------------------------- ----------------------------
Loss from operations (15,880,699) (40,078,484)
-------------------------- ----------------------------
Other income (expense):
Amortization of deferred finance costs and
discount on note payable (1,770,789) (3,524,399)
Interest expense (1,250,859) (1,069,884)
Interest and other income 731 26,129
-------------------------- ----------------------------
Total other income (expense) (3,020,917) (4,568,154)
-------------------------- ----------------------------
Loss before reorganization items (18,901,616) (44,646,638)
Reorganization Items
Professional and legal fees 158,727 -
Net loss $(19,060,343) $(44,646,638)
========================== ============================
Basic and diluted net loss per share $(0.16) $(0.39)
========================== ============================
Basic and diluted weighted average shares outstanding 119,357,245 115,541,973
========================== ============================
The accompanying notes are an integral part of these financial statements
7
Rancher Energy Corp.
Debtor In Possession
Statement of Changes in Stockholders' Equity
For the Nine Months Ended December 31, 2009
(Unaudited)
Additional Total
Paid-In Accumulated Stockholders'
------------
Shares Amount Capital Deficit Equity
------ ------ ------- ------- ------
Balance, April 1, 2009 119,016,700 $1,191 $92,582,001 $(68,735,029) $23,848,163
Common stock issued on exercise of options 500,000 5 - - 5
Cancelation of non-vested restricted stock (200,000) (2) 2 -
Stock-based compensation - - 262,529 - 262,529
Financing cost associated with beneficial
conversion feature of convertible debt 105,000 105,000
Net loss - - - (19,060,343) (19,060,343)
---------------- ---------- --------------- ----------------- -----------------
Balance, December 31, 2009 119,316,700 $1,194 $92,949,532 $(87,795,372) $5,155,354
================ ========== =============== ================= =================
The accompanying notes are an integral part of these financial statements.
8
Rancher Energy Corp.
Debtor In Possession
Statements of Cash Flows
(unaudited)
Nine Months Ended December 31,
2009 2008
Cash flows from operating activities:
Net loss $(19,060,343) $(44,646,638)
Adjustments to reconcile net loss to cash used for
operating activities:
Depreciation, depletion, and amortization 868,263 928,395
Impairment of unproved properties 13,525,642 39,300,000
Reorganization items, net 158,727 -
Accretion expense 119,480 117,771
Asset retirement obligation settlements - (146.401)
Interest expense beneficial conversion feature,
convertible notes payable 105,000 -
Interest expense converted to short-term debt 188,112 -
Amortization of deferred financing costs and discount
on note payable 1,665,789 3,524,398
Unrealized (gains) losses on derivative activities 455,960 (836,907)
Stock-based compensation expense 210,829 353,481
Services exchanged for common stock - directors 51,700 295,050
Loss on asset sale - 35,797
Changes in operating assets and liabilities:
Accounts receivable and prepaid expenses (199,375) (181,616)
Other assets 19,205 -
Accounts payable and accrued liabilities 1,154,390 (1,142,448)
-------------------------- ----------------------------
Net cash used for operating activities, before
reorganization (736,621) (2,399,118)
Cash effect of reorganization items (56,519) -
-------------------------- ----------------------------
Net cash used for operating activities (793,140) (2,399,118)
-------------------------- ----------------------------
Cash flows from investing activities:
Capital expenditures for oil and gas properties (3,805) (230,087)
Proceeds from sale of other assets 10,760 -
Increase in other assets - (440,101)
-------------------------- ----------------------------
Net cash used for investing activities 6,955 (670,188)
-------------------------- ----------------------------
Cash flows from financing activities:
Payment of deferred financing costs - (101,478)
Repayment of debt (98,125) (2,240,000)
Proceeds from issuance of convertible notes payable 140,000 -
Proceeds from issuance of common stock upon exercise
of stock options 5 8
-------------------------- ----------------------------
Net cash used for financing activities 41,880 (2,341,470)
-------------------------- ----------------------------
Decrease in cash and cash equivalents (744,305) (5,410,776)
Cash and cash equivalents, beginning of period 917,160 6,842,365
-------------------------- ----------------------------
Cash and cash equivalents, end of period $172,855 $1,431,589
========================== ============================
Non-cash investing and financing activities:
Cash paid for interest $613,479 $ 1,069,733
========================== ============================
Payables settled for oil and gas properties $ - $ 53,799
========================== ============================
Asset retirement asset and obligation $- $ 43,493
========================== ============================
Deferred finance costs, conveyance of overriding
royalty and net profits interest $1,500,000 $ 1,050,000
========================== ============================
9
Rancher Energy Corp.
Debtor in Pos session
Notes to Financial Statements
For the Nine Months Ended December 31, 2009
(Unaudited)
Note 1 - Organization and Summary of Significant Accounting Policies
Organization
------------
Rancher Energy Corp. ("Rancher Energy" or the "Company") was
incorporated in the state of Nevada on February 4, 2004. The Company acquires,
explores for, develops and produces oil and natural gas, concentrating on
applying secondary and tertiary recovery technology to older, historically
productive fields in North America.
Basis of Presentation
The accompanying unaudited financial statements include the accounts of
the Company's wholly owned subsidiary, Rancher Energy Wyoming, LLC, a Wyoming
limited liability company that was formed on April 24, 2007. In management's
opinion, the Company has made all adjustments, consisting of only normal
recurring adjustments, necessary for a fair presentation of financial position,
results of operations, and cash flows. The financial statements should be read
in conjunction with financial statements included in the Company's Annual Report
on Form 10-K for the year ended March 31, 2009. The accompanying financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial information. They do not
include all information and notes required by generally accepted accounting
principles for complete financial statements. However, except as disclosed
herein, there has been no material change in the information disclosed in the
notes to financial statements included in the Company's Annual Report on Form
10-K for the year ended March 31, 2009. Operating results for the periods
presented are not necessarily indicative of the results that may be expected for
the full year.
Bankruptcy Filing
-----------------
On October 28, 2009, the Company filed a voluntary petition (the
"petition") for relief in the United States Bankruptcy Court, District of
Colorado under Chapter 11 of Title 11 of the U.S. Bankruptcy Code (the
"Bankruptcy Court"). The Company will continue to operate its business as
"debtor-in-possession" under the jurisdiction of the Bankruptcy Court and in
accordance with the applicable provisions of the Code and orders of the
Bankruptcy Court. See Note 2 "Proceedings Under Chapter 11 of the Bankruptcy
Code" for details regarding the Bankruptcy filing and the Chapter 11 case.
The accompanying financial statements have been prepared on the basis
of accounting principles applicable to a going concern, which contemplates the
realization of assets and extinguishment of liabilities in the normal course of
business. However, the petition raises substantial doubt about the Company's
ability to remain a going concern. The Company's continuation as a going concern
may be contingent upon, among other things, its ability (i) to obtain
Debtor-in-Possession financing; (ii) to reduce administrative, operating and
interest costs and liabilities through the bankruptcy process; (iii) to generate
sufficient cash flow from operations; (iv) to obtain confirmation of a plan of
reorganization under the Bankruptcy Code; and (v) to obtain financing to
facilitate an exit from bankruptcy. We are currently evaluating various courses
of action to address the operational and liquidity issues the Company is facing
and are in the process of formulating plans for improving operations. There can
be no assurance that any of these efforts will be successful. The accompanying
financial statements do not include any adjustments that might result should we
be unable to continue as a going concern. In the event the Company's
restructuring activities are not successful and it is required to liquidate,
additional significant adjustments in the carrying value of assets and
liabilities, the revenues and expenses reported and the balance sheet
classifications used may be necessary.
10
Financial Accounting Standards Board (FASB) Accounting Standards
Codification (FASB ASC) 852-10 "Financial Reporting During Reorganization
Proceedings," which is applicable to companies in Chapter 11, generally does not
change the manner in which financial statements are prepared. However, it does
require that the financial statements for periods subsequent to the filing of a
Chapter 11 case distinguish transactions and events that are directly associated
with the reorganization from the ongoing operations of the business. Revenues,
expenses, realized gains and losses, and provisions for losses that can be
directly associated with the reorganization and restructuring of the business
must be reported separately as reorganization items in the statements of
operations beginning in the period ending December 31, 2009. The balance sheet
must distinguish pre-petition liabilities subject to compromise from both those
pre-petition liabilities that are not subject to compromise and from
post-petition liabilities. Liabilities that may be affected by a plan of
reorganization must be reported at the amounts expected to be allowed, even if
they may settled for lesser amounts. In addition, cash provided by
reorganization items, if any, must be disclosed separately in the statement of
cash flows. The Company adopted FASB ASC 852-10 effective on October 28, 2009
and will segregate those items as outlined above for all reporting periods
subsequent to such date.
Use of Estimates in the Preparation of Financial Statements
-----------------------------------------------------------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of oil and gas
reserves, assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting periods. Actual results could differ
from those estimates. Estimates of oil and gas reserve quantities provide the
basis for calculations of depletion, depreciation, and amortization (DD&A) and
impairment, each of which represents a significant component of the financial
statements.
Oil and Gas Producing Activities
--------------------------------
The Company uses the successful efforts method of accounting for its
oil and gas properties. Under this method of accounting, all property
acquisition costs and costs of exploratory and development wells are capitalized
when incurred, pending determination of whether the well has found proved
reserves. If an exploratory well does not find proved reserves, the costs of
drilling the well are charged to expense. Exploratory dry hole costs are
included in cash flows from investing activities as part of capital expenditures
within the statements of cash flows. The costs of development wells are
capitalized whether or not proved reserves are found. Costs of unproved leases,
which may become productive, are reclassified to proved properties when proved
reserves are discovered on the property. Unproved oil and gas interests are
carried at the lower of cost or estimated fair value and are not subject to
amortization.
Geological and geophysical costs and the costs of carrying and
retaining unproved properties are expensed as incurred. DD&A of capitalized
costs related to proved oil and gas properties is calculated on a
property-by-property basis using the units-of-production method based upon
proved reserves. The computation of DD&A takes into consideration restoration,
dismantlement, and abandonment costs and the anticipated proceeds from salvaging
equipment.
The Company complies with FASB ASC 932-360 "Extractive Activities - Oil
and Gas". The Company currently does not have any existing capitalized
exploratory well costs, and has therefore determined that no suspended well
costs should be impaired.
The Company reviews its long-lived assets for impairments when events
or changes in circumstances indicate that impairment may have occurred. The
impairment test for proved properties compares the expected undiscounted future
net cash flows on a property-by-property basis with the related net capitalized
costs, including costs associated with asset retirement obligations, at the end
of each reporting period. Expected future cash flows are calculated on all
proved reserves using a discount rate and price forecasts selected by the
11
Company's management. The discount rate is a rate that management believes is
representative of current market conditions. The price forecast is based on
NYMEX strip pricing, adjusted for basis and quality differentials, for the first
three to five years and is held constant thereafter. Operating costs are also
adjusted as deemed appropriate for these estimates. When the net capitalized
costs exceed the undiscounted future net revenues of a field, the cost of the
field is reduced to fair value, which is determined using discounted future net
revenues. An impairment allowance is provided on unproved property when the
Company determines the property will not be developed or the carrying value is
not realizable. The Company recognized $13.5 million and $39.3 million of
impairment of on unproved properties during the nine months ended December 31,
2009 and 2008, respectively.
Capitalized Interest
--------------------
The Company's policy is to capitalize interest costs to oil and gas
properties on expenditures made in connection with exploration, development and
construction projects that are not subject to current DD&A and that require
greater than six months to be readied for their intended use ("qualifying
projects"). Interest is capitalized only for the period that such activities are
in progress. To date the Company has had no such qualifying projects during
periods when interest expense has been incurred. Accordingly the Company has
recorded no capitalized interest.
Commodity Derivatives
---------------------
The Company accounts for derivative instruments or hedging activities
under the provisions of FASB ASC 815-10 "Derivatives and Hedging" FASB ASC
815-10 requires the Company to record derivative instruments at their fair
value. The Company's risk management strategy is to enter into commodity
derivatives that set "price floors" and "price ceilings" for its crude oil
production. The objective is to reduce the Company's exposure to commodity price
risk associated with expected crude oil production.
The Company has elected not to designate the commodity derivatives to
which they are a party as cash flow hedges, and accordingly, such contracts are
recorded at fair value on its balance sheets and changes in such fair value are
recognized in current earnings as income or expense as they occur.
The Company does not hold or issue commodity derivatives for
speculative or trading purposes. The Company is exposed to credit losses in the
event of nonperformance by the counterparty to its commodity derivatives. It is
anticipated, however, that its counterparty will be able to fully satisfy its
obligations under the commodity derivatives contracts. The Company does not
obtain collateral or other security to support its commodity derivatives
contracts subject to credit risk but does monitor the credit standing of the
counterparty. The price the Company receives for production in its three fields
is indexed to Wyoming Sweet crude oil posted price. The Company has not hedged
the basis differential between the NYMEX price and the Wyoming Sweet price.
Under the terms of our Term Credit Agreement issued in October 2007 the Company
was required hedge a portion of its expected future production, and it entered
into a costless collar agreement for a portion of its anticipated future crude
oil production. The costless collar contains a fixed floor price (put) and
ceiling price (call). If the index price exceeds the call strike price or falls
below the put strike price, the Company receives the fixed price and pays the
market price. If the market price is between the call and the put strike price,
no payments are due from either party. The table below summarizes the terms of
the Company's costless collar:
Derivative losses are included in cash flows from operating activities
in the accompanying Statements of Cash Flows. The table below summarizes the
realized and unrealized losses related to our derivative instruments for the
three and nine months ended December 31, 2009 and 2008.
Three Months Ended December 31, Nine Months Ended December 31,
2009 2008 2009 2008
---- ---- ---- ----
Realized gains (losses) on derivative instruments $- $144,285 $98,378 $(505,623)
Unrealized gains (losses) on derivative instruments (6,809) 1,442,626 (455,960) 1,505,792
---------------- ---------------- --------------- -----------------
Total realized and unrealized gains (losses)
recorded $(6,809) $1,586,911 $(357,582) $997,169
================ ================ =============== =================
12
The Company's hedge expired under its own terms on October 31, 2009. As of
December 31, 2009 the Company has no hedges in place.
Net Profits Interest
--------------------
The Company assigned a 10% Net Profits Interest (NPI) to its Lender,
under the terms of the Eighth Amendment to the Term Credit Agreement (see NOTE 5
- Short-term Note Payable). Net profit is defined as the excess of the sum of
crude oil proceeds plus hedge settlements, over the sum of lease operating,
marketing, transportation and production tax expenses. The Company is obligated
to pay to the Lender 10% of such excess, if any, on a monthly basis, so long as
the NPI remains in effect. The Company records amounts due under the NPI as
operating expense. For the nine months ended December 31, 2009, the Company
recognized $107,681 as NPI expense, including such amount as lease operating
expense in its Statement of Operations.
Net Loss Per Share
------------------
Basic net (loss) per common share of stock is calculated by dividing
net loss available to common stockholders by the weighted-average of common
shares outstanding during each period. Diluted net income per common share is
calculated by dividing adjusted net loss by the weighted-average of common
shares outstanding, including the effect of other dilutive securities. The
Company's potentially dilutive securities consist of in-the-money outstanding
options and warrants to purchase the Company's common stock. Diluted net loss
per common share does not give effect to dilutive securities as their effect
would be anti-dilutive.
The treasury stock method is used to measure the dilutive impact of
stock options and warrants. The following table details the weighted-average
dilutive and anti-dilutive securities related to stock options and warrants for
the periods presented:
For the Nine Months Ended December 31,
--------------------------------------
2009 2008
---- ----
Dilutive - -
Anti-dilutive 57,961,019 70,314,465
Reclassification
----------------
Certain amounts in the fiscal 2009 financial statements have been
reclassified to conform to the fiscal 2010 financial statement presentation.
Such reclassifications had no effect on net loss.
Other Significant Accounting Policies
-------------------------------------
Other accounting policies followed by the Company are set forth in Note
1 to the Financial Statements included in its Annual Report on Form 10-K for the
year ended March 31, 2009, and are supplemented in the Notes to Financial
Statements in this Quarterly Report on Form 10-Q for the nine months ended
December 31, 2009. These unaudited financial statements and notes should be read
in conjunction with the financial statements and notes included in the Annual
Report on Form 10-K for the year ended March 31, 2009.
13
Recent Accounting Pronouncements
--------------------------------
In June 2009, the Financial Accounting Standards Board ("FASB") issued
"FASB Accounting Standards Codification ("Codification"), as the single source
of authoritative US GAAP" for all non-governmental entities, with the exception
of the SEC and its staff. The Codification, which became effective July 1, 2009,
changes the referencing and organization of accounting guidance and is effective
for interim and annual periods ending after September 15, 2009. The Company
adopted the Codification on July 1, 2009 which provides for changes in
references to technical accounting literature (if used) in this Quarterly Report
on Form 10-Q and subsequent reports, but did not have a material impact on the
Company's financial position, results of operations or cash flows.
In September 2006, the FASB issued accounting guidance related to fair
value measurements and related disclosures. This new guidance defines fair
value, establishes a framework for measuring fair value, and expands disclosures
about fair value measurements. The Company adopted this guidance on April 1,
2008, as required for its financial assets and financial liabilities. However,
the FASB deferred the effective date of this guidance for one year as it relates
to fair value measurement requirements for nonfinancial assets and nonfinancial
liabilities that are not recognized or disclosed at fair value on a recurring
basis, which include, among others, those nonfinancial long-lived assets
measured at fair value for impairment assessment and asset retirement
obligations initially measured at fair value. Fair value used in the initial
recognition of asset retirement obligations is determined based on the present
value of expected future dismantlement costs incorporating our estimate of
inputs used by industry participants when valuing similar liabilities.
Accordingly, the fair value is based on unobservable pricing inputs and
therefore, is considered a level 3 value input in the fair value hierarchy (See
Note 5 "Fair Value Measurements" herein). The adoption of this accounting
guidance related to these items did not have a material impact on the Company's
financial position or results of operations.
In April 2009, the FASB issued additional guidance regarding fair value
measurements and impairments of securities which makes fair value measurements
more consistent with fair value principles, enhances consistency in financial
reporting by increasing the frequency of fair value disclosures, and provides
greater clarity and consistency in accounting for and presenting impairment
losses on securities. The additional guidance is effective for interim and
annual periods ending after June 15, 2009, with early adoption permitted for
periods ending after March 15, 2009. The Company adopted the provisions for the
period ending June 30, 2009. The adoption did not have a material impact on its
financial position or results of operations.
In April 2009, the FASB issued new accounting guidance related to
interim disclosures about the fair values of financial instruments. This
guidance requires disclosures about the fair value of financial instruments
whenever a public company issues financial information for interim reporting
periods. This guidance is effective for interim reporting periods ending after
June 15, 2009. The Company adopted this guidance upon its issuance, which
requires additional disclosures regarding the fair value of financial
instruments in this Quarterly Report on Form 10-Q and subsequent reports, but
had no material impact on the Company's financial statements. See Note 5 "Fair
Value Measurements" herein for the required disclosures.
In June 2009, the FASB issued new accounting guidance related to the
accounting and disclosures of subsequent events. This guidance incorporates the
subsequent events guidance contained in the auditing standards literature into
authoritative accounting literature. It also requires entities to disclose the
date through which they have evaluated subsequent events and whether the date
corresponds with the release of their financial statements. This guidance is
effective for all interim and annual periods ending after June 15, 2009. The
Company adopted this guidance upon its issuance and it had no material impact on
the Company's financial statements. The Company evaluates subsequent events up
to immediately prior to the issuance of its financial statements, and for
purposes of the accompanying financial statements, the Company has evaluated
subsequent events through February 19, 2010 the filing date of this 10-Q.
In August 2009, the FASB issued new accounting guidance to provide
clarification on measuring liabilities at fair value when a quoted price in an
active market is not available. This guidance became effective for us on October
1, 2009. The Company adopted this guidance on October 1, 2009, and it had no
material impact on its financial statements.
14
On December 31, 2008, the SEC adopted a final rule that amends its oil
and gas reporting requirements. The revised rules change the way oil and gas
companies report their reserves in their financial statements. The rules are
intended to reflect changes in the oil and gas industry since the original
disclosures were adopted in 1978. Definitions were updated to be consistent with
Petroleum Resource Management System. Other key revisions include a change in
pricing used to prepare reserve estimates, the inclusion of non-traditional
resources in reserves, the allowance for use of new technologies in determining
reserves, optional disclosure of probable and possible reserves and significant
new disclosures. The revised rules will be effective for the Company's Annual
Report on Form 10-K for the fiscal year ending March 31, 2010. The SEC is
precluding application of the new rules in quarterly reports prior to the first
annual report in which the revised disclosures are required and early adoption
is not permitted.
In January 2010, the FASB issued an Accounting Standards Update (ASU)
entitled Oil and Gas Reserve Estimation and Disclosures. This ASU amends the
FASB accounting standards to align the reserve calculation and disclosure
requirements with the requirements in the new SEC Rule, Modernization of Oil and
Gas Reporting Requirements. The ASU will be effective for annual reporting
periods ending on or after December 31, 2009.
In January 2010, the FASB issued guidance which requires an entity to disclose
the following:
o Separately disclose the amounts of significant transfers in and out of
Level 1 and Level 2 fair value measurements and describe reasons for
the transfers.
o Present separately information about purchases, sales, issuances and
settlements, on a gross basis, rather than on one net number, in the
reconciliation for fair value measurements using significant
unobservable inputs (Level 3).
o Provide fair value measurement disclosures for each class of assets
and liabilities.
o Provide disclosures about the valuation techniques and inputs used to
measure fair value for both recurring and nonrecurring fair value
measurements for fair value measurements that fall in either Level 2
or Level 3.
This guidance is effective for interim and annual reporting periods beginning
after December 15, 2009, except for the disclosures about purchases, sales,
issuance and settlement on the forward of activity in Level 3 fair value
measurements. Those disclosures are effective for fiscal years beginning after
December 15, 2010. The Company is currently in the process of evaluating the new
requirements.
In September 2009, the FASB issued its proposed updates to oil and gas
accounting rules to align the oil and gas reserve estimation and disclosure
requirements of Extractive Industries--Oil and Gas (Topic 932) with the
requirements in the SEC's final rule discussed above. The public comment period
for the FASB's proposed updates ended October 15, 2009; however, no final
guidance has been issued by the FASB. The Company is evaluating the potential
impact of any updates to the oil and gas accounting rules and will comply with
any new accounting and disclosure requirements once they become effective. The
Company anticipates that the following rule changes could have a significant
impact on its results of operations as follows:
o The price used in calculating reserves will change from a
single-day closing price measured on the last day of the company's
fiscal year to a 12-month average price, and will affect the
Company's depletion and ceiling test calculations.
o Several reserve definitions have changed that could revise the
types of reserves that will be included in the Company's year-end
reserve report.
Many of the Company's financial reporting disclosures could change as a result
of the new rules.
Note 2 - Proceedings Under Chapter 11 of the Bankruptcy Code
As discussed in Note 1 above, on October 28, 2009 (the "Petition
Date"), the Company filed a voluntary petition for relief under Chapter 11 of
the Bankruptcy Code with the Bankruptcy Court. The petition was filed in order
15
to enable the Company to pursue reorganization efforts under Chapter 11 of the
Bankruptcy Code. The Company continues to operate its business as
debtor-in-possession under the jurisdiction of the Bankruptcy Court and in
accordance with the applicable provisions of the Bankruptcy Code and orders of
the Bankruptcy Court. In general, as debtor-in-possession, the Company is
authorized under Chapter 11 to continue to operate as an ongoing business, but
may not engage in transactions outside of the ordinary course of business
without the prior approval of the Bankruptcy Court.
No assurance can be provided as to what values, if any, will be
ascribed in the bankruptcy proceedings to the Company's pre-petition
liabilities, common stock and other securities. Based upon the status of the
Company's plan of reorganization, we currently believe that it is uncertain
whether holders of our securities will receive any payment in respect of such
securities. Accordingly, extreme caution should be exercised with respect to
existing and future investments in any of these liabilities or securities.
Subject to certain exceptions under the Bankruptcy Code, the Bankruptcy
Filing automatically enjoins, or stays, the continuation of any judicial or
administrative proceedings or other actions against the Company or its property
to recover on, collect or secure a claim arising prior to the Petition Date.
Thus, for example, creditor actions to obtain possession of property from the
Company, or to create, perfect or enforce any lien against the property of the
Company, or to collect on or otherwise exercise rights or remedies with respect
to a pre-petition claim are enjoined unless and until the Bankruptcy Court lifts
the automatic stay with respect thereto.
In order to successfully exit Chapter 11 bankruptcy, the Company will
need to propose and obtain Bankruptcy Court confirmation of a plan of
reorganization that satisfies the requirements of the Bankruptcy Code. A plan of
reorganization would, among other things, resolve the Debtors' pre-petition
obligations, set forth the revised capital structure of the newly reorganized
entity and provide for corporate governance subsequent to exit from bankruptcy.
The Company has the exclusive right for 120 days after the Petition Date to file
a plan of reorganization and 60 additional days to obtain necessary acceptances.
Such periods may be extended by the Bankruptcy Court for cause to up to 18
months and 20 months, respectively, after the Petition Date. If the Company's
exclusivity period lapses, any party in interest may file a plan of
reorganization for the Company. In addition to the need for Bankruptcy Court
confirmation and satisfaction of Bankruptcy Code requirements, a plan of
reorganization must be accepted as described below by at least one class of
holders of impaired claims in order to be confirmed. A class of impaired claim
holders against or a class of equity interests in the Company is deemed to have
accepted the plan of reorganization if (i) at least one-half in number and
two-thirds in dollar amount of claims (exclusive of claims held by "insiders" as
that term is defined in the Bankruptcy Code) actually voting have voted to
accept the plan; and (ii) at least two-thirds in amount of equity interests
(exclusive of interests held by "insiders" as that term is defined in the
Bankruptcy Code) actually voting in each impaired class of equity interests has
voted to accept the plan. Under circumstances specified in the so-called
"cramdown" provisions of section 1129(b) of the Bankruptcy Code, the Bankruptcy
Court may confirm a plan even if such plan has not been accepted by all impaired
classes of claims and equity interests. A class of claims or equity interests
that does not receive or retain any property under the plan on account of such
claims or interests is deemed to have voted to reject the plan. The precise
requirements and evidentiary showing for confirming a plan notwithstanding its
rejection by one or more impaired classes of claims or equity interests depends
upon a number of factors, including the status and seniority of the claims or
equity interests in the rejecting class -- i.e., secured claims or unsecured
claims, subordinated or senior claims, preferred or common stock.
Under section 365 of the Bankruptcy Code, the Company may assume,
assume and assign, or reject executory contracts and unexpired leases, including
real property and equipment leases, subject to the approval of the Bankruptcy
Court and certain other conditions. Rejection constitutes a court-authorized
breach of the lease or contract in question and, subject to certain exceptions,
relieves the Company of its future obligations under such lease or contract but
creates a deemed pre-petition claim for damages caused by such breach or
rejection. Parties whose contracts or leases are rejected may file claims
against the Company for damages. Generally, the assumption of an executory
16
contract or unexpired lease requires the Company to cure all prior defaults
under such executory contract or unexpired lease, including all pre-petition
arrearages, and to provide adequate assurance of future performance. In this
regard, the Company expects that liabilities subject to compromise and
resolution in the Chapter 11 case will arise in the future as a result of damage
claims created by the Company's rejection of various executory contracts and
unexpired leases. Conversely, the Company would expect that the assumption of
certain executory contracts and unexpired leases may convert liabilities shown
in our financial statements as subject to compromise to post-petition
liabilities. Due to the uncertain nature of many of the potential claims, the
Company is unable to project the magnitude of such claims with any degree of
certainty at this time.
The Bankruptcy Court has established a deadline for the filing of
proofs of claim under the Bankruptcy Code of March 5, 2010, requiring the
Company's creditors to submit claims for liabilities not paid and for damages
incurred. There may be differences between the amounts at which any such
liabilities are recorded in the Company's financial statements and the amount
claimed by the Company's creditors. Litigation may be required to resolve any
such disputes or discrepancies.
There can be no assurance that a reorganization plan will be proposed
by the Company or confirmed by the Bankruptcy Court, or that any such plan will
be consummated.
The ability of the Company to continue as a going concern may depend
upon, among other things, (i) the Company's ability to comply with the terms and
conditions of the cash collateral orders entered by the Bankruptcy Court in
connection with the Bankruptcy Case; (ii) ) the ability of the Company to
generate cash from operations; (iii) the ability of the Company to maintain
adequate cash on hand; (iv) the ability of the Company to obtain confirmation of
and to consummate a plan of reorganization under the Bankruptcy Code; and, (v)
the cost, duration and outcome of the reorganization process. Uncertainty as to
the outcome of these factors raises substantial doubt about the Company's
ability to continue as a going concern. We are currently evaluating various
courses of action to address the operational and liquidity issues the Company is
facing. There can be no assurance that any of these efforts will be successful.
The accompanying unaudited financial statements do not include any adjustments
that might result should the Company be unable to continue as a going concern.
Preparing the accompanying unaudited financial statements on a going concern
basis contemplates the realization of assets and the discharge of liabilities in
the normal course of business for the foreseeable future.
As a result of the Bankruptcy Filing, realization of assets and
liquidation of liabilities are subject to uncertainty. While operating as a
debtor-in-possession under the protection of Chapter 11, and subject to
Bankruptcy Court approval or otherwise as permitted in the normal course of
business, the Company may sell or otherwise dispose of assets and liquidate or
settle liabilities for amounts other than those reflected in the condensed
financial statements. Further, a plan of reorganization could materially change
the amounts and classifications reported in our financial statements. Our
historical financial statements do not give effect to any adjustments to the
carrying value of assets or amounts of liabilities that might be necessary as a
consequence of confirmation of a plan of reorganization.
The uncertainty resulting from the Chapter 11 filing may hinder the
Company's ongoing business activities and its ability to operate, fund and
execute its business plan by impairing relations with property owners and
potential lessees, vendors and service providers; negatively impact the ability
of the Company to attract, retain and compensate key executives and employees
and to retain employees generally; limit the Company's ability to obtain trade
credit; and limit the Company's ability to maintain and exploit existing
properties and acquire and develop new properties.
Under the priority scheme established by the Bankruptcy Code, unless
creditors agree otherwise, post-petition liabilities and pre-petition
liabilities must be satisfied in full before shareholders of the Company are
entitled to receive any distribution or retain any property under a plan of
reorganization. The ultimate recovery, if any, to creditors and shareholders of
the Company will not be determined until confirmation and consummation of a plan
of reorganization. No assurance can be given as to what values, if any, will be
ascribed in the Chapter 11 case to each of these constituencies or what types or
amounts of distributions, if any, they would receive. Accordingly, the Company
urges that extreme caution be exercised with respect to existing and future
investments in any of the Company's liabilities and/or securities.
17
Reorganization Items
--------------------
Reorganization items represent the direct and incremental costs related
to the Company's Chapter 11 case, such as professional fees incurred, net of
interest income earned on accumulated cash during the Chapter 11 process. These
restructuring activities may result in additional charges and other adjustments
for expected allowed claims (including claims that have been allowed by the
Court) and other reorganization items that could be material to the Company's
financial position or results of operations in any given period.
Liabilities Subject to Compromise
Liabilities subject to compromise at December 31, 2009 and March 31,
2009 include the following pre-petition liabilities:
December 31, 2009 March 31, 2009
------------------------------------------------------------------------------------------------
Accounts payable, trade $165,781 $ -
Other payables and accrued liabilities 305,566 105,985
Property and ad valorem taxes payable 671,489 524,851
Convertible notes payable 140,000 -
---------------------------------------
Total liabilities subject to compromise $1,282,836 $630,836
=======================================
Note 3--Oil and Gas Properties
The Company's oil and gas properties are summarized in the following table:
December 31, March 31,
------------- --------------
2009 2009
Proved properties $19,374,998 $20,631,487
Unproved properties exclueded from DD&A 52,713,480 52,953,185
Equipment and other 364,202 374,962
------------------- -------------------
Subtotal Unevaluated Properties 53,077,682 53,328,147
------------------- -------------------
Total oil and gas properties 72,452,680 73,959,634
Less accumulated depletion, depreciation,
amortization and impairment (56,088,911) (41,840,978)
------------------- -------------------
$16,363,769 $32,118,656
=================== ===================
Assignment of Overriding Royalty Interest and Net Profits Interest
------------------------------------------------------------------
In conjunction with the issuance of short term debt in October 2007
(See Note 5), the Company assigned the Lender a 2% Overriding Royalty Interest
(ORRI), proportionally reduced when the Company's working interest is less than
100%, in all crude oil and natural gas produced from its three Powder River
Basin fields. The Company estimated that the fair value of the ORRI granted to
the Lender to be approximately $4,500,000 and recorded this amount as a debt
discount and a decrease of oil and gas properties. In October 2008 the Company
extended the maturity date of the short term debt by six months. As partial
consideration for the extension, the Company granted an increase in the
proportionate ORRI from 2% to 3%. The Company estimated that the fair value of
18
the incremental ORRI granted to the Lender to be approximately $1,050,000 and
has recorded this amount as a debt discount and a decrease of oil and gas
properties. In June 2009 the Company extended the maturity date of the short
term debt until October 15, 2009. As partial consideration for the extension,
the Company assigned the Lender a 10% Net Profits Interest (the "NPI") in all
crude oil and natural gas produced from its three Powder River Basin fields. The
Company estimated the fair value of the NPI to be approximately $1,500,000 and
recorded this amount as deferred finance costs and a decrease of oil and gas
properties.
Impairment of Unproved Properties
---------------------------------
In conjunction with its periodic assessment of impairment of unproved
properties, the Company reevaluated the carrying value of its unproved
properties giving consideration to the Company's financial condition, commodity
price volatility, difficulties in the global financial markets and the related
difficulties the Company has encountered in raising capital to develop the
properties. Accordingly, Company management determined to recognize impairment
during the nine months ended December 31, 2009 in an amount equal to the
remaining carrying value of its unproved properties, $13,525,642. For the same
period in 2008 the Company recognized impairment of unproved properties in the
amount of $39,300,000.
Note 4 - Asset Retirement Obligations
The Company recognizes an estimated liability for future costs
associated with the abandonment of its oil and gas properties. A liability for
the fair value of an asset retirement obligation and a corresponding increase to
the carrying value of the related long-lived asset are recorded at the time a
well is completed or acquired. The increase in carrying value is included in
proved oil and gas properties in the balance sheets. The Company depletes the
amount added to proved oil and gas property costs and recognizes accretion
expense in connection with the discounted liability over the remaining estimated
economic lives of the respective oil and gas properties. Cash paid to settle
asset retirement obligations are included in the operating section of the
Company's statements of cash flows.
The Company's estimated asset retirement obligation liability is based
on historical experience in abandoning wells, estimated economic lives,
estimates as to the cost to abandon the wells in the future, and federal and
state regulatory requirements. The liability is discounted using a
credit-adjusted risk-free rate estimated at the time the liability is incurred
or revised, as appropriate. Revisions to the liability result from changes in
estimated abandonment costs, changes in well economic lives, or if federal or
state regulators enact new requirements regarding the abandonment of wells.
A reconciliation of the Company's asset retirement obligation liability
during the nine months ended December 31, 2009 and 2008 is as follows:
2009 2008
---- ----
Beginning asset retirement obligations $1,280,680 $1,259,851
Liabilities incurred -
Liabilities settled - (147,661)
Changes in estimates - 43,493
Accretion expense 119,480 117,771
-------------------- -----------------
Ending asset retirement obligation $1,400,160 $1,273,454
-------------------- -----------------
Current $122,269 $320,768
Long-term 1,277,891 952,686
-------------------- -----------------
$1,400,160 $1,273,454
==================== =================
19
Note 5 -- Fair Value Measurements
The Company complies with FASB ASC 820-10 "Fair Value Measurements and
Disclosures" which defines fair value, establishes a framework for using fair
value to measure assets and liabilities, and expands disclosures about fair
value measurements. The Statement establishes a hierarchy for inputs used in
measuring fair value that maximizes the use of observable inputs and minimizes
the use of unobservable inputs by requiring that the most observable inputs be
used when available. Observable inputs are inputs that market participants would
use in pricing the asset or liability developed based on market data obtained
from sources independent of the Company. Unobservable inputs are inputs that
reflect the Company's assumptions of what market participants would use in
pricing the asset or liability developed based on the best information available
in the circumstances. The hierarchy is broken down into three levels based on
the reliability of the inputs as follows:
o Level 1: Quoted prices are available in active markets for identical
assets or liabilities;
o Level 2: Quoted prices in active markets for similar assets and
liabilities that are observable for the asset or liability; or
o Level 3: Unobservable pricing inputs that are generally less
observable from objective sources, such as discounted cash flow models
or valuations.
FASB ASC 820-10 requires financial assets and liabilities to be
classified based on the lowest level of input that is significant to the fair
value measurement. The Company's assessment of the significance of a particular
input to the fair value measurement requires judgment, and may affect the
valuation of the fair value of assets and liabilities and their placement within
the fair value hierarchy levels. The following table presents the company's
financial assets and liabilities that were accounted for at fair value on a
recurring basis as of December 31, 2009 by level within the fair value
hierarchy:
Fair Value Measurements Using
-----------------------------
Level 1 Level 2 Level 3
------- ------- -------
Assets: $- $- $-
Liabilities $- $- $ -
Asset retirement obligation $- $- $ 1,400,160
The Company's sole derivative financial instrument, a participating cap
costless collar agreement expired during the three months ended December 31,
2009. The fair value of the costless collar agreement was determined based on
both observable and unobservable pricing inputs and therefore, the data sources
utilized in these valuation models were considered level 3 inputs in the fair
value hierarchy. In the Company's adoption of FASB ASC 820-10-05, it considered
the impact of counterparty credit risk in the valuation of its assets and its
own credit risk in the valuation of its liabilities that are presented at fair
value. The Company established the fair value of its derivative instruments
using a published index price, the Black-Scholes option-pricing model and other
factors including volatility, time value and the counterparty's credit adjusted
risk free interest rate. The following table sets forth a reconciliation of
changes in the fair value of financial assets and liabilities classified as
level 3 in the fair value hierarchy:
2009 2008
Balance as of April 1 $455,960 $(836,907)
Total gains (losses) (realized or unrealized):
Included in earnings (357,582) 997,169
Included in other comprehensive income - -
Purchased, issuances and settlements (98,378) 680,223
Transfers in and out of Level 3 -
------------- -------------
Balance as of December 31 $- $840,485
============= =============
20
Change in unrealized gains (losses) included
in earnings relating to derivatives still held
as of December 31 $- $ 1,677,392
============= =============
Note 6- Short-term Note Payable
On October 16, 2007, the Company issued a Note Payable (the "Note") in
the amount of $12,240,000 pursuant to a Term Credit Agreement with a financial
institution (the "Lender"). All amounts outstanding under the Note were
originally due and payable on October 31, 2008 (the "Maturity Date") and bore
interest at a rate equal to the greater of (a) 12% per annum and (b) the
one-month LIBOR rate plus 6% per annum. The Note was amended on October 22,
2008, (the "First Amendment"), to extend the Maturity Date by six months from
October 31, 2008 to April 30, 2009. In consideration of the six month extension
and other terms included in First Amendment, the Company made a principal
payment to the Lender in the amount of $2,240,000, resulting in a new loan
balance of $10,000,000. The Note was amended six times between April 30, and May
27, 2009 to extend the Maturity Date for short periods of time while the Lender
and the Company finalized the terms of a longer extension.
On June 3, 2009 the Note was again amended (the "Eighth Amendment") to
among other things extend the maturity date until October 15, 2009. Under the
provisions of the Eighth Amendment, the Company executed and delivered a
Conveyance of Net Profits, granting to the Lender a net profits interest in and
to the Company's properties equal to 10% of the net profit attributable to the
Company's interest in and to all hydrocarbons produced or saved from its
properties. Under the terms of the Eighth Amendment, the Company had the right
to purchase from the Lender: (a) two-thirds (2/3), but not less, of the net
profits interest for the period beginning on June 3, 2009 and ending on August
7, 2009 for the sum of $2,000,000 in cash or (b) for the period beginning August
8, 2009 and ending on October 15, 2009, one-third (1/3), but not less, for the
sum of $1,333,333 in cash (the Company did not exercise either of the purchase
options). The Company did not make payment of the principal and accrued interest
on the maturity date, October 15, 2009.
Under the terms of the Eighth Amendment, all amounts outstanding under
the Term Credit Agreement, as amended, bear interest at a rate equal to the
greater of (a) 16% per annum and (b) the LIBOR rate, plus 6% per annum.
Furthermore, the Eighth Amendment specifies that 4% of the interest rate shall
be capitalized so that it is added to and becomes a part of the Principal Amount
in lieu of payment in cash. Under the terms of the Term Credit Agreement, as
amended, the Company is required to make monthly interest payments on the
amounts outstanding but is not required to make any principal payments until the
Maturity Date. The Company may prepay the amounts outstanding under the Term
Credit Agreement at any time without penalty.
The Company's obligations under the Term Credit Agreement, as amended,
are collateralized by a first priority security interest in its properties and
assets, including all rights under oil and gas leases in its three producing oil
fields in the Powder River Basin of Wyoming and all of its equipment on those
properties. Under the terms of the original Term Credit Agreement, the Company
granted the Lender a 2% Overriding Royalty Interest (ORRI), proportionally
reduced when the Company's working interest is less than 100%, in all crude oil
and natural gas produced from its three Powder River Basin fields. The First
Amendment granted an increase in the proportionate overriding royalty interests
("ORRI") assigned to the Lender from 2% to 3%. The Company estimated the fair
value of the 2% ORRI granted to the Lender to be approximately $4,500,000 and
the value of the increase ORRI to be approximately $1,050,000. These amounts
were recorded as discounts to the Note Payable and as decreases of oil and gas
properties. The Eighth Amendment granted a Conveyance of Net Profits to the
Lender. The Company estimated the fair value of the 10% NPI to be approximately
$1,500,000. This amount was recorded as deferred finance costs and was amortized
over the term of the Note, as amended. The Company recorded total amortization
of discounts and deferred finance costs of $1,770,789 and $2,914,392 for the
nine months ended December 31, 2009 and 2008 respectively.
21
As noted above, the Note Payable issued by the Company on October 16,
2007, matured on October 15, 2009. Payment of the principal balance of
approximately $10,188,000, plus accrued interest, was not made on the maturity
date, and therefore, an event of default occurred under the Term Credit
Agreement, as amended. On November 16, 2009, the Lender presented to the Company
a Notice of Event of Default, a Demand for Payment and a Notice of Intent to
Foreclose, collectively "the Notice"). The Notice declared all of the
obligations immediately due and payable and demands that the Company promptly
pay to Lender all of the obligations within ten days of receipt of the Notice,
and states that if the Company fails to pay the obligations in full as demanded,
the Lender intends to foreclose on the secured properties under the terms of the
Term Credit Agreement and other agreements. Effective as the date of the Notice,
interest under the Credit agreement will accrue at the default rate, and the
percentage of net revenue to be applied for debt service and other obligations
shall be 100%.
On October 16, 2009 the Lender gave instructions to the Company's bank
(the "Instruction") that under the terms of the Restricted Account and
Securities Control Agreement executed in conjunction with the Term Credit
Agreement, that as of the date of the Instruction, the Company shall no longer
have access to any funds held in identified accounts, and the Lender now had
exclusive right to direct the disposition of such funds. On October 21, 2009 the
Company's bank transferred the all remaining funds, $98,415, from the Company's
account to the Lender.
As discussed in Note 1 and Note 2 above, On October 28, 2009, the
Company filed a voluntary petition (the "petition") for relief in the United
States Bankruptcy Court, District of Colorado under Chapter 11 of Title 11 of
the U.S. Bankruptcy Code. (the "Bankruptcy Court"). Subject to certain
exceptions under the Bankruptcy Code, the Bankruptcy Filing automatically
enjoins, or stays, the continuation of any judicial or administrative
proceedings or other actions against the Company or its property to recover on,
collect or secure a claim arising prior to the Petition Date. Thus, for example,
creditor actions to obtain possession of property from the Company, or to
create, perfect or enforce any lien against the property of the Company, or to
collect on or otherwise exercise rights or remedies with respect to a
pre-petition claim are enjoined unless and until the Bankruptcy Court lifts the
automatic stay.
Note 7- Convertible Promissory Notes Payable
On October 27, 2009, the Company issued Convertible Promissory Notes
(the "Promissory Notes") totaling $140,000 in consideration for money loaned to
the Company of equal amount. One hundred thousand dollars of the Promissory
Notes were issued to four officers and/or directors ($25,000 each). The
remainder of the Promissory Notes were issued to existing shareholders. The
Promissory Notes bear interest at an annual rate equal to the greater of (i)
12%, or (ii) the prime rate (as published in the Wall Street Journal) plus 3%.
The Promissory Notes mature on November 1, 2010, and all obligations and
payments due under the Promissory Notes are subordinate to the Company's senior
debt. Principal and accrued interest are due on the maturity date. The
Promissory Notes are convertible, at the holder's option, into shares of the
Company's common stock at a conversion price of $0.02 per share, at any time
during the term of the Promissory Notes.
In accordance with ASC 470.20 "Debt with Conversion and Other
Options" the Company recognized the advantageous value of conversion rights
attached to the Promissory Notes. Such rights give the note holder the ability
to convert the Promissory Note into common stock at a price per share that is
less than the trading price to the public on the day of issuance. The beneficial
value in an amount of $105,000, is calculated as the intrinsic value (the market
price of the stock at the commitment date in excess of the conversion price) of
the beneficial conversion feature of the Promissory Notes and is recorded as
interest expense in the accompanying Statements of Operations and as additional
paid in capital in the accompanying Balance Sheet.
22
Note 8 - Contingencies
Threatened Litigation
---------------------
In a letter dated February 18, 2009 sent to each of the Company's
Directors, attorneys representing a group of persons who purchased approximately
$1,800,000 of securities (in the aggregate) in the Company's private placement
offering commenced in late 2006, alleged that securities laws were violated in
that offering. In April 2009, the Company entered into tolling agreements with
the purchasers to toll the statutes of limitations applicable to any claims
related to the private placement. The Company's Board of Directors directed the
Special Committee to investigate these allegations. The Company denies the
allegations and believes they are without merit. The Company cannot predict the
likelihood of a lawsuit being filed, its possible outcome, or estimate a range
of possible losses, if any, that could result in the event of an adverse verdict
in any such lawsuit. Any suit against the Company is stayed by the Chapter 11
case, and, insofar as these claims are asserted against the Company, they are
subject to the claim process imposed by the Bankruptcy Code and the possible
imposition of section 510 of the Bankruptcy Code.
See also Note 12 - Subsequent Events for discussion of litigation filed
by the Company after December 31, 2009.
Note 9 - Income Taxes
As of December 31, 2009, because the Company believes that it is more
likely than not that its net deferred tax assets, consisting primarily of net
operating losses, will not be utilized in the future, the Company has fully
provided for a valuation of its net deferred tax assets.
The Company is subject to United States federal income tax and income
tax from multiple state jurisdictions. Currently, the Internal Revenue Service
is not reviewing any of the Company's federal income tax returns, and agencies
in states where the Company conducts business are not reviewing any of the
Company's state income tax returns. All tax years remain subject to examination
by tax authorities, including for the period from February 4, 2004 through March
31, 2009.
Note 10--Common Stock
The Company's capital stock as of December 31, 2009 and 2008 consists
of 275,000,000 authorized shares of common stock, par
value $0.00001 per share.
Issuance of Common Stock
------------------------
During the nine months ended December 31, 2009, the Company issued
500,000 shares to a former officer of the Company upon the exercise of stock
options. No other shares of stock were issued during the period.
Note 11--Share-Based Compensation
Chief Executive Officer (CEO) Options
-------------------------------------
During the nine months ended December 31, 2009, the Company's former
CEO exercised options to acquire 500,000 shares of common stock, for a
cumulative exercise price of $5.00 ($0.00001/share).
Restricted Stock Cancellation
-----------------------------
During the nine months ended December 31, 2009, 200,000 shares of
restricted stock that had been issued to former directors, but not vested, were
cancelled. Such cancellation has been reflected as a reduction of common stock
and an increase in additional paid in capital in the accompanying Balance Sheet
and Statement of Changes in Stockholders' Equity.
23
Grant of Options to Directors
-----------------------------
On October 27, 2009 in conjunction with the execution of Management
Retention Agreements (the "Retention Agreement"), each of the Company's four
directors was granted options to purchase 2,500,000 share of the Company's
common stock at an exercise price of $0.035 per share. The options expire on
December 31, 2019 and are exercisable 10% on the date of grant and 90% on or
after the earliest to occur of: i) November 1, 2010; ii) the confirmation by the
court of a Reorganization Plan for the company filed with the Unites States
Bankruptcy Court; iii) the dismissal of the Company from Chapter 11 Bankruptcy
with approval of the court; iv) an event of merger, consolidation, sale of
assets or other transaction which results in the holders of the Company's common
stock immediately before such transaction owning less the 50% of the stock
outstanding immediately after the transactions: v) any other change of Control
as described in the Retention Agreement, or vi) a Voluntary Termination for Good
Reason, as set forth in the Retention Agreement.
The Company determined the fair value of the options to be $0.0255 per
underlying common share. The value was determined by using the Black-Scholes
valuation model using the following assumptions:
Volatility 125.14%
Expected option term 3 years
Risk-free interest rate 1.375%
Expected dividend yield 0.000%
The Company recognized stock based compensation expense relating to the
Director's options of $63,600 for the nine months ended December 31, 2009 and
expects to recognize the remaining compensation expense of $229,075 relating to
the unvested options over the next 10 months.
2006 Stock Incentive Plan
-------------------------
On October 27 2009 the Company's Board of Directors granted to two
employees and one non-employee options to purchase 1,700,000 shares of common
stock at an exercise price of $0.035 per share, under the provisions of the 2006
Stock Incentive Plan (the "Plan"). The options expire on October 27, 2014 and
are exercisable 10% on the date of grant and 90% on or after the earliest to
occur of: i) November 1, 2010; ii) the confirmation by the court of a
Reorganization Plan for the company filed with the Unites States Bankruptcy
Court; iii) the dismissal of the Company from Chapter 11 Bankruptcy with
approval of the court; iv) an event of merger, consolidation, sale of assets or
other transaction which results in the holders of the Company's common stock
immediately before such transaction owning less the 50% of the stock outstanding
immediately after the transactions, or: v) any other change of Control as
described in the Plan
The Company determined the fair value of the options to be $0.0255 per
underlying common share. The value was determined by using the Black-Scholes
valuation model using the following assumptions:
Volatility 125.14%
Expected option term 3 years
Risk-free interest rate 1.375%
Expected dividend yield 0.000%
During the nine months ended December 31, 2009, options to purchase
70,000 shares of common stock granted to employees expired. The options had
exercise prices ranging from of $0.18 to $1.18.
24
Total estimated unrecognized compensation cost from unvested stock options
issues under the Plan as of December 31, 2009 was approximately $77,000, which
the Company expects to recognize over the next ten months. As of December 31,
2009, there were 2,206,000 options outstanding under the 2006 Stock Incentive
Plan and 7,794,000 options are available for issuance. Note 12 - Subsequent
Events
Litigation
----------
On February 12, 2010, the Company filed an adversary proceeding in the
Bankruptcy Court against GasRock Capital LLC , Case No. 10-01173-MER. The
complaint seeks to avoid the interest of GasRock in the 10% NPI conveyed to
GasRock in connection with the Eighth Amendment to the Term Credit Agreement and
the additional 1% ORRI conveyed to the Lender in October 2008 in connection with
an extension of the short term note. The primary basis of the complaint is that
the Lender gave less than fair equivalent value for the conveyances at a time
when the Company was insolvent, or when the conveyances left the Company with
insufficient capital. In other words, the Company has claimed that the value of
the conveyances was in excess of a reasonable fee for the extensions, and, as a
result, the conveyances were "constructively fraudulent" under both applicable
Bankruptcy law and the Uniform Fraudulent Transfers Act.
In addition, the Company has challenged the conveyance of the NPI and
the 1% ORRI, together with the original 2% ORRI conveyed to Lender when its loan
was first made, on the grounds that they should be recharacterized as security
interests and not outright transfers of title. The Company has also claimed that
the conveyances rendered the Loan usurious under Texas law. Further, the Company
has sought to have the NPI and 1% ORRI avoided as preferences under ss. 547 of
the Bankruptcy Code and to equitably subordinate the Lender's claim.
Although the Company believes its claims are well-taken, the Company
expects the Lender to vigorously defend against the complaint, and no assurance
can be given that the Company will be successful in whole or in part.
Item 2. Management's Discussion and Analysis of Financial Conditions and Results
of Operations
Proceedings under Chapter 11
----------------------------
On October 28, 2009, we filed a voluntary petition for relief under
Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") in the
United States Bankruptcy Court for the District of Colorado (the "Court") (Case
number 09-32943) We will continue to operate our business as
"debtor-in-possession" under the jurisdiction of the Court and in accordance
with the applicable provisions of the Bankruptcy Code and the order of the
Court, as we devote renewed efforts to resolve our liquidity problems and
develop a reorganization plan.
Pursuant to the provisions of the Bankruptcy Code, we are not
permitted to pay any claims or obligations which arose prior to the filing date
(prepetition claims) unless specifically authorized by the Court or as may
ultimately be provided in a plan of reorganization. Similarly, claimants may not
enforce any claims against us that arose prior to the date of the filing. In
addition, as a debtor-in-possession, we have the right, subject to the Court's
approval, to assume or reject any executory contracts and unexpired leases in
existence at the date of the filing. Parties having claims as a result of any
such rejection may file claims with the Court which will be dealt with as part
of the Chapter 11 case.
It is our intention to address all of our prepetition claims in a plan
of reorganization in our Chapter 11 case. At this juncture, it is impossible to
predict with any degree of certainty how such a plan will treat such claims and
the impact that our Chapter 11 cases and any reorganization plan will have on
25
the trading market for our stock. Generally, under the provisions of the
Bankruptcy Code, holders of equity interests may not participate under a plan of
reorganization unless the claims of creditors are satisfied in full under the
plan or unless creditors accept a reorganization plan which permits holders of
equity interests to participate. The formulation and implementation of a plan of
reorganization in the Chapter 11 cases could take a significant period of time.
Forward-Looking Statements
--------------------------
The statements contained in this Quarterly Report on Form 10-Q that are
not historical are "forward-looking statements", as that term is defined in
Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange
Act), that involve a number of risks and uncertainties. These forward-looking
statements include, among others, the following:
o business strategy;
o ability to raise debtor in possession financing and the terms thereof;
o ability to develop a plan of reorganization acceptable to the
Bankruptcy Court and to emerge from bankruptcy;
o ability to complete a sale of the Company, all or a significant
portion of its assets or financing or other strategic alternatives;
o ability to obtain the financial resources to continue operations, to
repay secured debt, to enhance current production and to conduct the
EOR projects;
o water availability and waterflood production targets;
o carbon dioxide (CO2) availability, deliverability, and tertiary
production targets;
o construction of surface facilities for waterflood and CO2 operations
and a CO2 pipeline;
o inventories, projects, and programs;
o other anticipated capital expenditures and budgets;
o future cash flows and borrowings;
o the availability and terms of financing;
o oil reserves;
o reservoir response to water and CO2 injection;
o ability to obtain permits and governmental approvals;
o technology;
o financial strategy;
o realized oil prices;
o production;
o lease operating expenses, general and administrative costs, and
finding and development costs;
o availability and costs of drilling rigs and field services;
o future operating results; and
26
o plans, objectives, expectations, and intentions.
These statements may be found under "Management's Discussion and
Analysis of Financial Condition and Results of Operations", and other sections
of this Quarterly Report on Form 10-Q. Forward-looking statements are typically
identified by use of terms such as "may", "could", "should", "expect", "plan",
"project", "intend", "anticipate", "believe", "estimate", "predict",
"potential", "pursue", "target" or "continue", the negative of such terms or
other comparable terminology, although some forward-looking statements may be
expressed differently.
The forward-looking statements contained in this Quarterly Report are
largely based on our expectations, which reflect estimates and assumptions made
by our management. These estimates and assumptions reflect our best judgment
based on currently known market conditions and other factors. Although we
believe such estimates and assumptions to be reasonable, they are inherently
uncertain and involve a number of risks and uncertainties that are beyond our
control. In addition, management's assumptions about future events may prove to
be inaccurate. Management cautions all readers that the forward-looking
statements contained in this Quarterly Report on Form 10-Q are not guarantees of
future performance, and we cannot assure any reader that such statements will be
realized or the forward-looking events and circumstances will occur. Actual
results may differ materially from those anticipated or implied in the
forward-looking statements due to the factors listed in the "Risk Factors"
section and elsewhere in our Annual Report on Form 10-K for the year ended March
31, 2009. All forward-looking statements speak only as of the date of this
Quarterly Report on Form 10-Q. We do not intend to publicly update or revise any
forward-looking statements as a result of new information, future events or
otherwise. These cautionary statements qualify all forward-looking statements
attributable to us or persons acting on our behalf.
Organization
------------
We are an independent energy company that explores for and develops
produces, and markets oil and gas in North America. We operate three oil fields
in the Powder River Basin, Wyoming. Our business plan is to use CO2 injection to
increase oil production in these oil fields.
Since August 2008 we have been exploring alternatives to improve
liquidity, including raising capital, refinancing outstanding debt, applying for
a Department of Energy Grant under the American Recovery and Reinvestment Act,
or the potential sale of the Company or a significant portion of its assets. Due
to volatile commodity prices and the global financial crisis, we have been
unsuccessful to date.
On September 30, 2009, at a meeting of the Company's shareholders, the
following individual were elected to replace the six standing directors: Andrei
Stytsenko, Silvia Soltan, Vladimir Vaskevich, Mathijs van Houweninge, A.L. "Sid"
Overton and Jeffrey B. Bennett. On October 1, 2009, the Board of Directors
terminated the employment of John Works, the Company's President, Chief
Executive Officer, Chief Financial Officer, Secretary and Treasurer. On October
2. 2009 the Board of Directors appointed Jon C. Nicolaysen President and Chief
Executive Officer and Mathijs van Houweninge as Secretary and Treasurer of the
Company, each to serve until the Board's next annual meeting or until their
successors are appointed. On October 21, 2009, Mr. Stytsenko, Mr. Vaskevich and
Ms. Soltan, resigned their positions as Directors of the Company. On October 27,
2009, Jon C. Nicolaysen was appointed to the Board of Directors
We did not repay our short term debt on its maturity date, October 15,
2009 resulting in an event of default and the commencement of foreclosure
proceedings by GasRock Capital, the Lender. On October 28, 2009, we filed a
voluntary petition for relief in the United States Bankruptcy Court, District of
Colorado under Chapter 11 of Title 11 of the U.S. Bankruptcy Code (the "Code").
We have reached a Bankruptcy Court approved agreement with the Lender for use of
cash collateral and we intend to continue to operate our business as a
"debtor-in-possession" in accordance with the applicable provisions of the Code
and orders of the Bankruptcy Court. We are actively engaged in discussions with
potential DIP finance providers that, if successful, would enable us to submit a
plan of reorganization and, with Bankruptcy Court approval, emerge from
bankruptcy and pursue our business plan.
27
The following summarizes our goals and objectives for the next twelve
months:
o Reduce operating and administrative expenses to ensure that within the
short term we are able to operate within the constraints of the use of
cash collateral agreement;
o Secure DIP financing that would enable us to enhance crude oil
production from our existing wells;
o Emerge from Chapter 11 Bankruptcy under the provisions of a Bankruptcy
Court approved plan of reorganization, or otherwise achieve the
dismissal from Chapter 11 with the approval of the Bankruptcy Court.
Results of Operations
---------------------
Three months ended December 31, 2009 Compared to Three Months December 31, 2008.
The following is a comparative summary of our results of operations:
Three Months Ended December 31,
2009 2008
---- ----
Revenues:
Oil production (in barrels) 14,484 16,997
Net oil price (per barrel) $ 67.01 $ 43.95
Oil sales $ 970,502 $ 746,967
Derivative gains (losses) (6,809) 1,586,911
------------------------------------------------
Total revenues 963,693 2,333,878
Operating expenses:
Production taxes 143,769 90,940
Lease operating expenses 411,150 831,559
Depreciation, depletion, amortization and accretion 338,005 391,508
Impairment of unproved properties 13,525,642 32,500,000
Exploration expense 3,341 4,293
General and administrative expense 568,716 780,261
------------------------------------------------
Total operating expenses 14,990,623 34,598,561
------------------------------------------------
Loss from operations (14,026,930) (32,264,683)
------------------------------------------------
Other income (expense):
Interest expense and financing costs (699,271) (1,171,886)
Interest and other income 7 6,811
------------------------------------------------
Total other income (expense) (699,264) (1,165,075)
------------------------------------------------
Loss before reorganization items (14,726,194) (33,429,758)
------------------------------------------------
Reorganization items 158,727 -
------------------------------------------------
Net loss $ (14,884,921) $ (33,429,758)
===================================================
28
Overview. For the three months ended December 31, 2009, we reported a
net loss of $14,884,921, or $0.12 per basic and fully-diluted share, compared to
a net loss of $33,429,758 or $0.29 per basic and fully-diluted share, for the
corresponding three months of 2008. Discussions of individually significant
period to period variances follow.
Revenue, production taxes, and lease operating expenses. For the three
months ended December 31, 2009, we recorded crude oil sales of $970,502 on
14,484 barrels of oil at an average price of $67.01, as compared to revenues of
$746,967 on 16,997 barrels of oil at an average price of $43.95 per barrel in
2008. The year-to-year variance reflects a volume variance of $(110,439) and a
price variance of $333,973. The decreased volume in 2009 reflects the loss of
several producing wells due to mechanical problems in late 2008 and early 2009,
coupled with routine production decline from year to year. Following the
bankruptcy filing and reaching agreement with our secured lender for the use of
cash collateral we have begun efforts to stop the production decline by
repairing wells and surface facilities that had been offline due to lack of
available capital. Production taxes (including ad valorem and property taxes) of
$143,769 in 2009 as compared to $90,940 in 2008 remained constant at
approximately 12.5% of crude oil sales revenues. Lease operating expenses
decreased to $411,150 ($28.39/bbl) in 2009 as compared to $831,559 ($48.92/bbl)
in 2008. The year to year variance reflects a volume variance of $122,946 and a
cost variance of $297,463. The per barrel decrease in 2009 compared to 2008
reflects costs saving efforts undertaken to preserve capital, coupled with a
lack of significant well or surface facility repair work in the 2009 quarter as
compared to the 2008 quarter. As mentioned above, late in the current period we
have begun a program to repair wells and surface facilities to increase
production. These efforts will likely result in higher operating expenses in
future periods.
Derivative losses. In connection with short term debt financing entered
into in October 2007, we entered into a crude oil derivative contract with an
unrelated counterparty to set a price floor of $63 per barrel for 75% of our
estimated crude oil production for the next two years, and a price ceiling of
$83.50 for 45% of the same level of production. During the three months ended
December 31, 2009 we recorded total losses on the derivative activities of
$6,890 compared to derivative gains of $1,586,911 in 2008. The 2009 losses were
comprised completely of unrealized losses, compared to $144,285 of realized
losses and $1,442,627 of unrealized gains for the comparable 2008 quarter.
Depreciation, depletion, amortization and accretion. For the three
months ended December 31, 2009, we reflected total depreciation, depletion,
amortization and accretion of $338,005 comprised of $252,368 ($17.42/bbl)
related to oil and gas properties, $46,816 related to other assets and accretion
of the asset retirement obligation of $38,821. The comparable amounts for the
2008 period were $350,847 comprised of $305,210 ($17.96/bbl), related to oil and
gas properties, $45,637 related to other assets and accretion of asset
retirement obligation of $40,661
Impairment of unproved properties. In consideration of the difficulties
in the global financial markets, volatile commodity prices and reflecting the
lack of success in securing financing to conduct our CO2 enhanced oil recovery
projects, we determined during the three months ended December 31, 2009 to
recognize full impairment of the carrying value of our unproved properties. This
decision reflects management's current plans to stabilize and gradually increase
production from existing wells and facilities before commencing the more
comprehensive CO2 projects. In the three months ended December 31, 2008 we
recognized a partial impairment of unproved properties in the amount of
$32,500,000.
Reorganization items. The $158,727 of costs reflected as reorganization
items in the three months ended December 31, 2009, include those items of
expense specifically related our reorganization following the filing of a
voluntary petition for relief under Chapter 11 of the Bankruptcy Code with the
Bankruptcy Court on October 28, 2009. These costs consist primarily of
professional fees to legal counsel for assistance with the filing process and
the development of a reorganization plan. We expect these expenses to continue
to be significant as we progress through the bankruptcy process.
29
General and administrative expense. For the three months ended December
31, 2009, we reflected general and administrative expenses of $568,716 as
compared to $780,261 for the corresponding three months ended December 31, 2008.
Period to period comparisons and explanations of significant variances follow:
Three Months Ended
December 31,
Expense Category 2009 2008 Discussion
Salaries, payroll taxes and Decrease reflects staff cuts and salary renegotiations following
benefits $242,081 $306,838 appointment of new management
Consultants 36,015 52,090 Decrease primarily reflects lower accounting and administrative
fees as more responsibilities assumed by employees.
Travel & entertainment 14,307 7,710 Increase reflects travel costs for new Board members to corporate
offices in Denver, Colorado as they assumed control of Company.
Prior year Board meetings were held telephonically.
IT 17,970 24,240 Decrease reflects cost cutting measures enacted following appoint-
ment of new management, primarily IT consultant fees.
Legal fees 103,822 46,741 Increase reflects pre bankruptcy debtor counsel fees ($37K) and
general counsel fees upon establishing new Board of Directors.
Audit, SOX and tax compliance 12,000 26,886 Decrease reflects cost cutting measures and efficiencies in
quarterly review process.
Investor relations, shareholders 6,856 18,885 Decrease reflects cancellation of contract with outside investor
meeting relations consultant.
Office rent, communication & 117,624 150,595 Decrease reflects timing of expense recognition (4 months of office
other office expenses rent expense in prior year period vs. 3 months in current year
period)
Insurance 32,988 37,096 -
Stock based compensation 84,066 143,563 Decrease reflects fact that former CEO's stock options fully vested
in first quarter of current year, partially offset by stock option
grants to new directors and management.
Director fees 15,000 80,500 Decrease reflects termination of previous Board's compensation
arrangement upon election of new Board of Directors.
Field overhead recoveries (114,013) (114,883) -
TOTAL G&A $568,716 $780,261
Interest expense and financing costs. For the three months ended
December 31, 2009, we reflected interest expense and financing costs of $699,271
as compared to $1,171,886 for the corresponding three months ended December 31,
2008. The 2009 amount is comprised of interest paid and payable on the Note
Payable issued in October 2007, as amended, of $460,165, and amortization of
deferred financing costs and discount on Note Payable of $239,106. Comparable
amounts for the 2008 period were $323,190 of interest on the Note Payable and
$323,190 of deferred finance and discount amortization. The higher interest on
Note Payable reflects a 4% increase in the interest rate occurring as part of
the amendment to the Term Credit Agreement in June 2009 for the entire three
month period, coupled with the default interest rate in effect (additional 2%)
since the event of default occurred on October 15, 2009.
30
Nine months ended December 31, 2009 Compared to Nine Months December 31, 2008.
The following is a comparative summary of our results of operations:
Nine Months Ended December 31,
2009 2008
---- ----
Revenues:
Oil production (in barrels) 41,447 51,239
Net oil price (per barrel) $ 60.24 $ 90.59
Oil sales $ 2,498,376 $ 4,641,836
Derivative gains (losses) (357,582) 997,169
------------------------------------------------
Total revenues 2,140,794 5,639,005
Operating expenses:
Production taxes 338,547 564,590
Lease operating expenses 1,088,163 2,004,422
Depreciation, depletion, amortization,
and accretion 987,742 1,046,166
Impairment of unproved properties 13,525,642 39,300,000
Exploration expense 15,173 13,896
General and administrative expense 2,066,226 2,788,415
Total operating expenses 18,021,493 45,717,489
Loss from operations (15,880,699) (40,078,484)
Other income (expense):
Interest expense and financing costs (3,021,648) (4,594,283)
Interest and other income 731 26,129
Total other income (expense) (3,020,917) (4,568,154)
Loss before reorganization items (18,901,616) (44,646,638)
Reorganization items 158,727
Net loss $ (19,060,343)$ (44,646,638)
=================================================
Overview. For the nine months ended December 31, 2009, we reported a
net loss of $19,060,343, or $0.16 per basic and fully-diluted share, compared to
a net loss of $44,646,638 or $0.29 per basic and fully-diluted share, for the
corresponding nine months of 2008. Discussions of individually significant
period to period variances follow.
Revenue, production taxes, and lease operating expenses. For the nine
months ended December 31, 2009, we recorded crude oil sales of $2,498,376 on
41,477 barrels of oil at an average price of $60.24, as compared to revenues of
$4,641,836 on 51,239 barrels of oil at an average price of $90.59 per barrel in
2008. The year-to-year variance reflects a volume variance of $(884,358) and a
price variance of $(1,259,102). The decreased volume in 2009 reflects the loss
of several producing wells due to mechanical problems in late 2008 and early
2009, coupled with routine production decline from year to year. Following the
bankruptcy filing and after reaching agreement with our secured lender for the
use of cash collateral we have begun efforts to stop the production decline by
repairing wells and surface facilities that had been offline due to lack of
available capital. Production taxes (including ad valorem and property taxes) of
$338,547 in 2009 as compared to $564,590 in 2008, remained constant at
approximately 12.5% of crude oil sales revenues. Lease operating expenses
31
decreased to $1,088,163 ($23.37/bbl) in 2009 as compared to $2,004,422
($39.12/bbl) in 2008. The year to year variance reflects a volume variance of
$381,880 and a cost variance of $534,378. The per barrel decrease in 2009
compared to 2008 reflects costs saving efforts undertaken to preserve capital,
coupled with a lack of significant well or surface facility repair work in the
2009 period as compared to the 2008 period. As mentioned above, late in the
current period we have begun a program to repair wells and surface facilities to
increase production. These efforts will likely result in higher operating
expenses in future periods.
Derivative losses. In connection with short term debt financing entered
into in October 2007, we entered into a crude oil derivative contract with an
unrelated counterparty to set a price floor of $63 per barrel for 75% of our
estimated crude oil production for the next two years, and a price ceiling of
$83.50 for 45% of the same level of production. During the nine months ended
December 31, 2009 we recorded total losses on the derivative activities of
$357,582 compared to gains of $997,169 in 2008. The 2009 losses were comprised
of $98,378 of realized gains and $455,960 of unrealized losses, compared to
$505,623 of realized losses and $1,502,792 of unrealized gains for the
comparable 2008 quarter.
Depreciation, depletion, amortization. For the nine months ended
December 31, 2009, we reflected total depreciation, depletion, amortization and
accretion of $987,742 comprised of $722,290 ($17.41/bbl) related to oil and gas
properties, $145,973 related to other assets and accretion of asset retirement
obligation of $119,480. The comparable amounts for the 2008 period were
$1,046,166 comprised of $784,283 ($15.31/bbl), related to oil and gas
properties, $144,132 related to other assets, and accretion of asset retirement
obligation of $117,771. The increase in per barrel DD&A reflects decreases in
the crude oil reserve base used to calculate such DD&A in 2009 compared to 2008.
Impairment of unproved properties. In consideration of difficulties in
the global financial markets, volatile commodity prices and reflecting the lack
of success in securing financing to conduct our CO2 enhanced oil recovery
projects, we determined during the nine months ended December 31, 2009 to
recognize full impairment of the carrying value of our unproved properties. This
decision reflects management's current plans to stabilize and gradually increase
production from existing wells and facilities before commencing the more
comprehensive CO2 projects. In the nine months ended December 31, 2008 we
recognized a partial impairment of unproved properties in the amount of
$39,300,000.
Reorganization items. The $158,727 of costs reflected as reorganization
items in the nine months ended December 31, 2009, include those items of expense
specifically related our reorganization following the filing of a voluntary
petition for relief under Chapter 11 of the Bankruptcy Code with the Bankruptcy
Court on October 28, 2009. These costs consist primarily of professional fees to
legal counsel for assistance with the filing process and the development of a
reorganization plan. All professional fees are subject to review and approval by
the Bankruptcy Court. We expect these expenses to continue to be significant as
we progress through the bankruptcy process.
General and administrative expense. For the nine months ended December
31, 2009, we reflected general and administrative expenses of $2,066,266 as
compared to $2,788,415 for the corresponding nine months ended December 31,
2008. Period to period comparisons and explanations of significant variances
follow:
Nine Months Ended December 31,
-------------------------------- ------------------------- --------------- ---------------------------------------------------------
Expense Category 2009 2008 Discussion
-------------------------------- ------------------------- --------------- ---------------------------------------------------------
Decrease reflects staff cuts (currently 4 full time
employees in corporate office vs. 7 in prior year) and
Salaries, payroll taxes and salary renegotiations following appointment of new
benefits $825,239 $1,008,880 management
Consultants 98,983 245,368 Decrease reflects lower fees paid to accounting
consultants $98K, land administration and operations
consultants $27K and engineering consultants $23K as more
responsibilities were assumed by employees, as opposed to
consultants
32
Travel & entertainment 21,525 78,429 Decrease reflects cost cutting measures enacted late in
2008 period.
IT 55,619 96,299 Decrease reflects lower staff count and reduced need for
IT coupled with cost cutting measures enacted following
appointment of new management
Increase reflects fees associated with renegotiation of
senior secured debt (7 extensions), proxy preparation,
issues surrounding the annual meeting, debtor counseling
Legal fees 398,308 233,999 fees prior to filing of bankruptcy
Decrease primarily reflects efficiencies achieved in
audit and quarterly review process in the third year of
Audit, SOX and tax compliance 96,430 191,773 such process.
Investor relations, 18,919 71,776 Decrease reflects termination of contract with outside
shareholders meeting investor relations professional.
Office rent, communication & 346,538 450,595 Decrease reflects timing of expense recognition (10
other office expenses months of office rent expense in prior year period vs. 9
months in current year period ($30K), lower communication
costs, $10K, lower office supply, postage and profession-
al dues $27K, and termination of maintenance agreement on
accounting software $20K and other general cost cutting
measures
Insurance 130,364 112,311 Increase reflects higher director and officer liability
insurance costs in current year
Stock based compensation 262,529 431,031 Decrease reflects fact that former CEO's stock options
fully vested in first quarter of current year, partially
offset by stock option grants to new directors and
management.
Director fees 164,500 245,000 Decrease reflects termination of previous Board's
compensation arrangement upon election of new Board of
Directors.
Field overhead recoveries (352,728) (377,046) -
TOTAL G&A $2,066,226 $2,788,415
Interest expense and financing costs. For the nine months ended
December 31, 2009, we reflected interest expense and financing costs of
$3,021,648 as compared to $4,594,283 for the corresponding nine months ended
December 31, 2008. The 2009 amount is comprised of interest paid on the Note
Payable issued in October 2007, as amended, of $1,244,804, interest penalty on
non-timely filed Wyoming severance tax reports of $6,055, and amortization of
deferred financing costs and discount on Note Payable of $1,770,789. Comparable
amounts for the 2008 period were$1,069,884 of interest on the Note Payable and
$3,524,399 of deferred finance and discount amortization. The higher interest on
Note Payable reflects a 4% increase in the interest rate occurring as part of
the amendment to the Term Credit Agreement in June 2009.
33
Liquidity and Capital Resources
-------------------------------
On October 15, 2009, short term debt in the amount of approximately
$10,188,000 matured. We were unable to repay the short term debt, which
constituted an Event of Default under the terms of the Term Credit Agreement. On
October 16, 2009 we received notice of the Event of Default from the Lender,
GasRock Capital LLC (GasRock), and notice of their intent to foreclose on the
properties securing the debt. On October 21, 2009 GasRock swept the remaining
$98,000 from our operating bank account, leaving us without the ability to meet
operating expense obligations, or pay staff or other administrative expenses.
On October 27, 2009 we raised $140,000 in cash through the issuance
of convertible promissory notes to certain of our officers, directors and
shareholders and used the funds to retain counsel to provide debtor advice and
to provide working capital. The promissory notes mature on November 1, 2010 and
bear interest at an annual rate equal to the greater of (i) 12%, or (ii) the
prime rate (as published in the Wall Street Journal) plus 3%. All obligations
and payments due under the promissory notes are subordinate to the Company's
senior debt. Principal and accrued interest are due on the maturity date. The
promissory notes are convertible, at the holder's option, into shares of the
Company's common stock at a conversion price of $0.02 per share, at any time
during the term of the promissory notes.
On October 28, 2009 we filed a voluntary petition for relief in the
United States Bankruptcy Court, District of Colorado under Chapter 11 of Title
11 of the U.S. Bankruptcy Code. (the "Bankruptcy Court"). We have reached
agreement with GasRock, and the Bankruptcy Court has approved, an order for use
of cash collateral. Under the terms of the order we receive the proceeds from
crude oil sales and are able to pay operating, and administrative costs in
accordance with the approved cash collateral budget. This arrangement has
enabled us to meet all allowable operating and administrative obligations and to
build an operating cash reserve totaling $172,000 as of December 31, 2009,
increasing to $430,000 as of January 31, 2010.
We intend to continue to operate our business as
"debtor-in-possession" under the jurisdiction of the Bankruptcy Court and in
accordance with the applicable provisions of the Code and orders of the
Bankruptcy Court. The Company is currently holding discussions with a number of
potential DIP financing sources and is developing its restructuring plans should
such financing be successful. In addition, the Company has prepared and filed
with the Bankruptcy Court certain financial, operating reports and other
required documents. There is no assurance the Company efforts to raise DIP
financing will be successful or that the restructuring plans will enable the
Company to emerge from bankruptcy.
Going Concern
-------------
The report of our independent registered public accounting firm on the
financial statements for the year ended March 31, 2009 and 2008 includes an
explanatory paragraph relating to the uncertainty of our ability to continue as
a going concern. As of December 31, 2009 we have cash reserves of $172,000,
negative working capital of $10.2 million and we have incurred a cumulative net
loss of $87.8 million for the period from inception (February 4, 2004) to
December 31, 2009. Our ability to continue as a going concern is dependent on
our success in restructuring under Chapter 11 of the Bankruptcy Code.
Our primary source of liquidity to meet operating expenses and fund
capital expenditures is our access to debt and equity markets. The debt and
equity markets, public, private, and institutional, have been our principal
source of capital used to finance a significant amount of growth, including
property acquisitions. We will need substantial additional funding to emerge
from bankruptcy, continue operations and to pursue our business plan. The recent
unprecedented events in global financial markets have had a profound impact on
the global economy. Many industries, including the oil and natural gas industry,
are impacted by these market conditions. Some of the key impacts of the current
financial market turmoil include contraction in credit markets resulting in a
34
widening of credit risk, devaluations and high volatility in global equity,
commodity, natural resources and foreign exchange markets, and a lack of market
liquidity. A continued or worsened slowdown in the financial markets or other
economic conditions, including but not limited to, employment rates, business
conditions, lack of available credit, the state of the financial markets and
interest rates may adversely affect our ability to emerge successfully from
bankruptcy and to pursue future opportunities.
The following is a summary of Rancher Energy's comparative cash flows:
For the Nine Months Ended
December 31,
----------------------------------------
2009 2008
-------------------- -------------------
Cash flows from (used for):
$(793,140) $(2,399,118)
Operating activities
Investing activities 6,955 (670,188)
Financing activities 41,880 (2,341,470)
Cash flows used for operating activities decreased substantially in
2009 as a result of lower general and administrative and lease operating
expenses as discussed above, coupled with realized derivative gains in the
period, as compared to realized losses in the 2008 period.
Investing activities in 2009 reflect a modest positive cash flow
resulting from the sale of surplus field equipment in the period, compared to
oil and gas capital expenditures of $230,000 and expenditures to increase bonds
and other assets of $440,000 in the 2008 period.
Cash flows from financing activities in 2009 reflect proceeds from the
issuance of promissory notes to directors and shareholders ($140,000) offset by
the pay down of $98,000 of the principal balance of our senior secured debt. The
comparable figures for 2008 reflect the pay down of the senior secured debt of
$2,240,000 and the payment of deferred finance costs of $101,000.
Off-Balance Sheet Arrangements
------------------------------
Under the terms of the Term Credit Agreement entered into in October
2007 we were required to hedge a portion of our expected production and we
entered into a costless collar agreement for a portion of our anticipated future
crude oil production. The costless collar contains a fixed floor price (put) and
ceiling price (call). If the index price exceeds the call strike price or falls
below the put strike price, we receive the fixed price and pay the market price.
If the market price is between the call and the put strike price, no payments
are due from either party. During the nine months ended December 31, 2009, we
reflected realized gains of $98,378 and unrealized gains of $455,960 from the
hedging activity, as compared to realized losses of $505,623 and unrealized
gains of $1,502,792 for the comparable 2008 period. Our hedge contract expired
on October 31, 2009.
We have no other off-balance sheet financing nor do we have any
unconsolidated subsidiaries.
Critical Accounting Policies and Estimates
------------------------------------------
Critical accounting policies and estimates are provided in Part II,
Item 7, Management's Discussion and Analysis of Financial Condition and Results
of Operations, to the Annual Report on Form 10-K for the fiscal year ended March
31, 2009. Additional footnote disclosures are provided in Notes to Consolidated
Financial Statements in Part I, Financial Information, Item 1, Financial
Statements to this Quarterly Report on Form 10-Q for the three months ended
September 30, 2009.
35
Item 3. Quantitative and Qualitative Disclosure About Market Risk.
Commodity Price Risk
--------------------
Because of our relatively low level of current oil and gas production,
we are not exposed to a great degree of market risk relating to the pricing
applicable to our oil production. However, our ability to raise additional
capital at attractive pricing, our future revenues from oil and gas operations,
our future profitability and future rate of growth depend substantially upon the
market prices of oil and natural gas, which fluctuate widely. With increases to
our production, exposure to this risk will become more significant. We expect
commodity price volatility to continue. Under the terms of our Term Credit
Agreement we entered into in October 2007, we were required hedge a portion of
our expected future production.
Financial Market Risk
---------------------
The debt and equity markets have recently exhibited adverse conditions.
The unprecedented volatility and upheaval in the capital markets impacted our
ability to refinance or extend our existing short term debt when it matured on
October 15, 2009. Alternatively, market conditions may affect the availability
of capital for prospective purchasers of our assets or equity. Item 4 and Item
4T. Controls and Procedures.
Disclosure Controls and Procedures
----------------------------------
We conducted an evaluation under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Accounting Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures. The term "disclosure controls and
procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (Exchange Act), means controls and other
procedures of a company that are designed to ensure that information required to
be disclosed by the company in the reports it files or submits under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the Securities and Exchange Commission's rules and forms.
Disclosure controls and procedures also include, without limitation, controls
and procedures designed to ensure that information required to be disclosed by a
company in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the company's management, including its
principal executive and principal financial officers, or persons performing
similar functions, as appropriate to allow timely decisions regarding required
disclosure. We identified the following material weakness in our internal
control over financial reporting and, as a result of this material weakness, we
concluded as of March 31, 2009 and as of the end of the period covered by this
Quarterly Report that our disclosure controls and procedures were not effective.
We did not adequately segregate the duties of different personnel
within our Accounting Department due to an insufficient complement of staff and
inadequate management oversight.
We have limited accounting personnel with sufficient expertise in
generally accepted accounting principles to enable effective segregation of
duties with respect to recording journal entries and to allow for appropriate
monitoring of financial reporting matters and internal control over financial
reporting. Specifically, the Chief Accounting Officer has involvement in the
creation and review of journal entries and note disclosures without adequate
independent review and authorization. This control deficiency is pervasive in
nature and impacts all significant accounts. This control deficiency also
affects the financial reporting process including financial statement
preparation and the related note disclosures.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial
reporting during the most recently completed fiscal quarter that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
36
PART II. OTHER INFORMATION.
Item 1. Legal Proceedings
On October 28, 2009 we filed a voluntary petition for relief in the
United States Bankruptcy Court for the district of Colorado.
On February 12, 2010 we filed an adversary proceeding in the Bankruptcy
Court against GasRock Capital LLC , Case No. 10-01173-MER, seeding to avoid
certain interests assigned to GasRock in connection with the original Term
Credit Agreement and subsequent amendments thereto. See Note 12 - Subsequent
Events, of Part 1 - Financial Information, of this quarterly filing for further
information regarding this proceeding
See also Note 6 - Contingencies, of Part 1 - Financial Information, of
this quarterly filing for a description of threatened litigation.
Item 1A. RISK FACTORS
Not applicable to smaller reporting companies.
ITEM 2. CHANGES IN SECURITIES
NONE.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE.
ITEM 5. OTHER INFORMATION
NONE.
ITEM 6. EXHIBITS
Exhibits. The following is a complete list of exhibits filed as part of this
Form 10-Q. Exhibit numbers correspond to the numbers in the Exhibit Table of
Item 601 of Regulation S-K.
Exhibit 31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act
Exhibit 31.2 Certification of Chief Accounting Officer pursuant to Section
302 of the Sarbanes-Oxley Act
Exhibit 32.1 Certification of Principal Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act
Exhibit 32.2 Certification of Principal Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RANCHER ENERGY CORP., Registrant
Dated: February 19, 2010 By: /s/ Jon C. Nicolaysen
------------------------------
Jon C. Nicolaysen, President,
Chief Executive Officer,
(Principal Executive Officer)
Dated: February 19, 2010 By: /s/ Richard E. Kurtenbach
-----------------------------
Richard E. Kurtenbach, Chief
Accounting Officer
(Principal Accounting Officer)
3
