Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information. The Company’s shares of common stock, $0.001 par value per share, trade on the Over-the-Counter Bulletin Board Market, or OTCBB, under the symbol “JDOG.”
The following table sets forth the high and low closing sale prices as reported on the OTCBB for the Company’s common stock for each quarter within the Company’s last two fiscal years. Because the Company’s common stock is traded on the OTCBB, these quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.
Holders. As of February 18, 2011, the Company’s shares of common stock were held of record by approximately 1,595 shareholders. Since the Company has not recently mailed a proxy requesting a reply from the stockholders, the number of additional stockholders owning stock held by brokerage firms and other financial institutions is difficult to determine at this time.
Dividends. The Company paid no cash distributions to its stockholders during 2010 and 2009. However, the Company declared and paid $108,000 in preferred stock dividends for each of the years ended December 31, 2010 and 2009. The Company is restricted by its loan agreement with Charter One from paying dividends on its common stock or making cash distributions to its stockholders and from paying dividends in excess of those regularly accruing on not more than two million dollars of preferred stock.
Issuance of Common Stock. The Company did not issue common stock to its directors or employees during 2010 or 2009.
Issuance of Preferred Stock. The Company did not issue preferred shares during 2010 or 2009.
Purchases of Common Stock. The Company did not purchase any shares of its common stock in 2010 or 2009.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
John D. Oil and Gas Company, formerly Liberty Self-Stor, Inc. is a corporation organized under the laws of the State of Maryland.
The Company entered into the business of extracting and producing oil and natural gas products during 2006. The Company currently has two segments: one that is drilling and operating natural gas wells with oil as a by-product in Northeast Ohio and one composed of the remaining self-storage facility located in Painesville, Ohio. The Company cannot guarantee success under its business plan as drilling wells for oil and natural gas is a high-risk enterprise and there is no guarantee the Company will become profitable. To date, the Company’s oil and gas operations have not been profitable. The decline in the overall market price of natural gas over the last couple of years severely affected the viability of any future drilling because our lower cash flow makes it economically difficult to incur the high costs of drilling a well. Additionally, our production will continue to decline if the Company is not drilling any new wells. Although the oil production is profitable with the higher oil market pricing, this revenue is not enough to offset the lower natural gas production and operating expenses.
Without additional wells being drilled and the Company’s substantial debt financing, the Company will continue to show losses and be unprofitable. Therefore, the Company is concerned about its viability as a going concern.
As previously disclosed in the Company’s Form 8-K filed on June 25, 2010 with the Securities and Exchange Commission, on June 18, 2010, the Company, along with Mr. Osborne, the Richard M. Osborne Trust, Great Plains and Oz Gas Ltd. (companies owned by Mr. Osborne), have entered into a Forbearance Agreement with Charter One pursuant to which Charter One agreed to forbear from enforcing its rights and remedies under the Company’s fully-drawn $9.5 million line of credit as well as the other parties’ loan agreements until July 1, 2011, subject to no further events of default including the payments due under the Forbearance Agreement. Pursuant to the Forbearance Agreement and during the forbearance period, the parties must pay Charter One $400,000 per month, including a $40,000 per month forbearance fee, until all amounts under the loan agreements have been paid in full. At December 31, 2010, the Loan Parties were in compliance with the required payments. See Note 5 “Line of Credit and Long-Term Debt” to the Company’s consolidated financial statements for more information.
Discussions with Charter One are ongoing and there is no certainty that these discussions will result in satisfactory terms of a revised loan agreement or a revised loan agreement at all. If Charter One demands repayment of the outstanding amounts payable at the end of the forbearance period, the Company does not have the available cash to repay the line of credit and will need financing from other sources to repay Charter One. If alternative financing is not available, the Company will default and may be unable to continue operations.
During August 2009, Liberty Self Stor, LTD defaulted on its $1.2 million loan from First Merit Bank, N.A. On May 11, 2010, Liberty Self Stor, LTD and First Merit Bank signed a loan modification agreement which waived the prior defaults. The terms of the mortgage include a five year term, maturing on June 1, 2014, with a ten year amortization period at a variable rate of the 30 day LIBOR plus 250 basis points. Monthly payments include principal of $10,370 plus interest.
Critical Accounting Policies
The Company’s discussion and analysis of its financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. A “critical accounting policy” is one which is both important to the portrayal of a company’s financial condition and results, and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company believes the following critical accounting policies present our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Principles of Consolidation
Pursuant to the terms of the partnership agreement of LSS I, the Company, as sole general partner, controls LSS I. Accordingly, the Company accounts for its investment in LSS I utilizing the consolidation method. The investment in an unconsolidated affiliate, Kykuit, is accounted for using the equity method. All significant inter-company transactions and balances have been eliminated. The well in Lucky Brothers is accounted for as a joint interest venture.
Accounts Receivable
The Company has certain trade receivables consisting of oil and natural gas sale obligations due under normal trade terms. The Company currently sells its production to a related party through an oil and natural gas agreement, extending credit on an unsecured basis to them. In evaluating its allowance for possible losses, the Company performs a review of outstanding receivables. The trade receivables outstanding are typically three months of natural gas production due to the timing and accounting treatment by the main distribution pipeline company in Northeast Ohio and related party accounting treatments. At December 31, 2010 and 2009, the Company’s credit evaluation indicated that it has no need for an allowance for possible losses and had no such losses in 2010 and 2009.
The Company’s accounts receivable, arising from the self-storage business, are due from individuals as well as business entities. Tenants are required to pay their rent on the first of each month. Past due amounts are those that are outstanding longer than the contractual payment terms. If an account is more than 75 days past due, the Company generally writes off the balance directly to expense. For such past due accounts, the Company has the right to auction the contents of the rented space, which allows for recovery of written-off balances. Any such recoveries are credited to income when received. Approximately, $2,000 of bad debt expense was incurred in 2010 and 2009.
Property and Equipment
All property and equipment is depreciated using the straight-line method over estimated useful lives of twenty five years for buildings and improvements and five to seven years for furniture and equipment.
The Company uses the successful efforts method of accounting for oil and natural gas producing activities. Under this method, acquisition costs for proved and unproved properties are capitalized when incurred. Exploration costs, including geological and geophysical costs, the costs of carrying and retaining unproved properties and exploratory dry hole drilling costs, are expensed. Development costs, including the costs to drill and equip development wells and successful exploratory drilling costs to locate proved reserves, are capitalized. Upon sale or retirement of a proved property, the cost and accumulated depreciation and depletion and amortizations are eliminated from property accounts and the resultant gain or loss is recognized.
Exploratory drilling costs are capitalized when incurred pending the determination of whether a well has found proved reserves. If a well is determined to be successful, the capitalized drilling costs will be reclassified as part of the cost of the well. If a well is determined to be unsuccessful, the capitalized drilling costs will be charged to expense in the period the determination is made. The Company is involved in exploratory drilling only to the extent that it is a partner of Kykuit, which is doing exploratory drilling in Montana. The Company is an owner and managing member of Kykuit, an unconsolidated affiliate.
Development costs of proved oil and natural gas properties, including estimated dismantlement, restoration, abandonment costs and acquisition costs, are depreciated and depleted on a well by well basis by the units-of-production method using estimated proved developed reserves. The costs of oil and natural gas properties are periodically assessed for impairment.
Asset Impairment
The Company reviews its self-storage property and capitalized well costs for impairment when events or changes in circumstances indicate the carrying amounts of the properties may not be recoverable. When such conditions exist, management estimates future cash flows from operations and ultimate disposition of the individual properties. This income approach to determine the fair value of these assets is based on level 3 inputs, including estimated reserve quantities, gas prices, operating costs and discount rates. If the estimated undiscounted future cash flows are less than the carrying amount of the asset, an adjustment to reduce the carrying amount to the related property’s estimated fair market value would be recorded and an impairment loss would be recognized. The Company wrote off $-0- in 2010 and the costs related to one well amounting to $145,444 in 2009.
Asset Retirement Obligation
The Company accounts for its asset retirement obligations in accordance with generally accepted accounting principles in the United States of America (“GAAP”) which requires the fair value of an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. For the Company, asset retirement obligations primarily relate to the abandonment, dismantling and plugging of oil and natural gas wells. The present value of the estimated asset retirement cost is capitalized as part of the long-lived asset. The capitalized asset retirement cost is depreciated and the asset retirement obligation is accreted over the estimated life of the well. The Company plugged no wells in 2010 and two wells during 2009.
Revenue Recognition
The Company recognizes revenue from its oil and natural gas interests in producing wells as oil and natural gas is sold to a purchaser at a fixed or determinable price when delivery has occurred, title and risk of loss have transferred to the purchaser and the collectability of revenue is reasonably assured. The Company has a management agreement with a related party to transport the Company’s natural gas production through the related party’s pipeline and include this natural gas with the related party’s natural gas in order to fulfill production volume contracts they currently have in place. The Company utilizes the sales method to account for gas production volume imbalances. Under this method, revenue is recognized only when gas is produced and sold on the Company’s behalf. The Company had no material gas imbalances at December 31, 2010.
Income Taxes
Effective January 1, 2006, the Company became a “C” Corporation for tax purposes.
In establishing a provision for income taxes, the Company must estimate when in the future certain items will affect taxable income. Deferred taxes are recorded for future tax consequences of events that have been recognized in the financial statements or tax returns, based upon enacted tax laws and rates. Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not.
The Company has net operating loss carry forwards (NOLS) and a valuation allowance to offset any tax effects. The Company has no unrecognized tax benefits and therefore, there was no effect on the Company’s effective tax rate. Any tax penalties or interest expense will be recognized in income tax expense. No interest and penalties were accrued as of December 31, 2010 or 2009, or paid during the periods then ended. The Company does not anticipate a significant change over the next twelve months to any tax liability.
The Company is open to federal and state tax audits until the applicable statute of limitations expire. There are currently no federal or state income tax examinations underway for the Company. The tax years after 2007 remain open to examination by the major taxing jurisdictions in which we operate, although no material changes to unrecognized tax positions are expected within the next twelve months. The Company does, however, have prior year net operating losses which remain open for examination.
Liquidity and Capital Resources
Liquidity represents the Company’s ability to generate sufficient amounts of cash to meet its financial commitments. The Company’s cash flow from operating and financing activities will not be sufficient to meet its anticipated operating requirements in the foreseeable future.
The Company requires substantial capital expenditures to maintain and/or grow production and reserves. We depend on debt or equity financing to pay for exploration and operations. The current economic environment makes it more difficult to obtain debt or equity financing on acceptable terms to address our liquidity issues. Capital may not be available to meet these continuing costs, or if capital is available, it may not be on terms acceptable to us.
The Company’s $9.5 million line of credit with Charter One matured on August 1, 2009. On August 20, 2009, Charter One received a judgment in its favor against the Company, Mr. Osborne and the Richard M. Osborne Trust, jointly and severally for $9.5 million plus interest and late charges.
On June 18, 2010, the Company, along with Richard M. Osborne, the Trust, Great Plains and Oz Gas Ltd. (companies owned by Mr. Osborne), have entered into a Forbearance Agreement with Charter One pursuant to which Charter One will forbear from enforcing its rights and remedies under the Company’s line of credit as well as the other parties’ loan agreements until July 1, 2011, subject to no further events of default including the payments due under the Forbearance Agreement.
The Company, Mr. Osborne, the Trust, Great Plains and Oz Gas are collectively referred to in the Forbearance Agreement and herein as the “Loan Parties.”
Under the Forbearance Agreement, Charter One’s agreement to forbear is conditioned upon and subject to the following conditions:
•
No material adverse change in the condition of the Loan Parties;
•
An assignment and grant of a security interest by the Company and Great Plains of each of their ownership interests in the Alpha and Panzica wells;
•
A pledge by the Loan Parties of their ownership interests in Kykuit Resources LLC ; and
In addition, commencing July 1, 2010 and each month thereafter until all amounts under the judgments and loan agreements have been paid in full, the Loan Parties shall pay Charter One $400,000, including the $40,000 forbearance fee. The Company had previously felt they would pay one third of the $400,000, but due to lack of cash, they have decided to accrue interest and one third of the $40,000 monthly fee and legal fees. The monthly $400,000 is being paid by the other Loan Parties. Such payments by the Loan Parties shall be applied first to Charter One’s fees and expenses, second to accrued but unpaid interest due under the judgments, and third to principal amounts due under the judgments. Charter One has applied a default rate to the loan from January 4, 2010 thru June 18, 2010. The Company does not agree with the default rate and therefore has not booked approximately $171,000 of additional interest expense. It is the Company’s position that the interest for the period from judgment date to forbearance date should remain at the original contract rate at the date of judgment, based upon the per diem interest amount expressly stated in that judgment. Attorneys for the Company also support that position and have so stated in letters to Charter One and for purposes of the annual audit. Charter One contends that the judgments will bear interest at LIBOR plus 1.75% with a LIBOR floor of 3.00%. The Company believes that there is an interest rate cap of 3.00%. The parties are in discussions regarding the applicable interest rate. If the Loan Parties repay $10 million and if after application of such repayment the outstanding balance of the judgments does not exceed 65% of the current producing reserve value (as that term is defined in the Loan Agreements) of the Company, Great Plains and Oz Gas, then the pledge of Mr. Osborne’s Kykuit interests and his Gas Natural Inc. shares shall be released. In addition, the Company must deposit all proceeds of its operations into accounts maintained by Charter One but during the forbearance period Charter One will not take any action to set off funds in any such account.
The forbearance period is effective until July 1, 2011, subject to the earlier termination upon the occurrence of any events of default by any of the Loan Parties, including non-payment of any amounts due by any of the Loan Parties under the Forbearance Agreement. See Note 5 “Line of Credit and Long-Term Debt” to the Company’s consolidated financial statements for more information.
Discussions with Charter One are ongoing but there is no certainty that these discussions will result in satisfactory terms for a revised loan agreement.
Because the Company does not have the available cash to repay the line of credit, if the required payments are not made by the Company or any of the other Loan Parties, or other events of default occur, under the Forbearance Agreement or if prior to the end of the forbearance period the Company is unsuccessful in refinancing its line of credit with Charter One or if the Company is unsuccessful in obtaining substitute financing, there is substantial doubt about the Company’s ability to continue as a going concern.
During August 2009, Liberty Self Stor, LTD defaulted on its $1.2 million loan from First Merit Bank, N.A.
On May 11, 2010, Liberty and First Merit signed a loan modification agreement which waived the prior defaults and continued the terms set forth under the original loan commitment letter dated March 25, 2009 for the Painesville facility. Those terms include a five year term, maturing on June 1, 2014, with a ten year amortization period at a variable rate of the 30 day LIBOR plus 250 basis points. Monthly payments include principal of $10,370 plus interest.
The items affecting operating cash flow and cash and cash equivalents are discussed more fully in the “Material Changes in Results of Operations” section.
The Company’s current assets decreased $46,487 or 8.3%, to $515,640 at December 31, 2010 from $562,127 at December 31, 2009. Current assets at December 31, 2010 were lower than at December 31, 2009 largely due to the decrease in accounts receivable.
The Company’s current liabilities decreased $955,755, or 8.5% to $10,306,221 at December 31, 2010, from $11,261,976 at December 31, 2009. The decrease is primarily due to moving the Painesville property loan from current liabilities to long term debt after settling with First Merit Bank N.A..
The Company had a positive cash flow from operating activities of $426,710 for the year ended December 31, 2010 compared to a positive cash flow of $865,896 for the year ended December 31, 2009. The decreased positive cash flow is a result of less cash collected on accounts receivable in 2010 as compared to 2009, net of fewer accounts payable paid in 2010 than in 2009.
The Company had a negative cash flow from investing activities of $223,160 for the year ended December 31, 2010 compared to a negative cash flow of $696,252 for the year ended December 31, 2009. The year ended 2010 improved compared to 2009 largely due to reduced cash investments in Kykuit and in oil and natural gas wells, net of additional property and equipment purchases in 2010 as compared to 2009.
The Company had a negative cash flow from financing activities of $205,606 for the year ended December 31, 2010 compared to a negative cash flow of $225,873 for the year ended December 31, 2009. The negative cash flow for the year ended December 31, 2010 decreased largely due to the receipt of loan funds for a new vehicle.
The following table sets forth the maturity dates and the total of the Company’s long-term debt and line of credit as of December 31, 2010, as well as future commitments under the Company’s office space lease.
The items affecting operating cash flow and cash and cash equivalents are discussed more fully in the “Material Changes in Results of Operations” section.
Material Changes in Results of Operations
Revenues from Operations
Total revenues from operations decreased $1,408,463, or 34.8%, to $2,636,782 for the year ended December 31, 2010, compared to $4,045,245 for the same period in 2009. The decrease is due to lower natural gas production, since new wells are not being drilled and production from existing wells is decreasing, and lower contract pricing in 2010, offset by the real estate property tax refund received.
Expenses from Operations
Total operating expenses decreased $2,720,865, or 40.4%, to $4,020,625 for the year ended December 31, 2010 from $6,741,490 for the same period in 2009. This decrease is primarily attributable to a decrease in depreciation, depletion and amortization and impairment expenses on our wells and a decrease in loss from our unconsolidated affiliate compared to the same period in 2009.
Interest expense increased $24,744, or 5.5%, to $473,302 for the year ended December 31, 2010 compared to $448,558 for the same period in 2009. Interest expense was slightly higher in 2010 due to the higher default rate being charged during part of the year, while 2009 was also high due to eight months of charges for a swap agreement which matured in August 2009.
Accretion expense for the year ended December 31, 2010 was $24,580 compared to $45,905 for the same period in 2009.
Oil and natural gas production costs decreased $22,483, or 3.3%, to $664,699 for the year ended December 31, 2010 compared to $687,182 for the same period in 2009. The decrease is primarily the result of a decrease in water hauling, service rig rental and well repairs and maintenance, partially offset by higher payments and accruals for county production taxes and telemeter charges.
Self-storage property operating expenses increased $23,985, or 20.9%, to $138,524 for the year ended December 31, 2010 compared to $114,539 for the same period in 2009. The increase is largely due to repairs, utility payments and snowplowing expenses.
Legal and professional fees decreased $11,196, or 3.0%, to $356,658 for the year ended December 31, 2010 compared to $367,854 for the same period in 2009. Although the legal and professional fees decreased for the year ended December 31, 2010 compared to the same period in 2009, both years are significantly higher than is usual for the Company. The large expenses are directly related to the forbearance settlement on June 18, 2010 with RBS Citizens, N.A. whereby the Company has had to pay its attorney expenses and the bank’s as part of the court settlement.
Property taxes and insurance expenses decreased $61,262, or 44.6%, to $76,230 for the year ended December 31, 2010 compared to $137,492 for the same period in 2009. The decrease is due to a reduction in the property values, and consequently the property taxes, on two parcels at the Painesville storage facility and the non-renewal of the Directors and Officers insurance plan during 2009. The reduction in property values and property taxes resulted from a reassessment requested by the Company.
General and administrative expenses decreased $157,959, or 20.7%, to $605,023 for the year ended December 31, 2010 compared to $762,982 for the same period in 2009. The decrease in general and administrative expenses for the year ended December 31, 2010 is largely due to a decrease in employees and benefits, director meeting expense, and fewer expenditures in most categories.
Loss from unconsolidated affiliate expense decreased $474,908 for the year ended December 31, 2010 compared to for the same period in 2009. The Company recorded impairment losses of $143,197 and $588,309 in 2010 and 2009, respectively.
Impairment and dry well costs from operations for the year ended December 31, 2010 was $0 compared to $145,444 for one well during the same period in 2009. Impairments and dry wells could happen in future years, particularly in an aggressive drilling program or when market prices of production is very low, as is the current case.
Depreciation, depletion and amortization expenses decreased $1,875,017, or 55.5%, to $1,506,097 for the year ended December 31, 2010 compared to $3,381,114 for the same period in 2009. The current depletion expense is lower than the same period in 2009 largely due to the reduction in the Company’s depletable base from prior year expense.
Net Loss
The Company had a net loss from operations of $1,383,843, for the year ended December 31, 2010 compared to a net loss of $2,696,245 for the same period in 2009. The large reduction in the net loss was due to decreased depreciation, depletion, and amortization expenses, that were partially offset by a reduction in production revenue; decreased impairment loss on Kykuit; a refund of real estate taxes in 2010; and lower operating expenses as compared to 2009.
Net Loss attributable to Non-Controlling Interest
The Company had net income attributable to its non-controlling interest in LSS I of $103,972 for the year ended December 31, 2010 and a net loss of $81,544 for the same period in 2009. Although LSS I has usually recorded a loss in prior periods, during the year ended December 31, 2010, it had income due to the decrease in the property values on the Painesville property in which a refund payment was received.
Net Loss attributable to John D. Oil and Gas Company
The Company had a net loss attributable to John D. interests of $1,487,815 for the year ended December 31, 2010 compared to a net loss of $2,614,701 for the same period in 2009. The loss in 2010 is less compared to 2009 largely due to reduced operating expenses and depletion expense, while 2010 also had reduced natural gas production revenue from decreased production volumes and lower pricing than 2009.
Interest Rate Risk
Interest rate risk is the risk that interest rates will increase, which will result in an increase in the Company’s interest expense on its variable rate loans.
The loan on the Painesville facility and the Charter One line of credit, totaling approximately $10.5 million, are tied to variable interest rates. If the Company’s interest rates on the loans were to increase by 1% per year, the Company’s interest expense would increase approximately $105,000 on an annual basis. The Company’s line of credit was previously fixed through the use of an interest rate swap until August 2009 which had minimized the risk. Additionally the line of credit interest rate is fixed at 4.75% for one year until July 2011. However if interest rates increase, the Company’s results of operations may be materially and adversely affected.
Off-Balance Sheet Arrangements
The Company had one off-balance sheet arrangement at December 31, 2010, with respect to its investment in Kykuit. While the Company is not liable for the contribution obligations of other members of Kykuit, the Company is investing additional funds since other members are not investing at this time. During 2010 and 2009, the Company invested cash of $93,440 and $514,414, respectively, in Kykuit as part of their cash calls and to make up the difference for other members not investing.
Forward-Looking Statements
Statements that are not historical facts, including statements about the Company’s confidence in its prospects and strategies and its expectations about growth, are forward-looking statements that involve risks and uncertainties. These risks and uncertainties, many of which are beyond our control, may include statements about our:
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ability to continue as a going concern;
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liquidity and our ability to meet our debt obligations;
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business strategy;
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financial strategy;
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drilling locations;
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natural gas and oil reserves;
•
realized natural gas and oil prices;
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production volumes;
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lease operating expenses, general and administrative expenses and finding and development costs;
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future operating results; and
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plans, objectives, expectations and intentions.
All of these types of statements, other than statements of historical fact, included in this report are forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “could,” “should,” “expect,” “plan,” “project,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “pursue,” “target,” “continue,” the negative of these terms or other comparable terminology.
The forward-looking statements contained in this 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 these 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. We caution all readers that the forward-looking statements contained in this report 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 factors listed in the “Risk Factors” section and elsewhere in this report. All forward-looking statements speak only as of the date of this report. 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.
Income Taxes
Effective January 1, 2006, the Company became a “C” Corporation for tax purposes.
At December 31, 2010 and 2009, the Company had net operating loss carry forwards (NOLS) for future years of approximately $16.6 million and $15.9 million, respectively. These NOLS will expire at various dates through 2028. Utilization of the NOLs could be limited if there is a substantial change in ownership of the Company and is contingent on future earnings. In addition, the Company has a $41,187 alternative minimum tax (AMT) credit that carries forward indefinitely.
The Company has provided a valuation allowance equal to 100% of the total net deferred asset in recognition of the uncertainty regarding the ultimate amount of the net deferred tax asset that will be realized.
Recently Issued Accounting Pronouncements
Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses
In July 2010, the FASB issued ASU No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” This ASU amends disclosure requirements with respect to the credit quality of financing receivables and the related allowance for credit losses. Entities will be required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about their financing receivables and related allowance for credit losses. Disclosures to be made as of the end of a reporting period are effective for the Company’s reporting period ending December 31, 2010; and the disclosures about activity that occurs during a reporting period will be effective for the Company’s reporting period ending March 31, 2011. Since this ASU will only amend disclosure requirements, not accounting practice, the adoption of this ASU did not have a material impact on the Company’s financial position, results of operations or cash flows.
The Company reviewed all other recently issued, but not yet effective, accounting pronouncements and does not believe any such pronouncements will have a material impact on the financial statements.
Item 8.
Item 8.
Financial Statements and Supplementary Data
The Company’s Report of Independent Registered Public Accounting Firm and Consolidated Financial Statements are filed as part of this report.
Item 9A.
Item 9A.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of December 31, 2010, the Company’s principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our chief executive officer and chief financial officer each concluded that the Company’s disclosure controls and procedures were not effective in light of the identification of a material weakness in the Company’s internal controls over financial reporting as discussed below.
Management’s Report on Internal Control over Financial Reporting
The management of the Company is responsible for establishing and maintaining an adequate system of internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our Consolidated Financial Statements for external purposes in accordance with generally accepted accounting principles defined in the Exchange Act.
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the registrant’s annual or interim financial statements will not be prevented or detected on a timely basis.
We carried out an evaluation under the direction of our chief executive officer and chief financial officer, of the effectiveness of our internal control over financial reporting. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control over Financial Reporting - Guidance for Smaller Public Companies (2006).” Based on that evaluation, our management concluded that our internal controls over financial reporting were not effective as of December 31, 2010 due to control deficiencies that constitute a material weakness.
In connection with management’s assessment of our internal control over financial reporting described above, management has identified the following material weakness in our internal control over financial reporting as of December 31, 2010:
The Company’s size and staff limitations have prevented it from being able to employ sufficient resources to enable the Company to have an adequate level of supervision and segregation of duties within the internal control system. At times, the Company has one person responsible for processing transactions and reporting them. This creates certain incompatible duties and a lack of review over the financial reporting process that would likely fail to detect errors in spreadsheets, calculations or other documentation. Existing management attempts to provide oversight for most functions but lack of personnel makes the task virtually impossible in some situations. In addition this lack of segregation of duties led management to conclude that the Company’s disclosure controls and procedures were not effective to give reasonable assurance that the information required to be disclosed in reports that the Company files under the Exchange Act are recorded, processed and reported as and when required. These control deficiencies could result in a material misstatement in our interim or annual financial statements that would not be prevented or detected on a timely basis.
In order to mitigate this material weakness, all financial reports are reviewed by two of the Company’s board members for reasonableness. All unexpected results are investigated.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Notwithstanding the material weakness described above, to the best of their knowledge, the Company’s management believes that the financial statements included in this Annual Report on Form 10-K fairly present, in all material respects, the Company’s financial condition, results of operations and cash flows for the periods presented in conformity with U.S. generally accepted accounting principles.
Changes in Internal Control over Financial Reporting
The Company has reduced its office staff which hampers the Company’s ability to maintain adequate segregation of duties which led to control deficiencies that constitute a material weakness in our internal control over financial reporting.
Attestation Report of Independent Registered Public Accounting Firm
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report is not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that require the Company to provide only management’s report in this annual report.
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
Directors and Executive Officers. Below are the names, ages, positions and certain other information concerning our current directors and executive officers:
Richard M. Osborne, 65, has been chairman, chief executive officer and a director of John D. Oil and Gas since September 1999. He has been a director since 2003, chairman of the board since 2005 and chief executive officer since November 2007 of Gas Natural Inc., a publicly-held public utility company. He is the president and chief executive officer of OsAir, Inc., a company he founded in 1963, which operates as a property developer and manufacturer of industrial gases for pipeline delivery. From 2006 to February 2009 he was a director of Corning Natural Gas Corporation, a publicly-held public utility company in Corning, New York and from September 2008 to January 2009 he was a director of PVF Capital Corp., a publicly-held holding company for Park View Federal Savings Bank in Solon, Ohio. Richard Osborne’s background as chairman and chief executive officer of various public companies and many years of experience owning and managing companies in energy and utility related industries provides the board with invaluable management and operational direction.
Gregory J. Osborne, 32, has been president and chief operating officer of John D. Oil and Gas since April 2006 and a director since February 2006. From 2003 until joining John D. Oil and Gas, he was president of Great Plains Exploration LLC, an oil and gas exploration company based in Mentor, Ohio that owns and operates oil and gas wells. From 2001 until joining Great Plains, he served as executive vice president of Orwell Natural Gas Company, a regulated gas public utility company operating in Ohio. He is a director of Gas Natural Inc., a publicly-held public utility company. He is the son of Richard Osborne, our chairman and chief executive officer. Gregory Osborne’s managerial experience and service on the board of various energy related companies provides the board with a wide range of industry specific knowledge.
Thomas J. Smith, 66, has been a director of John D. Oil and Gas since 1998. In November 2007, he was appointed vice president and chief financial officer of Gas Natural Inc., a publicly-held public utility company. He also served as Gas Natural Inc.’s interim president from August 2007 to November 2007 and has been a director of Gas Natural Inc. since 2003. From 1999 to 2006, he served as our president and chief operating officer. Mr. Smith’s financial and disclosure experience gained as the chief financial officer of publicly-held companies, as well as his experience as a director of energy and utility related companies provides extensive specialized knowledge and expertise to our board.
Carolyn Coatoam, 65, was appointed chief financial officer and assistant secretary of John D. Oil and Gas on December 31, 2010. Ms. Coatoam has been employed as a consultant to Richard M. Osborne, the Company’s Chief Executive Officer, since June 2009. From 1996 to 2009, she worked for the consulting firm of Niche Systems & Support, Inc., on an assignment to a publicly-held distributor of industrial products. Ms. Coatoam began her career with Deloitte & Touche. Subsequently, she served as the chief financial officer for Mr. Concrete Inc. and Coatoam & Co. Inc. until 2005. She is an inactive certified public accountant.
Section 16(a) Beneficial Ownership Reporting Compliance. Section 16(a) of the Securities Exchange Act of 1934 requires our directors and executive officers, and persons who own more than 10% of our common stock, to file with the Securities and Exchange Commission (SEC) initial reports of ownership and reports of changes in ownership of our common stock. Our officers, directors and greater than 10% stockholders are required by the SEC to furnish us with copies of all Section 16(a) forms they file. Based solely on review of copies of reports furnished to us or written representations that no reports were required, we believe that all Section 16(a) filing requirements were met timely in 2010.
Code of Business Conduct and Ethics. The Company has adopted a code of conduct and ethics that applies to all officers, directors and employees of John D. Oil and Gas, including our principal executive officer, principal financial officer, principal accounting officer, and any person performing similar functions. A copy of the code is available on our website at www.johndoilandgas.com. Any amendments or waivers to our code of conduct and ethics that apply to our chief executive officer or chief financial officer will be promptly disclosed to our stockholders.
Audit Committee. Following the resignations of the audit committee members and most of the remaining directors on August 26, 2009, the Company was left with only three directors (Richard M. Osborne, Gregory J. Osborne and Thomas J. Smith), none of whom are independent pursuant to applicable laws and regulations and listing standards of NASDAQ. Currently, our board does not have a separately-designated audit committee and the entire board acts as the audit committee. Mr. Smith would qualify as an “audit committee financial expert” but he is not independent.
Director and Executive Officer Compensation Decisions. Our chairman and chief executive officer generally determines the compensation for our executive officers and compensation is then approved by the full board. We do not have a compensation committee. Our board believes a compensation committee is not necessary because of the level and type of compensation paid to our executive officers and because executive officer compensation is approved by our full board. The compensation of our outside directors was also approved by our full board. The board also administers our Amended and Restated 1999 Stock Option and Award Plan.
Summary Compensation Table. The following table summarizes the compensation paid by us to our chairman and chief executive officer and any other executive officer receiving more than $100,000 in total compensation annually. We do not believe that our compensation practices are reasonably likely to have a material adverse effect on the Company.
*
Richard Osborne does not receive compensation for serving as our chairman and chief executive officer.
Executive Officer Outstanding Equity Awards at December 31, 2010. None of our executive officers had any outstanding equity awards at December 31, 2010.
Executive Officer Employment Agreements. None of our executive officers has an employment agreement with us.
Director Compensation. Richard M. Osborne, Gregory J. Osborne and Thomas J. Smith did not receive compensation for serving on our board during 2010.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth the amount and nature of the beneficial ownership of our common stock as of March 29, 2010 by each person known by us to own more than 5% of the outstanding shares, each director, each executive officer in our summary compensation table, and all our current directors and executive officers as a group.
Equity Compensation Plan Information
The following table summarizes information, as of December 31, 2010, relating to our Amended and Restated 1999 Stock Option and Award Plan. The plan provides for the issuance of up to 300,000 shares of common stock to key employees, officers and directors. As of December 31, 2010, there were 35,000 shares of restricted stock and no options outstanding and the maximum number of shares available for future grant under the plan was 265,000 shares. Under the plan, the option price may not be less than 100% of the common stock fair market value on the date of grant (in the event of incentive stock options, 110% of the fair market value if the employee owns more than 10% of our outstanding common stock).
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Richard M. Osborne, our chairman and chief executive officer, is the sole manager of Liberty Self-Stor II, Ltd., an Ohio limited liability company, which owns a truck rental business that provides trucks for short-term rental to the general public, including tenants of our self-storage facility, and provides for the retail sale of locks, boxes, packing materials, propane gas and related merchandise at the self-storage facility. John D. Oil and Gas has a cost sharing agreement with Liberty Self-Stor II with respect to the sharing of employees and space at the offices of the self-storage facility for the benefit of both companies. As of December 31, 2010, Liberty Self-Stor II owed us $3,806 associated with these transactions, as well as for cash advances between the companies.
On December 28, 1999, our stockholders approved the lease of our executive offices from OsAir, Inc., a company owned by Mr. Osborne. The lease had a three year term maturing on March 31, 2009 for $1,350 per month. The lease was extended on March 25, 2009 for a three year term at $2,000 per month. As of December 31, 2010, $24,000 of this expense is included in our general and administrative expenses.
On September 28, 2006, the Company entered into an unsecured loan agreement for a line of credit with a one year term with Mr. Osborne and Charter One Bank for up to $5.0 million dollars in total borrowings with interest at a rate of 1.75% over LIBOR adjusted monthly. The Charter One liability was jointly loaned, so the Company and Mr. Osborne were each liable for the debt of the other.
The loan was subsequently revised several times until on March 28, 2008, the Company entered into the First Amended and Restated Loan and Security Agreement (the “Loan Agreement”) between the Company, Mr. Osborne (the Company and Mr. Osborne together, the “Borrowers”), and Charter One. The Loan Agreement extended the maturity date to August 1, 2009, continuing with the original interest rate calculation of 1.75% over LIBOR adjusted monthly. Under the agreement, only the Company could borrow on the line of credit when any amounts are paid down against the $9.5 million outstanding on the loan. The Company and Great Plains Exploration LLC, a company owned by Mr. Osborne (“Great Plains”), agreed that the related party loan of $3.8 million from Great Plains was satisfied in full and terminated upon the Company’s entry into the new Charter One loan and assumption of the $3.8 million portion of the line of credit drawn by Mr. Osborne. Therefore, the Company had $9.5 million in outstanding debt to Charter One and $0 in outstanding debt to Great Plains at March 31, 2008. As part of this loan agreement, Mr. Osborne has pledged several real estate properties that he personally owns, to provide sufficient collateral allowing the Company to enter into the loan agreement. The Company did not meet the reserve collateral requirements for a $9.5 million loan without additional collateral.
The Company’s $9.5 million line of credit with Charter One matured on August 1, 2009. On August 20, 2009, Charter One received a judgment in its favor against the Company and Mr. Osborne, related to the $9.5 million line of credit. The average balance during 2010 was $9.5 million and the weighted average interest rate was 3.55%. The average balance during 2009 was $9.5 million and the weighted average interest rate was 2.12%.
On June 18, 2010, the Company, Mr. Osborne, the Richard M. Osborne Trust (the “Trust”), Great Plains, and Oz Gas, Ltd. (companies owned by Mr. Osborne) entered into a Forbearance Agreement with Charter One regarding the Company’s $9.5 million line of credit under the Loan Agreement and regarding the $25.0 million loan agreement between Great Plains, Oz Gas and Mr. Osborne and Charter One, dated August 2, 2007 (together, the “Loan Agreements”). The Company, Mr. Osborne, the Trust, Great Plains and Oz Gas are collectively referred to in the Forbearance Agreement and herein as the “Loan Parties.”
Pursuant to the Forbearance Agreement and during the forbearance period, Charter One agreed to, among other things, forbear from exercising its rights and remedies arising out of the judgments and the Loan Agreements and to stay any action on its motion for the appointment of a receiver.
Under the Forbearance Agreement, Charter One’s agreement to forbear is conditioned upon and subject to the following conditions:
•
No material adverse change in the condition of the Loan Parties;
•
An assignment and grant of a security interest by the Company and Great Plains Exploration of each of their ownership interests in the Alpha and Panzica wells;
•
A pledge by the Loan Parties of their ownership interests in Kykuit Resources LLC; and
In addition, commencing July 1, 2010 and each month thereafter until all amounts under the judgments and loan agreements have been paid in full, the Loan Parties shall pay Charter One $400,000, including the $40,000 forbearance fee. The Company had previously planned to pay one third of the $400,000, but due to lack of cash, they have decided to accrue interest and one third of the $40,000 monthly fee and legal fees. The monthly $400,000 is being paid by the other Loan Parties. Such payments by the Loan Parties shall be applied first to Charter One’s fees and expenses, second to accrued but unpaid interest due under the judgments, and third to principal amounts due under the judgments. Charter One contends that the judgments will bear interest at LIBOR plus 1.75% with a LIBOR floor of 3.00%. The Company believes that there is an interest rate cap of 3.00%. The parties are in discussions regarding the applicable interest rate. If the Loan Parties repay $10 million and if after application of such repayment the outstanding balance of the judgments does not exceed 65% of the current producing reserve value (as that term is defined in the Loan Agreements) of the Company, Great Plains and Oz Gas, then the pledge of Mr. Osborne’s Kykuit interests and his Gas Natural Inc. shares shall be released. In addition, the Company must deposit all proceeds of its operations into accounts maintained by Charter One but during the forbearance period Charter One will not take any action to set off funds in any such account.
The forbearance period is effective until July 1, 2011, subject to the earlier termination upon the occurrence of any events of default by any of the Loan Parties, including non-payment of any amounts due by any of the Loan Parties under the Forbearance Agreement.
Because the Company does not have the available cash to repay the line of credit, if the required payments are not made by the Company or any of other Loan Parties, or other events of default occur, under the Forbearance Agreement or if prior to the end of the forbearance period the Company is unsuccessful in refinancing the line of credit with Charter One or if the Company is unsuccessful in obtaining substitute financing, there is substantial doubt about the Company’s ability to continue as a going concern.
Discussions with Charter One are ongoing but there is no certainty that these discussions will result in satisfactory terms of a revised loan agreement or a revised loan agreement at all. If Charter One demands repayment of the outstanding amounts payable at the end of the forbearance period, the Company does not have the available cash to repay the line of credit and will need financing from other sources to repay Charter One.
Effective January 1, 2006, the Company entered into a contract with Great Plains for well operations and sale of natural gas and oil production, net of pipeline costs. The term of the agreement was one year from the effective date. It was extended as of January 1, 2007 and shall be extended for consecutive one year periods unless terminated earlier.
The Company is a fifty percent partner and the operating manager of Lucky Brothers LLC, a company whose other partners are almost all related to Mr. Osborne. The partnership owned one well at December 31, 2010. The purpose of Lucky Brothers LLC is to engage in a joint venture for drilling wells. The Company has invested $174,392 in well tangibles and intangibles at December 31, 2010 and 2009.
The Company purchases well supplies from Big Oats Oilfield Supply Company, a company owned by Mr. Osborne.
At December 31, 2010, the Company had a $12,000 invoice outstanding to Oz Gas Ltd., a company owned by Mr. Osborne, for payments made on the Company’s behalf to Charter One during 2010.
The Company paid Orwell Trumbull Pipeline, LLC, a company owned by Mr. Osborne, for telemeter charges in 2010.
On August 3, 2007, Kykuit Resources, LLC purchased from Hemus, Ltd. a 75% interest in certain oil, natural gas and mineral rights located in the Montana Breaks area of Montana. At the same time, Kykuit and Hemus executed a joint venture development agreement pursuant to which Kykuit agreed to develop and operate all of their joint leasehold interests in the Montana Breaks. On May 1, 2008, Kykuit entered into an assignment pursuant to which Hemus assigned all of its remaining rights, title and interest in certain oil and natural gas and mineral leases located in Montana to Kykuit for $250,000. John D. Oil and Gas is the managing member of Kykuit and currently owns 21.79% of Kykuit. The current investment by John D. Oil and Gas in this venture was $736,953 at December 31, 2010.
Richard Osborne owns interests in Kykuit. Gas Natural, Inc., a publicly-held public utility company of which Richard Osborne is the chairman and chief executive officer and a significant stockholder, also owns an interest in Kykuit. Thomas J. Smith, a director of John D. Oil and Gas, is also vice president, chief financial officer and a director of Gas Natural, Inc.
On February 28, 2006, we entered into a registration rights agreement with the Richard M. Osborne Trust, of which Richard Osborne is the sole trustee, and any other stockholders who become parties to the agreement pursuant to its terms, which provides, among other things, certain piggyback registration rights to the stockholders who are parties to the agreement and that we will file a registration statement with the SEC upon the demand of the Osborne Trust.
The following tables summarize the related party transactions for accounts receivable of oil and natural gas production, capitalized costs for wells, outstanding accounts payable, revenues received and payments paid for expenses to related parties for the periods indicated. The accounts receivable from various companies owned by Mr. Osborne in the accompanying consolidated balance sheets represent amounts owed to the Company for minor cost sharing transactions and are listed in the following table for the years ended December 31, 2010 and 2009.
We believe that the terms of the transactions and the agreements described above are on terms at least as favorable as those which we could have obtained from unrelated parties. On-going and future transactions with related parties will be:
•
on terms at least as favorable as those that we could obtain from unrelated parties,
•
for bona fide business purposes, and
•
approved by a majority of disinterested and non-employee directors, if any.
Director Independence. Following the resignations of the audit committee members and most of the remaining directors on August 26, 2009, the Company was left with only three directors (Richard M. Osborne, Gregory J. Osborne and Thomas J. Smith), none of whom are independent pursuant to applicable laws and regulations and listing standards of NASDAQ. Currently, our board does not have a separately-designated audit committee and the entire board acts as the audit committee. Mr. Smith would qualify as an “audit committee financial expert” but he is not independent.
Item 14.
Item 14.
Principal Accountant Fees and Services
Maloney + Novotny, our independent auditors, billed $91,520 in 2010 and $96,648 in 2009 for audit fees for the audit of our annual consolidated financial statements, the review of financial statements included in our quarterly reports on Form 10-Q, and services that are typically rendered in connection with statutory and regulatory filings or engagements. Maloney + Novotny did not render any other services to us in 2010 and 2009.
Audit Committee Pre-Approval Policies and Procedures. The Company’s directors approved the engagement of the auditors engaged by John D. Oil and Gas to render audit or permissible non-audit services for the year ended December 31, 2010. The directors also reviewed the scope of any audit and other assignments given to our auditors to assess whether these assignments would affect their independence. In 2010, the Company’s directors reviewed all services provided by Maloney + Novotny to ensure that they were within the scope previously approved.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
*
Filed herewith

Management agreement or compensatory plan or arrangement
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: March 31, 2011 JOHN D. OIL AND GAS COMPANY
By: /s/ Richard M. Osborne
Richard M. Osborne
Chairman and Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Richard M. Osborne
Richard M. Osborne
Chairman, Chief Executive Officer and Director
(Principal Executive Officer)
Dated: March 31, 2011
/s/ Carolyn Coatoam
Carolyn Coatoam
Chief Financial Officer
(Principal Financial and Accounting Officer)
Dated: March 31, 2011
/s/ Gregory J. Osborne
Gregory J. Osborne, President and Director
Dated: March 31, 2011
/s/ Thomas J. Smith
Thomas J. Smith, Director
Dated: March 31, 2011
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of
John D. Oil and Gas Company
We have audited the accompanying consolidated balance sheets of John D. Oil and Gas Company (a Maryland corporation) and Subsidiary as of December 31, 2010 and 2009, and the related consolidated statements of operations and comprehensive loss, shareholders’ equity, and cash flows for each of the two years in the period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of John D. Oil and Gas Company and Subsidiary as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
As more fully described in Note 2, to the consolidated financial statements, the Company has suffered recurring losses and has $9.5 million of debt currently due and subject to a forbearance that raises substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Maloney + Novotny LLC
Cleveland, Ohio
March 31, 2011
John D. Oil and Gas Company and Subsidiary
Consolidated Balance Sheets
The accompanying notes to consolidated financial statements are an integral part of these statements.
John D. Oil and Gas Company and Subsidiary
Consolidated Statements of Operations and Comprehensive Income
For The Years Ended December 31, 2010 and 2009
The accompanying notes to consolidated financial statements are an integral part of these statements.
John D. Oil and Gas Company and Subsidiary
Consolidated Statements of Shareholders’ Equity
For The Years Ended December 31, 2010 and 2009
The accompanying notes to consolidated financial statements are an integral part of these statements.
John D. Oil and Gas Company and Subsidiary
Consolidated Statements of Cash Flows
The accompanying notes to consolidated financial statements are an integral part of these statements.
John D. Oil and Gas Company and Subsidiary
Notes to Consolidated Financial Statements
For The Years Ended December 31, 2010 and 2009
1. Summary of Significant Accounting Policies
General
John D. Oil and Gas Company, formerly Liberty Self-Stor, Inc. (the “Company”), is a corporation organized under the laws of the State of Maryland.
The Company was originally a self-storage company from 1999 to 2005 when it sold all but two of its facilities. By May 2007, one self-storage facility in Painesville remained which generates revenue through self-storage rentals and retail leases. The self-storage facility is operated through a partnership agreement between Liberty Self-Stor Ltd. (“Ltd”) and the Company. Ltd has a 70.1% equity interest and the Company has a 29.9% equity interest in the operating partnership of LSS I Limited Partnership (“LSS I”). The members of Ltd consist of Richard M. Osborne, Chairman and Chief Executive Officer of the Company, Thomas J. Smith, a director and the former President and Chief Operating Officer of the Company, and Retirement Management Company, an Ohio corporation owned by Mr. Osborne. These members have Class A limited partnership interests that are redeemable for cash or, at the election of the Company, convertible into shares of the Company’s stock based on an exchange factor. The current exchange factor is .1377148 of a share for each unit.
In 2006, the Company entered into the business of extracting and producing oil and natural gas products, drilling oil and natural gas wells in Northeast Ohio. The Company currently has fifty-eight producing wells. The Company cannot guarantee success under its business plan as drilling wells for oil and natural gas is a high-risk enterprise and there is no guarantee the Company will become profitable.
Principles of Consolidation
Pursuant to the terms of the partnership agreement of LSS I Limited Partnership, the Company, as sole general partner, controls LSS I. Accordingly, the Company accounts for its investment in LSS I utilizing the consolidation method. The investment in an unconsolidated affiliate, Kykuit Resources LLC (“Kykuit”) is accounted for using the equity method. All significant inter-company transactions and balances have been eliminated. The well in Lucky Brothers is accounted for as a joint interest venture.
Use of Estimates
The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of our assets, liabilities, revenues, costs and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates all of these estimates, including those related to the provision for possible losses, deferred tax assets and liabilities, depreciation and depletion, and certain accrued liabilities. The Company bases estimates on historical experience and on various other assumptions that we believe reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The Company’s financial statements are based on a number of significant estimates, including collectability of receivables, selection of useful lives for property and equipment and timing and costs associated with its retirement obligations. Estimates of economically recoverable oil and natural gas reserve quantities and future net cash flows depend on a number of variable factors and assumptions that are hard to predict and may vary considerably from actual results. Estimated oil and natural gas reserve quantities are the basis for the calculation of depreciation, depletion and impairment of oil and natural gas properties.
The Company’s oil and natural gas business makes it vulnerable to changes in wellhead prices of crude oil and natural gas. Such prices have been volatile in the past and can be expected to continue to be volatile. Proved reserves are based on current oil and natural gas prices and estimated reserves, which is considered a significant estimate by the Company, and is subject to change.
Accounts Receivable
The Company has certain trade receivables consisting of oil and natural gas sale obligations due under normal trade terms. The Company currently sells its production to a related party through an oil and natural gas agreement, extending credit on an unsecured basis to them. In evaluating its allowance for possible losses, the Company performs a review of outstanding receivables. The trade receivables outstanding are typically three months of natural gas production due to the timing and accounting treatment by the main distribution pipeline company in Northeast Ohio and related party accounting treatments. At December 31, 2010 and 2009, the Company’s credit evaluation indicated that it has no need for an allowance for possible losses and had no such losses in 2010 and 2009.
The Company’s accounts receivable, arising from the self-storage business, are due from individuals as well as business entities. Tenants are required to pay their rent on the first of each month. Past due amounts are those that are outstanding longer than the contractual payment terms. If an account is more than 75 days past due, the Company generally writes off the balance directly to expense. For such past due accounts, the Company has the right to auction the contents of the rented space, which allows for recovery of written-off balances. Any such recoveries are credited to income when received. Approximately $2,000 of bad debt expense was incurred in 2010 and 2009.
Property and Equipment
All property and equipment is depreciated using the straight-line method over estimated useful lives of twenty five years for buildings and improvements and five to seven years for furniture and equipment.
The Company uses the successful efforts method of accounting for oil and natural gas producing activities. Under this method, acquisition costs for proved and unproved properties are capitalized when incurred. Exploration costs, including geological and geophysical costs, the costs of carrying and retaining unproved properties and exploratory dry hole drilling costs, are expensed. Development costs, including the costs to drill and equip development wells and successful exploratory drilling costs to locate proved reserves, are capitalized. Upon sale or retirement of a proved property, the cost and accumulated depreciation and depletion and amortizations are eliminated from property accounts and the resultant gain or loss is recognized.
Exploratory drilling costs are capitalized when incurred pending the determination of whether a well has found proved reserves. If a well is determined to be successful, the capitalized drilling costs will be reclassified as part of the cost of the well. If a well is determined to be unsuccessful, the capitalized drilling costs will be charged to expense in the period the determination is made. The Company is involved in exploratory drilling only to the extent that it is a partner of Kykuit, which is doing exploratory drilling in Montana. The Company is an owner and managing member of Kykuit, an unconsolidated affiliate.
Development costs of proved oil and natural gas properties, including estimated dismantlement, restoration, abandonment costs and acquisition costs, are depreciated and depleted on a well by well basis by the units-of-production method using estimated proved developed reserves. The costs of oil and natural gas properties are periodically assessed for impairment.
Asset Impairment
The Company reviews its self-storage property and capitalized well costs for impairment when events or changes in circumstances indicate the carrying amounts of the properties may not be recoverable. When such conditions exist, management estimates future cash flows from operations and ultimate disposition of the individual properties. This income approach to determine the fair value of these assets is based on level 3 inputs, including estimated reserve quantities, gas prices, operating costs and discount rates. If the estimated undiscounted future cash flows are less than the carrying amount of the asset, an adjustment to reduce the carrying amount to the related property’s estimated fair market value would be recorded and an impairment loss would be recognized. The Company wrote off $-0- in 2010 and the costs related to one well amounting to $145,444 in 2009.
Asset Retirement Obligation
The Company accounts for its asset retirement obligations in accordance with generally accepted accounting principles in the United States of America (“GAAP”) which requires the fair value of an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. For the Company, asset retirement obligations primarily relate to the abandonment, dismantling and plugging of oil and natural gas wells. The present value of the estimated asset retirement cost is capitalized as part of the long-lived asset. The capitalized asset retirement cost is depreciated and the asset retirement obligation is accreted over the estimated life of the well.
The following table presents the Company’s asset retirement obligation activity for the years ended December 31:
The Company plugged no wells in 2010 and two wells in 2009.
Revenue Recognition
The Company recognizes revenue from its oil and natural gas interests in producing wells as oil and natural gas is sold to a purchaser at a fixed or determinable price when delivery has occurred, title and risk of loss have transferred to the purchaser and the collectability of revenue is reasonably assured. The Company has a management agreement with a related party to transport the Company’s natural gas production through the related party’s pipeline and include this natural gas with the related party’s natural gas in order to fulfill production contracts they currently have in place. The Company uses the sales method to account for any gas production volume imbalances. Under this method, revenue is recognized only when gas is produced and sold on the Company’s behalf. The Company had no material gas imbalances at December 31, 2010 and 2009.
The Company’s revenue from self-storage operations is derived primarily from monthly rentals of self-storage units. Rental revenue is recognized in the period the rent is earned which is typically on a monthly basis.
The Company also leases certain commercial space in its Painesville property under long-term lease agreements through December 31, 2019. Total lease revenue related to these leases was $214,469 and $199,029 for the years ended December 31, 2010 and 2009, respectively. Revenue under these long-term lease agreements is recognized on a straight-line basis over the respective lease terms.
Future minimum lease revenue from operations under non-cancelable leases excluding options to renew for each of the five succeeding annual periods ending December 31 and thereafter are as follows:
Stock-Based Compensation
On June 16, 2009 at the Company’s Annual Meeting, of the stockholders who voted, 81.7% voted to approve amendments to the Company’s stock option plan. The plan was extended another ten years.
Of the 300,000 stock options that may be granted, none were outstanding as of December 31, 2010 and 2009. Stock options totaling 25,000 shares at a weighted average price of $0.56 were terminated in the second quarter of 2009 when an employee was no longer employed by the Company. Additionally, the former President and Chief Operating Officer of the Company was granted 35,000 restricted shares that amortize ratably over a five year vesting period until August of 2011. The compensation expense recorded for the restricted shares for the years ended December 31, 2010 and 2009 was $4,548.
On June 20, 2008, the Company granted a warrant to purchase 50,000 shares of common stock to Richard M. Osborne in return for Mr. Osborne providing collateral for the Company’s credit facility with RBS Citizens, N.A., d/b/a Charter One (“Charter One”). The fair value of the warrant was expensed in 2008. The warrant has an exercise price of $1.00 per share and a term of five years.
Income Taxes
Effective January 1, 2006, the Company became a “C” Corporation for tax purposes.
In establishing a provision for income taxes, the Company must estimate when in the future certain items will affect taxable income. Deferred taxes are recorded for future tax consequences of events that have been recognized in the financial statements or tax returns, based upon enacted tax laws and rates. Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not.
The Company has net operating loss carry forwards (NOLS) and a valuation allowance to offset any tax effects. The Company has no unrecognized tax benefits and therefore, there is no anticipated effect on the Company’s effective tax rate. Any tax penalties or interest expense will be recognized in income tax expense. No interest and penalties were accrued as of December 31, 2010 or 2009, or paid during the periods then ended. The Company does not anticipate a significant change over the next twelve months to any tax liability.
The Company is open to federal and state tax audits until the applicable statute of limitations expire. There are currently no federal or state income tax examinations underway for the Company. The tax years after 2007 remain open to examination by the major taxing jurisdictions in which we operate, although no material changes to unrecognized tax positions are expected within the next twelve months. The Company does, however, have prior year net operating losses which remain open for examination.
Fair Value of Financial Instruments
The fair value of the Company’s financial instruments is determined by using available market information and appropriate valuation methodologies. The Company’s principal financial instruments are cash, accounts receivable, accounts payable and debt. Cash, accounts receivable and accounts payable, due to their short maturities and liquidity, are carried at amounts which reasonably approximate fair value. Based upon rates available for similar borrowings, the Company’s book value approximated the fair value of its debt at December 31, 2010 and December 31, 2009.
Recently Issued Accounting Pronouncements
In July 2010, the FASB issued ASU No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” This ASU amends disclosure requirements with respect to the credit quality of financing receivables and the related allowance for credit losses. Entities will be required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about their financing receivables and related allowance for credit losses. Disclosures to be made as of the end of a reporting period are effective for the Company’s reporting period ending December 31, 2010; and the disclosures about activity that occurs during a reporting period will be effective for the Company’s reporting period ending March 31, 2011. Since this ASU will only amend disclosure requirements, not accounting practice, the adoption of this ASU did not have a material impact on the Company’s financial position, results of operations or cash flows.
The Company reviewed all other recently issued, but not yet effective, accounting pronouncements and does not believe any such pronouncements will have a material impact on the financial statements.
Reclassifications
Certain reclassifications of prior year comparative amounts have been made to conform to the December 31, 2010 presentation. These reclassifications had no effect on net loss or equity as previously reported.
2. Going Concern
The Company’s independent registered accounting firm has indicated in their audit report in an explanatory paragraph that the Company has suffered recurring losses and has $9.5 million of debt currently due and subject to a forbearance agreement that raises substantial doubt about its ability to continue as a going concern at December 31, 2010. The Company’s audited consolidated financial statements as of December 31, 2010 have been prepared on the assumption that the Company will continue as a going concern and do not include any adjustments that might result from the outcome of this uncertainty. The Company has incurred substantial losses, which have strained its financial resources, and the Company’s liabilities exceed its assets at December 31, 2010. The Company’s $9.5 million line of credit with RBS Citizens, N.A. d/b/a Charter One (“Charter One”) was due August 1, 2009 and was in default. On August 24, 2009, Charter One received a judgment in its favor against the Company and Mr. Osborne related to this debt. On June 18, 2010, the Company, and other parties, and Charter One entered into a forbearance agreement, (“the Forbearance Agreement”) pursuant to which Charter One will forbear from enforcing its rights and remedies under the Company’s line of credit as well as the other parties’ loan agreements until July 1, 2011, subject to no further events of default including the payments due under the Forbearance Agreement. The Company does not have the available cash to repay the line of credit with Charter One. The Company is meeting with Charter One on a regular basis to reach a loan agreement satisfactory to both parties. Additionally, the Company is seeking funds from other financial institutions. See Note 5 “Line of Credit and Long Term Debt” to these consolidated financial statements for more information.
3. Property and Equipment
Property and equipment consists of the following at December 31:
4. Investment in Unconsolidated Affiliates
The Company is an owner and managing member of an unconsolidated affiliate, Kykuit Resources LLC, which is accounted for using the equity method of accounting. The Company began investing in Kykuit during the third quarter of 2007. In 2008, the Company sold 25% of its interest in Kykuit at cost for approximately $1.4 million. The Company had an 18.8% ownership in Kykuit at December 31, 2008. Some of the Kykuit partners opted out of further cash investments during 2009, increasing the Company’s ownership percentage at December 31, 2009 to 20.83%. The Company’s investment was further increased to 21.79% at December 31, 2010.
At December 31, 2010, the investment by the Company in this venture was $736,953 which included a loss in the investment of $143,197; an account payable of $124,000; and a cumulative net book loss of $883,377. At December 31, 2009, the investment by the Company in this venture was $705,965 which included a loss in the investment of $588,309, an account payable of $10,490 and a cumulative net book loss of $119,556. The Company’s recorded loss of $143,197 in 2010 represented 21.79% of a reduction in on undrilled leases, which was also recorded by Kykuit. The Company recorded a loss of $588,309 on the investment representing 20.83% of an 85% reduction in the value of the exploratory wells in Kykuit at December 31, 2009. Kykuit recorded an impairment expense on its books at December 31, 2010 which had the same affect after the 85% reduction to the Company. The Company did not record any additional loss for this transaction in 2010. The following table displays the balance sheet of Kykuit at December 31, 2010, and 2009 and the income statement for the same years ended:
Kykuit Resources LLC
Balance Sheet
Kykuit Resources LLC.
Statement of Operations
For The Years Ended December 31, 2010 and 2009
5. Line of Credit and Long-Term Debt
On September 28, 2006, the Company entered into an unsecured loan agreement for a line of credit with a one year term with Mr. Richard M. Osborne, the Company’s Chairman and CEO, and Charter One Bank for up to $5.0 million dollars in total borrowings with interest at a rate of 1.75% over LIBOR adjusted monthly. The Charter One liability was jointly loaned, so the Company and Mr. Osborne were each liable for the debt of the other.
The loan was subsequently revised several times until on March 28, 2008, the Company entered into the First Amended and Restated Loan and Security Agreement (the “Loan Agreement”) between the Company, Richard M. Osborne (the Company and Mr. Osborne together, the “Borrowers”), and Charter One. The Loan Agreement extended the maturity date to August 1, 2009, continuing with the original interest rate calculation of 1.75% over LIBOR adjusted monthly. Under the agreement, only the Company could borrow on the line of credit when any amounts are paid down against the $9.5 million outstanding on the loan. The Company and Great Plains Exploration LLC a company owned by Mr. Osborne (“Great Plains”), agreed that the related party loan of $3.8 million from Great Plains was satisfied in full and terminated upon the Company’s entry into the new Charter One loan and assumption of the $3.8 million portion of the line of credit drawn by Mr. Osborne. Therefore, the Company had $9.5 million in outstanding debt to Charter One and $0 in outstanding debt to Great Plains at March 31, 2008. As part of this loan agreement, Mr. Osborne has pledged several real estate properties that he personally owns, to provide sufficient collateral allowing the Company to enter into the loan agreement. The Company did not meet the reserve collateral requirements for a $9.5 million loan without additional collateral.
The Company’s $9.5 million line of credit matured on August 1, 2009. On August 20, 2009, Charter One received a judgment in its favor against the Company and Mr. Osborne related to the $9.5 million line of credit. The average balance during 2010 was $9.5 million and the weighted average interest rate was 3.55%. The average balance during 2009 was $9.5 million and the weighted average interest rate was 2.12%.
The Company’s line of credit with Charter One was almost fully drawn for $9.5 million at December 31, 2010 at a rate of 4.75%. Charter One contends that the interest rate at December 31, 2010 is LIBOR plus 1.75% with a LIBOR floor of 3.00%. The Company believes that there is an interest rate cap of 3.00%. The parties are in discussions regarding the applicable interest rate. Also, Charter One has applied a default rate to the loan from January 4, 2010 thru June 18, 2010. The Company does not agree with the default rate and therefore has not booked approximately $171,000 of additional interest expense. It is the Company’s position that the interest for the period from judgment date to forbearance date should remain at the original contract rate at the date of judgment, based upon the per diem interest amount expressly stated in that judgment. Attorneys for the Company also support that position and have so stated in letters to Charter One and for purposes of the annual audit.
On June 18, 2010, the Company, Mr. Osborne, the Richard M. Osborne Trust (the “Trust”), Great Plains, and Oz Gas, Ltd. (companies owned by Mr. Osborne) entered into a Forbearance Agreement with Charter One regarding the Company’s $9.5 million line of credit under the Loan Agreement and regarding the $25.0 million loan agreement between Great Plains, Oz Gas and Mr. Osborne and Charter One, dated August 2, 2007 (together, the “Loan Agreements”). The Company, Mr. Osborne, the Trust, Great Plains and Oz Gas are collectively referred to in the Forbearance Agreement and herein as the “Loan Parties.”
Pursuant to the Forbearance Agreement and during the forbearance period, Charter One agreed to, among other things, forbear from exercising its rights and remedies arising out of the judgments and the Loan Agreements and to stay any action on its motion for the appointment of a receiver.
Under the Forbearance Agreement, Charter One’s agreement to forbear is conditioned upon and subject to the following conditions:
•
No material adverse change in the condition of the Loan Parties;
•
An assignment and grant of a security interest by the Company and GPE of each of their ownership interests in the Alpha and Panzica wells;
•
A pledge by the Loan Parties of their ownership interests in Kykuit Resources LLC; and
•
A pledge by Mr. Osborne of not less than 800,000 shares of common stock of Gas Natural Inc. with such stock having a market value of not less than $9.6 million pursuant to a pledge agreement.
In addition, commencing July 1, 2010 and each month thereafter until all amounts under the judgments and loan agreements have been paid in full, the Loan Parties shall pay Charter One $400,000, including the $40,000 forbearance fee. The Company had previously felt they would pay one third of the $400,000, but due to lack of cash, they have decided to accrue interest and one third of the $40,000 monthly fee and legal fees. The monthly $400,000 is being paid by the other Loan Parties. Such payments by the Loan parties shall be applied first to Charter One’s fees and expenses, second to accrued but unpaid interest due under the judgments, and third to principal amounts due under the judgments. Charter One contends that the judgments will bear interest at LIBOR plus 1.75% with a LIBOR floor of 3.00%. The Company believes that there is an interest rate cap of 3.00%. The parties are in discussions regarding the applicable interest rate. If the Loan Parties repay $10 million and if after application of such repayment the outstanding balance of the judgments does not exceed 65% of the current producing reserve value (as that term is defined in the Loan Agreements) of the Company, Great Plains and Oz Gas, then the pledge of Mr. Osborne’s Kykuit interests and his Gas Natural Inc. shares shall be released. In addition, the Company must deposit all proceeds of its operations into accounts maintained by Charter One but during the forbearance period Charter One will not take any action to set off funds in any such account.
The forbearance period is effective until July 1, 2011, subject to the earlier termination upon the occurrence of any events of default by any of the Loan Parties, including non-payment of any amounts due by any of the Loan Parties under the Forbearance Agreement.
Because the Company does not have the available cash to repay the line of credit, if the required payments are not made by the Company or any of other Loan Parties, or other events of default occur, under the Forbearance Agreement or if prior to the end of the forbearance period the Company is unsuccessful in refinancing the line of credit with Charter One or if the Company is unsuccessful in obtaining substitute financing, there is substantial doubt about the Company’s ability to continue as a going concern.
Discussions with Charter One are ongoing but there is no certainty that these discussions will result in satisfactory terms of a revised loan agreement or a revised loan agreement at all. If Charter One demands repayment of the outstanding amounts payable at the end of the forbearance period, the Company does not have the available cash to repay the line of credit and will need financing from other sources to repay Charter One.
The Painesville facility was encumbered by a mortgage with First Merit Bank, N.A. by agreement dated June 9, 2009. The loan was deemed to be in default by First Merit Bank, N.A in August 2009 when Charter One sought judgments against the Company regarding its line of credit.
On May 11, 2010, Liberty Self Stor, LTD and First Merit Bank, N.A signed a loan modification agreement which waived the prior defaults. The terms of the mortgage include a five year term, maturing on June 1, 2014, with a ten year amortization period at a variable rate of the 30 day LIBOR plus 250 basis points. Monthly payments include principal of $10,370 plus interest. The current rate on December 31, 2010 was 2.76%. The principal amount of the loan as of December 31, 2010 and 2009 were $1,010,364 and $1,145,174, respectively.
The repayment terms for the Painesville loan includes the following principal payments over the next four years ending December 31 are as follows:
In February 2010, the Company entered into a loan for the purchase of a vehicle which matures in February 2015. The interest rate is fixed at 2.90%. The outstanding principal amount of the loan as of December 31, 2010 was $54,041. The future minimum loan payments over the next five years ending December 31 are as follows:
For the years ended December 31, 2010 and 2009 respectively, the Company expensed $473,302 and $427,122 in interest on its debt instruments.
6. Notes Payable to Related Party
The Company entered into an agreement with Mr. Osborne for an unsecured revolving demand note dated January 1, 2006. Interest is payable annually at the prime rate with principal being due on demand. The revolving demand note does not include an expiration date or a limit on the amount that the Company may borrow. The prime rate at December 31, 2010 was 3.25%. There were no outstanding balances under the note at December 31, 2010 and 2009, respectively.
On February 13, 2009, Great Plains loaned the Company $600,000 to fund the Company’s ongoing capital requirements. On July 25, 2009, the Note and interest outstanding on the $600,000 loan from Great Plains were fully paid. The Company used the receipt of currently owed production funds and additional advance monies against the production receivable to make the payment.
Interest expense on related party notes payable, included in total interest was $0 and $21,436 for the years ended December 31, 2010 and 2009, respectively.
7. Stockholder’s Equity
Effective February 12, 2008, the Company filed Articles Supplementary to its Articles of Incorporation, as amended, restated and supplemented with the State Department of Assessment and Taxation of Maryland designating 5,000 Series A Preferred Shares, par value $0.001 per share. Dividends accumulate on the Series A Preferred Shares at the rate of 8% per annum and must be paid on a quarterly basis. Failure to pay dividends on a timely basis results in the imposition of a default rate of 10% per annum that continues until the default is cured by the Company by payment of all accrued dividends. Further, the initial default by the Company entitles the holders of the Series A Preferred Shares to elect, as a class, one director to the Company’s Board of Directors who shall serve until the Series A Preferred Shares are liquidated or converted.
The Series A Preferred Shares have voting rights only with respect to certain extraordinary actions that would impair the rights of holders of the Series A Preferred Shares, such as a merger, reorganization or issuance of a class or series of stock on parity with or senior to the Series A Preferred Shares. Each of the Series A Preferred Shares is convertible into common shares by dividing the sum of $1,000 and any accrued but unpaid dividends on the Series A Preferred Shares by the conversion price of $1.00 (the “Conversion Price”). The Conversion Price is proportionately increased (or decreased, as the case may be) for combinations, stock splits and similar events that would affect the number of shares of the Company’s common stock outstanding. The Series A Preferred Shares have a liquidation preference of $1,000 per share, plus any accrued but unpaid dividends.
The Company sold an aggregate of 1,350 shares of its Series A Convertible Preferred Shares in a private placement to a total of nine accredited investors during the first six months of 2008. All Series A Preferred Shares were sold at a price of $1,000 per share for a total of $1,350,000 with no underwriting discounts or commissions, as no underwriters were used to facilitate the transactions.
The Company did not issue stock in 2010 or 2009.
8. Earnings/Loss Per Share
Basic income (loss) per share of common stock for the years ended December 31, 2010 and 2009 is determined by dividing net income (loss) less declared preferred stock dividends by the weighted average number of shares of common stock outstanding during the period.
The restricted stock awards, Class A Limited Partnership conversion and warrants for the years ended December 31, 2010 and 2009 were anti-dilutive and had no effect on diluted earnings per share. The Company’s Class A Limited Partnership exchange factor is .1377148 per share.
The Company paid no cash distributions to its common stockholders during 2010 and 2009. However, the Company declared and paid $108,000 in preferred stock dividends for both of the years ended December 31, 2010 and 2009.
9. Income Taxes
The reconciliation of the federal statutory income tax rate to the Company’s effective income tax rate applicable to income from continuing operations is as follows:
The following table represents the Company’s significant deferred tax assets and liabilities at December 31, 2010 and 2009:
At December 31, 2010 and 2009, the Company had net operating loss carry forwards (NOLS) for future years of approximately $16.6 and $15.9 million, respectively. These NOLS will expire at various dates through 2028. Utilization of the NOLs could be limited if there is a substantial change in ownership of the Company and is contingent on future earnings. In addition, the Company paid $41,187 for alternative minimum tax (AMT) in 2006, creating a tax credit that carries forward indefinitely.
The Company has provided a valuation allowance equal to 100% of the total net deferred asset in recognition of the uncertainty regarding the ultimate amount of the net deferred tax asset that will be realized. In 2006, the Company began operating in the oil and natural gas business, which is subject to many risks. The Company also expects to continue generating tax losses in the next few years due to timing differences.
10. Other Related Party Transactions
Mr. Osborne is the sole manager of Liberty Self-Stor II, Ltd., an Ohio limited liability company, which is the owner of a truck rental business, which makes trucks available for short-term rental to the general public, including tenants of the Company’s self-storage facility, and provides for the retail sale of locks, boxes, packing materials and related merchandise at the self-storage facility. The Company has entered into a cost sharing agreement with Liberty Self-Stor II, Ltd. with respect to the sharing of employees and space at the office of the self-storage facility for the benefit of both companies. Liberty Self-Stor II, Ltd. owed the Company funds associated with these transactions, as well as for cash advances between the companies, which are included in accounts receivable from related parties in the accompanying consolidated balance sheets and listed in the table below.
The Company leases its executive offices from OsAir, Inc., a company owned by Mr. Osborne for $2,000 per month. The current lease has a three year term maturing on April 1, 2012. Rent expense totaled $24,000 and $22,050 for the years ending December 31, 2010 and 2009, respectively, and is included in general and administrative expenses.
Effective January 1, 2006, the Company entered into a contract with Great Plains for well operations and sale of natural gas and oil production, net of pipeline costs. The term of the agreement was one year from the effective date. It was extended as of January 1, 2007 and shall be extended for consecutive one year periods unless terminated earlier.
The Company is a fifty percent partner and the operating manager of Lucky Brothers LLC, a company whose other partners are almost all related to Mr. Osborne. The partnership owns one well at December 31, 2010. The purpose of Lucky Brothers LLC is to engage in a joint venture for drilling wells. The Company has invested $174,392 in well tangibles and intangibles at December 31, 2010 and 2009.
The Company purchases well supplies from Big Oats Oilfield Supply Company, a company owned by Mr. Osborne.
At December 31, 2010, the Company had a $12,000 invoice outstanding to Oz Gas Ltd., a company owned by Mr. Osborne, for payments made on the Company’s behalf to Charter One. See Note 5 “Line of Credit and Long Term Debt” to these consolidated financial statements for more information.
In 2010, the Company paid Orwell Trumbull Pipeline, LLC, a company owned by Mr. Osborne, for telemeter charges.
The Company is an owner and managing member of an unconsolidated affiliate, Kykuit Resources LLC (“Kykuit”), which is accounted for using the equity method of accounting. The Company had a 21.79% and a 20.83% ownership in Kykuit at December 31, 2010 and 2009, respectively. On June 18, 2010, the Company pledged its interest in Kykuit to Charter One in connection with the Forbearance Agreement. For the year ended December 31, 2010, the Company paid $93,440, including $10,940 previously recorded in accounts payable. Additionally the Company had $124,000 in accounts payable for a cash call and $36,391 in accounts payable for borrowed funds owed to Kykuit. The investment by the Company in this venture is $736,953 which includes cash totaling $1,496,330, an accounts payable of $124,000 and a cumulative net book loss of $883,377 at December 31, 2010. Additional information is disclosed in Note 4 to these financial statements.
Mr. Osborne, the Company’s Chairman and Chief Executive Officer, and Gas Natural Inc., a publicly-held public utility company of which Mr. Osborne is the Chairman, Chief Executive Officer and a significant stockholder, owns interests in Kykuit. Mr. Osborne’s personal interests in Kykuit were pledged to Charter One in connection with the Forbearance Agreement.
The following tables summarize the related party transactions for accounts receivable of oil and natural gas production, capitalized costs for wells, outstanding accounts payable, revenues received and payments paid for expenses to related parties for the periods indicated. The accounts receivable from various companies owned by Mr. Osborne in the accompanying consolidated balance sheets represent amounts owed to the Company for minor cost sharing transactions and are listed in the following table for the years ended December 31:
Marc C. Krantz, a director and secretary of the Company until August 26, 2009, is the managing partner of the law firm of Kohrman Jackson & Krantz PLL, which provides legal services to the Company.
J. R. Smail, a director of the Company until August 26, 2009, is the operator of five wells in which the Company has joint interest. At December 31, 2009, the consolidated financial statements included accounts receivable for oil and gas sales of $13,551; revenue from oil and gas sales of $84,265; and operating expenses of $41,708 from Smail.
11. Financial Information Relating to Industry Segments
The Company reports operating segments and reportable segments by business activity according to GAAP, “Disclosure about Segments of an Enterprise and Related Information.” The Company includes revenues from external customers, interest revenue and expense, depreciation, depletion and amortization and other operating expenses in its measure of segment profit or loss.
The Company’s operations are classified into two principal industry segments. The following table presents the twelve months ended December 31, 2010 and 2009:
12. Commitments and Contingencies
Environmental Matters
The oil and gas industry is subject, by its nature, to environmental hazards and clean-up costs. At this time, management knows of no substantial costs from environmental accidents or events for which it may be currently liable.
Oil and Gas Contracts
Effective January 1, 2006, the Company entered into a contract with Great Plains Exploration, LLC for well operations and sale of natural gas and oil production to third parties. The term of the agreement was one year from the effective date. It was extended as of January 1, 2007 and shall be extended for consecutive one year periods unless terminated earlier. The original contract was amended November 14, 2006 and filed as exhibit 10.4 to our Form 10-QSB for the quarter ended September 30, 2006. The Amendment No. 1 to the Oil and Gas Operations and Sale Agreement modified the original terms to create less cumbersome paperwork in tracking cost sharing between the companies.
13. Supplemental Disclosures About Oil and Natural Gas Producing Activities
- Unaudited
Estimated Proved Reserves
Users of this information should be aware that the process of estimating quantities of “proved” crude oil and natural gas reserves is very complex. There are numerous uncertainties inherent in estimating quantities of proved reserves, including many factors beyond the control of the Company, such as additional development activity, evolving production history and reassessment of the viability of production under varying prices and other economic conditions. As a result, revision to existing estimates may occur.
There are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting future rates of production and timing of development expenditures including many factors beyond the control of the Company. In December 2008, the SEC announced that it had approved revisions designed to modernize the oil and gas company reserves reporting requirements. In addition, in January 2010 the FASB issued an accounting standard update to provide consistency with the SEC rules. We adopted the rules effective December 31, 2009 and the rule changes, including those related to pricing and technology, which are included in our reserves estimates.
Application of the new rules resulted in the use of lower prices at December 31, 2010 and 2009 for both oil and gas than would have resulted under the previous rules, which required use of year-end oil and gas prices. Because of the changes in assumptions, the 2010 and 2009 reserve valuations below may not be comparable to those of prior years. The estimated future cash flows are determined based on the prior 12 month average prices for crude oil, current allowable prices (adjusted for periods beyond the contract period to prior 12 month average prices) applicable to expected natural gas production, estimated production of proved crude oil and natural gas reserves, estimated future production and development costs of reserves and future retirement obligations (net of salvage), based on current economic conditions, and the estimated future income tax expense, based on year-end statutory tax rates (with consideration of future tax rates already legislated) to be incurred on pretax net cash flows less the tax basis of the properties involved. Such cash flows are then discounted using a 10% rate.
The following table presents the Company’s estimated gross proved oil and natural gas reserves, which are all located in the continental United States and all are based on reserve reports prepared by Schlumberger Data and Consulting Services for the years ended December 31:
Capitalized Costs Relating to Oil and Natural Gas Producing Activities for the years ended December 31.
Costs Incurred in Oil and Natural Gas Producing Activities for the years ended December 31.
Standardized Measure of Discounted Future Net Cash Flows at December 31, (in thousands of dollars).
Effective for the year ended 2009, SEC reporting rules required that year-end reserve calculations and future cash inflows be based on the simple average of the first day of the month price for the previous twelve month period. The 12-month average pricing for 2010 used in the above table for natural gas sold at the Henry Hub, Louisiana was $4.376 and Ergon West Virginia Oil was $73.73. The 12-month average pricing for 2009 used in the above table for natural gas sold at the Henry Hub, Louisiana was $3.867 and West Texas Intermediate oil at Cushing, Oklahoma was $61.18.
Future operating expenses are based on year end costs and assume continuation of existing economic conditions.
Changes in the Standardized Measure of Discounted Future Net Cash Flow at December 31, (in thousands of dollars).
The methodology and assumptions used in calculating the standardized measure are those required by GAAP. It is not intended to be representative of the fair market value of the Company’s proved reserves. The valuation of revenues and costs does not necessarily reflect the amounts to be received or expended by the Company. In addition to the valuations used, numerous other factors are considered in evaluating known and prospective oil and gas reserves.